-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LwQJHEckVsVyCRbsX7WZpJrnVUj50Lpa1pJel0M9Fgzy+QI7ZYCZfZhQ+43G8Q4I zIPO3iXbNIp0BsMmCXTtTQ== 0000950128-97-000670.txt : 19970329 0000950128-97-000670.hdr.sgml : 19970329 ACCESSION NUMBER: 0000950128-97-000670 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRESTIGE BANCORP INC CENTRAL INDEX KEY: 0001011145 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 251785128 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20715 FILM NUMBER: 97567808 BUSINESS ADDRESS: STREET 1: 710 OLD CLAIRTON RD CITY: PLEASANT HILLS STATE: PA ZIP: 15236 BUSINESS PHONE: 4126551190 MAIL ADDRESS: STREET 1: 710 OLD CLAIRTON ROAD CITY: PLEASANT HILLS STATE: PA ZIP: 15236 10-K 1 PRESTIGE BANCORP, INC. 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSIONS WASHINGTON, D.C. 20549 FORM 10-K [ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Act of 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 1996 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [NO FEE REQUIRED] COMMISSION FILE NUMBER: 333-2692 PRESTIGE BANCORP, INC. (Exact name of registrant as specified in its charter) PENNSYLVANIA 25-1785128 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization Identification Number)
710 OLD CLAIRTON ROAD, PLEASANT HILLS, PENNSYLVANIA 15236 (Address of principal executive offices) Registrant's telephone number, including area code: (412) 655-1190 Securities Registered Pursuant to Section 12(b) of the Act: ______________ Securities Registered Pursuant to Section 12(g) of the Act: X -------------- COMMON STOCK, PAR VALUE $1.00 PER SHARE (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. Yes __X__ No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of March 20, 1997, the aggregate market value of the 963,023 shares of Common Stock of the Registrant issued and outstanding on such date, excluding the 68,097 shares held by all directors and executive officers, was $14.3 million. This figure is based on the reported closing bid in the NASDAQ system of $16.00 per share of the Registrant's Common Stock as of March 20, 1997. Although directors and executive officers were assumed to be "affiliates" of the Registrant for purposes of this calculation, the classification is not to be interpreted as an admission of such status. As of March 20, 1997, there were issued and outstanding 963,023 shares of the Registrant's Common Stock. DOCUMENTS INCORPORATED BY REFERENCE 1. Annual Report to Shareholders for the fiscal year ended December 31, 1996 (Parts I, Item I, II and IV). 2. Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 1997 (Part III). ================================================================================ 2 PART I ITEM 1. BUSINESS GENERAL PRESTIGE BANCORP, INC. The Company was organized as a corporation under the laws of the Commonwealth of Pennsylvania in March 1996 at the direction of the Board of Directors of Prestige Bank, a Federal Savings Bank (the "Savings Bank") for the purpose of acquiring all of the capital stock to be issued by the Savings Bank in a conversion under and pursuant to the applicable rules and regulations of the Office of Thrift Supervision, Department of the U.S. Treasury (the "OTS") of the charter of the Savings Bank from a federal mutual chartered savings association to a federal stock chartered savings association (the "Conversion"). The Company has received the approval of the OTS to become a savings and loan holding company. The Company currently conducts business as a unitary savings and loan holding company. As of December 31, 1996, the Company holds the shares of the Savings Bank's common stock acquired in the Conversion, a loan receivable from the Prestige Bancorp Employee Stock Ownership Plan (the "ESOP") and an equity investment of $200,000 in the common stock of three unrelated savings associations or their related holding companies. The Company has no significant liabilities. The Company has no plans to change these business activities. The Company is engaged principally in community banking activities through its savings association subsidiary. At December 31, 1996, the Company had total consolidated assets of $114.6 million, total consolidated deposits of $83.8 million, total consolidated liabilities (including deposits) of $99.2 million and total consolidated equity of $15.4 million. The Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Savings Bank. The Company does not employ any persons other than officers who are also officers of the Savings Bank. The Company utilizes the support staff of the Savings Bank from time to time. The profitability of the Company is highly dependent on the profitability of the Savings Bank. The Company's executive office is located at the home office of the Savings Bank at 710 Old Clairton Road, Pleasant Hills, Pennsylvania 15236, and its telephone number is (412) 655-1190. PRESTIGE BANK, A FEDERAL SAVINGS BANK The Savings Bank is a federally chartered savings bank that was organized under the laws of the United States in 1935. The deposits of the Savings Bank are insured by the Savings Association Insurance Fund (the "SAIF") administered by the Federal Deposit Insurance Corporation (the "FDIC"). The Savings Bank conducts business from its executive offices located in Pleasant Hills, Pennsylvania and 3 full-service offices located in Allegheny County, Pennsylvania. At December 31, 1996, the Savings Bank had total assets of $114.4 million, total deposits of $87.5 million, total liabilities (including deposits) of $102.8 million and total equity of $11.6 million. The Savings Bank's lending operations follow the traditional pattern of a savings association by primarily emphasizing the origination of one-to-four family residential loans for portfolio retention and to a substantially lesser degree, the origination of commercial real estate loans, construction loans on residential properties and consumer loans, including home equity or home improvement loans, automobile loans, student loans, credit card loans and cash collateral personal loans. The loan portfolio contains no loans to foreign governments, foreign enterprises or foreign operations of domestic companies. Deposit services offered by the Savings Bank include passbook savings accounts, money market savings accounts, NOW accounts, non-interest bearing checking accounts and certificates of deposit with a minimum maturity of 6 months and a maximum maturity of 5 years. The Savings Bank does not utilize the services of deposit brokers. The gross earnings of the Company on a consolidated basis for the fiscal year ending December 31, 1996, by loan category and investment securities are shown on page 11 of the 1996 Annual Report to Shareholders. The gross interest expense of the Company on a consolidated basis for the fiscal year ending December 31, 1996 is shown on page 3 of the 1996 Annual Report to Shareholders. The amounts of the various deposit 2 3 products of the Company (through its sole subsidiary, the Savings Bank) by category for the fiscal year ending December 31, 1996 is shown on page 33 of the 1996 Annual Report to Shareholders. The Company's and the Savings Bank's profitability is highly dependent on its net interest income which is the difference between income earned on interest-earning assets less interest paid on interest-bearing liabilities. The Company and Savings Bank are subject to interest rate risk and attempts to minimize that risk by better matching asset and liability maturities and rates. The business of each of the Company and the Savings Bank is influenced by prevailing economic conditions and governmental policies, both foreign and domestic. The actions and policy directive of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") determine to a significant degree the cost and the availability of funds obtained from money market sources for lending and investing. The Federal Reserve Board's policies and regulations also influence, directly and indirectly, the rates of interest paid by thrift institutions on their time and savings deposits. The nature and impact on the Company and the Savings Bank of future changes in economic conditions and monetary and fiscal policies, both foreign and domestic, are not predictable. In addition to its three branch offices, the Savings Bank operates three automated teller machines ("ATMs"), one at each of the branch offices. The Savings Bank is affiliated with a regional ATM network. The Savings Bank ended 1996 with a staff of 38 employees which comprised of 31 full-time and 7 part-time employees. Full-time equivalent employees averaged 34 in 1996. The Savings Bank's principal executive offices are located at 710 Old Clairton Road, Pleasant Hills, Pennsylvania 15236 and its telephone number is (412) 655-1190. COMPETITION The Savings Bank's market area is primarily located in the southern portion of the Pittsburgh metropolitan area. The largest employers in the Pittsburgh area include the U.S. Government, the Pennsylvania State Government, USAir Group, Inc., the University of Pittsburgh Medical Center, Westinghouse Electric Corp., the University of Pittsburgh, PNC Bank Corp and Mellon Bank Corp. With the contraction of the steel industry in the Pittsburgh area over the last 15 years, the number of manufacturing jobs in the Pittsburgh area has declined as well as the overall population for the Pittsburgh area. The Savings Bank's business and operating results are affected significantly by the general economic conditions prevalent in its primary market area including population levels, which are expected to decline. The Savings Bank experiences significant competition in its local market area in both originating loans and attracting deposits. Its most direct competition comes from commercial banks, other thrift institutions and mortgage banking companies. Many of these institutions maintain a state-wide or regional presence and, in some cases, a national presence. Technological innovations have also led to greater competition as well. With the advent of automated transfer payment systems, competition between depository and nondepository institutions has increased. These changes have led to even greater competition among commercial banks, thrift institutions, credit unions, brokerage firms, money market mutual funds, mutual bond funds, finance and insurance companies, mortgage banking firms and retail establishments. The recent economic conditions in the Savings Bank's market area and the reduction in population in the greater Pittsburgh metropolitan area in the last ten years has resulted in a reduction in the demand for mortgage loans which meet the underwriting criteria of the Savings Bank. This has led to change in the composition of loan origination by the Savings Bank. Loan originations for one to four family residential mortgages constituted $9.9 million for 1992, or 88.4% of all loan origination for such year, compared to loan origination for one to four family residential mortgages of $17.1 million for 1996, or 64.3% of all loan origination for such year. Federal legislation in recent years has eliminated many of the distinctions between commercial banks and thrift institutions and holding companies and allowed bank holding companies to acquire thrift institutions. 3 4 Such legislation has generally resulted in an increase in the competition encountered by thrift institutions and has resulted in a decrease in both the number of thrift institutions and the aggregate size of the thrift industry. Commercial banks and thrift institutions have recently experienced increasing consolidation. In the event of a downturn in the economy or competitive pressures resulting from increasing consolidation, the Savings Bank may experience reduced demand for mortgage loans. Effective June 1, 1997, interstate branch banking will become permissible subject to certain restrictions. Such interstate branch banking will result in increased competition for deposits. The Savings Bank may have difficulty attracting deposits in an environment of economic downturn, increased consolidation or interstate branch banking. SUPERVISION AND REGULATION PRESTIGE BANCORP. INC. General. The Company, as a savings and loan holding company within the meaning of Home Owners' Loan Act of 1933, as amended ("HOLA"), has registered with the OTS and will be subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, the Savings Bank will be subject to certain restrictions in its dealings with the Company and any other affiliates thereof. Federal Activities Restrictions. There are few restrictions on the activities of a savings and loan holding company which holds only one subsidiary savings association so long as such savings association meets the "qualified thrift lender" test (the "QTL Test"). In the first instance no savings and loan holding company and no non-savings association subsidiary of a savings and loan holding company may engage in any activity or render any service for or on behalf of any savings association for the purpose, or with the effect of, evading any law or regulation applicable to the related savings association. In addition, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings association, the Director may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings association; (ii) transactions between the savings association and its affiliates; and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, under OTS regulations, any savings and loan holding company is required to register as a bank holding company within one year of the failure of the QTL Test by its subsidiary insured institution. Under such circumstances, the holding company would become subject to all of the provisions of the Bank Holding Company Act of 1956, as amended ("BHC Act"), and other statutes applicable to bank holding companies, in the same manner and to the same extent as if the company were a bank holding company. The Savings Bank currently satisfies the QTL Test. If the Company were to acquire control of another savings association, other than through merger or other business combination with the Savings Bank, the Company would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings association meets the QTL Test, as set forth below, the activities of the Company and any of its subsidiaries (other than the Savings Bank or other subsidiary savings associations) would thereafter be subject to further restrictions. No multiple savings and loan holding company or subsidiary thereof which is not a savings association shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof any business activity, other than: (i) furnishing or performing management services for a subsidiary savings association; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association; (iv) holding or managing properties used or occupied by a subsidiary savings association; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple savings and loan holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding 4 5 companies. The activities described in (i) through (vi) above may only be engaged in after giving the OTS prior notice and being informed that the OTS does not object to such activities. In addition, the activities described in (vii) above also must be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. Limitations on Transactions with Affiliates. Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act ("FRA"). An affiliate of a savings association is any company or entity which controls, is controlled by or is under common control with the savings association. In a holding company context, the parent holding company of a savings association (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the savings association. Generally, Sections 23A and 23B (i) limit the extent to which the savings association or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such association's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the association or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings association may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association. In addition, Sections 22(h) and (g) of the FRA places restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings institution (a "principal stockholder"), and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings institution's loans to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution's unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 1996, the Savings Bank was in compliance with the above restrictions. Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Director of the OTS, (i) control of any other savings association or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings association or holding company thereof which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings association, other than a subsidiary savings association, or of any other savings and loan holding company. The Director of the OTS may only approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state if (i) the multiple savings and loan holding company involved controls a savings association which operated a home or branch office located in the state of the association to be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings association pursuant to the emergency acquisition provisions of the Federal Deposit Insurance Act, or (iii) the statutes of the state in which the association to be acquired is located specifically permit institutions to be acquired by the state-chartered associations or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations). Restrictions on Dividends from Subsidiary Savings Bank. Every subsidiary savings association must give the Director of the OTS not less than thirty days notice of the proposed declaration by the board of directors of 5 6 such savings association of a dividend on the stock of such savings association held by its parent holding company. Thus, the Savings Bank must notify the OTS thirty days before declaring any dividend to the Company. Federal Securities Laws. The Company's Common Stock is registered with the SEC under the Exchange Act. The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act. PRESTIGE BANK, A FEDERAL SAVINGS BANK General. The Savings Bank is subject to examination and comprehensive regulation by the OTS which is the Savings Bank's chartering authority. The Savings Bank is also regulated by the FDIC, the administrator of the SAIF which provides insurance for the deposits of the Savings Bank. The Savings Bank is subject to certain reserve requirements established by the Board of Governors of the Federal Reserve System ("FRB") and is a member of the FHLB of Pittsburgh, which is one of the 12 regional banks comprising the Federal Home Loan Bank System (the "FHLB System"). The Savings Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to test the Savings Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the SAIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Savings Bank and their operations. Certain of the regulatory requirements applicable to the Savings Bank are referred to below or elsewhere herein. Business Activities. The activities of savings institutions are governed by HOLA, and in certain respects, the Federal Deposit Insurance Act ("FDI Act"). The Federal banking statutes, as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") (1) restrict the solicitation of brokered deposits by savings institutions that are troubled or not well-capitalized, (2) prohibit the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, (3) restrict the aggregate amount of loans secured by non-residential real estate property to 400% of capital, (4) permit savings and loan holding companies to acquire up to 5% of the voting shares of non-subsidiary savings institutions or savings and loan holding companies without prior approval, and (5) permit bank holding companies to acquire healthy savings institutions. Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the national bank limits on loans to one borrower. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the Savings Bank's unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. At December 31, 1996, the Savings Bank's largest aggregate amount of loans to any one borrower consisted of $1.0 million which was below the Savings Bank's loans to one borrower limit of $1.7 million at such date. QTL Test. The HOLA requires savings institutions to meet a QTL Test. Under the QTL test, a savings association is required to maintain at least 65% of its "portfolio assets" (total assets less (i) specified liquid assets up to 20% of total assets, (ii) intangibles, including goodwill, and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) on a monthly basis in 9 out of every 12 months. 6 7 A savings association that fails the QTL Test must either convert to a bank charter or operate under certain restrictions. As of December 31, 1996, the Savings Bank maintained 89.99% of its portfolio assets in qualified thrift investments and, therefore, met the QTL Test. Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Association") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without the approval of the OTS, make capital distributions during a calendar year equal to the greater of (1) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year; or (ii) 75% of its net earnings for the previous four quarters; provided that the institution would not be undercapitalized, as that term is defined in the OTS Prompt Corrective Action regulations, following the capital distribution. Any additional capital distributions would require prior regulatory approval. The Savings Bank currently qualifies as a Tier 1 Association. In the event the Savings Bank's capital fell below its fully-phased in requirement or the OTS notified it that it was in need of more than normal supervision, the Savings Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Liquidity. The Savings Bank is required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified U.S. Government, state or Federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement may be changed from time to time by the OTS to any amount within the range of 4.0% to 10% depending upon economic conditions and the savings flow of member institutions, and is currently 5%. OTS regulations also require each savings institution to maintain an average daily balance of short-term liquid assets at a specified percentage (currently 1%) of the total of its net withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Savings Bank's average monthly liquidity ratio at December 31, 1996 was 12.9%, which exceeded the then applicable requirements. The Savings Bank has never been subject to monetary penalties for failure to meet its liquidity requirements. Assessments. Savings institutions are required by OTS regulation to pay assessments to the OTS to fund the operations of the OTS. The general assessment, paid on a semi-annual basis, is computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the institution's latest quarterly thrift financial report. The assessments paid by the Savings Bank for the years ended December 31, 1996 and 1995 totaled $30,000 and $29,000, respectively. Branching. Under OTS regulations, Federally chartered savings associations are permitted, subject to OTS approval, to branch nationwide to the extent allowed by Federal statute. This permits Federal savings associations with interstate networks to diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by Federal savings associations. The OTS will evaluate a branching applicant's record of compliance with the Community Reinvestment Act, as amended ("CRA") as part of any grant of permission to establish a new branch. A poor CRA record may be the basis for denial of a branching application. Community Reinvestment. Under the CRA, as implemented by OTS regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular 7 8 community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA rating system identifies four levels of performance that may describe an institution's record of meeting community needs: "outstanding", "satisfactory", "needs to improve" and "substantial noncompliance". The CRA also requires all institutions to make public disclosure of their CRA ratings. The Savings Bank received a "Satisfactory" CRA rating in its most recent Federal examination by the OTS. Brokered Deposits. Under FDIC regulations, well-capitalized institutions that are not troubled are subject to no brokered deposit limitations, while adequately capitalized institutions are able to accept, renew or roll over brokered deposits only (i) with a waiver from the FDIC and (ii) subject to the limitation that they do not pay an effective yield on any such deposit which exceeds by more than (a) 75 basis points of the effective yield paid on deposits of comparable size and maturity in such institution's normal market area for deposits accepted in its normal market area or (b) 120 basis points for retail deposits and 130 basis points for wholesale deposits, respectively, of the current yield on comparable maturity U.S. treasury obligations for deposits accepted outside the institution's normal market area. Undercapitalized institutions are not permitted to accept brokered deposits and may not solicit deposits by offering an effective yield that exceeds by more than 75 basis points of the prevailing effective yields on insured deposits of comparable maturity in the institution's normal market area or in the market area in which such deposits are being solicited. Although there exist no prohibitions under FDIC regulations, the Savings Bank does not solicit nor accept brokered deposits. The Savings Bank does not currently intend to change this policy. Transactions with Related Parties. The Savings Bank's authority to engage in transactions with related parties or "affiliates" (i.e., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) or to make loans to certain insiders, is limited by Sections 23A and 23B of the FRA. Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings institution and also limits the aggregate amount of transactions with all affiliates to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with nonaffiliated companies. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to nonaffiliated companies. Notwithstanding Sections 23A and 23B, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies under Section 4(c) of the BHC Act. Further, no savings institution may purchase the securities of any affiliate other than a subsidiary. The Savings Bank's authority to extend credit to executive officers, directors and 10% stockholders, as well as entities controlled by such persons, is currently governed by Sections 22(g) and 22(h) of the FRA, and Regulation O thereunder. Among other things, these regulations require such loans to be made on terms substantially the same as those offered to unaffiliated individuals and do not involve more than the normal risk of repayment, place limits on the amount of loans the Savings Bank may make to such persons based, in part, on the Savings Bank's capital position, and require certain approval procedures to be followed. The OTS regulations, with certain minor variances, apply Regulation O to savings institutions. Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring enforcement action against all "institution-related parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Civil penalties cover a wide range of violations and actions and range up to $25,000 per day unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. Criminal penalties for most financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years. In addition, regulators have substantial discretion to impose enforcement action on an institution that fails to comply with its regulatory 8 9 requirements, particularly with respect to the capital requirements. Possible enforcement action ranges from the imposition of a capital plan and capital directive to receivership, conservatorship or the termination of deposit insurance. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the director, the FDIC has authority to take such action under certain circumstances. Standards for Safety and Soundness. The FDI Act, as amended by FDICIA, requires each Federal banking agency to prescribe for all insured depository institutions and their holding companies standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, liquidity, capital levels and compensation, fees and benefits and such other operational and managerial standards as the agency deems appropriate. Under the FDI Act, if an insured depository institution or its holding company fails to meet any of its standards described above, it will be required to submit to the appropriate Federal banking agency a plan specifying the steps that will be taken to cure the deficiency. If an institution fails to submit an acceptable plan or fails to implement the plan, the appropriate Federal banking agency will require the institution or holding company, to correct the deficiency and until corrected, may impose restrictions on the institution or the holding company including any of the restrictions applicable under the prompt corrective action regulations. The Federal banking agencies recently adopted a final regulation and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Safety and Soundness Guidelines") and a final rule which will implement the safety and soundness standards established by FDICIA. The Safety and Soundness Guidelines and the final rule set forth the safety and soundness standards that the Federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Safety and Soundness Guidelines address internal controls and information systems: internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and compensation, fees and benefits. The agencies also adopted a proposed rule which proposes asset quality and earnings standards which, if adopted in final, would be added to the Safety and Soundness Guidelines. If the appropriate Federal banking agency determines that an institution fails to meet any standard prescribed by the Safety and Soundness Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans. Capital Requirements. OTS capital regulations require savings institutions to meet three capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) a leverage ratio (core capital) equal to at least 3% of total adjusted assets and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted assets. Tangible capital is defined as core capital less all intangible assets (including supervisory goodwill), plus purchased mortgage servicing rights valued at the lower of the maximum percentage established by the OTS or the amount includable in core capital. Core capital is defined as common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, and qualifying supervisory goodwill, less nonqualifying intangible assets. The capital standards require core capital (as defined above) equal to at least 3% of adjusted total assets (as defined by regulation). As a result of the prompt corrective action provisions of FDICIA, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. At December 31, 1996, the Savings Bank had no intangibles which would affect the application of these tests. The OTS requires that only those savings associations rated a composite one (the highest rating) under the CAMEL rating system for savings associations will be permitted to operate at nor near the regulatory minimum leverage ratio of 3%. All other savings associations will be required to maintain a minimum leverage ratio of 4% to 5%. The OTS will assess each individual savings association through the supervisory process on a case-by-case basis to determine the applicable requirement. 9 10 The risk-based capital standard for savings institutions requires the maintenance of total risk-based capital (which is defined as core capital plus supplementary capital) of 8.0% of risk-weighted assets. The components of supplementary capital include, among other items, cumulative perpetual preferred stock, perpetual subordinated debt, mandatory convertible subordinated debt, intermediate-term preferred stock and the allowance for loan and lease losses. The portion of the allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, supplementary capital is limited to 100% of core capital. A savings association must calculate its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors as determined by the OTS, which range from 0% for cash to 100% for delinquent loans, property acquired through foreclosure, commercial loans and other assets. In August, 1995, the OTS and Federal Financial Institutions Examination Council ("FFIEC") announced that effective October 1, 1995, they would not require institutions to include unrealized gains and losses on available for sale debt securities when calculating regulatory capital. This announcement reversed prior OTS policy concerning the implementation of SFAS No. 115. As a result, institutions must now value available for sale debt securities at amortized cost, rather than at fair value, for purposes of calculating regulatory capital. Institutions are still required to comply with SFAS No. 115 for financial reporting purposes. In August 1993, the OTS adopted a final rule incorporating an interest-rate component into the risk-based capital regulation. Under the rule, an institution with a greater that "normal" level of interest rate risk is subject to a deduction of its interest rate risk component from total capital for purposes of calculating its risk-based capital requirement. An institution with a greater than "normal" interest rate risk is defined as an institution that would suffer a loss of net portfolio value exceeding 2.0% of the estimated economic value of its assets in the event of a 200 basis point increase or decrease (with certain minor exceptions) in interest rates. The interest rate risk component is calculated, on a quarterly basis, as one-half of the difference between an institutions's measured interest rate risk and 2.0, multiplied by the economic value of its assets. The rule also authorizes the Director of the OTS, or his designee, to waive or defer an institutions's interest rate risk component on a cases-by-case basis. The final rule was originally to be effective as of January 1, 1994, subject however to a three quarter "lag" time between the reporting date of the data used to calculate an institution's interest rate risk and the effective date of each quarter's interest rate risk component. However, in October 1994, the Director of the OTS indicated that it would waive the capital deduction for institutions with greater that "normal" interest rate risk until the OTS publishes an appeals process. In August 1995, the OTS issued Thrift Bulletin No. 67 which allows eligible institutions to request adjustment to their interest rate risk component as calculated by the OTS, or to request to use their own models to calculate their interest rate component. The OTS also indicated that it will delay invoking its interest rate rule requiring institutions with above normal interest rate risk exposure to adjust their regulatory capital requirement until new procedures are implemented and evaluated. The OTS has not yet established an effective date for the capital deduction. In any event, management of the Savings Bank does not believe that the OTS' adoption of an interest rate risk component to the risk-based capital requirement will adversely affect the Savings Bank's regulatory capital position. At December 31, 1996, the Savings Bank met each of its capital requirements. For further information on the Savings Bank capital levels, see pages 34 and 35 of the 1996 Annual Report to Shareholders. For further information on the application of the interest rate risk component, see pages 9 and 10 of the 1996 Annual Report. Prompt Corrective Regulatory Action. Under the OTS Prompt Corrective Action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. Generally, a savings institution that has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1 capital ratio that is less than 4.0% is considered to be undercapitalized. A savings institution that has total risk-based capital less than 6.0%, a Tier 1 risk-based capital ratio of less than 3% or a leverage ratio that is less than 3.0% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized". Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is critically undercapitalized. The regulation also 10 11 provides that a capital restoration plan must be filed with the OTS within 45 days of the date an institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized". In addition, numerous mandatory supervisory actions become immediately applicable to the institution, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. As of December 31, 1996, the Savings Bank was classified as a "well-capitalized" institution (an institution with 10% or more total risk-based capital ratio, a Tier I risk-based capital ratio of 6% or more, and a leverage capital ratio of 5.0% or more), and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure and as such is not subject to any prompt corrective action measures. Insurance of Deposit Accounts. The FDIC assigns an institution to one of three capital categories based on the institution's financial information, as of the reporting period ending seven months before the assessment period, consisting of 1) well capitalized, 2) adequately capitalized or 3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary Federal regulator and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. There are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Prior to October 1, 1996, assessment rates for members of the SAIF ranged from 23 basis points for an institution in the highest category (i.e., well-capitalized and healthy) to 31 basis points for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern). After September 30, 1996, assessment rate varied from 0 basis points for an institution rated in the highest category to 27 basis points for an institution rated in the lowest category. For the fiscal year ending December 31, 1997, the insurance fund assessment payable by the Savings Bank is 6.45 basis points which is a reduction from the general assessment of 23 basis points applicable to the Savings Bank for the first and the second six-month period of the fiscal year ended December 31, 1996. The FDIC sets the assessment rate for institutions on a semi-annual basis. The FDIC is authorized to raise the assessment rates in certain circumstances. If the FDIC determined to increase the assessment rates for all institutions, institutions in all risk categories could be affected. The FDIC has exercised this authority several times in the past and may raise insurance premiums in the future. Pursuant to the Deposit Insurance Funds Act of 1996, the FDIC imposed a one time special assessment of 65.7 basis points against insured deposits of the Savings Bank as of March 31, 1995. This special assessments was charged against all financial institutions with deposits insured by the SAIF. This special assessment was used to provide a capital infusion into the SAIF. The money collected will capitalize the thrift fund and let thrift premiums be brought in line with those of commercial banks by the year 2000. This legislation also provided that this special assessment is fully deductible against the income of the Savings Bank for the fiscal year ending December 31, 1996. Although this special assessment charged to the Savings Bank was $501,727, the after-tax effect of such special assessment was approximately $308,000. This legislation has as a goal the merger of the thrift fund into the stronger Bank Insurance Fund (BIF) by 1999, but not until the bank and thrift charters are combined. Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Savings Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Federal Home Loan Bank System. The Savings Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Savings Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in the FHLB 11 12 in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. The Savings Bank was in compliance with this requirement with an investment in FHLB stock at December 31, 1996, of $754,000. The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. For the years ended December 31, 1996, 1995 and 1994, dividends from the FHLB to the Savings Bank amounted to $46,413, $48,667 and $41,050, respectively. If dividends were reduced, or interest on future FHLB advances increased, the Savings Bank's net interest income would likely also be reduced. Further, there can be no assurance that the impact of FDICIA and the FIRREA on the FHLBs will not also cause a decrease in the value of the FHLB stock held by the Savings Bank. Federal Reserve System. The Federal Reserve Board regulations require savings institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: For accounts aggregating $54.0 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts greater than $54.0 million, the reserve requirement is $1.6 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $54.0 million. The first $4.2 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The Savings Bank is in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the FRB may be used to satisfy liquidity requirements imposed by the OTS. Because required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve Bank or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce the Savings Bank's interest-earning assets. FHLB System members are also authorized to borrow from the Federal Reserve "discount window," but Federal Reserve Board regulations require institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank. FIRREA requires the OTS to establish accounting standards to be applicable to all savings associations for purposes of complying with regulations, except to the extent otherwise specified in the capital standards. Such standards must incorporate generally accepted accounting principles to the same degree as is prescribed by the Federal banking agencies for banks or may be more stringent than such requirements. On September 2, 1992, the OTS amended a number of its accounting regulations and reporting requirements (effective October 2, 1992). The amendments reflected the adoption by the OTS of the following standards: (i) regulatory reports will incorporate generally accepted accounting principles when generally accepted accounting principles are used by Federal banking agencies; (ii) savings association transactions, financial condition and regulatory capital must be reported and disclosed in accordance with OTS regulatory reporting requirements that will be at least as stringent as for national banks; and (iii) the director of the OTS may prescribe regulatory reporting requirements more stringent than generally accepted accounting principles whenever the director determines that such requirements are necessary to ensure the safe and sound reporting and operation of savings associations. The OTS anticipates further similar revisions to its regulations in the near future. The OTS adopted a statement of policy ("Statement") set forth in Thrift Bulletin 52 concerning (i) procedures to be used in the selection of a securities dealer, (ii) the need to document and implement prudent policies and strategies for securities, whether held to maturity, trading or for sale, and to establish systems and internal controls to ensure that securities activities are consistent with the financial institution's policies and strategies, (iii) securities trading and sales practices that may be unsuitable in connection with securities held in an investment portfolio, (iv) high-risk mortgage securities that are not suitable for investment portfolio holdings for financial institutions, and (v) disproportionately large holdings of long-term, zero-coupon bonds that may constitute an imprudent investment practice. The Statement applies to 12 13 investment securities, high-yield, corporate debt securities, loans, mortgage-backed securities and derivative securities, and provides guidance concerning the proper classification of, and accounting for, securities held to maturity, sale, and trading. Securities held to maturity, sale or trading may be differentiated based upon an institution's desire to earn an interest yield (held to maturity), to realize a holding gain from assets held for indefinite periods of time (held for sale), or to earn a dealer's spread between the bid and asked prices (held for trading). Depository institution investment portfolios are maintained to provide earnings consistent with the safety factors of quality, maturity, marketability and risk diversification. Securities that are purchased to accomplish these objectives may be reported at their amortized cost only when the depository institution has both the intent and ability to hold the assets for long-term investment purposes. Securities held to maturity may be accounted for at amortized cost, securities held for sale are to be accounted for at the lower of cost or market, and securities held for trading are to be accounted for at market. The Savings Bank believes that its investment activities have been and will continue to be conducted in accordance with the requirements of OTS policies and generally accepted accounting principles. Special Liquidation Rights. In connection with the Conversion, a special "liquidation account" was established for the benefit of the eligible account holders and the supplemental eligible account holders of the Savings Bank determined in accordance with the plan of conversion adopted by the Savings Bank under applicable law governing the conversion of mutual savings banks. This liquidation account is equal to the amount of the net worth of the Savings Bank as of the date of its latest statement of financial condition contained in the final prospectus used in connection with the Conversion. This amount is $7,085,000. Each eligible account holder and supplemental eligible account holder, if he were to continue to maintain his deposit account at the Savings Bank, would be entitled, on a complete liquidation of the Savings Bank after Conversion, to an interest in the liquidation account prior to any payment to the stockholders of the Savings Bank. Each such eligible account holder or supplemental eligible account holder of the Savings Bank will have a pro rata interest in the total liquidation account for each of his, her or its, as the case may be, deposit accounts based on the proportion that the balance of each such deposit account on the eligibility record dates for such account holders bore to the balance of all deposit accounts in the Savings Bank on each of the such eligibility record date. Under certain circumstances the interests of an eligible account holder or a supplemental eligible account holder may be terminated. Were a mutual savings bank to liquidate, all claims of creditors (including those of depositors, to the extent of deposit balances) would be paid first. Thereafter, if there were any assets remaining, depositors would receive such remaining assets, pro rata, based upon the deposit balances in their deposit accounts immediately prior to liquidation. These liquidation rules survived the Conversion. In the event that the Savings Bank were to be liquidated after Conversion, all claims of creditors (including those of depositors, to the extent of their deposit balances) would also be paid first, followed by distribution of the "liquidation account" to the eligible account holders and the supplemental eligible account holders of the Savings Bank, with any assets remaining thereafter distributed to the Company as the holder of the Savings Bank's capital stock. Pursuant to the rules and regulations of the OTS, a post-Conversion merger, consolidation, sale of bulk assets or similar combination or transaction with another insured savings institution would not be considered a liquidation and, in such a transaction, the liquidation account would be required to be assumed by the surviving institution. FEDERAL AND STATE TAXATION General. The Company and the Savings Bank are subject to the corporate tax provisions of the Code, as well as certain additional provisions of the Code which apply to thrift and other types of financial institutions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company and the Savings Bank. Fiscal Year. The Company and the Savings Bank will file a consolidated Federal income tax return on a December 31 year end basis. Method of Accounting. The Company maintains its books and records for Federal income tax purposes using the accrual method of accounting. The accrual method of accounting generally requires that items of 13 14 income be recognized when all events have occurred that establish the right to receive the income and the amount of income can be determined with reasonable accuracy, and that items of expense be deducted at the later of (i) the time when all events have occurred that establish the liability to pay the expense and the amount of such liability can be determined with reasonable accuracy or (ii) the time when economic performance with respect to the item of expense has occurred. Bad Debt Reserves. With a limited exception, effective for taxable years beginning after 1995, the Small Business Job Protection Act of 1996 (the "1996 Act") repealed the reserve method of accounting for bad debts by savings institutions. The reserve method permitted savings institutions to establish reserves for bad debts and to make annual additions thereto which qualified as deductions from taxable income for federal tax purposes. Prior to the effective date of repeal, the bad debt deduction was generally based on a savings institution's actual loss experience (the "Experience Method") or, if certain definitional tests relating to the composition of assets and the nature of its business were met, by reference to a percentage of the savings institution's taxable income (the "Percentage Method"). The 1996 Act provides a limited exception to the repeal of the reserve method by retaining the Experience Method for savings institutions, such as the Savings Bank, which have assets with adjusted bases of $500 million or less. The Percentage Method is no longer available for any savings institution. For taxable years ended on or before December 31, 1995, the Savings Bank generally had elected to use the Percentage Method to compute the amount of its bad debt deduction. Under the Experience Method, the deductible annual addition continues to be the amount necessary to increase the balance of the reserve at the close of the taxable year to the greater of (i) the amount which bears the same ratio to loans outstanding at the close of the taxable year as the total net bad debts sustained during the current and five preceding taxable years bear to the sum of the loans outstanding at the close of those six years, or (ii) the lower of (x) the balance in the reserve account at the close of the Savings Bank's "base year," which was its tax year ended December 31, 1987, or (y) if the amount of loans outstanding at the close of the current year is less than the amount of loans outstanding at the close of the base year, the amount which bears the same ratio to loans outstanding at the close of the current year as the balance of the reserve at the close of the base year bears to the amount of loans outstanding at the close of the base year. Under the Percentage Method, the bad debt deduction with respect to qualifying real property loans was computed as a percentage of the Savings Bank's taxable income before such deduction, as adjusted for certain items (such as capital gains and the dividends received deduction). Under the Percentage Method, a qualifying institution such as the Savings Bank generally could deduct 8% of its taxable income. The 1996 Act mandates that a savings institution required to change its method of computing reserves for bad debts shall take into income ratably over a six year period its "applicable excess reserve", commencing with the first taxable year beginning after 1995. Under a special rule that is applicable only for taxable years that begin after December 31, 1995 and before January 1, 1998, if a savings institution meets the "residential loan requirement" for a taxable year, the recapture of the applicable excess reserve that would otherwise be required to be taken into account will be suspended. The effect of this is that all savings institutions will be required to recapture their applicable excess reserves within six, seven or eight years after the effective date of the change. The Savings Bank's "applicable excess reserves" would be the excess of (1) the balance in its reserve account as of the close of its last taxable year beginning before January 1, 1996, over (2) the greater of the balance of (a) its pre-1988 reserves, or (b) what the Savings Bank's reserves would have been at the close of its last taxable year beginning before January 1, 1996, had the Savings Bank always used the Experience Method. As of December 31, 1996, the Savings Bank had approximately $37,000 of applicable excess reserves. Approximately $6,200 of which will be recaptured on an annual basis. If the Savings Bank maintains the applicable residential loan requirement, this recapture will commence no later than its taxable year beginning January 1, 1998. The base year (i.e. December 31, 1987) bad debt reserve under the Percentage Method is permanently suspended, and therefore not subject to recapture, unless a base year loan contraction occurs in a subsequent 14 15 year. A base year loan contraction occurs when the total loans at the end of the year is less than the total loans at December 31, 1987. In such cases, a proportionate reduction to the base year bad debt reserve at December 31, 1987 is required and the reduction to the reserve is recaptured. Furthermore, the base year bad debt reserve constitutes a restriction for tax purposes of the Bank's use of retained earnings for distributions or redemptions. In accordance with FASB statement No. 109, the Bank has recorded deferred income tax associated with the temporary differences related to the portion of the bad debt reserve arising in tax years after December 31, 1987. For the period before December 31, 1987, there is an unrecognized deferred tax liability of approximately $565,000 at December 31, 1996. If the suspended base year bad debt reserve at December 31, 1987 is reduced by certain excess distributions, redemptions or a base year loan contraction, income tax expense will be recognized at the prevailing tax rate. The Savings Bank will meet the residential loan requirement if, for a taxable year, the principal amount of residential loans made by it are generally not less than the average principal amount of residential loans made by it during the six most recent taxable years beginning before January 1, 1996. Distributions. If the Savings Bank were to distribute cash or property to its sole stockholder having a total fair market value in excess of its accumulated tax-paid earnings and profits, or were to distribute cash or property to its stockholder in redemption of its stock, the Savings Bank would generally be required to recognize as income an amount which, when reduced by the amount of Federal income tax that would be attributable to the inclusion of such amount in income, is equal to the lesser of: (i) the amount of the distribution or (ii) the sum of (a) the amount of the accumulated bad debt reserve of the Savings Bank with respect to qualifying real property loans (to the extent that additions to such reserve exceed the additions that would be permitted under the Experience Method) and (b) the amount of the Savings Bank's supplemental bad debt reserve. The Savings Bank will continue to deduct additions to its bad debt reserves in the same manner as it has in past years. Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is payable to the extent such AMTI is in excess of an exemption amount. The Code provides that an item of tax preference is the excess of the bad debt deduction allowable for a taxable year pursuant to the percentage of taxable income method over the amount allowable under the experience method. The other items of tax preference that constitute AMTI include (a) tax exempt interest on newly-issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) for taxable years beginning after 1989, 75% of the excess (if any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). Net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Federal Income Tax Returns. The Savings Bank's Federal income tax returns have been filed for taxable years through December 31, 1995. The Savings Bank has not been notified by the IRS that it intends to examine any of the corporate income tax returns filed by the Savings Bank. Under the current statute of limitations, the Savings Bank's returns for taxable years ending December 31, 1992 and prior are free from examination by the IRS. Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Savings Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Savings Bank will not file a consolidated tax return, except that if the Company owns more than 20% of the stock of a corporation distributing a dividend, 80% of any dividends received may be deducted. State and Local Taxation. The Savings Bank is subject to the Mutual Thrift Institutions Tax of the Commonwealth of Pennsylvania based on the Savings Bank's financial net income determined in accordance with generally accepted accounting principles with certain adjustments. The tax rate under the Mutual Thrift 15 16 Institutions Tax is 11.5%. Interest on Commonwealth of Pennsylvania and Federal obligations is excluded from net income. An allocable portion of net interest expense incurred to carry the obligations is disallowed as a deduction. Three year carryforwards of losses are allowed. The Company is subject to the Corporate Net Income Tax and the Capital Stock Tax of the Commonwealth of Pennsylvania. STATISTICAL DISCLOSURE BY SAVINGS AND LOAN HOLDING COMPANIES Information regarding statistical disclosure for a savings and loan holding company required by the Securities Act Industry Guide 3 is set forth in the portions of the 1996 Annual Report which are incorporated herein by reference. I. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential. Information required by this section is presented on pages 10 through 12 of the 1996 Annual Report and is incorporated herein by reference. II. Investment Portfolio. Information required by this section is presented on pages 27 through 32 of the 1996 Annual Report and is incorporated herein by reference. III. Loan Portfolio. Information required by this section is presented on pages 17 through 25 of the 1996 Annual Report and is incorporated herein by reference. IV. Summary of Loan Loss Experience. Information required by this section is presented on pages 23 through 27 of the 1996 Annual Report and is incorporated herein by reference. V. Deposits. Information required by this section is presented on pages 32 through 34 of the 1996 Annual Report and is incorporated herein by reference. VI. Return on Equity and Assets. Information required by this section is presented on pages 3 through 4 of the 1996 Annual Report and is incorporated herein by reference. VII. Short-Term Borrowing. Information required by this section is presented on page 34 of the 1996 Annual Report and is incorporated herein by reference. EXECUTIVE OFFICERS OF THE COMPANY
NAME AGE POSITION WITH REGISTRANT -------------------------------------- --- ----------------------------------------- Robert S. Zyla........................ 49 President Patricia A. White..................... 50 Vice President, Secretary and Treasurer James M. Hein......................... 33 Controller
Each of Robert S. Zyla, Patricia A. White and James M. Hein were elected to their respective positions in connection with the Conversion. After the Annual Meeting of the shareholders of the Company, the Board of Directors of the Company has a reorganization meeting and elects the executive officers of the Company. The positions held by the executive officers of the Savings Bank during the past five years are as follows:
NAME TERM POSITION WITH SAVINGS BANK -------------------------------- ---------- ---------------------------------------- Robert S. Zyla.................. 1992-1996 President/CEO and Treasurer(1) Patricia A. White............... 1992-1996 Executive Vice President and Secretary James M. Hein................... 1992-1996 Controller and Chief Financial Officer(2)
- --------- (1) Mr. Zyla assumed the additional title of Chief Executive Officer and Treasurer on January 18, 1995. (2) Mr. Hein assumed the additional title of Chief Financial Officer on January 17, 1996. 16 17 ITEM 2. PROPERTIES The following table sets forth certain information with respect to the Savings Bank's branch offices and operations center at December 31, 1996.
NET BOOK VALUE AMOUNT OF DESCRIPTION/ADDRESS LEASED/OWNED OF PROPERTY DEPOSITS ------------------- ------------- -------------- --------- (IN THOUSANDS) Corporate and Main Office: - -------------------------- 710 Old Clairton Road Owned $562 $37,308 Pleasant Hills, Pennsylvania 15236 Branch Offices: - --------------- 543 Brownsville Road Owned $451 $32,166 Mt. Oliver, Pennsylvania 15210 6257 Library Road Owned $180 $17,979 Bethel Park, Pennsylvania 15102
The Board of Directors of the Company and the Savings Bank have authorized the expansion and remodeling of the Corporate Headquarters of the Company and the Savings Bank. Management intends to construct a 4,000 square foot addition to this Corporate Headquarters. The total estimated cost of this project is $600,000. In April, 1996, the Savings Bank exercised its option to purchase a parcel of land in Bethel Park, Pennsylvania located within 3/4 of a mile of the current Bethel Park branch office of the Savings Bank. The purchase price for this parcel was $250,000. The current book value of this property is $265,717. The Company and the Savings Bank are currently exploring the development of this property. Management is considering the construction of a an office building on this parcel. No final decision has been made to start this project. ITEM 3. LEGAL PROCEEDINGS The Company is involved in routine legal proceedings occurring in the ordinary course of business which in the aggregate are believed by management to be immaterial to the financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS During the fourth quarter of the fiscal year of the Company ending December 31, 1996, no matter was submitted to a vote of the security holders of the Company through the solicitation of proxies or otherwise. 17 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Pages 2-5 of the 1996 Annual Report to Shareholders is herein incorporated by reference. ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA Pages 2-5 of the 1996 Annual Report to Shareholders is herein incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Pages 6-17 of the 1996 Annual Report to Shareholders are herein incorporated by reference. ITEM 8. FINANCIAL STATEMENTS Pages 36-58 of the 1996 Annual Report to Shareholders are herein incorporated by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no change in public accountants for the Company or the Savings Bank during the last two fiscal years. PART III ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT Information concerning Directors of the Registrant and Executive Officers of the Registrant who are not Directors are incorporated herein by reference to pages 4-7 of the Registrant's definitive Proxy Statement dated March 31, 1997. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference to pages 7-10 of the Registrant's definitive Proxy Statement dated March 31, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain owners and management is incorporated herein by reference to pages 2-5 of the Registrant's definitive Proxy Statement dated March 31, 1997. ITEM 13. CERTAIN TRANSACTIONS Information concerning certain relationships and transactions is incorporated herein by reference to pages 8, 9, 16 and 17 of the Registrant's definitive Proxy Statement dated March 31, 1997. 18 19 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS The following information appearing in the Registrant's 1996 Annual Report to Shareholders for the year ended December 31, 1996 is incorporated by reference from Item 8 hereof (see Exhibit 13).
PAGES IN ANNUAL REPORT SECTION ANNUAL REPORT --------------------- ------------- Independent Auditors' Report 36 Consolidated Balance Sheet 37 Consolidated Statements of Income 38 Consolidated Statements of Stockholders' Equity 39 Consolidated Statements of Cash Flows 40 Notes to Consolidated Financial Statements 41-58
(a)(2) FINANCIAL STATEMENT SCHEDULES All financial schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements. (a)(3) EXHIBITS REQUIRED BY ITEM 601
PAGE # WHERE ATTACHED EXHIBITS REFERENCE TO ARE LOCATED IN THIS PRIOR FILING OR FORM 10-K REPORT REGULATION S-K EXHIBIT NUMBER OR THE INTEGRATED EXHIBIT NUMBER DOCUMENT ATTACHED HERETO ANNUAL REPORT -------------- -------- -------------- ------------------ 3.1 Certificate of Incorporation of * Not Applicable Prestige Bancorp, Inc. 3.2 Bylaws of Prestige Bancorp, Inc. * Not Applicable 4 Rights of Security Holders ***** Not Applicable 10.1 1997 Recognition and Retention Plan and *** Not Applicable Trust for Officers, Directors and Employees** 10.2 1997 Stock Option Plan for Officers, *** Not Applicable Directors and Employees** 10.3 Employment Agreement among the Company, * Not Applicable the Savings Bank and Robert S. Zyla, Patricia A. White and James M. Hein, dated June 27, 1996** 10.4 Loan Documents with FHLB of Pittsburgh 10.4 (filed with SEC; copy available from Company on request) 11 Statement re Computation of Per Share **** Page 3 of the Annual Earnings Report
19 20
PAGE # WHERE ATTACHED EXHIBITS REFERENCE TO ARE LOCATED IN THIS PRIOR FILING OR FORM 10-K REPORT REGULATION S-K EXHIBIT NUMBER OR THE INTEGRATED EXHIBIT NUMBER DOCUMENT ATTACHED HERETO ANNUAL REPORT -------------- -------- --------------- ------------------- 13 Annual Report to Shareholders Not Applicable **** 21 Subsidiaries of Registrant * Not Applicable 27 Financial Data Schedule (For SEC use only) (For SEC use only)
- --------- * Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 33-83666) filed by the Company with the SEC on May 9, 1996, as amended. ** Management plan or compensatory plan or arrangement. *** Incorporated by reference from the Company's definitive proxy statement for its 1997 Annual Meeting filed by the Company with the SEC on April 4, 1997. **** The Annual Report for 1996 is included as part of this integrated filing of 1996 Annual Report to Shareholders and Form 10-K Report. ***** Articles 6 and 14 of the Articles of Incorporation of Prestige Bancorp, Inc. Such Certificate of Incorporation can be found as an exhibit to the Company's Registration Statement on Form S-1 (File No. 33-83666) filed by the Company with the SEC on May 9, 1996, as amended. A summary discussion on certain limitations on the rights of Stockholders can be obtained at pages 16 and 17 and pages 98 through 108 of the final prospectus filed by the Company with the SEC in connection with such Form S-1. (b) REPORTS ON FORM 8-K The Registrant did not file any reports on Form 8-K during the quarter ended December 31, 1996. 20 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report [to be executed on] its behalf by the undersigned, thereunto duly authorized. Date: March 31, 1997 PRESTIGE BANCORP, INC. /s/ ROBERT S. ZYLA By:____________________________ Robert S. Zyla President and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ ROBERT S. ZYLA /s/ MICHAEL R. MACOSKO - ---------------------------------- ---------------------------------- Robert S. Zyla Michael R. Macosko President and Director Director (Principal Executive Officer) Date: March 31, 1997 Date: March 31, 1997 /s/ JOHN A. STIVER /s/ MARK R. SCHOEN - ---------------------------------- ---------------------------------- John A. Stiver Mark R. Schoen Chairman of the Board of Directors Director Date: March 31, 1997 Date: March 31, 1997 /s/ PATRICIA A. WHITE /s/ CHARLES P. MCCULLOUGH - ---------------------------------- ---------------------------------- Patricia A. White Charles P. McCullough Treasurer, Secretary and Director Director Date: March 31, 1997 Date: March 31, 1997 /s/ MARTIN W. DOWLING /s/ JAMES M. HEIN - ---------------------------------- ---------------------------------- Martin W. Dowling James M. Hein Director Controller Date: March 31, 1997 (Principal Financial and Accounting Officer) Date: March 31, 1997 21 EX-10.4 2 PRESTIGE BANCORP, INC. 1 Exhibit 10.4 FEDERAL HOME LOAN BANK OF PITTSBURGH FLEXLINE COMMITMENT APPLICATION - ------------------------------------------------------------------------------- Prestige Bank, FSB ("Member") hereby applies to the Federal Home Loan Bank of Pittsburgh ("Bank") for a Commitment on the terms described below and pursuant to the terms and conditions of the Advances, Collateral Pledge and Security Application if the Bank is not satisfied as to Member's creditworthiness; if Member is not in compliance with the terms of the Master Agreement and the Bank's Credit Policies at the time of funding of the Advance; or if the Member's primary federal regular or insurer notifies the Bank that the member has been restricted from using Bank advances. Commitment Begin Date: 03/25/97 Commitment Expiration Date: 03/24/93 Amount Requested: $8,185,000.00 (Not to exceed 10% of Institution's Maximum Borrowing Capacity in effect at the time the Commitment is executed.) Flexline Advances funded hereunder which are not earlier repaid will nature on the Commitment Expiration Date. A Member may, with the Bank's approval, renegotiate the terms of this Commitment, including its renewal, at any time prior to the Commitment Expiration Date. Such renegotiations require the Member to complete and submit a new Flexline Commitment Application prior to the effective date of the change. The Bank shall have no obligation to renegotiate a Flexline Commitment and reserves the right to reduce or terminate this Flexline Commitment at any time without prior notice to Member. Member's Current Financial Information (GAAP Basis) as of: 12/31/97 (000's) - ------------------------------------------------------------------- 1. Total Assets $114,449 5. Total Other Borrowings $_________________ 2. Goodwill and Other Intangible Assets $________ 6. Total FHLB Advances $14,477 3. Total Liabilities $102,820 7. QTL __X__ Yes _____ No 4. Net Worth $ 11,629 8. Qualified Asset Ratio 90% _________________ as of 12/31/96
Disclosure under warranties and representations from reverse side of this Application: =============================================================================== Member acknowledges that any Advance hereunder is subject to the terms and conditions on the reverse side of this Application and the terms and conditions of the Master Agreement and the Bank's Credit Policies as in effect from time to time. Member acknowledges that if the Bank approves the Advance by signing this Application, this will constitute the agreement of Member and the Bank to the Advance on the ____ set forth herein and in the Master Agreement and that this Application will become part of the Master Agreement. Date:______________ By _______________________________________________ 2 Authorized Signature Name and Title:______________________________________________________________ (Print or Type) - ----------------------------------------------------------------------------- FOR FEDERAL HOME LOAN BANK USE ONLY Commitment No. _______________________ Approval Date: _______________________ _________________________________ Authorized Signature Title _________________________________ Authorized Signature Title Effective Date 3/1/96 FHLB-Pittsburgh -2- 3 FEDERAL HOME LOAN BANK OF PITTSBURGH "REPOPLUS" ADVANCE MASTER APPLICATION - ------------------------------------------------------------------------------- Prestige Bank ("Member") hereby enters into this "RepoPlus" Advance Master Application ("Application") with the Federal Home Loan Bank of Pittsburgh ("Bank") to apply to receive Advances from time to time during the term hereof on the terms and conditions described below and subject to the Banks Credit Policies and the Advances, Collateral Pledge and Security Agreement between the Bank and Member ("Master Agreement"). The Bank shall have no obligation to make an Advance under this Application if the Bank is not satisfied as to Member's creditworthiness; if Member is not in compliance with the terms of the Master Agreement and the Bank's Credit Policies at the time of funding of the Advance; or if the Member's primary federal regulator or insurer notifies the Bank that the Member has been restricted from using Bank Advances. The term of this Application is for 1 year beginning on the Approval Date. Advances funded under this Application will be granted for terms of 1 to 92 days and will bear interest at a fixed rate set at the time of the funding request. Member will receive from the Bank an Advice of Transaction ("Advice") of each Advance funded hereunder stating the principal amount, the rate and the maturity date of such Advance. Such Advices shall be conclusive and binding on the Member and the Member shall be estopped from challenging the same on any grounds and from denying its obligation to repay an Advance. Payment of interest and principal will be due upon maturity of the Advance. =============================================================================== Member acknowledges that any Advance hereunder is subject to the terms and conditions on the reverse side of this Application and the terms and conditions of the Master Agreement and the Bank's Credit Policies as in effect from time to time. Member acknowledges that if the Bank approves this Application by signing the Application, this will constitute the agreement of Member and the Bank to the Advances hereunder on the terms and conditions set forth herein, and that this Application and all Advices issued in connection with Advances hereunder will become part of the Master Agreement. Date: 4/23/96 By ------------------- -------------------------------- Authorized Signature Name and Title: ---------------------------------------------------------------- (Print or Type) - ------------------------------------------------------------------------------- FOR FEDERAL HOME LOAN BANK USE ONLY Maturity Date -------------- Approval Date: ------------- -------------------------------------------------- Authorized Signature Title -------------------------------------------------- Authorized Signature Title 4 ADVANCES, COLLATERAL PLEDGE AND SECURITY AGREEMENT 5 ADVANCES, COLLATERAL PLEDGE AND SECURITY AGREEMENT This Advances, Collateral Pledge and Security Agreement (the "Master Agreement"), dated as May 19, 1993, between Prestige Bank, FSB with its principal place of business at 710 Old Clairton Road, Pittsburgh, PA 15236 (the "Member") and the Federal Home Loan Bank of Pittsburgh, with its principal place of business at One Riverfront Center, Twenty Stanwix Street, Pittsburgh, Pennsylvania 15222-4893 (the "Bank"). WHEREAS, the Bank, subject to the provisions of the Federal Home Loan Bank Act ("Bank Act"), the Rules and Regulations of the Federal Housing Finance Board ("FHFB Regulations"), the policies of the FHFB and the Bank's Credit Policies (as hereinafter defined) is authorized to make available Advances and Other Credit Products to its members; and WHEREAS, Member desires from time to time to apply for such Advances and Other Credit Products that may be available to it; and WHEREAS, the Bank requires that such Advances and Other Credit Products provided by the Bank be secured pursuant to this Master Agreement, and Member agrees to provide such security as requested by the Bank by the means set forth in this Master Agreement. NOW THEREFORE, intending to be legally bound, the member and the Bank agree as follows: GENERAL Section 1.01. Definitions. As used herein, the following terms shall have the following meanings. "Advances" means any and all loans or other extensions of credit now or hereafter granted by the Bank to the Member, including all loans or extensions of credit by the Bank to the Member prior to the date hereof. "Advance Application" means a writing or electronic transmission, in such form or forms as shall be specified by the Bank from time to time, by which the Member requests, and which if executed by the Bank shall evidence, an Advance. "Capital Stock" means all of the capital stock of the Bank and all payments which have been or hereafter are made on account of subscriptions to and all unpaid dividends on such Capital Stock. "Collateral" means all tangible and intangible property, including the proceeds thereof, heretofore assigned, transferred -1- 6 or pledged to the Bank by the Member as collateral for loans or other extensions of credit prior to the date hereof, and all Capital Stock, Deposits, Mortgage Collateral, Securities Collateral and Other Collateral, including the proceeds thereof and collections on any and all of the foregoing, which are now or hereafter pledged to the Bank pursuant to Section 3.01 hereof. "Collateral Maintenance Level" means such aggregate Fair Market Value of Qualifying Collateral as is specified in the Bank's Collateral Policy or as may be otherwise specified in writing by the Bank from time to time as being the Collateral Maintenance Level that the member is required to maintain hereunder. The Bank may increase or decrease the Collateral Maintenance Level at any time. "Collateral Policy" shall mean the Bank's Collateral Policy as in effect from time to time. "Credit Policies" shall mean the Bank's Master Credit, Advances, Interest Rate Exchange, Standby Letter of Credit, Collateral and other Policies relating to Advances and Other Credit Products offered by the Bank, all as in effect from time to time. "Deposits" shall mean all deposit accounts maintained by the member with the Bank, all money, cash and checks, drafts, notices, bills, bills of exchange and bonds deposited therein or credited thereto, any increases, renewals, extensions, substitutions and replacements thereof, whether or not deposited in any such deposit account and all statements, certificates, passbooks and instruments representing any such deposit account. "Fair Market Value" means the weighted fair market value of Collateral determined in such a manner as is specified in the Bank's Collateral Policy or as may be otherwise specified in writing by the Bank from time to time. The Bank may change the method of determining Fair Market Value at any time and the Bank's determination of Fair market Value shall be conclusive. "Indebtedness" means all obligations, liabilities or indebtedness of the member to the Bank, due or to become due, direct or indirect, absolute or contingent, joint or several, now existing or hereafter at any time created, arising or incurred, under this Master Agreement, Advance Applications, Other Credit Product Agreements, Advances, Other Credit Products, Deposits, including any overdrafts or other charges in connection therewith, any obligations for any other services (including without limitation safekeeping, operating and other correspondent services) provided by the Bank, including any applications, commitments, other agreements or documents relating to the foregoing, any amendments to any of the foregoing agreements or documents and any obligation sunder indemnification provisions in any such agreements or documents, and any renewal, extension or -2- 7 substitution of any such obligations, liabilities and indebtedness, including attorneys' fees of the Bank in the collection thereof and the enforcement of any remedies with respect to any Collateral therefor. "Mortgage Collateral" means Mortgage Documents and all security agreements, guaranties, insurance policies, certificates, binders, commitments or reports relating thereto, including title insurance, private mortgage insurance and hazard and liability insurance, surveys, bonds, participation agreements, purchase commitments, hedge contracts or other agreements to purchase, guaranty or insure any mortgage loans or securities to be issued by the Member, any other agreement, instrument or document pertaining to, affecting or obtained by the Member in connection with the loans covered by the Mortgage Documents, financing statements perfecting the Member's security interest in any of the foregoing, certificates, evidences of recordation, applications, underwriting materials, appraisals, notices, opinions of counsel, loan servicing data, files, correspondence, computer programs, tapes, discs, cards, account records and all other electronically stored or written records or materials relating to the loans covered by the Mortgage Documents. "Mortgage Documents" means mortgages, deeds of trust or other security deeds in land and interests in real property and the improvements and fixtures located thereon (herein "mortgages") and all notes, bonds or other instruments evidencing loans secured thereby (herein "mortgage notes") and any endorsements and assignments thereof to the Member. "Other Collateral" means such items of tangible and intangible property, other than Capital Stock, Deposits, Mortgage Collateral and Securities Collateral, which are offered as collateral by the Member to the Bank and are specifically accepted by the Bank as Collateral for Advances and Other Credit Products. "Other Credit Products" means any and all commitments or obligations under which the Bank agrees to make Advances to the Member or payments on behalf of or for the account of the member, including without limitation letters of credit, guarantees or other arrangements intended to facilitate transactions between the Member and third parties, or under which the Bank enters into a credit or financial accommodation, agreement or other arrangement with the Member, including without limitation interest rate exchange transactions (such as interest rate swap, cap, collar and floor agreements) and such other products or services as may be offered by the Bank from time to time pursuant to its Credit Policies and irrespective of whether the Bank's obligation is contingent or conditional. "Other Credit Product Agreement" means a writing or electronic transmission in such form as shall be specified by the Bank, -3- 8 executed by the Bank and the Member and setting forth the obligations of the Bank and Member, including without limitation any reimbursement agreement, interest rate exchange agreement, confirmation, applications, notices, advice or other instruments between the Bank and the Member. "Outstanding Commitments" means, at any point in time, the maximum aggregate principal amount of Advances or payments which the Bank may be obligated to make to the Member under Advance Applications or Other Credit Product Agreements then in effect. "Qualifying Collateral" means Collateral other than Capital Stock which: (I) meets the definition of Qualifying Collateral under the Bank's Collateral Policy; (II) is owned by the Member free and clear of any liens, encumbrances or other interests other than the assignment to the Bank hereunder; (III) has not been in default within the most recent 12-month period excepting only, in the case of Mortgage Collateral, payments which are overdue by not more than 30 days or, if specifically agreed to by the Bank, 90 days; (IV) in the case of Mortgage Collateral, relates to residential real property which is covered by fire and hazard insurance in an amount at least sufficient to discharge the mortgage loan in full in case of loss and as to which all real restate taxes are current; and (V) in the case of Mortgage Collateral, does not secure an indebtedness on which any director, officer, employee, attorney or agent of the Member or any Federal Home Loan Bank is personally liable. The Bank may change the definition of Qualifying Collateral at any time, and the Bank's determination of Qualifying Collateral shall be conclusive. "Securities Collateral" means all securities or certificates evidencing a direct or indirect interest in a group of loans secured by mortgages, including without limitation, mortgage-backed securities, collateralized mortgage-backed obligations and real estate mortgage investment conduits, including Federal Home Loan Mortgage Corporation mortgage participation certificates, Federal National Mortgage Association mortgage pass-through certificates and Government national Mortgage Association modified pass-through mortgage-backed certificates, and all Mortgage Documents and items of Mortgage Collateral owned or otherwise acquired by the Member relating to the loans underlying such securities or certificates; consolidated obligations of the Federal Home Loan Bank System; obligations of or guaranteed by the United States; and obligations of or guaranteed by agencies or instrumentalities of the United States. -4- 9 ADVANCES AND OTHER CREDIT PRODUCTS Section 2.01. Application for Advances and Other Credit Products. Each Advance and Other Credit Product shall be based upon and evidenced by an Advance Application or Other Credit Product Agreement, as applicable, that has been executed by the Member and the Bank. Notwithstanding the foregoing, however, the Bank may make an Advance or Other Credit Product to the Member based upon information furnished by the member to the Bank and upon terms agreed to by the Bank and the Member by telephonicor other unwritten communication; provided that the Bank's records as to the amount, rate of interest, repayment period and other terms of each such Advance or Other Credit Product shall be conclusive and the Member shall be estopped from challenging the same on any grounds and from denying its obligation to repay such Advance or Other Credit Product. In such event the Member shall execute and deliver a completed Advance Application or Other Credit Product Agreement to the Bank within the required period of time following the making of such Advance or Other Credit Product as set forth by the Bank in writing from time to time. Each Advance, Advance Application, Other Credit Product and Other Credit Product Agreement shall be subject to the terms of the Credit Policies and applicable law, regulations and limitations, all as in effect from time to time, including the Bank Act, the FHFB Regulations and the statements of policy and guidelines of the FHFB, which shall be deemed to be incorporated by reference into this Master Agreement. Section 2.02. Repayment of Advances and Other Credit Products. The Member agrees to repay each Advance or Other Credit Product in accordance with this Master Agreement and the terms and conditions of the Advance Application or Other Credit Product Agreement. Unless otherwise specified in the Bank's Credit Policies or may be otherwise specified in writing by the Bank from time to time, interest shall be paid at the time of each payment of all or part of the principal of each Advance on the amount of principal so repaid and shall be paid on the first business day of each month on the daily outstanding principal amount of each Advance during the prior month (other than principal amounts which have been repaid during such month), in each case at the rate applicable to such Advance as stated in the related Advance Application. The Member shall pay to the Bank, immediately and without demand, interest on any past due amount owing on any Advance or Other Credit Product at the rate in effect and being charged by the Bank from time to time on overdrafts on demand deposit accounts of its members. The Member shall maintain in the Member's demand deposit account(s) with the Bank an amount at least equal to the amounts then currently due and payable to the Bank on outstanding Advances and Other Credit -5- 10 Products. The Member hereby authorizes the Bank to debit the member's demand deposit account(s) with the Bank for all amounts due and payable on any Advance or Other Credit Product and for all other amounts due and payable hereunder. In the event that the amount in the Member's demand deposit account is, at any time, insufficient to pay such due and payable amounts, the Bank may without notice to the Member apply any Deposits then in the possession of the Bank to the payment of such due and payable amounts. Section 2.03. Payment of Prepayment Charges. Any prepayment fees or charges for which provision is made, whether under the Advance Application. Other Credit Product Agreement, or otherwise, shall be payable at the time of any voluntary or involuntary payment of the principal of such Advance or Other Credit Product prior to the originally scheduled maturity thereof, including without limitation payments that are made as a part of a liquidation of the Member or that become due as a result of an acceleration pursuant to Section 4.10 hereof, whether such payment is made by the Member, by a conservator, receiver, liquidator or trustee of or for the Member, or by any successor to or any assignee of the Member. Section 2.04. Right of Bank to Make Payments with Respect to Outstanding Commitments. In the event that there are one or more Outstanding Commitments at the time of an Event of Default under Section 4.01 hereof, the Bank may, at its option, make any payments due thereunder from time to time by crediting a special account with the Bank over which the Bank has sole dominion and control. Amounts credited to such special account shall be deemed to have satisfied the Bank's obligations under the Outstanding Commitments. When all such obligations have been satisfied, the Bank shall disburse the balance, if any, in such account first to the satisfaction of any amounts then due and owing by the Member to the Bank then to the Member or its successors in interest. Payments made pursuant to this section shall be payable on demand and shall bear interest at the rate in effect and being charged by the Bank from time to time on overdrafts on demand deposit accounts of its members. SECURITY AGREEMENT Section 3.01. Creation of Security Interest. As security for all Indebtedness, including without limitation all Advances and Other Credit Products, the Member hereby assigns, transfers, and pledges to the Bank, and grants to the Bank a security interest in all of the Capital Stock, Deposits, Mortgage Collateral, Securities Collateral and Other Collateral (collectively Collateral), now or hereafter owned by the Member, -6- 11 and all proceeds thereof, provided, however, that Mortgage Collateral, Securities Collateral and Other Collateral that is encumbered or disposed of by the member in conformity with the requirements of Section 3.03(a) hereof shall not be subject to the security interest created hereunder. Without limitation of the foregoing, all tangible and pledged by the Member to the Bank as Collateral for Advances and Other Credit Products prior to the date hereof is hereby assigned, transferred and pledged to Bank as Collateral hereunder. Section 3.02. Member's Representations and Warranties Concerning Collateral. The Member represents and warrants to the Bank, as of the date hereof and the date of all Advances or Other Credit Products secured hereunder, as follows: (a) The Member owns and has marketable title to the Collateral and has the right and authority to grant a security interest in the Collateral and to subject all of the Collateral to this Master Agreement; (b) The information contained in any certification, status report, schedule, or other documents required hereunder and any other information given from time to time by the Member as to each item of Collateral is true, accurate and complete in all material respects; (c) The Member maintains Qualifying Collateral which has a Fair Market Value that is at least equal to the then current Collateral Maintenance Level and which meets the standards and requirements from time to time established by the Bank's Collateral Policy, the Bank Act and the FHFB Regulations; and (d) No part of any real property or interest in real property that is the subject of Collateral which is Qualifying Collateral contains or is subject to the effects of toxins or hazardous materials or other hazardous substances (including those defined in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. 9601 et seq.; the Hazardous Materials Transportation Act, 49 U.S.C. 1801 et seq.; the Resource Conservation and Recovery Act, 42 U.S.C. 6901 et seq.; and in the regulations adopted and publications promulgated pursuant to said laws) the presence of which could subject the Bank to any liability under applicable state or Federal law or local ordinance either at any time that such property is pledged to the Bank or upon the enforcement by the Bank of its security interest therein. -7- 12 Section 3.03. Collateral Maintenance Requirement. (a) The Member shall at all times maintain as Collateral an amount of Qualifying Collateral which has a Fair Market Value that is at least equal to the then current Collateral Maintenance Level. The Member shall not assign, pledge, transfer, create any security interest in, sell, or otherwise dispose of any Collateral if such Collateral is held by or on behalf of the Bank pursuant to Section 3.04 hereof, or the Bank has otherwise perfected its security interest in such Collateral, or at the time of or immediately after such action. Member is not or would not be in compliance with the collateral maintenance requirements of the first sentence of this Section 3.03(a) or is or would be otherwise in default under this Master Agreement. (b) Collateral shall beheld by the member in trust for the benefit of, and subject to the direction and control of the Bank, and will be physically safeguarded by the Member with at least the same degree of care as the Member uses in physically safeguarding its other property. Without limitation of the foregoing, Member shall take all action necessary or desirable to protect and preserve the Collateral and the Bank's interest therein, including without limitation the maintaining of insurance on property securing mortgages constituting Collateral (such policies and certificates of insurance or guaranty relating to such Mortgages are herein called "insurance"), the collection of payments under all mortgages and under all insurance, and otherwise assuring that the loans comprising the Mortgage Collateral are serviced in accordance with the standards of a reasonable and prudent mortgagee. The Member, as the Bank's agent, shall collect all payments when due on all Collateral. If the Bank requires, the Member shall hold such collections separate from its other monies and apply them to the reduction of Indebtedness as it becomes due; otherwise, the Bank consents to the member's use and disposition of all such collections. (c) Upon request by the Bank or as may be provided in the Collateral Policy, the Member shall specify and describe to the Bank and/or physically segregate any Collateral in a manner as required by the Bank. Section 3.04. Delivery of Collateral. (a) Upon the Bank's request which may be made at any time for any reason, or at any time that the member becomes subject to any mandatory collateral delivery requirements pursuant to the Collateral Policy or that may be otherwise established in writing by the Bank, the Member shall -8- 13 immediately deliver to the Bank, or to a custodian designated by the Bank, all Collateral including such Qualifying Collateral as may be necessary so that the Fair Market Value of Qualifying Collateral held by the Bank, or such custodian, meets or exceeds the Collateral Maintenance Level at all times, and take any and all other action as may be specified by the Bank to perfect the Bank's security interest in the Collateral, including the filing of financing statements. Collateral delivered to the Bank shall be endorsed or assigned in recordable form by the member to the Bank as directed by the Bank. With respect to Mortgage Collateral that is to be delivered hereunder, the Member shall deliver the Mortgage Documents with necessary endorsements and assignments relating thereto unless otherwise directed by the Bank. Concurrently with the initial delivery of Collateral and at such other times as provided in the Collateral Policy or as the Bank may otherwise request, the Member will deliver to the Bank a status report and accompanying schedules, all in form and substance satisfactory to the Bank and dated as of the then most recent valuation date, describing the Collateral held by the Bank or its custodian. (b) With respect to uncertificated securities pledged to the Bank as Securities Collateral or Other Collateral hereunder, the delivery requirements contained in this Master Agreement shall be satisfied by the transfer of a security interest in such securities to the Bank, such transfer to be effected in such securities to the Bank, such transfer to be effected in such manner and to be evidenced by such documents as shall be specified by the Bank. (c) The Member agrees to pay to the Bank such reasonable fees and charges as may be assessed by the Bank to cover the Bank's overhead and other costs relating to the receipt, holding, redelivery and reassignment of Collateral and to reimburse the Bank upon request for all recording fees and other reasonable expenses, disbursements and advances incurred or made by the Bank in connection therewith (including the reasonable compensation and the expenses and disbursements of any custodian that may be appointed by the Bank hereunder, and the agents and legal counsel of the Bank and of such custodian). Section 3.05. Withdrawal or Reassignment of Collateral. Upon receipt by the Bank of writings in form and substance satisfactory to the Bank constituting (I) a request from the member for the withdrawal or reassignment of Collateral which has been delivered pursuant to Section 3.04 hereof, or as to which the Bank has otherwise perfected its security interest, (II) a detailed listing of the Collateral to be withdrawn or reassigned, -9- 14 and (III) a certificate of a responsible officer of the Member certifying that the Fair Market Value of the Qualifying Collateral that will be held by the Bank, as appropriate, after such withdrawal or reassignment would not be less than the Collateral Maintenance Level, provided, that the Bank's valuation of such delivered Collateral confirms that the member's Collateral Maintenance Level will be satisfied after such withdrawal or reassignment, then, the Bank shall redeliver or reassign to the Member the Collateral specified in said officer's certificate. Notwithstanding anything to the contrary herein contained, while an Event of Default hereunder shall have occurred and be continuing, or at any time that the Bank in good faith deems itself insecure, the Member may not obtain any such withdrawal or reassignment. Section 3.06. Additional Collateral. The Bank may at any time require the Member to maintain and deliver to the Bank additional Collateral over that amount of Qualifying Collateral required to meet the member's Collateral Maintenance Level or substitutions of Collateral. The Member expressly agrees to maintain and deliver such additional Collateral or substitutions of Collateral as the Bank shall require. Section 3.07. Reports, Collateral Audit; Access. (a) In accordance with the Collateral Policy and at such other times as the Bank may request, the Member shall furnish to the Bank, in form and substance satisfactory to the Bank, a certification or report that it maintains Qualifying Collateral with a Fair Market Value sufficient to meet the Collateral Maintenance Level. If the Fair Market Value of Qualifying Collateral owned by the Member, free and clear of any liens or encumbrances, shall at any time fall below the Collateral Maintenance Level, the Member shall immediately notify the Bank. The Member shall request annually an audit report prepared by the Member's external independent auditor in accordance with generally accepted auditing standards certifying that the member owns, free and clear of any liens or encumbrances, Qualifying Collateral with a Fair Market Value at least equal to the Collateral Maintenance Level, and deliver such report to the Bank within 120 days of each fiscal year end of the Member, including an explanation for any exceptions or qualifications in the report or any failure to obtain such report. The Member agrees that the Bank shall have access at all reasonable times to the Collateral in the member's possession and to the Member's books and records of account relating to such Collateral. The Member shall permit the Bank to examine, inspect, audit and take copies or make extracts from its books and records and to discuss its affairs with its independent auditor as often as the Bank may reasonably request. Promptly upon their becoming available to the member, -10- 15 the member shall provide to the Bank any reports including management letters submitted to the Member by its independent auditor in connection with any annual, interim or special audit. The Member agrees that examination reports prepared by local, state or federal authorities may be furnished by such authorities to the Bank upon request. If requested by the Bank, the Member shall furnish to the Bank a written report covering such matters regarding the Collateral as the bank may require, including listing of mortgages, securities, and unpaid principal balances thereof, and certifications concerning the status of payments on mortgages and of taxes and insurance on property securing mortgages. If so requested by the Bank, the Member shall promptly report to the Bank any event which reduces the principal balance of any mortgage or security by five percent (5%) or more, whether by prepayment, foreclosure sale, insurance or guaranty payment or otherwise. (b) All Collateral and the satisfaction by the Member of the Collateral Maintenance Level shall be subject to audit and verification by or on behalf of the Bank. Such audits and verifications may occur without notice during the Member's normal business hours or upon reasonable notice at such other times as the Bank may reasonably request. The Member shall provide access to, and shall make adequate working facilities available to, the representatives or agents of the Bank for purposes of such audits and verifications. The Member agrees to pay to the Bank such reasonable fees and changes as may be assessed by the Bank to cover overhead and other costs relating to such audit and verification. Section 3.08. Additional Documentation. The Member shall make, execute, record and deliver to the Bank such financing statements, assignments, listings, powers, notices and other documents with respect to the Collateral and the Bank's security interest therein as directed by the Bank and in form and substance satisfactory to the Bank. Section 3.09. Bank's Responsibilities as to Collateral. The Bank's duty as to the Collateral shall be solely to use reasonable care in the custody and preservation of the Collateral in its possession, which shall not include any steps necessary to preserve rights against prior parties nor the duty to send notices, perform services, or take any action in connection with the management of the Collateral. The Bank shall not have any responsibility or liability for the form, sufficiency, correctness, genuineness or legal effect of any instrument or document constituting a part of the Collateral, or any signature thereon or the description or misdescription, or value of property represented, or purported to be represented, by and such document or instrument. The Member agrees that any and all -11- 16 Collateral may be removed by the Bank from the state or location where situated, and may there be dealt with by the Bank as provided in this Master Agreement. Section 3.10. Bank's Rights as to Collateral; Power of Attorney. At any time or times, at the expense of the member, the Bank may, in its discretion, before or after the occurrence of an Event of Default as defined in Section 4.01 hereof, in its own name or in the name of its nominee or of the Member, do any or all things and take any and all actions that are pertinent to the protection of the Bank's interests hereunder are lawful under the laws of the Commonwealth of Pennsylvania, or the laws of any jurisdiction under which the Bank may be exercising its rights hereunder, including the following: (a) Terminate any consent given hereunder; (b) Notify obligors on any Collateral to make payments thereon directly to the Bank; (c) Endorse any Collateral in the Member's name; (d) Enter into any extension, compromise, settlement, or other agreement relating to or affecting any Collateral; (e) Take any action the Member is required to take or which is otherwise necessary to: (i) sign and record a financing statement or otherwise perfect a security interest in any or all of the Collateral; or (ii) obtain, preserve, protect, enforce or collect the Collateral; (f) Take control of any funds or other proceeds generated by the Collateral and use the same to reduce Indebtedness as it becomes due; and (g) Cause the Collateral to be transferred to its name or the name of its nominee. The Member hereby appoints the Bank as its true and lawful attorney, with full power of substitution, for and on behalf of the member and in its name, place and stead, to prepare, execute and record endorsements and assignments to the Bank of all or any item of Collateral, giving or granting to the Bank, as such attorney, full power and authority to do or perform every lawful act necessary or proper in connection therewith as fully as the member might or could do. The Member hereby ratifies and confirms all that the Bank shall lawfully do or cause to be done by virtue of this special power of attorney. This special power of attorney is granted for a period commencing on the date hereof and continuing until the discharge of all Indebtedness and all obligations of the Member hereunder regardless of any default by -12- 17 the member, is coupled with an interest and is irrevocable for the period granted. Section 3.11. Subordination of Other Loans to Mortgage Collateral. The Member hereby agrees that all mortgage notes which are part of the Mortgage Collateral and any notes secured by personal property ("personalty notes") which may become part of the Other Collateral shall have priority in right and remedy over any claims, however evidenced, for other loans, whether made before or after the date of such mortgage or personalty notes which are secured by the mortgages or security agreements securing such mortgage or personalty notes but are not part of the Collateral, and shall be satisfied out of the property covered by such mortgages or security agreements before recourse to such property may be obtained for the repayment of such other loans. To this end, the Member hereby subordinates the lien of such mortgages and security agreements with respect to such other loans to the lien of such mortgages and security agreements with respect to such mortgage and personalty notes. The Member further agrees to retain possession of any promissory notes evidencing such other loans and not to pledge, assign or transfer the same, except that the same may be pledged to the Bank as part of the Collateral. DEFAULT; REMEDIES Section 4.01. Events of Default; Acceleration. In the event of the occurrence of any of the following events or conditions of default ("Event of Default"), the Bank may at its option, by a notice to the Member, declare all Indebtedness and accrued interest thereon, including any prepayment fees or charges which are payable in connection with the payment prior to the originally scheduled maturity of any Indebtedness, to be immediately due and payable without presentment, demand, protest or any further notice; (a) Failure of the member to pay when due any interest on or principal of any Advance or any amount payable in connection with any Other Credit Product; or (b) Failure of the member to perform any promise or obligation or to satisfy any condition or liability contained herein, in an Advance Application, or in any Other Credit Product Agreement to which the Member and the Bank are parties; or (c) Any representation, statement, or warranty made or furnished in any manner to the Bank by or on behalf of the member in connection with any Advance or Other Credit Product or any certification of the Fair Market Value of Qualifying -13- 18 Collateral shall have been false or misleading in any material respect when made or furnished; or (d) Failure of the member to maintain Qualifying Collateral which has a Fair Market Value that is at least equal to the then current Collateral Maintenance Level, free of any encumbrances or claims as required herein; or (e) The issuance of any tax, levy, seizure, attachment, garnishment, levy of execution, or other process with respect to the Collateral; or (f) Any failure to pay or suspension of payment by the Member to any creditor of sums due or the occurrence of any event which results in another creditor having the right to accelerate the maturity of any indebtedness of the Member under any security agreement, indenture, loan agreement, or comparable undertaking; or (g) Application for or appointment of a conservator or receiver for the member or of any subsidiary of the Member or the member's property, entry of a judgment or decree adjudicating the member or any subsidiary of member insolvent or bankrupt or an assignment by the member or any subsidiary of the member for the benefit of creditors; or (h) Sale by the member of all or a material part of the member's assets or the taking of any other action by the Member to liquidate or dissolve; or (i) Termination of the Member's membership in the Bank, or the Member's ceasing to be a type of financial institution that is eligible under the Bank Act to apply for membership in the Bank; or (j) Merger, consolidation or other combination of the Member with an entity which is not a member of the Bank if the nonmember entity is the surviving entity; or (k) With respect to Advances made pursuant to Section 11(ff)(4) of the Bank Act, if the creditor liabilities of the Member, excepting liabilities to the Bank, are increased in any manner to an amount exceeding five percent (5%) of the member's net assets; or (l) The Bank in good faith determines that a material adverse change has occurred in the financial condition of the Member, or the member fails to comply with the Bank's Credit Policies or other applicable policies including the requirement of creditworthiness as determined by the Bank in its discretion. -14- 19 Section 4.02. Remedies. (a) Upon the occurrence of any Event of Default, the Bank shall have all of the rights and remedies provided by applicable law, which shall include, but not be limited to, all of the remedies of a secured party under the Uniform Commercial Code as in effect in the Commonwealth of Pennsylvania. In addition, the Bank may take immediate possession of any of the Collateral or any part thereof wherever the same may be found without judicial process or by action. The Bank may require the Member to assemble the Collateral and make it available to the Bank at a place designated by the Bank which is reasonably convenient to both parties. The Bank may sell, assign and deliver the Collateral or any part thereof at public or private sale for such price as the Bank deems appropriate without any liability for any loss due to decrease in the market value of the Collateral during the period held. The Bank shall have the right to purchase all or part of the Collateral at such sale. If the Collateral includes insurance or securities which will be redeemed by the issuer upon surrender, or any accounts or deposits in the possession of the Bank, the Bank may realize upon such Collateral without notice to the member. If any notification of intended disposition of any of the Collateral is required by applicable law, such notification shall be deemed reasonable and properly given if mailed, postage prepaid, at least 5 days before any such disposition to the address of the member appearing on the records of the Bank. The proceeds of any sale shall be applied in the order that the Bank, in its sole discretion, may choose. The Member agrees to pay all the costs and expenses of the Bank in the collection of the Indebtedness and enforcement of the Bank's rights and remedies in case of default, including, without limitation, reasonable attorneys' fees. The Bank shall, to the extent required by law, apply any surplus after payment of the Indebtedness, provision for repayment to the Bank of any amounts to be paid or advanced under Outstanding Commitments, and all costs of collection and enforcement to third parties claiming a secondary security interest in the Collateral, with any remaining surplus paid to the member. The member shall be liable to the Bank for any deficiency remaining. (b) If the Indebtedness, accrued interest thereon and other amounts or charges owing by the member shall have become due and payable (by acceleration or otherwise), the bank shall have the right, at any time or from time to time to the fullest extent permitted by law, in addition to all other rights and remedies available to it, without prior notice to the Member, to set off against and to appropriate and apply to such due and payable amounts any debt owing to, and any other funds held in any manner for the account of, the -15- 20 member by the Bank, including without limitation all Deposits now or hereafter maintained by the member with the Bank. Such right shall exist whether or not such debt owing to or funds held for the account of the member is natured or unmatured, and regardless of the existence or adequacy of any collateral, guaranty or any other security, right or remedy available to the Bank. The Member hereby consents to and confirms the foregoing arrangements and confirms the Bank's rights of banker's lien and set off. Nothing in this Master Agreement shall be deemed a waiver or prohibition of or restriction on the Bank's rights of banker's lien or set off. (c) The member acknowledges that the breach by the Member of the provisions of this Agreement and in particular Section 3.04 hereof would cause irreparable injury to the Bank and that remedies at law for any such breach will be inadequate, and consents and agrees that the Bank shall be entitled, without the necessity of proof of actual damage, to specific performance of the terms of this Agreement and to injunctive relief in any proceedings which may be brought to enforce the provisions of this Agreement. The Member waives the right to assert the defense that such breach or violation can be compensated adequately in damages in an action of law. MISCELLANEOUS Section 5.01. General Representations, Warranties and Covenants by the Member. The Member hereby represents and warrants that, as of the date hereof and the date of each Advance or Other Credit Product hereunder: (a) The Member will truly and accurately represent and warrant its status as a Qualified Thrift Lender as defined in the Bank Act on any Advance Application or Other Credit Product Agreement between Member and the Bank. (b) The Member will truly and accurately represent and warrant the purpose of any Advance or Other Credit Product on any Advance Application or Other Credit Product Agreement between Member and the Bank. (c) The Member will furnish any financial, collateral or other information requested by the Bank in connection with any Advance or Other Credit Product. (d) The Member is not, and neither the execution of nor the performance of any transactions or obligations of the Member under any Advance Application, Other Credit Product -16- 21 Agreement or this Master Agreement shall, with the passage of time, the giving of notice or otherwise, cause the Member to be: (I) in violation of its charter or articles of incorporation bylaws, the Bank Act, the FHFB Regulations, any other law or administrative regulation, agreement, or any court decree; or (II) in default under or in breach of any indenture, contract or other instrument or agreement to which the Member is a party or by which it or any of its property is bound. (e) The Member is not in default under any Advance Application or Other Credit Product Agreement with the Bank. (f) The Member has full power and authority and has received all corporate and governmental authorizations and approvals (including without limitation those required under the Bank Act and the FHFB Regulations) as may be required to enter into and perform its obligations under any Advance Application, Other Credit Product Agreement or this Master Agreement, to obtain Advances and Other Credit Products. (g) The information given by the Member in any writing provided, electronic transmission or in any oral statement made, in connection with any Advance Application or Other Credit Product Agreement, is true, accurate and complete in all material respects. (h) The Member will at all times maintain and accurately reflect the terms of this Master Agreement (including the Bank's security interest in the Collateral) and all Advances and Other Credit Products hereunder on its books and records. (i) The Member shall indemnify and hold the Bank harmless from and against any and all costs, claims, expenses, damages, and liabilities with respect to any action which may be instituted by any person against the Bank as a result of any transaction contemplated by this Master Agreement or action or nonaction arising from this Master Agreement, except where the same results solely from the gross negligence or willful misconduct of the Bank. In addition, the Member shall indemnify and hold the Bank harmless from and against any and all costs, claims, expenses, damages, and liabilities resulting in any way from the presence or effects of any toxic or hazardous substances or materials in, on, or under any real property or interest in real property that is subject to or included in the Collateral. The Member also agrees to reimburse the Bank such reasonable fees and charges as may be assessed by the Bank to cover overhead and other cost, including reasonable attorney's fees, incurred in the administration of this Master Agreement, any Advance Application or Other Credit Product Agreement. -17- 22 Section 5.02. Assignment. The Bank may assign or negotiate to any other Federal Home Loan Bank or to any other person or entity, with or without recourse, any Indebtedness of the Member or participations therein, and the Bank may assign or transfer all or any part of the Bank's right, title and interest in and to this Master Agreement and may assign and deliver the whole or any part of the Collateral to the transferee, which shall succeed to all the powers and rights of the Bank in respect thereof, and the Bank shall thereafter be forever relieved and fully discharged from any liability or responsibility with respect to the transferred Collateral. The Member may not assign or transfer any of its rights or obligations hereunder without the express prior written consent of the Bank. Section 5.03. Discretion of Bank to Grant or Deny Advances and Other Credit Products. Nothing contained herein or in any documents describing or setting forth the Bank's credit program or Credit Policies shall be construed as an agreement or commitment on the part of the Bank to grant Advances or extend Other Credit Products hereunder, the right and power of the Bank in its discretion to either grant or deny any Advance of Other Credit Product requested hereunder being expressly reserved. Section 5.04. Amendment; Waivers. No modification, amendment or waiver of any provisions of this Master Agreement or consent to any departure therefrom shall be effective unless executed by the party against whom such change is asserted and shall be effective only in the specific instance and for the purpose for which given. No notice to or demand on the Member in any case shall entitle the Member to any other or further notice or demand in the same, or similar or other circumstances. Any forbearance, failure or delay by the Bank in exercising any right, power, or remedy hereunder shall not be deemed to be a waiver thereof, and any single or partial exercise by the Bank of any right, power or remedy hereunder shall not preclude the further exercise thereof. Every right, power and remedy of the Bank shall continue in full force and effect until specifically waived by the Bank in writing. Section 5.05. Jurisdiction; Legal Fees. In any action or proceeding brought by the Bank or the Member in order to enforce any right or remedy under this Master Agreement, the parties hereby consent to, and agree that they will submit to, the jurisdiction of the United States District Court for the Western District of Pennsylvania or, if such action or proceeding may not be brought in federal court, the jurisdiction of the -18- 23 courts of the Commonwealth of Pennsylvania located in Allegheny County. The Member agrees that, if any action or proceeding is brought by the Member seeking to obtain any legal or equitable relief against the Bank under or arising out of this Master Agreement or any transaction contemplated hereby, and such relief is not granted by the final decision, after any and all appeals, of a court of competent jurisdiction, the Member will pay all attorneys' fees and other costs incurred by the Bank in connection therewith. Section 5.06. Notices. Any notice, advice, request, consent or direction given, made or withdrawn pursuant to this Master Agreement shall be in writing or by electronic transmission, and shall be deemed to have been duly given to and received by a party hereto when it shall have been mailed to such party at its address given above by first class mail, or if given by hand or by electronic transmission, when actually received by such party at its principal office. Section 5.07. Signatures of Member. The Secretary or the Assistance Secretaries of the Member shall from time to time certify to the Bank on forms provided by the Bank the names and specimen signatures of the persons authorized to apply on behalf of the Member to the Bank for Advances and Other Credit Products and otherwise act for and on behalf of the Member in accordance with this Master Agreement. Such certifications are incorporated herein and made a part of this Master Agreement and shall continue in effect until expressly revoked by the Member notwithstanding that subsequent certifications may authorize additional persons to act for and on behalf of Member. Section 5.08. Applicable Law; Severability. In addition to the terms and conditions specifically set forth herein and in any Advance Application or Other Credit Product Agreement between the Bank and the Member, this Master Agreement and all Advances and Other Credit Products extended hereunder shall be governed by the statutory and common law of the United States and, to the extent federal law incorporates or defers to state law, the laws (exclusive of the choice of law provisions) of the Commonwealth of Pennsylvania, including the Uniform Commercial Code as in effect in the Commonwealth of Pennsylvania. In the event that any portion of this Master Agreement conflicts with applicable law or the Credit Policies, such conflict shall not affect other provisions of this Master Agreement which can be given effect without the conflicting provision, and to this end the provisions of this Master Agreement are declared to be severable. -19- 24 Section 5.09. Successors and Assigns. This Master Agreement shall be binding upon and inure to the benefit of the successors and assigns of the Member and the Bank, provided that the Member may not assign any of its rights or obligations hereunder without the prior written consent of the Bank. The Bank may sell, transfer or assign or grant participations in Advances or Other Credit Products. Section 5.10. Entire Agreement. This Master Agreement and the other documents referenced herein relating to Advances and Other Credit Products embody the entire agreement and understanding between the parties hereto relating to the subject matter hereof. This Master Agreement amends, restates and supersedes all prior agreements between such parties which relate to such subject matter, and all Advances and Other Credit Products made by the Bank to the Member prior to the execution of this Master Agreement shall be governed by the terms of this Master Agreement and not by the terms of the prior agreement. IN WITNESS WHEREOF, the Member and the Bank have caused this Master Agreement to be signed in their names by their duly authorized officers as of the date first above mentioned. ________________________________ Federal Home Loan Bank of (Name of Member) Pittsburgh By:_____________________________ By:____________________________ Title:__________________________ Title:_________________________ By:____________________________ Title:_________________________ -20- 25 MEMBER ACKNOWLEDGMENT State of Pennsylvania ) ) County of Allegheny ) On this 4th day of June, 1993, before me, a notary public, the undersigned officer personally appeared Robert S. Zyla, who acknowledged himself to be the President of Prestige Bank, A Federal Savings Bank, and that he as such President, being authorized to do so, executed the foregoing instrument for the purposes therein contained by signing the name of such institution by himself as President. IN WITNESS WHEREOF, I hereunto set my hand and official seal. ----------------------------- Notary Public BANK ACKNOWLEDGMENT State of Pennsylvania ) ) County of Allegheny ) On this 8th day of June, 1993, before me, a notary public, the undersigned officers personally appeared Leigh A. Dunhoff and Craig C. Howie who acknowledged themselves to be the V.P.-Credit Admin. and V.P.-Product Development respectively, of the Federal Home Loan Bank of Pittsburgh, and that they as such Vice President-Credit Administration and V.P.-Product Development, being duly authorized to do so, executed the foregoing instrument for the purposes therein contained by signing the name of the institution by themselves as V.P.-Credit Administration and V.P.-Product Development. IN WITNESS HEREOF, I hereunto set my hand and official seal. ----------------------------- Notary Public EX-13 3 PRESTIGE BANCORP, INC. 1 Exhibit 13 PRESTIGE BANCORP, INC. 710 Old Clairton Road, Pittsburgh, PA 15236-4300 - 412-655-1190 - (Fax) 412-655-1772 March 31, 1997 To Our Shareholders & Customers: We are pleased to present our first Annual Report of Prestige Bancorp, Inc. (the "Company"), the parent company of Prestige Bank, a Federal Savings Bank. On June 27, 1996, Prestige Bancorp, Inc. became a public company by selling 963,023 shares of its common stock at $10.00 per share. Eight hundred eighty-four (884) individuals or entities purchased the stock. The net proceeds from this initial public offering provided Prestige Bancorp, Inc. with more than $8 million in new capital. We are proud of the Company's stock performance since becoming a public company. The initial public offering sold at $10.00 per share, and the reported closing price as of the close of trading on March 19, 1997 was $15.75 per share. The Company's Board of Directors declared the first quarterly cash dividend at $.03 per share for stockholders of record as of March 1, 1997, payable on March 21, 1997. In addition, the initiation of a 5% stock repurchase program was announced in which the Company intends to repurchase 48,151 shares. For the year ending December 31, 1996, the Company recorded net income of $146,000 compared to $161,000 for 1995, a decrease of 9.3%. These earnings were negatively impacted by a one-time charge of $502,000 ($308,000 after tax) that the Bank was required to record as a result of legislation signed into law on September 30, 1996 which recapitalized the Savings Association Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation (FDIC). The legislation required all institutions whose deposits are insured by SAIF to pay a one-time special assessment in the amount of 65.7 basis points on the aggregate amount of deposits held as of March 31, 1995. Excluding this one-time charge, net income for 1996 would have increased 182% to $454,000 as compared to the same period in 1995. Our Strategic Business Plan will focus on the leveraging of our capital position and asset growth. We are committed to building shareholder value and providing the best financial service to our customers. We will continue to explore new technologies so that we will be able to provide our customers with the most up-to-date and reliable information on our products and services. We invite you to use the 24-Hour Teller, our telephone voice response system, by calling 655-1479 or 800-375-7667. You may also access information concerning the Bank's products via our world wide web home page (Internet) at http://www.prestigebank.com. By using technology, we hope to improve our internal operations and achieve greater efficiency at a lower cost. I would like to express my appreciation to my "teammates" for a job well done over the past year. The continued growth and success of Prestige Bancorp, Inc. are an attribute to the dedication, commitment and hard work of our directors, officers and employees. On behalf of the directors, officers and employees of Prestige Bancorp, Inc. and Prestige Bank, I would like to thank you for your confidence. Sincerely, /s/ ROBERT S. ZYLA Robert S. Zyla President 2 GENERAL INFORMATION Prestige Bancorp, Inc. (the "Company") was formed in March, 1996 in connection with the conversion of Prestige Bank, A Federal Savings Bank (the "Savings Bank") from a mutual chartered savings association to a stock chartered savings association (the "Conversion"). Upon completion of the Conversion on June 27, 1996, the Company commenced operations as the holding company of the Savings Bank, then existing as a stock chartered federal savings association. The Company is organized as a Pennsylvania corporation. The Savings Bank is a stock-chartered savings bank organized under the laws of the United States of America which conducts business from offices located in Allegheny County, Pennsylvania. The Savings Bank's operations date back to 1935 with the incorporation of First Federal Savings and Loan Association of Mt. Oliver in Allegheny County, Pennsylvania which, in March, 1991, converted its charter from a federal mutual savings and loan association to a Federal mutual savings bank and took the name Prestige Bank, A Federal Savings Bank. On June 27, 1996, the Savings Bank converted to a stock-chartered savings bank. The Savings Bank's deposits are insured by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") to the maximum extent permitted by law. The consolidated operating results of the Company and the Savings Bank depend primarily upon net interest income, which is determined by the difference between interest and dividend income on interest-earning assets, principally loans, investment securities and other investments and mortgage-backed securities and interest expense on interest-bearing liabilities, which consist of deposits and advances from the Federal Home Loan Bank of Pittsburgh. Other than the stock of the Savings Bank, the Company holds only a loan receivable from the Prestige Bank Employee Stock Ownership Plan (the "ESOP"), less than 5% equity interest in three unrelated savings associations or their respective holding companies and a money-market account with the Savings Bank. The consolidated net income of the Company also is affected by the Savings Bank's provision for loan losses, as well as the level of other consolidated income, including late charges, and other expenses, such as salaries and employee benefits, net occupancy and equipment expense, Federal deposit insurance and miscellaneous other expenses, and income taxes. The common stock of the Company is traded on the National Association of Securities Dealers Automated Quotations ("NASDAQ") system (symbol "PRBC"). The approximate number of holders of record of the Company's Common Stock at March 20, 1997 was 668. It is the policy of the Company to retain a substantial portion of its earnings to finance its business. On January 15, 1997, the Company declared a quarterly cash dividend and intends to consider the continued payment of dividends on a regular basis; however, the declaration of dividends is discretionary with the Board of Directors of the Company, and there is no assurance regarding the payment of future dividends by the Company. The quarterly dividend declared on January 15, 1997, was $.03 per share and was payable on March 21, 1997 to shareholders of record March 1, 1997. Information as to the high and low stock prices for each quarter of fiscal years 1996 and 1995 is included on page 5 of this Report. 3 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA The selected financial and other data of the Company and the Savings Bank set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information, including the Financial Statements and related Notes, appearing elsewhere herein.
AS OF OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1996 1995 1994 1993 1992 -------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) SELECTED FINANCIAL DATA: Total assets...................................... $114,640 $91,841 $87,745 $82,522 $78,269 Investment securities............................. 18,386 6,720 5,653 5,161 6,048 Mortgage-backed securities........................ 13,519 15,845 16,632 17,792 11,109 Loans receivable, net............................. 76,545 61,408 60,635 55,067 54,691 Cash and cash equivalents......................... 2,148 4,394 1,540 2,045 3,704 Deposits.......................................... 83,821 80,731 75,313 74,727 71,549 FHLB of Pittsburgh advances....................... 14,477 2,977 4,261 461 0 Stockholders' equity(1)........................... 15,430 7,178 7,049 6,521 5,823 Nonperforming assets(2)........................... 391 348 391 351 334 SELECTED OPERATING DATA: Interest income................................... $ 6,748 $ 5,719 $ 5,314 $ 5,410 $ 6,162 Interest expense.................................. 3,683 3,406 2,620 2,634 3,191 -------- ------- ------- ------- ------- Net interest income............................... $ 3,065 $ 2,313 $ 2,694 $ 2,776 $ 2,971 Provision for loan losses......................... 44 36 36 36 44 -------- ------- ------- ------- ------- Net interest income after provision for loan losses.......................................... $ 3,021 $ 2,277 $ 2,658 $ 2,740 $ 2,927 Other income...................................... 297 222 294 310 307 Other expenses.................................... 3,102(5) 2,255 2,058 1,913 1,849 -------- ------- ------- ------- ------- Income before income tax expense.................. $ 216 $ 244 $ 894 $ 1,137 $ 1,385 Income tax expense................................ 70 83 346 452 520 -------- ------- ------- ------- ------- Net income........................................ $ 146(6) $ 161 $ 548 $ 685 $ 865 ======== ======= ======== ======= ======= SELECTED OPERATING RATIOS(3): Return on average assets.......................... .14% .18% .64% .85% 1.12% Return on average equity.......................... 1.22% 2.26% 8.08% 11.11% 15.96% Average yield earned on interest-earning assets... 6.93 6.66 6.41 6.88 8.19 Average rate paid on interest-bearing liabilities..................................... 4.21 4.22 3.38 3.58 4.50 Average interest rate spread(4)................... 2.72 2.44 3.03 3.30 3.69 Net interest margin(4)............................ 3.15 2.69 3.25 3.53 3.95 Ratio of interest-earning assets to interest-bearing liabilities.................... 111.31 106.34 107.03 106.75 105.95 Operating expenses as a percent of average assets.......................................... 3.09 2.54 2.41 2.37 2.39 Average equity to average assets.................. 11.86 8.02 7.97 7.63 7.00 ASSET QUALITY RATIOS(3): Nonperforming loans as a percent of total loans... .44% .50% .64% .63% .52% Nonperforming assets as a percent of total assets.......................................... .34 .38 .45 .43 .43 Allowance for loan losses as a percent of total loans........................................... .40 .46 .49 .48 .42 Charge-offs to average loans receivable outstanding during the period................... .04 .09 .00 .01 .04 PER SHARE DATA: Earnings Per Share................................ $ 0.00(7) N/A N/A N/A N/A Per Share Book Value.............................. 16.02 N/A N/A N/A N/A Per Share Market Value............................ 13.50 N/A N/A N/A N/A NUMBER OF OFFICES: Full-service offices at period end................ 3 3 3 3 3
3 4 - --------- (1) For years ending December 31, 1995, 1994, 1993 and 1992 this category was referred to as "Equity". (2) Nonperforming assets consist of nonperforming loans and real estate owned ("REO"). Nonperforming loans consist of non-accrual loans, while REO consists of real estate acquired through foreclosure and real estate acquired by acceptance of a deed-in-lieu of foreclosure. (3) Asset Quality Ratios are end of period ratios, except for charge-offs to average loans. With the exception of end of period ratios, all ratios are based on average monthly balances during the indicated periods and are annualized where appropriate. (4) Interest rate spread represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities, and net interest margin represents net interest income as a percent of average interest-earning assets. (5) But for the impact of the special assessment imposed by the Federal Deposit Insurance Corporation ("FDIC") on deposits of the Savings Bank as of March 31, 1995 the other expenses of the Company for 1996 would have been $2.6 million. (6) But for the impact of the special assessment described in Note 5 above, the net income of the Company would have been $454,000. (7) Earnings per share of the Company for the period from June 27, 1996 (date of conversion) to December 31, 1996, was less than one-half of one cent per share. But for the impact of the special assessment described in Note 5 above, the earnings per share of the Company would have been $.35 per share for the same period. On a weighted average share basis for the period from June 27, 1996 to December 1, 1996 the earnings per share of the Company was 3,070 (net income) divided by 886,755 (weighted average shares for such period) or $0.00346. 4 5 SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA The following table sets forth certain unaudited quarterly consolidated financial data regarding the Company:
MARCH 31(1) JUNE 30(2) SEPTEMBER 30(3) DECEMBER 31(3) ----------- ---------- --------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 QUARTER ENDED Interest income............................. $ 1,534 $ 1,631 $ 1,747 $ 1,837 Non-interest income......................... 70 78 73 77 ------- -------- ------- -------- Total operating income...................... 1,604 1,709 1,820 1,914 Interest expense............................ 906 916 899 963 Provision for loan losses................... 9 9 11 15 Non-interest expense........................ 595 649 1,151 708 ------- -------- ------- -------- Income (loss) before income taxes........... 94 135 (241) 228 Provision for income taxes.................. 36 50 (96) 80 ------- -------- ------- -------- Net income (loss)........................... $ 58 $ 85 $ (145) $ 148 ======= ======== ======= ======== Primary Earnings (loss) Per Common Share.... N/A N/A (.16)(7) .17 Stock Prices(4) High...................................... N/A $ 10.75(5) $ 12.25 $ 13.75 Low....................................... N/A $ 10.00(5) $ 9.75 $ 11.875 Cash Dividends Declared Per Common Share(6).................................. N/A None None None
MARCH 31(1) JUNE 30(1) SEPTEMBER 30(1) DECEMBER 31(1) ----------- ---------- --------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1995 QUARTER ENDED Interest income............................. $ 1,377 $ 1,407 $ 1,452 $ 1,483 Non-interest income......................... 30 58 73 61 ------- -------- ------- -------- Total operating income...................... 1,407 1,465 1,525 1,544 Interest expense............................ 779 850 876 901 Provision for loan losses................... 9 9 9 9 Non-interest expense........................ 567 543 556 589 ------- -------- ------- -------- Income before income taxes.................. 52 63 84 45 Provision for income taxes.................. 18 21 29 15 ------- -------- ------- -------- Net income.................................. $ 34 $ 42 $ 55 $ 30 ======= ======== ======= ======== Primary Earnings Per Common Share(6)........ N/A N/A N/A N/A Stock Prices(6) High...................................... N/A N/A N/A N/A Low....................................... N/A N/A N/A N/A Cash Dividends Declared Per Common Share(6).................................. N/A N/A N/A N/A
- --------- (1) Applies solely to business operations of the Savings Bank. (2) Reflects business activity of the Savings Bank and activities of the Company since June 27, 1996. (3) Reflects business activities of the Savings Bank and the Company for such quarter. (4) Stock prices are based on the closing bid prices reported on NASDAQ. (5) The common stock of the Company commenced trading on June 27, 1996 with an opening price of $10.00. (6) For each quarter ending before June 27, 1996 the Savings Bank operated business as a mutual chartered savings association and thus dividend payments and per share information is not applicable. (7) But for the impact of the special assessment imposed by the FDIC on the deposits of the Savings Bank as of March 31, 1995, the earnings per share of the Company for the third quarter of 1996 would have been $.18 per share. 5 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company completed the conversion of the Savings Bank to a federally stock chartered savings bank on June 27, 1996. The results of operations of the Company and the Savings Bank are consolidated and presented on a continuing historical entity basis. Any comparisons set forth in this Annual Report to any fiscal year ending prior to January 1, 1996 or to any date or any period ending prior to June 27, 1996 should be understood to be a comparison to the activities or results of the Savings Bank operating as a mutual chartered savings bank. CHANGES IN FINANCIAL CONDITION The Company's consolidated assets increased by $22.8 million or 24.8% from $91.8 million at December 31, 1995 to $114.6 million at December 31, 1996. The increase in total assets was primarily attributable to an increase in total loans receivable and investment securities which were partially offset by a reduction in cash and cash equivalents. The increase in total assets was funded by the proceeds of stock conversion of the Savings Bank, an increase in deposits and the leverage of the balance sheet through loans from the Federal Home Loan Bank of Pittsburgh ("FHLB of Pittsburgh"). Net proceeds of the Conversion available for investment was $8.2 million, total deposits increased by $3.1 million in 1996 and advances from the FHLB of Pittsburgh rose by $11.5 million during 1996. The Company's total loans receivable increased by $15.7 million or 25.4% from $61.7 million at December 31, 1995 to $77.4 million at December 31, 1996. This rise in total loan receivables can be traced to three main areas of growth. One-to-four family residential mortgages increased $9.8 million or 17.6%, as the Savings Bank expanded its efforts to contact realtors and priced its mortgage rates to attract new business. Consumer loans increased $3.7 million or 67.2%, as the Savings Bank intensified its efforts to attract consumer loans through expanded marketing and competitive rate pricing. Commercial business and commercial real estate loans increased 149.4% from $815,000 at December 31, 1995 to $2.0 million at December 31, 1996 as the Savings Bank used contacts and referrals to build its commercial and commercial real estate loan portfolio. Investment securities increased from $22.6 million at December 31, 1995 to $31.9 million at December 31, 1996. The increase occurred as the Company invested in U.S. Government agency securities with funds received by the FHLB of Pittsburgh. Cash and cash equivalents decreased by $2.2 million, or 51.1%, between December 31, 1995 and 1996, attributable to the investment of available funds in loan originations and in securities issued by the U.S. Government Agencies which were offset by funds received in connection with the conversion, and deposit and borrowing growth. The Savings Bank's total deposits increased $3.1 million or 3.8% from $80.7 million at December 31, 1995 to $83.8 million at December 31, 1996. The growth in deposits during fiscal 1996 was primarily a result of competitive rates that continue to be offered by the Savings Bank. Borrowings by the Savings Bank from the FHLB of Pittsburgh rose by $11.5 million, or 386.3%, from $3.0 million at December 31, 1995 to $14.5 million at December 31, 1996 as the Company proceeded to leverage the balance sheet following the influx of equity pursuant to the Conversion. Total equity increased $8.3 million or 115.0% to $15.4 million at December 31, 1996, a result of the sale of stock of the Company in connection with the Conversion and the consolidated net income for fiscal 1996 less the impact of the valuation of available-for-sale securities pursuant to Statement of Financial Accounting Standards ("SFAS") No. 115. The Savings Bank's assets increased by $4.1 million or 4.7% from $87.7 million at December 31, 1994 to $91.8 million at December 31, 1995. The increase in total assets was primarily attributable to an increase in consumer loan originations, and an increase in cash and cash equivalents held by the Savings Bank. The Savings Bank's total loans receivable increased by $515,000 or .84% from $61.2 million at December 31, 1994 to $61.7 million at December 31, 1995, mainly attributable to consumer loans, which increased $1.1 million or 24.3%. Cash and cash equivalents increased by $2.9 million or 185.3% between December, 1994 and 1995, attributable to repayments of loans and investments and increased deposits. The Savings Bank's total deposits 6 7 increased $5.4 million or 7.2% from $75.3 million at December 31, 1994 to $80.7 million at December 31, 1995. The increase in deposits during fiscal 1995 was primarily as a result of competitive rates offered by the Savings Bank. Total equity increased $129,000 or 1.8% to $7.2 million at December 31, 1995, as a result of the Savings Bank's net income for fiscal 1995 less the impact of the valuation of available-for-sale securities pursuant to SFAS No. 115. OPERATING STRATEGY The Company and the Savings Bank have experienced a decline in net income since 1992 primarily as a result of general economic conditions and increased competition. Although the Company's net income for the year ended December 31, 1996 declined from $161,000 for the year ended December 31, 1995 to $146,000 for the year ended December 31, 1996, net income for the fiscal year ended December 31, 1996 would have been $454,000 but for the impact of the special assessment imposed by the Federal Deposit Insurance Corporation ("FDIC") on the insured deposits of the Savings Bank. This special assessment was imposed on all commercial banks and savings associations with deposits insured by the Savings Association Insurance Fund pursuant to the mandates of the Deposit Insurance Funds Act of 1996. As described in greater detail below, the Company and Savings Bank intend to continue an emphasis on residential mortgage loans. However, as part of the business strategy to increase profitability, the Savings Bank will continue to widen its range of lending activities to include small business commercial loans, commercial real estate loans and consumer loans. Although such lending activities entail greater risk than residential mortgage lending, management is willing to accept such risks because of its belief that there are lending opportunities in its market area which are not being currently fulfilled by other financial institutions and management believes it can properly manage the risks of greater consumer and commercial lending. The Savings Bank experienced increased competition from mortgage brokers and other financial entities for its one-to-four family residential real estate lending activities in the early 1990s. The Savings Bank's total loans receivable attributable to one-to-four family residential loans, which amounted to $50.9 million or 65.1% of assets at December 31, 1992, was $65.1 million at December 31, 1996 but had declined as a percentage of assets to 56.8%. During the same period, the Savings Bank's total loans receivable attributable to commercial, commercial real estate, construction and consumer loans, which amounted to $4.1 million or 5.2% of assets at December 31, 1992, had increased to $12.2 million at December 31, 1996 or 10.7% of assets. At the same time, investment securities, which amounted to $17.2 million, or 21.9% of assets, at December 31, 1992 had increased to $31.9 million, or 27.8% of assets, at December 31, 1996. Management attributes this shift in asset composition to an increase in deposits and borrowings over the same period (from $71.5 million at December 31, 1992 to $98.3 million at December 31, 1996) and the need to invest such funds in interest-bearing assets. In addition, management desires to increase the Savings Bank's commercial and consumer loans and investment securities to offset its exposure to interest rate risk associated with long term fixed rate residential mortgages in excess of 15 years. The Savings Bank has reduced the percentage of adjustable rate mortgages in its mortgage portfolio. As of December 31, 1996, adjustable rate mortgages constituted 42.0% of the Savings Bank's one-to-four family residential mortgage portfolio and fixed rate mortgages made up the remaining portion of the Savings Bank's one-to-four family residential mortgage portfolio. In contrast as of December 31, 1995, adjustable rate mortgages composed 54.0% of the Savings Bank's one-to-four residential mortgage portfolio and fixed rate mortgages comprised the remaining portion of the Savings Bank's one-to-four family residential mortgage portfolio. Management presently intends to continue to reduce its emphasis on adjustable rate mortgages by providing a broad range of mortgage products with varying maturities. The Savings Bank strives to maintain deposits as its primary source of funds to meet loan demand and to maintain outstanding loan balances. However, in light of the increased equity of the Company which arose through the Conversion, management has taken a more aggressive approach to leverage the balance sheet of the Company and to fund the immediate growth in assets of the Savings Bank through increased borrowings from the FHLB of Pittsburgh. Investment securities and mortgage-backed securities are acquired based on Investment/Asset and Liability Committees ("ALCO") decisions when the Savings Bank has excess cash 7 8 and when management believes the yields and the maturities are attractive. Excess cash (cash in excess of vault cash and other operating cash needs) are deposited in an interest bearing demand deposit account with the FHLB of Pittsburgh. Cash and cash equivalents typically decline in periods of high loan demand and increase in periods of reduced loan demand. In periods of heavy loan demand the Savings Bank will borrow from the FHLB of Pittsburgh to satisfy loan demand and repay such borrowings from subsequent loan payments or increased deposits. As of December 31, 1995 outstanding borrowings from the FHLB of Pittsburgh stood at $3.0 million and as of December 31, 1996 such borrowings have increased to $14.5 million. This increased borrowing occurred as part of the Management's plan to increase the assets of the Savings Bank and increase the debt to equity leverage ratio in light of the increased equity that arose through the Conversion. Management's strategy in the past few years has been to invest the funds received from the repayments and prepayments of loans and mortgage-backed securities immediately into short-term, liquid investments. In the longer term, the Company anticipates the use of a significant portion of these funds to fund fixed-rate or adjustable-rate mortgage loans with various maturities and, depending upon then current interest rates and management's estimate of how such rates merit change, purchasing investment securities with various maturities. Although this strategy will have the effect of increasing the Savings Bank's interest rate exposure of the Company and the Savings Bank, management believes that the increased earnings potential offsets this increased interest rate risk. In the event the Savings Bank needs cash to fund additional consumer loans, commercial loans or commercial real estate loans, the Savings Bank will borrow funds from the FHLB of Pittsburgh. This strategy will increase interest expense but management feels the increased yields available through the extension of consumer, commercial and commercial real estate loans justify such increased interest expense. Management has promoted one-to-four family residential mortgage loans with fixed interest rates to 15 year terms or less whenever possible. Management continues to offer adjustable rate mortgage loans ("ARMs") for one-to-four family residential mortgages. U.S. Government and U.S. Government agency securities and mortgage-backed securities are purchased with contract maturities generally up to 15 years upon terms which management believes are attractive because of yield, call features to the security or market conditions. The Savings Bank has increased its exposure to consumer loans and commercial loans which combine higher yields and a shorter loan term. Management intends to continue the strategy set forth above and will also attempt to increase commercial and consumer loans. The foregoing investment strategy is based on management's assessment of future economic conditions and is necessarily subject to change. ASSET AND LIABILITY MANAGEMENT The principal objective of the Company's asset and liability management function is to evaluate the interest-rate risk included in its asset and liability mix to determine the level of risk appropriate given the Company's business focus, operating environment, capital and liquidity requirements and performance objectives, establish prudent asset concentration guidelines and manage the risk consistent with Board approved guidelines. The Savings Bank concentrates on maintaining a sufficient deposit base to fund loan activities and securities investments. A large core deposit base (defined as demand deposit accounts, passbook savings accounts and money market savings accounts) provides the Savings Bank with a lower cost source of funds relative to its alternative principal borrowing sources, i.e., advances from the FHLB of Pittsburgh. Management calculates its cost of funds and chooses interest-bearing assets in excess of its average cost of funds or its marginal cost of funding. In periods of relatively low interest rates the Savings Bank may price its certificates of deposit in excess of its competition to attract and maintain deposits (i) to avoid increased borrowing, or to reduce the outstanding borrowings, from the FHLB of Pittsburgh or (ii) to avoid selling investment securities to maintain liquidity needs. This strategy will result in periods of reduced net interest income and net income if the Savings Bank is unable to invest deposits in interest-bearing assets with sufficient yield to maintain its average interest rate spread between its assets and liabilities. In light of the increased equity of the Company as a result of the Conversion, management currently is striving to grow the assets of the Savings Bank. This management decision has lead to additional borrowings from the FHLB of Pittsburgh. 8 9 The Company seeks, through ALCO, to reduce the vulnerability of its operations to changes in interest rates and to manage the ratio of interest-rate sensitive assets to interest-rate sensitive liabilities within specified maturities or repricing dates. The ALCO reviews, among other things, the sensitivity of the Savings Bank's asset and liabilities to interest rate changes, unrealized gains and losses, purchase activity and maturities of all interest bearing assets and liabilities. In connection therewith, the ALCO generally reviews the Savings Bank's liquidity, cash flow needs, maturities of investments, deposits and borrowings and current market conditions and interest rates. The Chief Financial Officer and President of the Savings Bank have authority to adjust pricing weekly with respect to the Savings Bank's retail deposits. The OTS is in the process of implementing an interest rate risk component ("IRR") into its risk-based capital rules, which is designed to calculate on a quarterly basis the extent to which the value of an institution's assets and liabilities would change if interest rates increase or decrease. The IRR component has been proposed to be a dollar amount that will be deducted from total capital for the purpose of calculating an institution's risk-based capital requirement and is measured in terms of the sensitivity of its net portfolio value ("NPV") to changes in interest rates. NPV is the difference between incoming and outgoing discounted cash flows from assets, liabilities, and off-balance sheet contracts. An institution's IRR is measured as the change to its NPV as a result of a hypothetical 200 basis point change in market interest rates. A resulting change in NPV of more than 2% of the estimated market value of its assets would have required the institution to deduct from its capital 50% of that excess change. The following table presents the Savings Bank's NPV as of December 31, 1996, as calculated by the OTS in accordance with its model, based on information provided to the OTS by the Savings Bank. The chart does not include the impact of any interest or dividend earning assets held at the Company level. The effect of market rate shifts on these assets need not be reported to the OTS.
NET PORTFOLIO VALUE (NPV) ------------------------------------- (DOLLARS IN THOUSANDS) ------------------------------------- PERCENT CHANGE IN RATES NPV CHANGE OF (EXPRESSED AS EXPRESSED ESTIMATED BASIS POINTS) IN $ $ CHANGE(1) NPV(2) NPV RATIO(3) CHANGE(4) - --------------------------------------- --------- ----------- --------- ------------ --------- +400................................... $ 5,789 $ -8,461 -59% 5.43% -672bp +300................................... 7,978 -6,273 -44 7.30 -486 +200................................... 10,180 -4,071 -29 9.08 -307 +100................................... 12,290 -1,960 -14 10.71 -144 0..................................... 14,250 12.15 - -100................................... 15,995 1,745 +12 13.38 +122 - -200................................... 17,427 3,177 +22 14.33 +218 - -300................................... 18,620 4,370 +31 15.09 +293 - -400................................... $20,186 $ 5,936 +42% 16.07% +392bp
- --------- (1) Represents the excess (deficiency) of the estimated NPV assuming the indicated change in interest rates minus the estimated NPV assuming no change in interest rates. (2) Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates. (3) Calculated as the estimated NPV divided by the present value of the Savings Bank's assets. (4) Calculated as the excess (deficiency) of the NPV ratio assuming the indicated change in interest rates over the estimated NPV ratio assuming no change in interest rates. Any IRR deduction imposed against the capital of a savings association by regulations of the OTS does not take effect until the last day of the third quarter following the reporting date on which the reported IRR exceeds 200 basis points. Savings associations with assets under $300 million and risk based capital ratios in excess of 12% are exempt from reporting the NPV and IRR of such a savings association, but will be requested to supply selected information to the OTS. The OTS has issued a directive that it will not yet impose any deductions from regulatory capital for an IRR component. 9 10 Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model presented assumes that the composition of the Savings Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of the Savings Bank's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Savings Bank's net interest income and will differ from actual results. Based upon the above calculations the percent change of estimated NPV for a 200 basis point increasing in prevailing rates changed from a negative 12 at December 31, 1995 to a negative 29 at December 31, 1996. This increase was a direct result of ALCO's recommendation. Management will continue to review the NPV and IRR measurements. Based on the asset size of the Savings Bank and its strong risk based capital ratios, the Company believes that the Savings Bank does not have to deduct any amount from the regulatory capital of the Savings Bank as of December 31, 1996. Management uses the NPV and the IRR rule as an additional tool to evaluate the Savings Bank's asset and liability position. RESULTS OF OPERATIONS AVERAGE BALANCES, INTEREST INCOME, INTEREST EXPENSE AND YIELDS EARNED AND RATES PAID. The following table sets forth, for the periods and at the date indicated, information regarding the Company's average consolidated balance sheet. Information is based on average daily balances during the periods presented. For 1995 and 1994, all information presented is based solely on the business operations of the Savings Bank. 10 11
YEAR ENDED DECEMBER 31, AT ----------------------------------------------------------------------------------------- DECEMBER 31, 1996 1996 1995 1994 ------------ --------------------------- -------------------------- -------------------------- AVERAGE AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ RATE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ------------ -------- -------- ------- ------- -------- ------- ------- -------- ------- (DOLLARS IN THOUSANDS) Interest-earning assets: Investment securities (1).................. 6.73% $ 11,609 $ 657 5.66% $6,562 $ 335 5.11% $6,277 $ 290 4.62% Loans receivable (2) Commercial........... 9.35 $ 574 $ 51 8.89 Real estate loans.... 7.37 62,537 4,568 7.31 56,655 3,937 6.95 54,664 3,734 6.83 Consumer............. 7.93 6,147 459 7.47 4,983 352 7.06 3,838 246 6.41 -------- ------ ------- ------ ------ ------ Total Loans Receivable........... 7.48 69,258 5,078 7.33 61,638 4,289 6.96 58,502 3,980 6.80 Mortgage-backed securities (1)....... 6.22 14,619 922 6.31 16,363 1,015 6.20 17,495 1,023 5.85 Other interest-earning assets............... 5.38 1,867 91 4.87 1,345 80 5.95 681 21 3.08 -------- ------ ------- ------ ------ ------ Total interest-earning assets............. 7.08% $ 97,353 $6,748 6.93% $85,908 $5,719 6.66% $82,955 $5,314 6.41% Non-interest-earning assets................. $ 3,086 $ 2,962 $ 2,272 Total assets......... $100,439 $88,870 $85,227 ======== ======= ======= Interest-bearing liabilities: Deposits............... 4.08% $ 82,294 $3,407 4.14% $77,711 $3,214 4.14% $74,315 $2,464 3.32% FHLB advances.......... 5.96 5,169 276 5.34 3,078 192 6.24 3,194 156 4.88 -------- ------ ------- ------ ------ ------ Total interest-bearing liabilities........ 4.22% $ 87,463 $3,683 4.21% $80,789 $3,406 4.22% $77,509 $2,620 3.38% Non-interest-bearing liabilities:........... $ 1,067 $ 952 $ 922 -------- ------- ------- Total liabilities.... $ 88,530 $81,741 $78,431 Equity................... $ 11,909 $ 7,129 $ 6,796 -------- ------- ------- Total liabilities and equity............. $100,439 $88,870 $85,227 ======== ======= ======= Net interest-earning assets................. $ 9,980 $ 5,119 $ 5,546 ======== ======= ======= Net interest income/interest rate spread................. 2.86% $3,065 2.72% $2,313 2.44% $2,694 3.03% ==== ====== ==== ====== ==== ====== ==== Net yield on interest-earning assets (3).................... 3.15% 2.69% 3.25% ==== ==== ==== Ratio of average interest-earning assets to average interest- bearing liabilities.... 111.31% 106.34% 107.03% ====== ====== ======
- --------- (1) The average yield for investment securities including held to maturity and available for sale is based upon historical amortized cost balances (2) Includes non-performing loans (3) Net interest income divided by interest-earning assets RATE/VOLUME ANALYSIS. The Savings Bank typically acquires funds in the form of customer deposits or borrowings from the FHLB of Pittsburgh in which it is a member. The Savings Bank then pays interest on such deposits and advances. In turn, a savings association will lend these funds to third parties or purchase investment securities which generate interest income for the savings association. The Savings Bank also operates in an environment of changing interest rates and fluctuating volumes of deposits, advances from third parties, loans made to third parties and securities bought, sold or repaid. The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Company's consolidated interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes 11 12 attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------- 1996 VS. 1995 1995 VS. 1994 ------------------------------------------- -------------------------------------------- INCREASE INCREASE (DECREASE) (DECREASE) DUE TO TOTAL DUE TO TOTAL -------------- INCREASE --------------- INCREASE RATE VOLUME RATE/VOLUME (DECREASE) RATE VOLUME RATE/VOLUME (DECREASE) ---- ------ ----------- ---------- ----- ------ ----------- ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable, net.................. $222 $491 $ 76 $ 789 $ 90 $209 $ 10 $ 309 Mortgage-backed securities........... 17 (108) (2) (93) 62 (66) (4) (8) Investment securities........... 36 258 28 322 30 13 2 45 Other interest-earning assets............... (15) 31 (5) 11 19 21 19 59 ---- ---- ----- ------ ----- ---- ----- ------ Total interest-earning assets............... 260 $672 $ 97 $1,029 $ 201 $177 $ 27 $ 405 ---- ---- ----- ------ ----- ---- ----- ------ Interest-bearing liabilities: Deposits............... 3 $190 $ 0 $ 193 $ 609 $113 $ 28 $ 750 FHLB advances.......... (27) 130 (19) 84 44 (6) (2) 36 ---- ---- ----- ------ ----- ---- ----- ------ Total interest-bearing liabilities............ (24) 320 (19) 277 653 107 26 786 ---- ---- ----- ------ ----- ---- ----- ------ Increase (decrease) in net interest income.... 284 $352 $ 116 $ 752 ($452) $ 70 $ 1 ($ 381) ==== ==== ===== ====== ====== ==== ===== ======
NET INCOME. The Company reported consolidated net income of $146,000, $161,000 and $548,000 for the fiscal years ended December 31, 1996, 1995 and 1994, respectively. For fiscal 1996, the $15,000 decrease in net income compared with fiscal 1995 was attributable to a $752,000 or 32.5% increase in net interest income and a $75,000 or 33.9% increase in other income and a $847,000 or 37.6% increase in other expenses. The 847,000 increase in total non-interest expense included a $502,000 special assessment imposed by the FDIC to promote the recapitalization of the Savings Association Insurance Fund ("SAIF") as required by the Deposit Insurance Funds Act of 1996. The special assessment by the FDIC affected all banking institutions with SAIF insured deposits. But for this special assessment, the Company's net income for the fiscal year ended December 31, 1996, would have been $454,000. The increased borrowings from the FHLB of Pittsburgh reduced the net margin on interest-earning assets for fiscal 1996. Non-interest expense also rose due to the additional professional fees related to operating the Company as a public reporting entity, the additional hiring of personnel and the implementation of an employee stock ownership plan. For fiscal 1995, the $387,000 decrease in net income compared with fiscal 1994 is primarily attributable to a $381,000 or 14.1% decrease in net interest income, a $72,000 or 24.5% decrease in other income and a $197,000 or a 9.6% increase in other expenses which was partially offset by a $263,000 or a 76.0% decrease in income tax expense. NET INTEREST INCOME. Net interest income before provision for loan losses amounted to $3.1 million during fiscal 1996, compared to $2.3 million during fiscal 1995 and compared to $2.7 million during fiscal 1994. During fiscal 1996, the $752,000, or 32.5%, increase in net interest income compared with fiscal 1995 was attributable to a $11.4 million, or 13.3%, increase in the average balance of interest-earning assets which was partially offset by an increase of $6.7 million, or 8.3%, increase in average interest-bearing liabilities. This increase in average interest-earning assets over average interest-bearing liabilities in 1996 was primarily attributable to the proceeds from the Company's stock offering. Another contributing factor was an increase in the average yield earned on interest-earning assets to 6.93% in 1996 from 6.66% in 1995, due primarily to increases in yields earned on loans receivable. The increases in both average balances and yield on earning assets, during fiscal 1996, increased interest income $1.0 million, or 18.0%, which more than offset a $277,000, 12 13 or 8.1%, increase in total interest expense. During fiscal 1995, the $381,000, or 14.1%, decrease from fiscal 1994 was attributable to a $786,000, or 30%, increase in total interest expense, which was partially offset by a $405,000, or 7.6%, increase in total interest income. The $1.0 million increase in total interest income during the year ended December 31, 1996 over the prior comparable period was primarily due to a $789,000, or 18.4%, increase in interest and fees on loans and a $322,000, or 96.1%, increase in interest and dividends on other investment securities. The increase in interest earned on loans and interest and dividends on other investment securities during fiscal 1996 was primarily due to a rise in average balances of loans receivable and on investment securities of $7.6 million, or 12.4%, and $5.0 million, or 76.9%, respectively. In addition, an increase in the average yield earned on loans receivables from 6.96% in 1995 to 7.33% in 1996 accounted for a portion of the increase in interest income. The increase in interest expense in 1996, compared with 1995, was primarily a result of an increase in the Savings Bank's average interest bearing liabilities from $80.8 million to $87.5 million. This increase resulted from an increased volume of average deposits of $4.6 million or 5.9% and a $2.1 million increase in average borrowings or 67.9%. The $381,000 reduction in net interest income during the year ended December 31, 1995 over the prior comparable period was primarily due to a $786,000 or 30% increase in total interest expense incurred by the Savings Bank for the fiscal year ending December 31, 1995. This increase was caused by a $750,000 or 30.4% increase in interest paid on deposits. While average daily deposits for the Savings Bank rose from $74.3 million in 1994 to $77.7 million in 1995, the average daily yield earned by depositors increased from 3.32% to 4.14%. In addition, during fiscal 1995, the Savings Bank decreased borrowings from the FHLB of Pittsburgh by $1.3 million by year end, however due to the increased rates offered by the FHLB of Pittsburgh during 1995, the Savings Bank incurred $36,000 of additional interest expense on FHLB of Pittsburgh advances as compared to fiscal 1994. The increase in interest expense in 1995, compared with 1994, was primarily a result of an increase in the Savings Bank's cost of funds from 3.38% to 4.22%. This increase of 84 basis points resulted from an increase in general market rates on deposits and advances from the FHLB of Pittsburgh and a shift to certificates of deposits from passbook and money market accounts. This increase was the primary reason for the decline in the net interest rate spread and net interest margin to 2.44% and 2.69%, respectively, for the year ended December 31, 1995 compared with a net interest rate spread and net interest margin of 3.02% and 3.25%, respectively, for the year ended December 31, 1994. PROVISION FOR LOAN LOSSES. The Savings Bank establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed to be appropriate based upon an assessment of prior loss experience, the volume and type of lending presently being conducted by the Savings Bank, industry standards, past due loans, economic conditions in the Savings Bank's market area generally and other factors related to the collectibility of the Savings Bank's loan portfolio. For the year ended December 31, 1996, the provisions for loan losses was $44,000. For each of the two years ended December 31, 1995 and 1994, provisions for loan losses were $36,000. During fiscal 1996, the Savings Bank charged $24,000 against the allowance for loan losses to reduce the carrying value of the Savings Bank's interest in a one-to-four family mortgage and to write off two credit card balances. At December 31, 1996, the Savings Bank's allowance for loan losses amounted to 89.88% of total non-performing loans and .40% of total loans receivable. Management and the directors of the Company and the Savings Bank believe that the provisions for loan losses are adequate. In light of the recent additional consumer and commercial loans management recognizes that it must pay heighten attention to any increases in delinquencies in these loans in evaluating the provision for loan losses. The Savings Bank calculates expected loan losses using an approach based primarily upon historical experience and current economic conditions. Although management utilizes its best judgment in providing for losses, there can be no assurance that the Savings Bank will not have to increase its provisions for loan losses in the future as a result of increases in higher risk commercial and consumer loans, future changes in the economy or for other reasons, which could adversely affect the Savings Bank's results of operations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the 13 14 Savings Bank's provision for loan losses and the carrying value of its other non-performing assets based on their judgments about information available to such regulatory agencies at the time of their examination. The Savings Bank was last examined by the OTS as of September 30, 1995. OTHER INCOME. Total other income amounted to $297,000 for the year ended December 31, 1996, an increase of $75,000 or 33.9% from the $222,000 earned in fiscal 1995. Increased loan application and transaction fees accounted primarily for the rise in total other income. The additional loan application and transaction fees have resulted in increased costs due to higher employee manhours to process such loan applications and to administer such transactions and loans. Total other income amounted to $222,000 for the year ended December 31, 1995, a decrease of $72,000 or 24.5% from the $294,000 earned in fiscal 1994. The primary reason for the decrease was a $28,000 one-time charge for a loss on the sale of the former Mt. Oliver office and a $7,000 write off of equipment and other assets. In addition, 1994 other income, net included a gain of $35,000 as the result of a legal settlement. Excluding these items, core other income remained relatively stable for the fiscal year ending December 31, 1995. OTHER EXPENSES. Total other expenses amounted to $3.1 million for the year ended December 31, 1996, an increase of $848,000 or 37.6% from the $2.3 million incurred in fiscal 1995. The SAIF special assessment accounted for $502,000 or 59.2% of this increase in 1996. Another reason for the increase was a $205,000 or 20.2% increase in salaries and employee benefits. This is attributable to the hiring of two employees to staff the newly formed mortgage service area and the hiring of a management information system employee along with the implementation of a employee stock ownership plan. The increase is also attributable to a rise in other expenses which increased $95,000 or 34.5% during 1996. The rise in other expenses was primarily the result of increased professional fees and other costs associated with operating the company as a public reporting entity. Total other expenses amounted to $2.3 million for the year ended December 31, 1995, an increase of $197,000 or 9.6% from the $2.1 million incurred in fiscal 1994. The increase is primarily attributable to increases in salaries and employee benefits, which increased by $82,000 or 8.8%. Approximately $60,000 of this increase was due to salary costs which increased due to the hiring of three additional employees and the annual wage increases provided to the Savings Bank's employees. The increase is also attributable to increases in premises and occupancy costs, which increased during 1995 by $54,000 or 20.7%. The rise in premises and occupancy costs during 1995 was due primarily to increased depreciation for equipment. Data processing costs climbed in 1995 by $21,000 to $154,000 for a total percentage increase of 15.8% over 1994 costs due mainly to the addition of monthly wide area network telephone line charges. INCOME TAXES. For the fiscal years ended December 31, 1996, 1995 and 1994, the Savings Bank incurred income tax expense of $69,000, $83,000 and $346,000. The effective tax rate was 32.3% during the year ended December 31, 1996, compared to 34.1% during the year ended 1995, and 38.7% in fiscal 1994. For further information, see Note 11 of the Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash flows are categorized as to whether they relate to the operating, investing or financing activities of the Company or the Savings Bank. Cash flow from operating activities includes net income plus or minus non-cash income statement items. Cash flow from investing activities includes proceeds from the sale or maturity of investment securities, principal payments collected on loans and mortgage-backed and related securities, loan originations and purchases of investments and mortgage backed and related securities. Cash flow from financing activities includes the increase or decrease in deposits, borrowings and escrows. The amount of principal repayments on loans and mortgage-backed and related securities are heavily influenced by the general level of interest rates in the economy. During periods in which the Savings Bank is unable to originate a sufficient amount of loans that it intends to retain, such as adjustable rate mortgage loans and other loans with shorter terms and during periods of high principal repayments, the Savings Bank will increase liquid assets, with remaining amounts invested in U.S. Government and federal agency securities and mortgage-backed and related securities. 14 15 Net cash used by operating activities for the year ended December 31, 1996 was approximately $207,000 whereas for year ended December 31, 1995, the cash used by operations was $5,000. The decrease of $202,000 in cash provided from operations during 1996 was primarily due to the $173,000 increase in accrued interest receivable and the $176,000 increase in other assets which was partially offset by a 138,000 increase in other liabilities. Net cash used by investing activities increased from $1.3 million in 1995 to $25.2 million in 1996. The primary reason for this $23.9 million increase was due to $17.2 million increase in loan originations and $10.9 million increase in purchases of investment and mortgage-backed securities. During 1996 the Savings Bank's new loan originations were $15.2 million in excess of their loan payments, while in 1995, the Savings Bank's loan originations exceeded the loan payments by $795,000. This increase in loan originations was a combination of increased loan demand, competitive rates offered by the Savings Bank and aggressive marketing efforts. Net cash provided by financing activities increased $18.6 million from $4.2 million in 1995 to $22.8 million in 1996. This net cash from financing activity is derived from three sources. First, the Company and the Savings Bank had access to the net proceeds of the Conversion for investment in securities and loan receivables. Second, during 1996, the Savings Bank's deposits rose by $3.1 million while there was a shift from certificates of deposit to core deposits. Third, the Company undertook to further leverage the Company in light of the influx of equity from the Conversion. In the process of such leveraging, the Savings Bank increased advances from the FHLB of Pittsburgh from $3.0 million as of December 31, 1995 to $14.5 million as of December 31, 1996. Absent the equity derived from the Conversion and the funds acquired in the leveraging of the Company that occurred in 1996, the primary sources of funds for the Savings Bank are deposits, repayments, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and funds provided from operations. The primary sources of funds for the Company are dividends from the Savings Bank, repayments by the ESOP of the loan it received from the Company, dividends on the equity investments in other companies and interest earned on deposits of the Company held at Savings Bank and short-term investments. While scheduled loan and mortgage-backed securities repayments and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the movement of interest rates in general, economic conditions and competition. The Savings Bank manages the pricing of its deposits to maintain a deposit balance deemed appropriate and desirable by its Board of Directors. In addition, the Savings Bank invests in short-term interest-earning assets which provides liquidity to meet lending requirements. The Savings Bank has also utilized advances from the FHLB of Pittsburgh, and currently maintains a total line of credit of $8.2 million with the FHLB of Pittsburgh, which line of credit will expire March 24, 1998 absent further extension. Although at December 31, 1996, there were no outstanding borrowings under this line of credit, at December 31, 1996, the Savings Bank has borrowed $14.4 million from the FHLB of Pittsburgh pursuant to various term loans with maturities of less than five years. Liquidity management is both a daily and long-term function. Excess liquidity is generally invested in short-term investments such as cash and cash equivalents, interest bearing deposits with other institutions (including the FHLB of Pittsburgh), U.S. Government, U.S. Government agencies and other qualified investments. On a longer-term basis, the Company, through the operation of the Savings Bank, maintains a strategy of investing in various mortgage-backed securities and other investment securities and lending products as described in greater detail under the heading "Business of the Company", which is hereinafter set forth. During the year ended December 31, 1996, the Savings Bank used its sources of funds primarily to meet its ongoing commitments to pay maturing savings certificates and savings withdrawals, to fund loan commitments, to fund purchases of additional investment securities for its portfolio and to increase the Savings Bank's commercial loan and consumer loan portfolios. The Company has no outstanding loan or purchase commitments. The Savings Bank has outstanding various commitments (i.e. one-to-four family loan commitments, credit card limits and commercial loans commitments) to extend credit approximating $5.4 million as of December 31, 1996. Certificates of deposit scheduled to mature in one year or less at December 31, 1996 totalled $28.4 million. 15 16 The Company and the Savings Bank experienced a decline in liquid assets during the past year as a result of increased loan originations and purchases of additional investment securities. Cash and cash equivalents have decreased by $2.2 million or 51.1% between December 31, 1995 and December 31, 1996. As of December 31, 1996, the consolidated cash and cash equivalents of the Company amounted to $2.1 million or 1.9% of assets, of which $1.4 million was invested in interest bearing accounts with the FHLB of Pittsburgh withdrawable on demand. The investment securities (including mortgage-backed securities) of the Company and the Savings Bank have an increase in dollar amount over the last few years, from $22.6 million or 24.6% of assets at December 31, 1995 to $31.9 million or 27.8% of assets at December 31, 1996. As of December 31, 1996, $341,000 of such investment securities (including mortgage-backed securities) of the Company and the Savings Bank mature within one year or less and $8.3 million have maturities of five years or less. The Company's consolidated net interest margin has increased from 2.69% for the year ended December 31, 1995 to 3.15% for the year ended December 31, 1996. Management of the Savings Bank believes that the Savings Bank has adequate resources, including principal prepayments and repayments of loans, mortgage-backed securities and maturing investments and access to loans from the FHLB of Pittsburgh, to fund all of its commitments to the extent required and to maintain flexibility to meet other market changes. Management believes that a significant portion of maturing deposits will remain with the Savings Bank. See Note 8 of the Notes to Consolidated Financial Statements. The Savings Bank is required by the OTS to maintain average daily balances of liquid assets and short-term liquid assets (as defined in OTS regulations) in amounts equal to 5% and 1%, respectively, of net withdrawable deposits and borrowings payable in one year or less to assure its ability to meet demand for withdrawals and repayment of short-term borrowings. The liquidity requirements may vary from time to time at the direction of the OTS depending upon economic conditions and deposit flows. The Savings Bank's average monthly liquidity ratio and short-term liquid assets at December 31, 1996 was 13.4% and 4.4%, respectively. The Company, as a separately incorporated holding company, has no significant operations other than serving as sole stockholder of the Savings Bank. On an unconsolidated basis, the Company has no paid employees. The Company's assets consist of its investment in the Savings Bank, its receivable from the ESOP, an equity investment with an aggregate market value of $200,000 in three savings associations or their holding companies and deposits maintained with the Savings Bank. Its sources of income will consist of earnings from the investment in such equities, interest or such deposits and interest from the ESOP obligation. The only expenses of the Company relate to its reporting obligations to the OTS, under the Exchange Act and related expenses as a publicly traded company. Management believes that the Company and the Savings Bank currently has adequate liquidity available to respond to its obligations. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements of the Company and related notes presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Company's consolidated assets and liabilities are critical to the maintenance of acceptable performance levels. RECENT ACCOUNTING PRONOUNCEMENTS In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," which provides for 16 17 standardized accounting for transfers and servicing of financial assets and extinguishment of liabilities. This statement is effective for related transactions occurring after December 31, 1996, however, the FASB has indefinitely delayed the effective date for certain portions of this statement pending further clarification. Management does not believe the effect of adoption of this standard will be material. In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", establishing financial accounting and reporting standards for stock-based employee compensation plans. This statement encourages all entities to adopt a new method of accounting to measure compensation cost of all employee stock compensation plans based on the estimated fair value of the award at the date it is granted. Companies are, however, allowed to continue to measure compensation cost for those plans using the intrinsic value based method of accounting, which generally does not result in compensation expense recognition for many plans. Companies that elect to remain with the existing accounting principles under Accounting Principles Board ("APB") Opinion No. 25 are required to disclose in a footnote to the financial statements pro forma net income and earnings per share, as if this statement had been adopted. The accounting requirements of this statement are effective for transactions entered into for fiscal years that begin after December 15, 1995. Management of the Company has not yet determined whether to adopt the new accounting method under SFAS No. 123 or the existing method under APB Opinion No. 25 for stock-based compensation plans if any such plans are adopted by the Company. BUSINESS OF THE COMPANY GENERAL The Company is a savings and loan holding company that holds the capital stock of one subsidiary, the Savings Bank. The Company owns a loan receivable from the ESOP and holds an equity investment in three savings associations or their holding companies and deposits maintained with the Savings Bank. The principal business operations of the Company are conducted through the Savings Bank. LENDING ACTIVITIES General. The Savings Bank's lending operations follow the traditional pattern of primarily emphasizing the origination of one-to-four family residential loans for portfolio retention and to a substantially lesser degree, the origination of commercial loans, commercial real estate loans, construction loans on residential properties and consumer loans, including home equity or home improvement loans, automobile loans, student loans, credit card loans, cash collateral personal loans and unsecured personal loans. At December 31, 1996, the Savings Bank's total loan portfolio amounted to $77.4 million, or 67.5% of total assets at that date. The Savings Bank has traditionally concentrated its lending activities on one-to-four family residential mortgages in its primary market. Consistent with its lending orientation, $65.1 million or 84.2% of the Savings Bank's total loan portfolio consisted of one-to-four family residential loans at December 31, 1996. Management intends that one-to-four family residential mortgage loans will be the primary lending activity of the Savings Bank. Consumer loans, which are of shorter maturity and at higher margins above cost of funds, have risen from $5.6 million at December 31, 1995, to $9.3 million at December 31, 1996. Each of the foregoing figures shows gross loan receivables with no allocation for bad debt reserve or other contra accounts. Management decided to increase home equity loans primarily because this type of loan is secured by real estate through a first or second lien. As a result, home equity loans have risen from $2.1 million at December 31, 1995 to $4.6 million at December 31, 1996. Management has also sought through the promotion of automobile, student and credit card loans to increase outstanding consumer loans. The percentage of consumer loans against total loan receivables has changed from 9.0% at December 31, 1995, to 12.0% at December 31, 1996. Management is committed to increase consumer loans. The Savings Bank is pursuing a policy to further grow its commercial loan and commercial real estate loan portfolio. Commercial loans and commercial real estate loans have risen from $815,000 at December 31, 17 18 1995, to $2 million at December 31, 1996 and is expected to continue to increase in 1997. Each of the foregoing figures shows gross loan receivables with no allocation for bad debt reserve or other contra accounts. Management has worked with existing contacts to seek out commercial loan and commercial real estate loans opportunities. The percentage of commercial loans and commercial real estate loans against total loan receivables has changed from 1.3% at December 31, 1995 to 2.6% at December 31, 1996. Management has set a goal to grow the commercial loan portfolio to $10 million by December 31, 1997. No special goals have been set on the growth of the commercial real estate portfolio. By statute, the Savings Bank must limit its commercial loans to no more than 10% of its assets. As of December 31, 1996, the total asset size of the Savings Bank was $114.4 million and 10% of such number is $11.4 million. The statutory ceiling on commercial real estate loans is substantially higher, i.e. 400% of the Savings Bank's capital, or at December 31, 1996 $46.6 million. Management intends to explore extending some commercial loans that carry a partial U.S. Government guarantee of the payment of principal and interest. The Savings Bank's primary market area consists of southern and southwestern portions of Allegheny County and, to a lesser extent, Washington and Westmoreland Counties. All of the Savings Bank's residential mortgage loans are secured by properties located in Pennsylvania, and a substantial portion of the real estate mortgage loans are secured by properties located within the Savings Bank's primary market area. LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition of the Savings Bank's loan portfolio by type of loan at the dates indicated.
AS OF DECEMBER 31, ------------------------------------------------------------------ 1996 1995 1994 ----------------- ------------------ ----------------- AMOUNT % AMOUNT % AMOUNT % ------- ----- ------- ------ ------- ------ (DOLLARS IN THOUSANDS) Real estate loans One-to-four family (1)..... $65,117 84.17% $55,367 89.68% $55,304 90.33% Construction............... 925 1.20 0 0.00 715 1.17 Commercial real estate..... 1,023 1.32 793 1.28 733 1.20 ------- ----- ------- ------ ------- ------ Total................... $67,065 86.69% $56,160 90.96% $56,752 92.70% ------- ----- ------- ------ ------- ------ Commercial loans............. $ 1,010 1.30% $ 22 0.04% $ 0 0.00% ------- ----- ------- ------ ------- ------ Consumer loans Home equity loans & lines................... $ 4,562 5.90% $ 2,053 3.33% $ 1,694 2.77% Student loans.............. 2,228 2.88% 2,220 3.60% 2,080 3.40% Automobile loans........... 1,515 1.96 713 1.15 253 0.41 Other consumer loans(1).... 984 1.27 569 0.92 443 0.72 ------- ----- ------- ------ ------- ------ Total................... $ 9,289 12.01% $ 5,555 9.00% $ 4,470 7.30% ------- ----- ------- ------ ------- ------ Total loans receivable(1).... $77,364 100% $61,737 100.00% $61,222 100.00% ======= ===== ======= ====== ======= ====== Less: Allowance for loan losses.................. $ 307 $ 287 $ 303 Loans in process........... 515 0 232 Deferred loan (costs) fees.................... (3) 42 52 ------- ------- ------- Loans receivable, net........ $76,545 $61,408 $60,635 ======= ======= =======
- --------- (1) Includes non-performing loans. 18 19 CONTRACTUAL MATURITIES. The following table sets forth the scheduled contractual maturities of the Savings Bank's loan portfolio at December 31, 1996. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdraft loans are reported as due in one year or less. The amounts shown for each period do not take into account loan prepayments and normal amortization of the Savings Bank's loan portfolio.
AT DECEMBER 31, 1996 -------------------------------------------------------------- COMMERCIAL ONE-TO-FOUR REAL FAMILY (1) ESTATE COMMERCIAL CONSUMER TOTAL ----------- ---------- ---------- -------- ------- (IN THOUSANDS) 1 year or less............................ $ 84 $ 0 $ 25 $ 459 $ 568 After 1 year through 5 years.............. 5,901 145 895 4,414 11,355 More than 5 years......................... 60,057 878 90 4,416 65,441 ------- ------ ------ ------ ------- Total amounts due......................... $66,042 $1,023 $1,010 $9,289 $77,364 ======= ====== ====== ====== ======= Interest rate terms on amounts due after 1 year: Fixed................................... $38,635 $ 367 $ 348 $5,268 $44,618 ======= ====== ====== ====== ======= Adjustable/Floating..................... $27,323 $ 656 $ 637 $3,562 $32,178 ======= ====== ====== ====== =======
- --------- (1) Includes construction loans of $925,000 for the construction of one-to-four family homes. At the completion of the construction period (usually less than one year) the loan will convert automatically to a traditional mortgage with a maturity in excess of five years. Scheduled contractual repayment of loans does not reflect the expected term of the Savings Bank's loan portfolio. The expected average life of loans is substantially less than their contractual terms because of scheduled amortization of principal, prepayments and due-on-sale clauses, which give the Savings Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are lower than current mortgage loan rates (due to refinancings of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstance, the weighted average yield on loans decreases as higher-yielding loans are repaid or refinanced at lower rates. 19 20 LOAN ORIGINATION, PURCHASE AND SALES ACTIVITY. The following table shows the loan origination, purchase and sale activity of the Savings Bank during the periods indicated.
YEAR ENDED DECEMBER 31, --------------------- 1996 1995 -------- ------- (IN THOUSANDS) Total loans at beginning of period.................................... $ 61,737 $61,222 Loan originations: Real estate One-to-four family............................................... $ 17,100 $ 5,852 Commercial real estate........................................... 512 0 Construction..................................................... 925 0 -------- ------- Total real estate loans originated............................. $ 18,537 $ 5,852 -------- ------- Commercial loans.................................................... $ 1,173 $ 23 -------- ------- Consumer loans Home equity loans and lines of credit............................ $ 3,868 $ 1,079 Student loans.................................................... 482 473 Automobile loans................................................. 1,242 652 Other consumer loans............................................. 1,284 524 -------- ------- Total consumer loans originated................................ $ 6,876 $ 2,728 -------- ------- Total loans originated........................................... $ 26,586 $ 8,603 -------- ------- Deduct: Principal loan repayments and prepayments........................... $(10,949) $(7,960) Transferred to real estate owned.................................... (10) (128) -------- ------- Subtotal:............................................................. $(10,959) $(8,088) -------- ------- Net increase in loans............................................... $ 15,627 $ 515 -------- ------- Total loans at end of period........................................ $ 77,364 $61,737 ======== =======
Applications for residential mortgage and consumer loans are taken at any of the Savings Bank's offices, while commercial loan, commercial real estate loan and construction loan applications are referred to the President of the Savings Bank. Residential mortgage loan applications are primarily developed from referrals from real estate brokers and builders, existing customers and walk-in customers. Commercial real estate loan and construction loan applications are obtained primarily from previous borrowers as well as referrals. Commercial loan applications arise from referrals at this time. The Savings Bank's lending policies allow all one-to-four residential mortgage loans $50,000 or less to be approved with two signatures of the President, Executive Vice President and/or the Chairman of the Board. One-to-four residential mortgage loans in excess of $50,000 are presented to the Loan Committee which consists of a member of management and two outside directors. Commercial loan applications under $25,000 may be approved with the signatures of two of the loan officers designated by the President or the Loan Committee. The Loan Committee has been authorized by the Board to grant loans up to $250,000, with loans in excess of this amount required to be presented to the full Board for review and approval. It has been the policy of the Savings Bank's management to present all mortgage loans which are not single-family residential loans to the Loan Committee and/or the Board of Directors for review and approval, and to have the Board of Directors review any loan application which would exceed $250,000. Under applicable regulations, the maximum amount of loans that the Savings Bank may make to any one borrower, including related entities, is limited to 15% of unimpaired capital and surplus, which legal lending limit amounted to $1.7 million at December 31, 1996. The Savings Bank currently is not a purchaser of residential or consumer loans. There are no current intentions to begin purchasing such loans. The Savings Bank has previously purchased loan participations secured primarily by commercial real estate located in Pennsylvania and Ohio. Such loans were presented to the Savings Bank from contacts primarily at other financial institutions, particularly those which have 20 21 previously done business with the Savings Bank. At December 31, 1996, none of the Savings Bank's total loans receivable consisted of participation interests. During 1995, the Savings Bank wrote-off one commercial loan participation and transferred the interest to the classification "other real estate owned" and valued the asset in accordance with an appraisal at $39,000. REAL ESTATE LENDING STANDARDS. Effective March 19, 1993, all financial institutions were required to adopt and maintain comprehensive written real estate lending policies that are consistent with safe and sound banking practices. These lending policies must reflect consideration of the Interagency Guidelines or Real Estate Lending Policies adopted by the Federal banking agencies in December 1992 ("Real Estate Lending Guidelines"). The Real Estate Lending Guidelines set forth uniform regulations prescribing standards for real estate lending. Real estate lending is defined as the extension of credit secured by liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate, regardless of whether a lien has been taken on the property. The policies must address certain lending considerations set forth in the Real Estate Lending Guidelines, including loan-to-value ("LTV") limits, loan administration procedures, underwriting standards, portfolio diversification standards, and documentation, approval and reporting requirements. These policies must also be appropriate to the size of the institution and the nature and scope of its operations, and must be reviewed and approved by the institution's board of directors at least annually. The LTV ratio framework, with a LTV ratio being the total amount of credit to be extended divided by the appraised value of the property at the time the credit is originated, must be established for each category of real estate loans. If not a first lien, the lender must combine all senior liens when calculating this ratio. The Real Estate Lending Guidelines, among other things, establish the following supervisory LTV limits: land development (75%); construction, commercial and non-residential (80%); improved property (80%) and one-to-four family residential (owner occupied) (no maximum ratio; however any LTV ratio in excess of 90% should require appropriate insurance or readily marketable collateral). Consistent with its lending philosophy, the Savings Bank's LTV limits are generally more restrictive than those in the Real Estate Lending Guidelines; construction and land development (75%); residential properties (90% in the case of one-to-four family owner-occupied residences); and commercial real estate (75%). The Savings Bank requires private mortgage insurance on any residential conventional mortgage loan that exceeds an 90% LTV ratio. While the ratios reflected above reflect the range of desired LTV ratio coverages, the Savings Bank will evaluate each applicant and the collateral to secure the loan on a case-by-case basis. ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LOANS. The Savings Bank has historically concentrated its lending activities on the origination of loans secured primarily by first mortgage liens on existing one-to-four family residences located within its market. At December 31, 1996, $65.1 million or 84.2% of the Savings Bank's total loan portfolio consisted of one-to-four family residential real estate loans, substantially all of which are conventional loans. The Savings Bank historically has and continues to emphasize the origination of fixed-rate mortgage loans with terms of up to 30 years and adjustable rate mortgage loans ("ARMs") up to 30 years which provide for periodic adjustments to the interest rate applicable to the loan. The ARMs currently held by the Savings Bank have up to 30-year terms and an interest rate which adjusts every one or three years in accordance with a designated index. Such loans have a 2% cap on any increase or decrease in the interest rate per period, and there is currently a limit of 4% to 6% on the amount that the interest rate can change over the life of the loan. To attract ARMs from time to time, the Savings Bank will offer initial interest rates below market loan rates. ARMs generally pose greater credit risk than fixed loans primarily because as interest rates rise, the required periodic payment by the borrower will rise, increasing the potential for default. At December 31, 1996, approximately $37.8 million or 58% of the one-to-four family residential loans in the Savings Bank's loan portfolio consisted of loans which provide for fixed rates of interest. Although these loans generally provide for repayments of principal over a fixed period of 5 to 30 years, it is the Savings Bank's experience that because of prepayments and due-on-sale clauses, such loans generally remain outstanding for a substantially shorter period of time. 21 22 Property appraisals on the real estate and improvements securing the Savings Bank's one-to-four family residential loans are made by independent appraisers approved by the Savings Bank's Board of Directors. Appraisals are performed in accordance with Federal regulations and policies. The Savings Bank obtains title insurance policies on most first mortgage real estate loans originated by it. If title insurance is not obtained or is unavailable, the Savings Bank obtains an abstract of title and title opinion. Borrowers also must obtain hazard insurance prior to closing and, when required by the United States Department of Housing and Urban Development, flood insurance. Borrowers are not required to escrow funds for real estate taxes but may elect to escrow funds with each monthly payment of principal and interest to a loan escrow account from which the Savings Bank makes disbursements for items such as real estate taxes as they become due. COMMERCIAL REAL ESTATE LOANS. On a limited basis, the Savings Bank originates mortgage loans for the acquisition and refinancing of commercial real estate properties (including multi-family complexes). At December 31, 1996, $1.0 million or 1.32% of the Savings Bank's total loan portfolio consisted of loans secured by existing commercial real estate properties. At December 31, 1996, the Savings Bank's commercial real estate loan portfolio consisted of 6 loans with an average principal balance of $171,000. The Savings Bank's commercial real estate loans are secured by apartment complexes, developed residential lots and small retail establishments. The Savings Bank's commercial real estate loan portfolio consists primarily of loans secured by properties located in Pennsylvania. Although terms vary, commercial real estate loans generally are amortized over a period of 10 to 15 years. The Savings Bank's commercial real estate loans have a weighted average maturity of approximately 13 years at December 31, 1996. The Savings Bank will originate these loans either with fixed interest rates or with interest rates which adjust in accordance with a designated index, which generally is negotiated at the time of origination. It is also the Savings Bank's general policy to obtain personal guarantees on its commercial real estate loans from the principals of the borrower and, when this cannot be obtained, to impose more stringent loan-to-value and other underwriting requirements. COMMERCIAL LOANS. At December 31, 1996, $1.0 million or 1.31% of the Savings Bank's total loan portfolio consisted of loans classified as commercial loans. The Savings Bank's commercial loans can be secured or unsecured depending upon the size of the loan and the credit analysis by the Savings Bank of the potential borrower. Lines of credit in excess of $25,000 are generally secured by a pledge of accounts receivable and inventory. The Savings Bank's commercial loan portfolio consists of borrowers primarily located in Western Pennsylvania. Commercial loans generally have shorter terms and higher interest rates than residential mortgage loans but generally involve more credit risk than residential mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. Fixed equipment may depreciate in value quicker than the principal repayment of the loan. Accounts receivable may prove to be difficult or impossible to collect in sufficient amounts to repay a line of credit. Inventory may disappear due to loss or theft or may decline in value due to age or change in market conditions or technology. The Savings Bank's evaluation of the creditworthiness of a borrower, or the value of a borrower's collateral, may fail to fully assess the risk of the loan in question and lead to a loss. CONSTRUCTION LOANS. The Savings Bank will occasionally originate loans to construct primarily one-to-four family residences, and, to a much lesser extent, loans to acquire and develop real estate for construction of residential and commercial properties. These construction lending activities generally are limited to the Savings Bank's primary market area. At December 31, 1996, $925,000 or 1.2% of the Savings Bank's total loan portfolio consisted of loans classified as construction loans. Prior to making a commitment to fund a construction loan, the Savings Bank's policy requires an appraisal of the property by independent appraisers approved by the Board of Directors. The Savings Bank uses qualified appraisers on all of its construction loans. Designated employees of the Savings Bank also review and inspect each project at the commencement of construction. In addition, the project is inspected by designated inspectors of the Savings Bank prior to every disbursement of funds during the term of the 22 23 construction loan. Such inspection includes a review for compliance with the construction plan, including materials specifications. Construction lending is generally considered to involve a higher level of risk as compared to one-to-four family residential lending for existing units, due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on real estate developers and managers. Moreover, a construction loan can involve additional risks because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost (including interest) of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. The Savings Bank has attempted to minimize the foregoing risks by, among other things, limiting the extent of its construction lending generally, by limiting its construction lending to residential properties and by emphasizing construction loans for residences extended to the individuals who will occupy the constructed home. In addition, the Savings Bank has adopted underwriting guidelines which impose stringent loan-to-value, debt service and other requirements for loans which are believed to involve higher elements of credit risk, by limiting the geographic area in which the Savings Bank will do business and by working with builders with whom it has established relationships or which have quality reputations. CONSUMER LOANS. The Savings Bank also offers automobile loans, home equity loans and lines of credit, student loans, deposit account secured loans and unsecured consumer loans. Automobile loans amounted to $1.5 million or 2.0% of the total loans receivable at December 31, 1996. Home equity loans and lines of credit amounted to $4.6 million or 5.9% of the total loans receivable at December 31, 1996. The student loan balance amounted to $2.2 million or 2.9% of the total loans receivable as of such date, deposit account secured loans had outstanding balances of $487,000 or .6% of total loans receivables as of such date and unsecured personal loans (including credit card balances outstanding) stood at $497,000 or .6% of total loans receivables as of such date. Automobile loans are secured by a lien on the title of the financed vehicle. The terms of the loan may not exceed 60 months. Rates on automobile loans may be fixed or floating. As of December 31, 1996, the entire automobile loan portfolio had fixed rate contracts. Automobile loans involve higher risk since the collateral rapidly depreciates. Defaults during the early months of the loan will likely result in a loss of principal due to the reduced value of the vehicle and the costs of repossession and sale. Automobile loans may be granted for up to 100% of the purchase price. The Savings Bank's home equity loans and lines of credit are secured by the underlying equity in the borrower's home. Home equity loans generally have fixed interest rates and terms of 5 to 15 years. Home equity lines of credit generally have variable interest rates based on the prime rate and terms of 5 to 15 years. The Savings Bank's home equity loans and home equity lines of credit require loan-to-value ratios of 100% or less after taking into consideration the first mortgage loan. The student loans made by the Savings Bank are guaranteed and serviced by the Pennsylvania Higher Education Assistance Agency. A deposit account secured loan is collateralized by deposits equal to no more than 90% of the principal balance of the loans. Unsecured personal loans depend solely on the creditworthiness of the borrower. In December 1995 the Savings Bank began issuing consumer credit cards to its existing customer base. Credit card loans outstanding amounted to $399,000 or .5% of the total loans receivable at December 31, 1996. Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. During 1996, the Savings Bank wrote-off two credit card loan balances with aggregate outstandings of $6,000. At December 31, 1996, $2,000 of the remaining consumer loans were classified as non-performing. ASSET QUALITY When a borrower fails to make a required payment on a loan, the Savings Bank attempts to cure the deficiency by contacting the borrower and seeking the payment. Late notices are sent and/or personal contacts 23 24 are made. In most cases, deficiencies are cured promptly. While the Savings Bank generally prefers to work with borrowers to resolve such problems, when a loan becomes 60 days delinquent the loan is classified as substandard and presented to the Classification Committee for evaluation. Following such evaluation if the loan continues to be delinquent past 90 days the Savings Bank institutes foreclosure, repossession, setoff or other proceedings, as necessary, to minimize any potential loss. Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. The Savings Bank does not accrue interest on loans past due 90 days or more. Real estate acquired by the Savings Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When a property is acquired, it is recorded at the lower of cost or fair value minus estimated cost to sell the property. Fair value is generally determined through the use of independent appraisals. Any write-downs resulting at acquisition are charged to the allowance for loan losses. All costs incurred in maintaining the Savings Bank's interest in the property are capitalized between the date the loan becomes delinquent and the date of acquisition. After the date of acquisition, all costs incurred in maintaining the property are expenses and costs incurred for the improvement or development of such property are capitalized. Under generally accepted accounting principles, the Savings Bank is required to account for certain loan modifications or restructurings as "troubled debt restructurings". In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Savings Bank for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrower that the Savings Bank would not otherwise consider. Debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings, however, and troubled debt restructurings do not necessarily result in non-accrual loans. For the year ended December 31, 1996, the Savings Bank had no troubled debt restructurings and had no interest income arising from troubled debt restructuring. DELINQUENT LOANS. The following table sets forth information concerning delinquent loans at the dates indicated, in dollar amounts and as a percentage of each category of the Savings Bank's loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
DECEMBER 31, 1996 DECEMBER 31, 1995 ------------------------------------------------------ ------------------------------------------------------ 90 DAYS OR 90 DAYS OR 30-59 DAYS 60-89 DAYS GREATER 30-59 DAYS 60-89 DAYS GREATER ---------------- ---------------- ---------------- ---------------- ---------------- ---------------- PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT OF LOAN OF LOAN OF LOAN OF LOAN OF LOAN OF LOAN AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- (DOLLARS IN THOUSANDS) Real estate loans: One-to-four family residences... $1,738 2.67% $ 75 .12% $ 339 .52% $2,076 3.75% $ 621 1.12% $ 306 .55% Commercial... 0 0 0 0 0 0 0 0 0 0 0 0 Consumer loans:....... $ 6 .06% $ 15 .16% $ 2 .02% $ 86 1.55% $ 1 .02% $ 0 0% ------ ----- ----- ------ ----- ----- Total...... $1,744 $ 90 $ 341 $2,162 $ 622 $ 306 ====== ===== ===== ====== ===== =====
24 25 NON-PERFORMING ASSETS. The following table sets forth the amounts and categories of the Savings Bank's non-performing assets at the dates indicated. The Savings Bank had no loans during the periods indicated below which should be classified as troubled debt restructurings.
DECEMBER 31, ------------------------ 1996 1995 1994 ---- ---- ---- (DOLLARS IN THOUSANDS) Non-accruing loans: One-to-four family residential(1)......................... $339 $306 $338 Consumer Loans(2)......................................... 2 0 0 Commercial participations(3).............................. 0 0 53 ---- ---- ---- Total nonperforming loans............................... 341 306 391 Real estate owned......................................... 50 42 0 ---- ---- ---- Total nonperforming assets.............................. $391 $348 $391 ==== ==== ==== Total nonperforming loans as a percentage of total loans................................................... .44% .50% .64% ==== ==== ==== Total nonperforming assets as a percentage of total assets.................................................. .34% .38% .45% ==== ==== ====
- --------- (1) Consists of an aggregate of 6, 8 and 12 loans at December 31, 1996, 1995 and 1994, respectively. (2) Consists of one loan at December 31, 1996. (3) Consists of 1 loan at December 31, 1994. The Savings Bank's total non-performing assets have increased from $348,000 or .38% of total assets at December 31, 1995 to $391,000 or .34% of total assets at December 31, 1996. The $43,000 increase in total non-performing assets between December 31, 1995 and 1996 principally reflects increases in non-performing loans. At December 31, 1996 and at December 31, 1995, approximately $15,000 and $22,000 in interest income, respectively, would have been recorded in the period then ended on loans accounted for on a non-accrual basis if such loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period. The Savings Bank had no accruing loans greater than 90 days delinquent. ALLOWANCE FOR LOAN LOSSES. An allowance for loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Allowances for loan losses are based on estimated net realizable value. Management's periodic evaluation is based upon examination of the loan portfolio, past loss experience, current economic conditions, the results of the most recent regulatory examinations, and other relevant factors. The allowance is increased by provisions for loan losses which are charged against income. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. In addition, there can be no assurance that bank regulators will agree with the Savings Bank on the systematic methodology for determining the adequacy of the allowance for loan losses during future examination. The Savings Bank could be required to increase its allowance for loan losses, thereby negatively affecting the Savings Bank's financial condition and earnings at that time. 25 26 The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods presented.
DECEMBER 31, --------------------------------- 1996 1995 1994 ------- ------- ------- (DOLLARS IN THOUSANDS) Average total loans................................ $69,258 $61,638 $58,502 ======= ======= ======= Allowance for loan losses, beginning of year....... $ 287 $ 303 $ 268 Charged-off loans(1)............................... (24) (53) (1) Recoveries on loans previously charged off......... 0 1 0 Provision for loan losses.......................... 44 36 36 Allowance for loan losses, end of period........... $ 307 $ 287 $ 303 ======= ======= ======= Net loans charged-off to average loans............. .04% .09% 0.00% ======= ======= ======= Allowance for loan losses to total loans........... .40% .46% .49% ======= ======= ======= Allowance for loan losses to nonperforming loans... 89.88% 93.79% 77.49% ======= ======= =======
- --------- (1) Consists of $18,000 of one-to-four family residential mortgage loans and $6,000 of consumer loans in 1996; consists of $23,000 of commercial real estate loans and $30,000 of one-to-four family residential loans in 1995; and consists of $1,000 of consumer loans in 1994. The Savings Bank's management is unable to determine in what loan category future charge-offs and recoveries may occur. The following schedule sets forth the allocation of the allowance for loan losses among various categories. This allocation is based upon historical experience. The entire allowance for loan losses is available to absorb future loan losses in any loan category.
DECEMBER 31, ----------------------------------------------------------- 1996 1995 1994 ----------------- ----------------- ----------------- % OF % OF % OF LOANS IN LOANS IN LOANS IN EACH EACH EACH CATEGORY CATEGORY CATEGORY TO TOTAL TO TOTAL TO TOTAL AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS ------ -------- ------ -------- ------ -------- (DOLLARS IN THOUSANDS) Real Estate: One-to-four family, commercial real estate, participation, construction and other real estate...................................... $227 73.94% $207 72.13% $224 73.93% Commercial Loan: Working capital and term loans for business uses........................................ 5 1.63 0 0 0 0 Consumer: Automobile, home equity, student, share and other consumer.............................. 75 24.43 80 27.87 79 26.07 ---- ------ ---- ------ ---- ------ Total.................................... $307 100.00% $287 100.00% $303 100.00% ==== ====== ==== ====== ==== ======
Effective December 21, 1993, the OTS, in conjunction with the Office of the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued an Interagency Policy Statement on the Allowance for Loan and Lease Losses ("Policy Statement"). The Policy Statement, which effectively supersedes previous OTS proposed guidance, includes guidance (i) on the responsibilities of management for the assessment and establishment of an adequate allowance and (ii) for the agencies' examiners to use in evaluating the adequacy of such allowance and the policies utilized to determine such allowance. The Policy Statement also sets forth quantitative measures for the allowance with respect to assets classified substandard and doubtful, described below, and with respect to the remaining portion of an institution's loan portfolio. Specifically, the Policy Statement sets forth the following quantitative measures which examiners may use to 26 27 determine the reasonableness of an allowance: (i) 50% of the dollar value of the portfolio that is classified doubtful must be accounted for in the allowance of the institution; (ii) 15% of the dollar value of the portfolio that is classified substandard must be accounted for in the allowance of the institution; (iii) for the portions of the portfolio that have not been classified (including loans designated special mention), estimated credit losses over the upcoming twelve months based on facts and circumstances available on the evaluation date must be accounted for in the allowance of the institution, and (iv) in the cases where the institution has an insufficient basis for determining this amount, an examiner may use industry average net charge-off rate for nonclassified loans and leases (based on a study of the Federal Reserve Board a rate of .50% for risk-weighted "pass" loans and 3% for special mention loans is acceptable). While the Policy Statement sets forth this quantitative measure, such guidance is not intended as a "floor" or "ceiling". Federal regulations require that each insured savings institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, Federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful" and "loss". Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. General loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital. At December 31, 1996, the Savings Bank had $341,000 of assets classified as "substandard" (all of which are set forth under "Non-Performing Assets" above) and no assets classified as "doubtful", "loss" or "special mention". INVESTMENT ACTIVITIES GENERAL. The investment activities of the Company are managed by the Board of Directors of the Company. Investment activity at the Company is minimal. The Company has chosen to take equity positions in three savings associations or their respective holding companies. The aggregate value of these investments is $200,000. These investments were selected on management's belief that the value of these institutions would appreciate. This equity investment represents .2% of the total consolidated assets of the Company and 1.1% of the total consolidated investment securities of the Company. Excess funds at the Company level are deposited into a money market account maintained at the Savings Bank. The Savings Bank's investment activities are managed by the President with the assistance of other senior officers designated by the Board of Directors of the Savings Bank. These activities are conducted in accordance with a written investment policy which is reviewed and approved by the Board of Directors at least annually. The Savings Bank's Asset and Liability Committee has been designated to work with management and the Board to implement and achieve the investment plan goals and to report at least quarterly to the Board in conjunction with its review of the Savings Bank's overall gap and interest rate risk position. As reflected in its investment policy, the Savings Bank's investment objective is to maintain a balance of high quality and diversified investments with a minimum of credit risk. Accordingly, the Savings Bank seeks a competitive return from its investments, but the rate of return is only one consideration which is weighed against the Savings Bank's other goals and objectives of liquidity and operating in a manner deemed by the Board to reflect safety and soundness. CASH AND CASH EQUIVALENTS. Cash and cash equivalents of the Savings Bank decreased by $2.2 million or 51.1% from fiscal 1995 to fiscal 1996. At December 31, 1996, cash and cash equivalents of the Savings Bank amounted to $2.1 million or 1.9% of total assets. The largest component in this category, which accounted for 27 28 the majority decrease during the period, is interest bearing deposits in banks, which amounted to $1.4 million at December 31, 1996. All such deposits were made with the FHLB of Pittsburgh. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES. As a savings and loan holding company, with majority ownership in one savings association which meets the requirement of a qualified thrift lender due to the level of its residential mortgage lending activities, the Company has broad investment powers. Other than 100% ownership of the Savings Bank, the Company has chosen only to maintain the loan to the ESOP, to invest in three known savings associations or their holding companies and to deposit the remaining funding of the Company in a money market account maintained at the Savings Bank. Funds on deposit with the Savings bank are used for either loans or investment securities as determined by the Savings Bank. The Savings Bank has authority to invest in various types of assets. The Savings Bank's Investment Committee appointed by the Board are authorized by the Board to: purchase or sell U.S. Government securities and securities issued by agencies thereof; purchase, sell or trade any securities qualifying as eligible liquidity; purchase mortgage-related securities; purchase participations in the secondary mortgage market; invest in repurchase agreements secured by securities eligible for investment by the Savings Bank; invest in mutual funds restricted to authorized investments; invest in deposits with the FHLB of Pittsburgh and other authorized investments; invest in various corporate securities and bonds that have at least an "AA" rating by Standard & Poor's; and invest in various other mutual funds and certain equity issues as authorized by the Board. The Board of the Savings Bank does not permit investments in highly speculative securities. The Savings Bank's investments are all classified as "held to maturity" or "available for sale" upon acquisition based upon the Savings Bank's intent and ability to hold such investments to maturity at the time of investment in accordance with generally accepted accounting principles. The investment securities and mortgage-backed securities of the Savings Bank which are classified as "held to maturity" are carried at amortized cost, with any discount or premium amortized to maturity. The investment securities and mortgage-backed securities of the Savings Bank which are classified as "available for sale" are carried at fair value and are repriced quarterly. All mutual fund investments are classified as investments available for sale. The Savings Bank maintains a portfolio of mortgage-backed securities as a means of investing in housing-related mortgage instruments without the costs associated with originating mortgage loans for portfolio retention and with limited credit risk of default which arises in holding a portfolio of loans to maturity. Mortgage related securities (which also are known as mortgage participation certificates or pass-through certificates) represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and repackage the participation interests in the form of securities, to investors such as the Savings Bank. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the FHLMC, the FNMA and the Government National Mortgage Association ("GNMA"). The FHLMC is a public corporation chartered by the U.S. Government and owned by the 12 Federal Home Loan Banks and Federally insured savings institutions. The FHLMC issues participation certificates backed principally by conventional mortgage loans. The FHLMC guarantees the timely payment of interest and the ultimate return of principal. The FNMA is a private corporation chartered by the U.S. Congress with a mandate to establish a secondary market for conventional mortgage loans. The FNMA guarantees the timely payment of principal and interest on FNMA securities. FHLMC and FNMA securities are not backed by the full faith and credit of the United States, but because the FHLMC and FNMA are U.S. Government sponsored enterprises, these securities are considered to be among the highest quality investments with minimal credit risks. The GNMA is a government agency within the Department of Housing and Urban Development which is intended to help finance government-assisted housing programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans, and the timely payment of principal and interest on GNMA securities are guaranteed by the GNMA and backed by the full faith and credit of the U.S. Government. Because the FHLMC, the FNMA and the GNMA were established to provide support for low-and middle-income housing, there are limits to the maximum size of loans that qualify for these programs. 28 29 Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages, i.e., fixed rate or adjustable rate, as well as repayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security thus approximates the life of the underlying mortgages. Mortgage-backed securities generally yield less than the loans which underlie such securities because of their payment guarantees or credit enhancements which offer nominal credit risk. In addition, mortgage-backed securities are more liquid than individual mortgage loans. Mortgage-backed securities issued or guaranteed by FNMA or FHLMC (except interest-only securities or the residual interests in collateralized mortgage obligations) are weighted at no more than 20% for risk-based capital purposes, compared to a weight of 50% to 100% for residential loans. The following tables set forth certain information relating to the Company's and Savings Bank's investment and mortgage-backed securities portfolio at the dates indicated:
DECEMBER 31, ------------------------------------------------------------------- 1996 1995 1994 ------------------- ------------------- ------------------- AMORTIZED % OF AMORTIZED % OF AMORTIZED % OF COST TOTAL COST TOTAL COST TOTAL --------- ------ --------- ------ --------- ------ (DOLLARS IN THOUSANDS) HELD TO MATURITY Investment securities: U.S. Government securities........ $ 2,002 19.00% $ 3,502 100.00% $ 2,497 55.55% Federal agency obligations........ 8,533 81.00 0 0 1,998 44.45 Marketable equity securities...... 0 0 0 0 0 0 --------- ------ --------- ------ --------- ------ Total investment securities.... 10,535 100.00% $ 3,502 100.00% $ 4,495 100.00% ======== ====== ======== ====== ======== ====== Average remaining contractual life of investment securities.......... 8.01 yrs. 2.50 yrs. 2.54 yrs. ==== ==== ==== Mortgage-backed securities: GNMA.............................. $ 1,361 13.71% $ 1,584 13.69% $ 1,783 10.72% FHLMC............................. 8,453 85.16 9,841 85.04 13,221 79.49 FNMA.............................. 113 1.13 147 1.27 1,628 9.79 --------- ------ --------- ------ --------- ------ Total mortgage-backed securities................... $ 9,927 100.00% $ 11,572 100.00% $ 16,632 100.00% ======== ====== ======== ====== ======== ======
DECEMBER 31, ------------------------------------------------------------------- 1996 1995 1994 ------------------- ------------------- ------------------- AMORTIZED % OF AMORTIZED % OF AMORTIZED % OF COST TOTAL COST TOTAL COST TOTAL --------- ------ --------- ------ --------- ------ (DOLLARS IN THOUSANDS) AVAILABLE FOR SALE Investment securities: Federal agency obligations........ $ 6,503 80.91% $ 1,999 60.83% $ 0 0% Marketable equity securities(1)... 1,535 19.09 1,287 39.17 1,219 100.00 --------- ------ --------- ------ --------- ------ Total investment securities.... $ 8,038 100.00% $ 3,286 100.00% $ 1,219 100.00% ======== ====== ======== ====== ======== ====== Average remaining contractual life of investment securities.......... 8.31 yrs. 2.75 yrs. N/A ==== ==== ===== Mortgage-backed securities: FHLMC............................. $ 2,356 63.93% $ 2,930 67.87% $ 0 0% FNMA.............................. 1,329 36.07 1,387 32.13 0 0 --------- ------ --------- ------ --------- ------ Total mortgage-backed securities................... $ 3,685 100.00% $ 4,317 100.00% $ 0 0% ======== ====== ======== ====== ======== ======
29 30 - --------- (1) Consists of (i) 130,888 shares in the Tocqueville Governmental Fund (formerly known as the Ivy Short-Term Bond Fund), a registered open-end diversified investment company for each of years ended December 31, 1996, 1995 and 1994, (ii) 5,000 shares of common stock of Pittsburgh Home Financial Corp, a savings and loan holding company for year ended December 31, 1996, (iii) 5,000 shares of common stock of Great American Financial Corp., a savings and loan holding company, for year ended December 31, 1996, and (iv) 5,000 shares of common stock of 1st Bergan Bancorp, Inc., a savings and loan holding company, for year ended December 31, 1996. The composition and maturities of the investment securities portfolio by contractual maturity are indicated in the following table:
DECEMBER 31, 1996 ------------------------------------------------------------------------------------ LESS THAN 1 TO 3 3 TO 5 OVER TOTAL INVESTMENT CARRYING 1 YEAR YEARS YEARS 5 YEARS SECURITIES VALUE --------- --------- --------- --------- -------------------- -------- AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR COST COST COST COST COST VALUE --------- --------- --------- --------- --------- ------- (DOLLARS IN THOUSANDS) U.S. government securities and federal agency obligations...... $ 0 $ 2,999 $ 1,003 $13,036 $17,038 $16,803 $16,868 Marketable equity securities (1)............................. 1,535 0 0 0 1,535 1,518 1,518 ------- ------- ------- ------- ------- ------- ------- Total investment securities....... $ 1,535 $ 2,999 $ 1,003 $13,036 $18,573 $18,321 $18,386 ======= ======= ======= ======= ======= ======= ======= Weighted average yield............ 5.50% 5.22% 5.50% 7.24% 6.68% N/A N/A ======= ======= ======= ======= ======= ======= =======
The weighted yield for investment securities including held to maturity and available for sale is based upon historical amortized cost balances. - --------- (1) Consists of (i) 130,888 shares in the Tocqueville Government Fund (formerly known as the Ivy Short-Term Bond Fund), a registered open-end diversified investment company, (ii) 5,000 shares of common stock of Pittsburgh Home Financial Corp, a savings and loan holding company, for year ended December 31, 1996, (iii) 5,000 shares of common stock of Great American Financial Corp., a savings and loan holding company, for year ended December 31, 1996, and (iv) 5,000 shares of common stock of 1st Bergan Bancorp, Inc., a savings and loan company for year ended December 31, 1996. The Bank's investment securities portfolio at December 31, 1996 did not contain securities of any issuer with an aggregate book value in excess of 10% of the Savings Bank's equity, excluding those issued by the United States Government or its agencies. The following table sets forth the contractual maturities of the Savings Bank's mortgage-backed securities at December 31, 1996.
DUE IN ---------------------------------------------------------------------------------------------------------------- LESS THAN 1 TO 3 3 TO 5 5 TO 10 10 TO 20 OVER 20 DECEMBER 31, 1996 CARRYING 1 YEAR YEARS YEARS YEARS YEARS YEARS AMORTIZED COST VALUE --------- ------------ ------------ ------------- --------- --------- ------------------- -------- AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR COST COST COST COST COST COST VALUE ------------ ------------ ------------- --------- --------- --------- ------- (DOLLARS IN THOUSANDS) GNMA.......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 1,361 $ 1,361 $ 1,398 $ 1,361 FHLMC......... 341 2,105 723 0 6,659 981 10,809 10,699 10,771 FNMA.......... 0 113 1,329 0 0 0 1,442 1,390 1,387 ------- ------ ------ ------ -------- ------- ------- ------- ------- Total......... $ 341 $2,218 $2,052 0 $ 6,659 $ 2,342 $13,612 $13,487 $13,519 ======= ====== ====== ====== ======= ======= ======= ======= ======= Weighted Average Yield....... 6.50% 5.67% 5.28% N/A 6.44% 7.18% 6.27% N/A N/A ======= ====== ====== ====== ======= ======= ======= ======= =======
The weighted yield for investment securities including held to maturity and available for sale is based upon historical amortized cost balances. 30 31 The following table sets forth the contractual maturities of the Savings Bank's securities classified as held-to-maturity at December 31, 1996.
DUE IN DECEMBER 31, 1996 ------------------------------------------------------------------------------------------- TOTAL MORTGAGE- DUE 1 BACKED YEAR OR 10 TO 20 OVER 20 SECURITIES LESS 1 TO 3 YEARS 3 TO 5 YEARS 5 TO 10 YEARS YEARS YEARS ------------------ AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR CARRYING COST COST COST COST COST COST COST VALUE VALUE --------- ------------ ------------ ------------- --------- --------- --------- ------- -------- U.S. Gov't & Agency Securities... $ 0 $ 999 $1,003 $ 8,033 $ 500 $ 0 $10,535 $10,470 $10,535 FHLMC Certificates... 341 762 0 0 6,659 691 8,453 8,381 8,453 GNMA Certificates... 0 0 0 0 0 1,361 1,361 1,398 1,361 FNMA Certificates... 0 113 0 0 0 0 113 116 113 ------- ------ ------ ------- ------- ------- ------- ------- ------- Total......... $ 341 $1,874 $1,003 $ 8,033 $ 7,159 $ 2,052 $20,462 $20,365 $20,462 ======= ====== ====== ======= ======= ======= ======= ======= ======= Weighted Average Yield....... 6.50% 6.46% 5.50% 7.39% 6.55% 7.06% 6.87% ======= ====== ====== ======= ======= ======= =======
The weighted yield for investment securities including held to maturity and available for sale is based upon historical amortized cost balances. The following table sets forth the contractual maturities of the Savings Bank's securities classified as available-for-sale at December 31, 1996.
DUE IN ------------------------------------------------------------------------------------------- DECEMBER 31, 1996 DUE 1 TOTAL MORTGAGE- YEAR OR 10 TO 20 OVER 20 BACKED SECURITIES LESS 1 TO 3 YEARS 3 TO 5 YEARS 5 TO 10 YEARS YEARS YEARS ------------------ AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR CARRYING COST COST COST COST COST COST COST VALUE VALUE --------- ------------ ------------ ------------- --------- --------- --------- ------- -------- Marketable Equity Securities... $ 1,535 $ 0 $ 0 $ 0 $ 0 $ 0 $ 1,535 $ 1,518 $ 1,518 U.S. Gov't & Agency Securities... 0 2,000 0 2,503 2,000 0 6,503 6,333 6,333 FHLMC Certificates... 0 1,343 723 0 0 290 2,356 2,318 2,318 GNMA Certificates... 0 0 0 0 0 0 0 0 0 FNMA Certificates... 0 0 1,329 0 0 0 1,329 1,274 1,274 ------- ------ ------ ------- ------- ------- ------- ------- ------- Total......... $ 1,535 $3,343 $2,052 $ 2,503 $ 2,000 $ 290 11,723 $11,443 $11,443 ======= ====== ====== ======= ======= ======= ======= ======= ======= Weighted Average Yield....... 5.50% 4.82% 5.28% 6.89% 7.05% 8.00% 5.89% ======= ====== ====== ======= ======= ======= =======
The weighted yield for investment securities including held to maturity and available for sale is based upon historical amortized cost balances. At December 31, 1996, the weighted average contractual maturity of all of the Savings Bank's mortgage-backed securities was approximately 11 years and the weighted average yield on the mortgage-backed securities portfolio was 6.27%. The actual maturity of a mortgage-backed security is less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and adversely affect its yield to maturity. The yield is based upon the interest income and the amortization of any premium or discount related to the mortgage-backed security. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying 31 32 mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Savings Bank may be subject to reinvestment risk because to the extent that the Savings Bank's mortgage-backed securities amortize or prepay faster than anticipated, the Savings Bank may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. At December 31, 1996, of the $13.6 million of mortgage-backed securities, an aggregate of $10.1 million were secured by fixed-rate mortgage loans and an aggregate of $3.5 million were secured by adjustable-rate mortgage loans. In February 1992, the OTS adopted a policy statement which states, among other things, that mortgage derivative products (including CMOs and CMO residuals and stripped mortgage backed securities) which possess average life or price volatility in excess of a benchmark fixed rate 30-year mortgage-backed pass-through security are "high-risk mortgage securities," are not suitable investments for depository institutions, must be carried in the institution's trading account or as assets held for sale, and must be marked to market on a regular basis. The Savings Bank has no "high risk" mortgage securities at December 31, 1996 and has no present intention to invest in such products. SOURCES OF FUNDS GENERAL. The principal source of funds for the Company is the repayment of the loan to the ESOP, dividends on its equity investments (including its ownership of all of the capital stock of the Savings Bank) and interest paid on deposits maintained at the Savings Bank. The Savings Bank's principal source of funds for use in lending and for other general business purposes has traditionally come from deposits obtained through the Savings Bank's branch offices. The Savings Bank also derives funds from amortization and prepayments of outstanding loans and mortgage-backed securities and from maturing investment securities. The Savings Bank has also borrowed, from time to time, from the FHLB of Pittsburgh. Loan repayments are a relatively stable source of funds, while deposits inflows and outflows are significantly influenced by general interest rates and money market conditions. DEPOSITS. The Savings Bank's current deposit products include passbook accounts, negotiable order of withdrawal ("NOW") accounts, non-interest bearing demand deposit accounts, money market deposit accounts and certificates of deposit ranging in terms from six months to five years. The Savings Bank's deposit products also include Individual Retirement Account ("IRA") and Keogh certificates. The Savings Bank's deposits are obtained primarily from residents in its primary market area of Allegheny County and portions of Washington County and Westmoreland County, all of which are located in Western Pennsylvania. The Savings Bank to a lesser extent obtains deposits from other locations in the greater Pittsburgh metropolitan area. The Savings Bank attracts deposit accounts by offering a wide variety of accounts, competitive interest rates, and convenient branch office locations and service hours. The Savings Bank primarily utilizes print media to attract new customers and savings deposits. The Savings Bank has never utilized the services of deposit brokers and had no brokered deposits at December 31, 1996. The Savings Bank presently operates three automated teller machines ("ATMs"), one at each of the branch offices. The Savings Bank is affiliated with a regional ATM network. The Savings Bank has been competitive in the types of accounts and in interest rates it has offered on its deposit products but does not necessarily seek to match the highest rates paid by competing institutions. At times of declining interest rates, the Savings Bank has chosen to aggressively price certificate of deposit rates to discourage disintermediation of deposits into competing investment products offered by other institutions. 32 33 The following table shows the distribution of, and certain other information relating to, the Savings Bank's deposits by type of deposit as of the dates indicated.
DECEMBER 31, ---------------------------------------------------------------- 1996 1995 1994 ------------------ ------------------ ------------------ AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Passbook and club accounts............. $15,476 18.46% $16,396 20.32% $18,053 23.97% Money market........................... 13,513 16.12 9,085 11.25 10,663 14.16 Certificates of deposit................ 43,683 52.12 45,842 56.78 37,905 50.33 NOW accounts........................... 8,595 10.25 7,325 9.07 7,382 9.80 Non-interest bearing................... 2,554 3.05 2,083 2.58 1,310 1.74 ------- ------ ------- ------ ------- ------ Total deposits....................... $83,821 100.00% $80,731 100.00% $75,313 100.00% ======= ====== ======= ====== ======= ======
The following table presents, by various interest rate categories, the amount of certificates of deposit at December 31, 1996 and the amounts at December 31, 1996 which mature during the periods indicated.
TOTAL AS OF DECEMBER 31, 1996 ------------ AMOUNTS AT DECEMBER 31, 1996 MATURING WITHIN ------------------------------------ AFTER ONE BUT WITHIN ONE THREE CERTIFICATES OF DEPOSIT YEAR YEARS THEREAFTER - ------------------------------------------------- ------- ---------- ---------- (DOLLARS IN THOUSANDS) 4.01% to 6.00%................................... $ 33,528 $27,311 $ 4,261 $1,956 6.01% to 8.00%................................... 10,155 1,054 6,477 2,624 -------- ------- -------- ------ Total certificate accounts..................... $ 43,683 $28,365 $ 10,738 $4,580 ======== ======= ======== ======
The following table presents the average balance of each deposit type and the average rate paid on each deposit type, net of early withdrawal penalties for the periods indicated.
DECEMBER 31, ---------------------------------------------------------------------- 1996 1995 1994 -------------------- -------------------- -------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID ------- --------- ------- --------- ------- --------- (DOLLARS IN THOUSANDS) Passbook and club accounts......... $16,112 2.55% $16,882 2.54% $20,141 2.57% Money market....................... 10,649 3.15 9,914 2.97 11,204 2.77 Certificates of deposit............ 45,522 5.54 42,456 5.58 34,858 4.34 NOW accounts....................... 8,009 1.73 7,017 1.72 7,137 1.73 Non-interest bearing............... 2,002 0.00 1,442 0.00 975 0.00 ------- ---- ------- ---- ------- ---- Total deposits..................... $82,294 4.14% $77,711 4.14% $74,315 3.32% ======= ==== ======= ==== ======= ====
The following table sets forth the Savings Bank's net savings flows during the periods indicated.
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 ------- ------- ------- (IN THOUSANDS) Beginning balance............................................. $80,731 $75,313 $74,727 (Decrease) Increase before interest credited.................. (317) 2,201 (1,875) Interest credited............................................. 3,407 3,217 2,461 Net savings increase.......................................... 3,090 5,418 586 ------- ------- ------- Ending balance................................................ $83,821 $80,731 $75,313 ======= ======= =======
33 34 The following table sets forth maturities of the Savings Bank's certificates of deposit of $100,000 or more at December 31, 1996 by time remaining to maturity.
IN THOUSANDS ------------ Three months or less............................................................ $ 410 Over three months through six months............................................ 2,368 Over six months through 12 months............................................... 1,013 Over 12 months.................................................................. 640 ------ Total......................................................................... $4,431 ======
BORROWINGS FROM FHLB OF PITTSBURGH AS OF DECEMBER 31. The following table sets forth the borrowing history of the Savings Bank from the FHLB of Pittsburgh for the last three years.
AT DECEMBER 31, ----------------------------- 1996 1995 1994 ------- ------ ------ (DOLLARS IN THOUSANDS) Amount Outstanding At Year End................................ $14,477 $2,977 $4,261 ======= ====== ====== Maximum Balance............................................... $15,077 $4,861 $5,161 ======= ====== ====== Average Balance............................................... $ 5,169 $3,078 $3,194 ======= ====== ====== Weighted Average Interest Rate: At end of year.............................................. 5.96% 6.25% 6.19% ======= ====== ====== During Year................................................. 5.34% 6.24% 4.88% ======= ====== ======
The Savings Bank utilized the increased borrowings during 1996 to meet increased loan demand. As of December 31, 1996, the Savings Bank also had a revolving credit commitment from the FHLB of Pittsburgh of $6.5 million all of which remained available for borrowing. This revolving credit commitment now expires on March 25, 1997 unless the Savings Bank and FHLB of Pittsburgh negotiate an extension. Management has no indication at this time the FHLB of Pittsburgh will be unwilling to, or has any reason not to, agree to an extension of this revolving credit commitment. To secure the repayment of any outstanding borrowings from the FHLB of Pittsburgh and any borrowings under this revolving credit commitment or any other credit product offered by the FHLB of Pittsburgh, the Savings Bank has pledged to the FHLB of Pittsburgh investments of the Savings Bank in U.S. Government and U.S. agency securities and U.S. Government and U.S. agency mortgage-backed securities and 100% of its unencumbered home loan mortgages. REGULATORY CAPITAL REQUIREMENTS Federally insured savings institutions are required to maintain minimum levels of regulatory capital. Pursuant to Federal regulations, the OTS has established capital standards applicable to all savings institutions. These standards generally must be as stringent as the comparable capital requirements imposed on national banks. The OTS also is authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. 34 35 At December 31, 1996, the Savings Bank exceeded all of the capital requirements applicable to it. Set forth below is a summary of the Savings Bank's compliance with the applicable capital standards as of December 31, 1996 and as of December 31 of each of the preceding four years.
AS OF AS OF AS OF AS OF AS OF DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993 DECEMBER 31, 1992 ------------------- ------------------ ------------------ ------------------ ------------------ PERCENT OF PERCENT OF PERCENT OF PERCENT OF PERCENT OF AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) ------- ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- (DOLLARS IN THOUSANDS) Tangible capital: (1) Requirement........ $ 1,719 1.50% $1,378 1.50% $1,316 1.50% $1,238 1.50% $1,174 1.50% Actual............. 11,787 10.28 7,228 7.87 7,049 8.03 6,500 7.90 5,823 7.44 Excess............. $10,068 8.78% $5,850 6.37% $5,733 6.53% $5,262 6.40% $4,649 5.94% Core capital: (2) Requirement........ $3,438 3.00% $2,757 3.00% $2,632 3.00% $2,476 3.00% $2,348 3.00% Actual............. 11,787 10.28 7,228 7.87 7,049 8.03 6,500 7.90 5,823 7.44 Excess............. $8,349 7.28% $4,471 4.87% $4,417 5.03% $4,024 4.90% $3,475 4.44% Risk-based capital: Requirement (4).... $ 4,064 8.00% $3,101 8.00% $2,985 8.00% $2,682 8.00% $2,676 8.00% Actual (3)......... 12,094 23.81 7,515 19.39 7,352 19.70 6,800 20.30 6,073 18.20 Excess............. $ 8,030 15.81% $4,414 11.39% $4,367 11.70% $4,118 12.30% $3,397 10.20%
- --------- (1) Tangible capital levels are shown as a percentage of tangible assets. Core capital levels are shown as a percentage of adjusted assets. Risk-based capital levels are shown as a percentage of risk-weighted assets. The difference between capital under generally accepted accounting principles ("GAAP") and regulatory tangible and core capital is attributable to $158,000 for the Company's net unrealized holding losses on available-for-sale securities to arrive at regulatory tangible and core capital of $11,787,000. (2) To be "adequately capitalized" for purposes of the OTS' Prompt Corrective Action regulations, core capital generally must be at least 4.0%. (3) The difference between capital under generally accepted accounting principles and regulatory risk-based capital is attributable to an addition to generally accepted accounting principles capital of $307,000 for the allowance for loan loss and $158,000 for the Savings Bank's net unrealized holding gains (losses) on available-for-sale securities to arrive at regulatory risk-based capital of $12,094. (4) Calculated based on the OTS requirement of 8.0% of risk-weighted assets. 35 36 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Prestige Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of Prestige Bancorp, Inc. (the Corporation) and Subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Prestige Bancorp, Inc. and Subsidiary as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As explained in Note 2 to the consolidated financial statements, effective January 1, 1995, the Corporation changed its method of accounting for loan losses. In addition, as also discussed in Note 2 to the consolidated financial statements, effective January 1, 1994, the Corporation changed its method of accounting for investments in debt and equity securities. ARTHUR ANDERSEN LLP Pittsburgh, Pennsylvania, January 14, 1997 (except with respect to the matters discussed in Note 18, as to which the date is March 3, 1997) 36 37 PRESTIGE BANCORP, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995
1996 1995 ------------ ----------- ASSETS Cash and due from banks......................................... $ 735,951 $ 779,397 Interest-bearing deposits with banks............................ 1,411,727 3,614,270 Investment securities: Available for sale............................................ 11,442,549 7,491,045 Held to maturity (market value $20,364,934 and $15,193,150, respectively).............................................. 20,461,927 15,074,601 Loans........................................................... 77,364,459 61,737,509 Less--Unearned income (deferred costs), net..................... (2,735) 42,204 Allowance for loan losses................................ 306,926 287,060 Loans in process......................................... 515,115 -- ------------ ----------- Net loans............................................. 76,545,153 61,408,245 ------------ ----------- Federal Home Loan Bank stock, at cost........................... 753,900 733,700 Premises and equipment, net..................................... 1,880,919 1,868,569 Accrued interest receivable..................................... 810,884 573,548 Deferred tax asset.............................................. 35,726 -- Other assets.................................................... 561,413 297,280 ------------ ----------- Total assets.................................................... $114,640,149 $91,840,655 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Noninterest-bearing deposits.................................. $ 2,554,148 $ 2,082,444 Interest-bearing deposits..................................... 81,267,320 78,648,228 ------------ ----------- Total deposits........................................ 83,821,468 80,730,672 Federal Home Loan Bank advances............................... 14,477,000 2,977,000 Advance payments by borrowers for taxes and insurance......... 622,057 571,780 Income taxes payable.......................................... 24,360 71,149 Deferred tax liability........................................ -- 45,317 Other liabilities............................................. 265,064 266,762 ------------ ----------- Total liabilities..................................... 99,209,949 84,662,680 ------------ ----------- Stockholders' Equity: Preferred stock, $1.00 par value; 5,000,000 shares authorized, none issued................................................ -- -- Common stock--Par $1.00 value; 10,000,000 shares authorized, 963,023 shares issued and outstanding...................... 963,023 -- Additional paid in capital.................................... 8,000,176 -- Unearned ESOP shares.......................................... (755,490) -- Retained earnings............................................. 7,390,945 7,245,432 Net unrealized holding gains (losses) on available for sale securities, net of taxes................................... (168,454) (67,457) ------------ ----------- Total stockholders' equity............................ 15,430,200 7,177,975 ------------ ----------- Total liabilities and stockholders' equity...................... $114,640,149 $91,840,655 ============ ===========
The accompanying notes are an integral part of these statements 37 38 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ---------- ---------- ---------- INTEREST INCOME: Interest and fees on loans............................ $5,078,301 $4,289,258 $3,980,325 Interest on mortgage-backed securities................ 922,491 1,014,922 1,023,267 Interest and dividends on other investment securities.......................................... 656,991 334,581 289,944 Interest on deposits in other financial institutions........................................ 90,584 80,180 20,751 ---------- ---------- ---------- Total interest income.......................... 6,748,367 5,718,941 5,314,287 ---------- ---------- ---------- INTEREST EXPENSE: Interest on deposits.................................. 3,406,804 3,213,488 2,463,689 Advances from Federal Home Loan Bank.................. 276,022 192,148 156,513 ---------- ---------- ---------- Total interest expense......................... 3,682,826 3,405,636 2,620,202 ---------- ---------- ---------- Net interest income............................ 3,065,541 2,313,305 2,694,085 ---------- ---------- ---------- PROVISION FOR LOAN LOSSES............................. 44,000 36,000 36,000 ---------- ---------- ---------- Net interest income after provision for loan losses...................................... 3,021,541 2,277,305 2,658,085 ---------- ---------- ---------- OTHER INCOME: Fees and service charges.............................. 260,685 217,937 219,035 Other income, net..................................... 36,327 3,893 75,010 ---------- ---------- ---------- Total other income............................. 297,012 221,830 294,045 ---------- ---------- ---------- OTHER EXPENSES: Salaries and employee benefits........................ 1,221,432 1,016,382 934,035 Premises and occupancy costs.......................... 326,200 314,513 261,098 Federal deposit insurance premiums.................... 175,984 174,225 170,684 Special SAIF assessment............................... 501,727 -- -- Data processing costs................................. 171,485 154,063 132,832 Advertising costs..................................... 86,157 93,740 102,208 Transaction processing costs.......................... 159,213 141,418 128,853 ATM transaction fees.................................. 92,174 86,243 69,012 Other expenses........................................ 369,282 274,623 258,857 ---------- ---------- ---------- Total other expenses........................... 3,103,654 2,255,207 2,057,579 ---------- ---------- ---------- Income before income tax expense...................... 214,899 243,928 894,551 INCOME TAX EXPENSE.................................... 69,386 83,069 346,123 ---------- ---------- ---------- NET INCOME............................................ $ 145,513 $ 160,859 $ 548,428 ========== ========== ========== Earnings per share (for period subsequent to initial issuance of common stock on June 27, 1996--Note 2).................................................. $ -- ========== Weighted average shares outstanding from June 27, 1996 to December 31, 1996................................ 886,755 ==========
The accompanying notes are an integral part of these statements 38 39 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NET UNREALIZED HOLDING GAINS (LOSSES) ON ADDITIONAL AVAILABLE FOR COMMON STOCK PAID-IN UNEARNED RETAINED SALE SECURITIES, $1.00 PAR VALUE CAPITAL ESOP SHARES EARNINGS NET OF TAXES TOTAL --------------- ---------- ----------- ---------- ---------------- ----------- BALANCE, December 31, 1993....... $ -- $ -- $ -- $6,536,145 $ (15,287) $ 6,520,858 Net income....................... -- -- -- 548,428 -- 548,428 Increase in net unrealized (losses) on available for sale securities, net of tax......... -- -- -- -- (20,176) (20,176) --------- ---------- --------- ---------- ---------- ----------- BALANCE, December 31, 1994....... -- -- -- 7,084,573 (35,463) 7,049,110 Net income....................... -- -- -- 160,859 -- 160,859 Increase in net unrealized (losses) on available for sale securities, net of tax......... -- -- -- -- (31,994) (31,994) --------- ---------- --------- ---------- ---------- ----------- BALANCE, December 31, 1995....... -- -- -- 7,245,432 (67,457) 7,177,975 Net income....................... -- -- -- 145,513 -- 145,513 Issuance and exchange of 963,023 shares of common stock as a result of the conversion....... 963,023 7,995,781 -- -- -- 8,958,804 77,014 shares acquired for ESOP........................... -- -- (770,410) -- -- (770,410) Allocation of 1,492 ESOP shares......................... -- 4,395 14,920 -- -- 19,315 Increase in net unrealized (losses) on available for sale securities, net of tax......... -- -- -- -- (100,997) (100,997) --------- ---------- --------- ---------- ---------- ----------- BALANCE, December 31, 1996....... $ 963,023 $8,000,176 $(755,490) $7,390,945 $ (168,454) $15,430,200 ========= ========== ========= ========== ========== ===========
The accompanying notes are an integral part of these statements 39 40 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ------------ ----------- ----------- OPERATING ACTIVITIES: Net income.............................................................. $ 145,513 $ 160,859 $ 548,428 ------------ ----------- ----------- Adjustments to reconcile net income to net cash (used) provided by operating activities-- Depreciation of premises and equipment.............................. 171,044 155,618 112,641 Amortization of premiums and discounts, net......................... (4,354) (2,791) (44,230) Non cash compensation expense related to ESOP benefit............... 30,071 -- -- Loss on sale of premises and equipment.............................. -- 32,675 -- Provision for loan losses........................................... 44,000 36,000 36,000 (Decrease) increase in other liabilities............................ (12,454) (139,473) 280,093 (Decrease) increase in income taxes payable......................... (60,524) (81,736) 60,928 Increase in accrued interest receivable............................. (237,334) (63,991) (14,745) Decrease (increase) in other assets................................. 1,584 (88,230) (67,896) Other, net.......................................................... 1,783 (13,862) 8,626 ------------ ----------- ----------- Total adjustments.............................................. (66,184) (165,790) 371,417 ------------ ----------- ----------- Net cash provided (used) by operating activities............... 79,329 (4,931) 919,845 ------------ ----------- ----------- INVESTING ACTIVITIES: Loan originations....................................................... (26,118,053) (8,875,462) (15,090,193) Principal payments on loans............................................. 10,935,360 8,080,275 9,513,168 Proceeds from maturity of held to maturity investment securities........ 1,700,000 500,000 2,000,000 Purchases of held to maturity investment securities..................... (8,735,000) (1,502,422) (2,479,184) Purchases of available for sale securities.............................. (4,747,900) (67,785) (48,261) Principal payments on available for sale mortgage-backed securities..... 637,010 -- -- Principal payments on held to maturity mortgage-backed securities....... 1,643,112 1,719,761 2,147,600 Purchases of mortgage-backed securities................................. -- (978,469) (989,688) Purchases of premises and equipment..................................... (183,397) (275,007) (791,266) Proceeds from sale of premises and equipment............................ -- 90,053 -- Purchase of land........................................................ (265,717) -- -- Purchase of Federal Home Loan Bank stock................................ (20,200) (40,000) (66,700) ------------ ----------- ----------- Net cash used by investing activities.......................... (25,154,785) (1,349,056) (5,804,524) ------------ ----------- ----------- FINANCING ACTIVITIES: Net change in advance payments by borrowers for taxes and insurance..... 50,277 74,635 (7,158) Proceeds from Federal Home Loan Bank advances........................... 44,850,000 2,027,000 9,700,000 Payments on Federal Home Loan Bank advances............................. (33,350,000) (3,311,400) (5,900,000) Net increase (decrease) in money market, NOW and passbook savings accounts.............................................................. 5,249,401 (2,519,341) (2,446,269) Net (decrease) increase in certificate accounts......................... (2,158,605) 7,936,529 3,033,140 Net proceeds from stock offering........................................ 8,188,394 -- -- ------------ ----------- ----------- Net cash provided by financing activities...................... 22,829,467 4,207,423 4,379,713 ------------ ----------- ----------- Net (decrease) increase in cash and cash equivalents........... (2,245,989) 2,853,436 (504,966) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.......................... 4,393,667 1,540,231 2,045,197 ------------ ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR................................ $ 2,147,678 $ 4,393,667 $ 1,540,231 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for income taxes.............................. $ 132,000 $ 129,770 $ 290,000 ============ =========== =========== Cash paid during the year for interest on deposits and borrowings....... $ 3,682,828 $ 3,408,936 $ 2,619,414 ============ =========== =========== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITY: Loans transferred to real estate owned.................................. $ 10,000 $ 80,716 $ 9,156 ============ =========== =========== Investment securities transferred from held to maturity to available for sale.................................................................. $ -- $ 6,316,596 $ 1,155,506 ============ =========== ===========
The accompanying notes are an integral part of these statements 40 41 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 AND 1995 1. PLAN OF CONVERSION: On February 14, 1996, the Board of Directors of Prestige Bank, F.S.B. (the Bank) adopted a Plan of Conversion (the Plan) from a federally chartered mutual savings bank to a federally chartered stock savings bank and the issuance of its stock to Prestige Bancorp, Inc., a newly formed Pennsylvania corporation (the Corporation). The Plan provided that the holding company offer nontransferable subscription rights to purchase common stock of the holding company. The rights were offered first to eligible account holders of record, a tax-qualified employee stock ownership plan to be adopted by the Bank, supplemental eligible account holders, certain other depositors and borrowers, and directors, officers and employees. The Corporation sold 963,023 shares of its common stock (including 77,041 shares to its newly formed Employee Stock Ownership Trust (the ESOP)) at $10.00 per share. Simultaneously there was a corresponding exchange all of the Bank's stock for approximately 50% of the net offering proceeds. The remaining portion of the net proceeds were retained by the Corporation net of $770,410 which was loaned to the ESOP for its purchase. The conversion and public offering was completed on June 27, 1996 with net proceeds from the offering, net of the ESOP loan, totaling $8,188,394 after offering expenses. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF OPERATIONS Prestige Bancorp, Inc. through its wholly-owned subsidiary, the Bank, is primarily engaged in the business of attracting deposits in the form of savings accounts and investing such funds in the origination or purchase of commercial loans, residential mortgage loans and consumer loans, including credit card services, and in mortgage-backed and other securities. The Bank conducts its business through three offices located in the Greater Pittsburgh Metropolitan Area. The following comprise the significant accounting policies which the Corporation follows in preparing and presenting its financial statements: PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiary, the Bank. All significant intercompany accounts and transactions have been eliminated in preparing the consolidated financial statements. CASH AND CASH EQUIVALENTS Cash and cash equivalents in the accompanying statements of cash flows include cash and due from banks and interest-bearing deposits with banks. Interest-bearing deposits are on deposit with domestic banks and are due within three months. The Corporation had no deposits in foreign banks or in foreign branches of United States banks. In addition, cash and due from banks at December 31, 1996 and 1995, included $77,000 and $117,000, respectively, of reserves required to be maintained under Federal Reserve Bank regulations. INVESTMENT SECURITIES Effective January 1, 1994, the Bank adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which specifies a methodology for the classification of such securities as either held to maturity, available for sale or as trading assets. Securities are classified at the time of purchase as investment securities held to maturity if it is management's intent and the Corporation has the ability to hold the securities until maturity. Debt securities classified as held to maturity are carried on the Corporation's books at cost, adjusted for amortization of premium and 41 42 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED accretion of discount using the interest method. Alternatively, investments are classified as available for sale if it is management's intent at the time of purchase to hold the securities for an indefinite period of time and/or to use the investments as part of the Corporation's asset/liability management strategy. Investments classified as available for sale include securities which may be sold to effectively manage interest rate risk exposure, prepayment risk and other factors (such as liquidity requirements). These available for sale securities are reported at fair value with unrealized aggregate appreciation (depreciation) excluded from income and credited (charged) to a separate component of equity on a net of tax basis. The Corporation presently is not authorized to and does not engage in trading activity. Gains or losses on the sale of available for sale securities are recognized in income upon realization using the specific identification method. LOANS RECEIVABLE Loans receivable are stated at their unpaid principal balances, including any allowances for anticipated loss. Interest on loans is credited to income as earned. Accrual of interest income is discontinued when reasonable doubt exists regarding collectibility, generally when payment of principal or interest is 90 days or more past due and repayment is less than assured. For loans which have been placed on a nonaccrual basis, previously accrued but unpaid interest is reversed and subsequently recognized only to the extent payment is received and recovery of principal is assured. ALLOWANCE FOR LOAN LOSSES AND REAL ESTATE OWNED The allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates. These estimates are continually reviewed and, as adjustments become necessary, they are reported in earnings in the period in which they become known. The allowance for possible loan losses is established through a provision charged to expense and recoveries. Effective January 1, 1995, the Bank adopted SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which was subsequently amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures." SFAS No. 114 addresses the treatment and disclosure of certain loans where it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. This standard defines the term "impaired loan" and indicates the method used to measure the impairment. The measurement of impairment may be based upon (a) the present value of expected future cash flows discounted at the loan's effective interest rate; (b) the observable market price of the impaired loan; or (c) the fair value of the collateral of a collateral dependent loan. Additionally, these statements require disclosure of how the creditor recognizes the interest income related to these impaired loans. The adoption of these statements did not have a material impact on the financial statements. The Corporation's policy is to review separately each of its commercial loans in order to determine if a loan is impaired. The Corporation also has identified two pools of small-dollar-value homogeneous loans which are evaluated collectively for impairment. These separate pools are for residential mortgage loans and for consumer loans. As facts such as a significant delinquency in payments of 90 days or more, a bankruptcy or other circumstances become known on specific loans within either loan pool, individual loans are reviewed and are removed from the pool if deemed to be impaired. The Corporation considers its specifically identified impaired loans to be collateral dependent; therefore, the fair value of the collateral of the impaired loans is evaluated in measuring the impairment. For its two loan pools, the Corporation calculates expected loan losses using a formula approach based primarily upon historical experience and current economic conditions. The Corporation's policy is to recognize interest on a cash basis for impaired loans and to charge off impaired loans when deemed uncollectible. 42 43 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED ORIGINATION FEES AND COSTS The Corporation defers all nonrefundable fees and capitalizes all material direct costs associated with each loan originated. The deferred fees and capitalized costs are accreted or amortized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for estimated prepayments based on the Corporation's historical prepayment experience. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation and amortization which is computed using the straight-line method over the estimated useful lives of the related assets which are from 2 to 50 years. DEPOSITS Interest on deposits is accrued and charged to expense monthly and is paid or credited in accordance with the terms of the respective accounts. EMPLOYEE BENEFITS The Corporation has a noncontributory pension plan covering substantially all employees of the Bank. Pension cost is charged to expense. Additionally, the Bank maintains a 401(k) plan for employees. The Bank does not match any employee contributions. Effective June 27, 1996, the Corporation established the ESOP plan, which acquired 77,041 shares in connection with the Plan of Conversion. As of December 31, 1996, 75,549 shares remain unearned. INCOME TAXES Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. EARNINGS PER SHARE Earnings per share of common stock for 1996 was computed by dividing net income subsequent to conversion by the weighted average number of shares outstanding subsequent to conversion on June 27, 1996. Earnings per share of the Corporation for the period from June 27, 1996, to December 31, 1996, was less than one-half of one cent per share. RISK MANAGEMENT OVERVIEW Risk identification and management are essential elements for the successful management of the Corporation. In the normal course of business, the Bank is subject to various types of risk, including interest rate, credit and liquidity risk. The Corporation controls and monitors these risks with policies, procedures and various levels of managerial and Board oversight. Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the magnitude, direction and frequency of changes in interest rates. Interest rate risk results from various repricing frequencies and the maturity structure of assets and liabilities. The Corporation uses its asset liability management policy to manage interest rate risk. 43 44 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from extending credit to customers and purchasing securities. The Corporation's primary credit risk occurs in the loan portfolio. The Corporation uses its credit policy and evaluation of the adequacy of the allowance for loan losses to control and manage credit risk. The Corporation's investment policy indicates the amount of credit risk that may be assumed in the investment portfolio. Liquidity risk represents the inability to generate cash or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers, as well as the obligations to depositors and the Federal Home Loan Bank (FHLB). The Corporation uses its asset liability management policy and its FHLB line of credit to manage liquidity risk. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from these estimates. FUTURE ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which provides for standardized accounting for transfers and servicing of financial assets and extinguishments of liabilities. This statement is effective for related transactions occurring after December 31, 1996, however, the FASB has indefinitely delayed the effective date for certain portions of this statement pending further clarification. Management does not believe the effect of adoption of this standard will be material. 3. INVESTMENT SECURITIES: The cost and market values of investment securities are summarized as follows: 44 45 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 3. INVESTMENT SECURITIES:--CONTINUED Investment securities held to maturity:
DECEMBER 31, 1996 ------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------- ---------- ---------- ----------- U.S. government and government agency obligations: Due after one and within five years......................... $ 2,001,817 $18,585 $ 34,157 $ 1,986,245 Due within ten years............ 8,033,495 -- 44,595 7,988,900 Due after ten years............. 500,000 -- 4,750 495,250 Federal Home Loan Mortgage Corporation (FHLMC) certificates: Due within one year............. 341,450 5,365 -- 346,815 Due after one and within five years......................... 762,019 2,372 -- 764,391 Due after ten years............. 7,349,663 3,882 83,648 7,269,897 Government National Mortgage Association (GNMA) certificates due after 10 years..................... 1,360,819 36,582 -- 1,397,401 Federal National Mortgage Association (FNMA) certificates due after one and within five years.............. 112,664 3,371 -- 116,035 ----------- ------- -------- ----------- $20,461,927 $70,157 $167,150 $20,364,934 =========== ======= ======== ===========
The maturities within the table above are based upon contractual maturity. Investment securities available for sale:
DECEMBER 31, 1996 ------------------------------------------------------ GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------- ---------- ---------- ----------- U.S. government and government agency obligations: Due after one and within five years......................... $ 2,000,000 -- $ 41,260 $ 1,958,740 Due within ten years............ 2,503,498 -- 56,323 2,447,175 Due after ten years............. 2,000,000 -- 73,440 1,926,560 Federal Home Loan Mortgage Corporation (FHLMC) certificates: Due after one and within five years......................... 2,065,943 163 45,028 2,021,078 Due after ten years............. 289,776 6,704 -- 296,480 Federal National Mortgage Association (FNMA) certificates due after one and within five years.............. 1,329,314 -- 54,837 1,274,477 Mutual fund investment............... 1,363,213 -- 45,174 1,318,039 Common stock portfolio............... 171,500 28,500 -- 200,000 ----------- ------- -------- ----------- $11,723,244 $35,367 $316,062 $11,442,549 =========== ======= ======== ===========
The maturities within the table above are based upon contractual maturity. 45 46 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 3. INVESTMENT SECURITIES:--CONTINUED Investment securities held to maturity:
DECEMBER 31, 1995 ------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------- ---------- ---------- ----------- U.S. government and government agency obligations........................ $ 3,502,280 $ 37,581 $ 8,064 $ 3,531,797 Federal Home Loan Mortgage Corporation (FHLMC) certificates... 9,840,500 78,425 20,706 9,898,219 Government National Mortgage Association (GNMA) certificates.... 1,584,387 27,971 -- 1,612,358 Federal National Mortgage Association (FNMA) certificates................ 147,434 3,342 -- 150,776 ----------- -------- ------- ----------- $15,074,601 $147,319 $28,770 $15,193,150 =========== ======== ======= ===========
Investment securities available for sale:
DECEMBER 31, 1995 ---------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- U.S government and government agency obligations.......................... $1,998,958 $ -- $ 38,646 $1,960,312 Federal Home Loan Mortgage Corporation (FHLMC) certificates................. 2,930,459 18,287 20,403 2,928,343 Federal National Mortgage Association (FNMA) certificates.................. 1,387,217 -- 42,322 1,344,895 Mutual fund investment................. 1,286,839 -- 29,344 1,257,495 ---------- ------- -------- ---------- $7,603,473 $18,287 $130,715 $7,491,045 ========== ======= ======== ==========
In the fourth quarter of 1995, concurrent with the adoption of its implementation guide on SFAS No. 115, the Financial Accounting Standards Board allowed a one-time reassessment of the SFAS No. 115 classifications of all securities currently held. The Corporation used the opportunity under this one-time reassessment to reclassify $6,316,596 in mortgage-backed and other securities from the held to maturity portfolio to the available for sale portfolio. In connection with this reclassification, gross unrealized gains of $18,329 and gross unrealized losses of $107,180 were recorded in available for sale securities and in equity on a net of tax basis. 46 47 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 3. INVESTMENT SECURITIES:--CONTINUED The activity of the net unrealized holding gains (losses) (net of tax basis) on available for sale securities for the years ended December 31, 1996 and 1995, respectively, are as follows:
1996 1995 --------- -------- Beginning balance in equity.................................. $ (67,457) $(35,463) Unrealized gains (losses) on securities transferred into available for sale during the reassessment period.......... -- (53,311) Net change in unrealized gains (losses) on securities held as available for sale during the period....................... (100,997) 21,317 -------- -------- Ending balance in equity..................................... $(168,454) $(67,457) ========= ========
Mortgage-backed securities include net unamortized discounts of $48,910 and $50,716 at December 31, 1996 and 1995, respectively. 4. LOANS RECEIVABLE: Loans receivable at December 31, 1996 and 1995, are summarized as follows:
1996 1995 ----------- ----------- Commercial, including commercial secured by real estate................................................. $ 2,032,794 $ 814,893 Real estate loans: 1-4 family............................................. 65,117,008 55,366,847 Construction........................................... 925,100 -- ----------- ----------- 66,042,108 55,366,847 Less--Undisbursed loan proceeds........................ 515,115 -- Deferred loan (costs)/fees...................... (2,735) 42,204 ----------- ----------- 65,529,728 55,324,643 ----------- ----------- Consumer loans: Home equity............................................ $ 4,562,094 $ 2,052,826 Student................................................ 2,228,756 2,220,329 Automobile............................................. 1,515,015 713,435 Share.................................................. 486,695 477,793 Credit cards........................................... 398,840 90,557 Personal unsecured/other............................... 98,157 829 ----------- ----------- 9,289,557 5,555,769 ----------- ----------- 76,852,079 61,695,305 Less--Allowance for loan losses........................ 306,926 287,060 ----------- ----------- $76,545,153 $61,408,245 =========== ===========
The credit cards are currently being serviced by a third party. At December 31, 1996 and 1995, the majority of the loan portfolio was secured by properties located in Western Pennsylvania. As of December 31, 1996, loans to customers engaged in similar activities and having similar economic characteristics, as defined by standard industrial classifications, did not exceed 10% of total loans. As of December 31, 1996 and 1995, the Bank had approximately $341,000 and $306,000 of nonaccrual loans. The Bank does not have any other significant off-balance sheet risk except for the commitments 47 48 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 4. LOANS RECEIVABLE:--CONTINUED referenced in Note 16. Deferred loan costs in 1996 occurred due to the Bank incurring direct costs in excess of loan origination fees received on certain new commercial loans. 5. ALLOWANCE FOR LOAN LOSSES: Activity with respect to the allowance for loan losses is summarized as follows:
1996 1995 1994 -------- -------- -------- Balance at beginning of year....................... $287,060 $303,312 $267,811 Provision for loan losses.......................... 44,000 36,000 36,000 Charge-offs........................................ (24,294) (52,884) (1,192) Recoveries......................................... 160 632 693 -------- -------- -------- Balance at end of year............................. $306,926 $287,060 $303,312 ======== ======== ========
The adoption of SFAS No. 114 at January 1, 1995, resulted in loans totaling $391,000 being specifically identified as impaired and an allocation being made of the existing allowance for loan losses of approximately $27,000. At December 31, 1996 and 1995, the Bank had loans totaling $341,000 and $306,000, respectively, specifically identified as impaired. No specific allocation of the allowance for loan losses was deemed necessary for these impaired loans at these dates. The average recorded balances for impaired loans during 1996 and 1995 were $267,000, and $406,000, respectively. Interest income recognized during the time within the period that the loans were impaired was not significant. For these same loans, the interest income recognized on a cash basis during the period of impairment was not significant. The Corporation records real estate owned at the lower of fair value or carrying cost based upon appraisals less estimated cost to sell. The Corporation had real estate owned assets of $49,872 and $41,872 at December 31, 1996 and 1995, respectively. 6. FEDERAL HOME LOAN BANK STOCK: The Bank is a member of the Federal Home Loan Bank System. As a member, the Bank maintains an investment in the capital stock of the Federal Home Loan Bank of Pittsburgh, at cost, in an amount not less than 1% of its outstanding mortgage loans or 1/20 of its outstanding notes payable, if any, to the Federal Home Loan Bank of Pittsburgh, whichever is greater, as calculated at December 31 of each year. 7. PREMISES AND EQUIPMENT: Office premises and equipment at December 31, 1996 and 1995, are summarized by major classification as follows:
1996 1995 ---------- ---------- Land....................................................... $ 224,817 $ 224,817 Building and improvements.................................. 1,776,892 1,694,348 Furniture, fixtures and equipment.......................... 876,264 775,414 ---------- ---------- Total, at cost........................................ 2,877,973 2,694,579 Less--Accumulated depreciation............................. 997,054 826,010 ---------- ---------- Premises and equipment, net................................ $1,880,919 $1,868,569 ========== ==========
48 49 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 7. PREMISES AND EQUIPMENT:--CONTINUED Depreciation and amortization expense was $171,044, $155,618 and $112,641 for the fiscal years ended December 31, 1996, 1995 and 1994, respectively. 8. DEPOSITS: The aggregate amount of short-term jumbo certificates of deposit, each with a minimum denomination of $100,000, was approximately $4,431,000 and $6,071,000 at December 31, 1996, and 1995, respectively. At December 31, 1996 the scheduled maturities of the certificate accounts are as follows: 1997......................................... $28,365,781 1998......................................... 8,140,174 1999......................................... 2,597,409 2000......................................... 3,847,330 2001 and thereafter.......................... 732,500 ----------- $43,683,194 ===========
Interest expense associated with deposits for each of the years ended is as follows:
1996 1995 1994 ---------- ---------- ---------- Interest on certificates of deposit........... $2,530,750 $2,379,871 $1,523,005 Interest on savings accounts.................. 410,460 428,583 517,943 Money market demand accounts.................. 334,873 294,353 309,890 Interest on NOW accounts...................... 138,772 121,322 123,560 Early withdrawal penalties.................... (8,051) (10,641) (10,709) ---------- ---------- ---------- $3,406,804 $3,213,488 $2,463,689 ========== ========== ==========
During the third quarter of 1996, the Bank recorded a one-time special assessment of 65.7 basis points on deposits of record as of March 31, 1995. This assessment, in the amount of $501,727 before tax (approximately $308,000 after tax) charged by the Federal Deposit Insurance Corporation, was to provide additional capital for the savings association insurance fund. 9. FEDERAL HOME LOAN BANK ADVANCES: Advances from the Federal Home Loan Bank consist of the following:
DECEMBER 31, 1996 ---------------------------------------- WEIGHTED MATURITY AVERAGE RATE BALANCE --------- ------------ ---------- 1997 5.99% $ 3,000,000 1999 5.95 5,000,000 2000 6.11 977,000 2001 4.97 5,500,000 ----------- $14,477,000 ===========
49 50 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 9. FEDERAL HOME LOAN BANK ADVANCES:--CONTINUED
DECEMBER 31, 1995 ----------------------------------------- WEIGHTED MATURITY AVERAGE RATE BALANCE --------- ------------ ----------- 1996 6.04% $1,000,000 1997 6.60 1,000,000 2000 6.11 977,000 ---------- $2,977,000 ==========
As of December 31, 1996 and 1995, the Bank had an available balance under its line of credit of approximately $6,512,000 and $8,605,600, respectively, in connection with the Federal Home Loan Bank of Pittsburgh's Cash Management Advance Program. Of the total advances above, there were no previous borrowings against the line of credit as of December 31, 1996 and 1995. The Bank had a "blanket" agreement with the Federal Home Loan Bank of Pittsburgh whereby the Bank pledged as collateral for these advances its investments in U.S. government and agency securities and U.S. government and agency mortgage-backed securities and 100% of its unencumbered home mortgage loan portfolio. The $5.5 million advance that matures in 2001 at 4.97% is a convertible 5-year maturity with a 3 month repricing structure. If the advance converts from the 4.97% to a quarterly adjustable rate advance, the Bank has the option of repaying the advance. 10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS: SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires all entities to disclose the estimated fair value of its financial instrument assets and liabilities. For the Corporation, as for most financial institutions, approximately 98% of its assets and liabilities are considered financial instruments, as defined in SFAS No. 107. Many of the Corporation's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Therefore, significant estimations and present value calculations were used for the purpose of this disclosure. Estimated fair values have been determined using the best available data and an estimation methodology suitable for each category of financial instruments. The following methods and assumptions were used in estimating its fair value disclosures for financial instruments: CASH AND SHORT TERM DEPOSITS The carrying amounts reported in the balance sheets for cash, due from banks and various interest-bearing deposits with banks approximate fair value due to their short-term maturity. INVESTMENT SECURITIES Fair values for investment securities are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. NET LOANS AND ACCRUED INTEREST RECEIVABLE The fair values for one-to-four family residential loans are estimated using discounted cash flow analyses, using yields from similar products in the secondary markets. The carrying amount of construction loans 50 51 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:--CONTINUED approximates its fair value given their short-term nature. The fair values of consumer and commercial loans are estimated using discounted cash flow analyses, using interest rates reported in various government releases and the Bank's own product pricing schedule for loans with terms similar to the Bank's. The fair values of multi-family and nonresidential mortgages are estimated using discounted cash flow analysis, using interest rates based on a national survey of similar loans. The carrying amount of accrued interest approximates its fair value. DEPOSIT LIABILITIES The fair values disclosed for deposits with no stated maturities (e.g., passbook savings accounts) are, by definition, equal to the amount payable on demand at the repricing date (i.e., their carrying amounts). Fair values of deposits with stated maturities (e.g., certificates of deposit) are estimated using a discounted cash flow calculation that applies a comparable Federal Home Loan Bank advance rate to the aggregated weighted average maturity on time deposits. FEDERAL HOME LOAN BANK ADVANCES The fair values disclosed for Federal Home Loan Bank advances are estimated using a discounted cash flow calculation that applies a comparable Federal Home Loan Bank advance rate to the aggregated weighted average maturity on advances. The estimated fair values and recorded book balances at December 31, 1996 and 1995 are as follows:
1996 1995 --------------------------- --------------------------- ESTIMATED RECORDED ESTIMATED RECORDED FAIR VALUE BALANCE FAIR VALUE BALANCE ----------- ----------- ----------- ----------- Cash and short term deposits......... $ 2,147,678 $ 2,147,678 $ 4,393,667 $ 4,393,667 Investment securities................ 31,807,483 31,904,476 22,684,195 22,565,646 Net loans............................ 76,278,000 76,545,153 61,830,000 61,408,245 Accrued interest receivable.......... 810,884 810,884 573,548 573,548 Deposits with no stated maturities... 40,138,273 40,138,272 34,888,874 34,888,874 Deposits with stated maturities...... 43,590,000 43,683,196 46,122,000 45,841,798 Federal Home Loan Bank advances...... 14,457,000 14,477,000 3,012,000 2,977,000 Commitments to originate loans....... 1,650,000 1,650,000 1,500,000 1,500,000
11. INCOME TAXES: The provision (benefit) for income taxes for each of the years ended is as follows:
1996 1995 1994 -------- ------- -------- Federal: Current........................................... $ 67,249 $30,940 $265,695 Deferred.......................................... (13,735) 43,615 17,359 -------- ------- -------- 53,514 74,555 283,054 State: Current........................................... 15,872 8,514 63,069 -------- ------- -------- Total income tax expense............................ $ 69,386 $83,069 $346,123 ======== ======= ========
51 52 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 11. INCOME TAXES:--CONTINUED Deferred income taxes result from timing differences in the recognition of revenue and expense for tax and financial reporting purposes. The following table presents the impact on income tax expense of the principal timing differences and the tax effect of each for the years ended:
1996 1995 1994 -------- ------- ------- Deferred tax expense (benefit): Deferred loan costs/fees........................... $ 1,845 $17,706 $ 6,381 Prepaid pension.................................... (796) 35,206 9,985 Vacation accrual................................... (700) (3,670) (381) Deferred lease accrual............................. -- -- 5,304 Provision for loan losses.......................... (14,960) (8,097) 8,251 Tax depreciation in excess of book depreciation.... 5,950 5,192 (2,290) ESOP compensation.................................. (5,074) -- -- Other, net......................................... -- (2,722) (9,891) -------- ------- ------- $(13,735) $43,615 $17,359 ======== ======= =======
The special tax benefit afforded to thrift institutions which allowed a bad debt deduction based upon 8% of taxable income was repealed in 1996. A small thrift with assets of less than $500 million may maintain a bad debt reserve equal to the greater of the allowable base year reserve (i.e. the thrift bad debt reserve at December 31, 1987) or the experience method reserve (six year moving average ratio of charge-offs to loans applied to year end loan balances). The portion of the bad debt reserve under the former (percentage of taxable income) method which exceeds the bad debt reserve under the present (base year or experience) method must be recaptured by recognizing such excess in taxable income ratably over a six year period. The six year recapture period generally starts in 1996, but may be delayed until 1997 or 1998 if certain residential loan origination tests are met in 1997 and 1998. The base year (i.e. December 31, 1987) bad debt reserve under the former method is permanently suspended, and therefore not subject to recapture, unless a base year loan contraction occurs in a subsequent year. A base year loan contraction occurs when the total loans at the end of the year is less than the total loans at December 31, 1987. In such cases, a proportionate reduction to the base year bad debt reserve at December 31, 1987 is required and the reduction to the reserve is recaptured. Furthermore, the base year bad debt reserve constitutes a restriction for tax purposes of the Bank's use of retained earnings for distributions or redemptions. In accordance with FASB statement No. 109, the Bank has recorded deferred income tax associated with the temporary differences related to the portion of the bad debt reserve arising in tax years after December 31, 1987. For the period before December 31, 1987, there is an unrecognized deferred tax liability of approximately $565,000 at December 31, 1996. If the suspended base year bad debt reserve at December 31, 1987 is reduced by certain excess distributions, redemptions or a base year loan contraction, income tax expense will be recognized at the prevailing tax rate. 52 53 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 11. INCOME TAXES:--CONTINUED A reconciliation from the expected federal statutory income tax rate to the effective rate expressed as a percentage of pretax income for each of the years ended is as follows:
1996 1995 1994 ---- ---- ---- Statutory federal tax rate................................. 34.0% 34.0% 34.0% State income taxes, net of federal income tax benefit...... 7.4 2.3 4.7 Effect of graduated federal tax rates...................... (5.6) (2.2) -- Other...................................................... (3.5) -- -- ----- ---- ---- 32.3% 34.1% 38.7% ==== ==== ====
Net deferred tax (assets) liabilities as of December 31, 1996 and 1995, are as follows:
1996 1995 -------- -------- Prepaid pension............................................... $ 27,088 $ 27,884 Vacation accrual.............................................. (14,563) (13,863) Allowance for loan losses..................................... 14,835 29,795 Valuation allowance for investments........................... (112,279) (44,971) Tax depreciation in excess of book depreciation............... 52,422 46,472 ESOP compensation............................................. (5,074) -- Other, net.................................................... 1,845 -- -------- -------- Net deferred tax (asset) liability............................ $(35,726) $ 45,317 ======== ========
12. PENSION PLAN: The Bank maintains a noncontributory defined benefit pension plan covering all eligible employees. The following table sets forth the plan's fund status and amounts recognized in the Corporation's statements of financial condition at December 31, 1996 and 1995, respectively.
1996 1995 --------- --------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $372,130 and $310,409.................... $ 380,136 $ 314,005 ========= ========= Projected benefit obligation for service rendered to date... $(746,125) $(623,455) Plan assets at fair value................................... 619,396 482,870 --------- --------- Projected benefit obligation in excess of plan assets....... (126,729) (140,585) Unrecognized net obligation at transition................... 59,200 63,972 Unrecognized net loss....................................... 147,201 158,625 --------- --------- Prepaid pension cost........................................ $ 79,672 $ 82,012 ========= =========
Approximately 98% of the plan's assets is primarily invested either directly or through mutual funds in common stocks, bonds, U.S. government and agency, and foreign securities. The remaining plan assets are on deposit with the Bank or in a cash management account. The Bank's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. 53 54 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 12. PENSION PLAN:--CONTINUED The components of pension expense are as follows for each of the years ended:
1996 1995 1994 -------- -------- -------- Service cost....................................... $ 51,209 $ 43,078 $ 42,076 Interest cost...................................... 45,200 39,991 36,197 Actual return on plan assets....................... (84,273) (63,071) 10,907 Amortization of transition asset................... 52,325 49,037 (22,148) -------- -------- -------- Net periodic pension cost.......................... $ 64,461 $ 69,035 $ 67,032 ======== ======== ========
For both reported periods, the rate of increase in future compensation levels was assumed to be 4.75%. The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.25% for each of the years ended December 31, 1996 and 1995. The expected long-term rate of return on assets was 7.25% for each of the years ended December 31, 1996 and 1995. Additionally, the Bank maintains a 401(k) plan for employees. The Bank does not match any employee contributions. 13. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST (ESOP): In 1996, the Company established the ESOP to enable employees to obtain ownership interests in the Corporation. In connection with the conversion described in Note 1, the Corporation made a $770,410 loan to the ESOP which was used to purchase 77,041 shares of the Corporation's common stock. The ESOP loan has a term of 15 years and bears interest at 7.0%. This loan is collateralized by the shares purchased by the ESOP. The Bank's contributions to the ESOP will be used to repay the ESOP loan, which requires semi-annual payments of $41,888 (includes principal and interest) which began on December 27, 1996. The Bank is obligated to contribute amounts sufficient to repay the ESOP loan. The ESOP uses such contributions to repay the loan made to the ESOP by the Corporation. These transactions occur simultaneously and, for accounting and reporting purposes, offset each other. The effect of the ESOP on the Corporation's financial statements is that the amount of the unearned ESOP shares of $755,490 at December 31, 1996, as reflected in shareholders' equity, will be amortized to compensation over the 15-year period of the ESOP loan. In addition, any difference between the market price of the Corporation's common stock and the $10 per share (the purchase price paid by the ESOP) will also be charged or credited to compensation expense (with the offset to additional paid-in capital) based on the semi-annual allocation to ESOP participants of approximately 2,568 shares. Total compensation expense recorded in 1996 for ESOP shares was $30,071. 14. RETAINED EARNINGS AND REGULATORY CAPITAL: The Bank is subject to various regulator capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total Tier I capital (as defined in the 54 55 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 14. RETAINED EARNINGS AND REGULATORY CAPITAL:--CONTINUED regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1996, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk based, Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios are also presented in the table. There was no deduction from capital for interest-rate risk.
TO BE WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ----------------- ----------------- ------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------- ----- ------- ------ (DOLLARS IN THOUSANDS) Total Capital (to Risk Weighted Assets): As of December 31, 1996.............. $12,094 23.81% =>4,064 =>8.0% =>5,080 =>10.0% As of December 31, 1995.............. $ 7,515 19.39% =>3,101 =>8.0% =>3,876 =>10.0% Tier 1 Capital (to Risk Weighted Assets): As of December 31, 1996.............. $11,787 23.20% =>2,032 =>4.0% =>3,048 => 6.0% As of December 31, 1995.............. $ 7,228 18.65% =>1,550 =>4.0% =>2,325 => 6.0% Tier 1 Capital (to Average Assets): As of December 31, 1996.............. $11,787 11.74% =>4,016 =>4.0% =>5,019 => 5.0% As of December 31, 1995.............. $ 7,228 8.13% =>3,555 =>4.0% =>4,444 => 5.0%
15. RELATED PARTY TRANSACTIONS: Certain directors and executive officers of the Corporation, including their immediate families and companies in which they are principal owners, are loan customers of the Bank. In management's opinion, such loans are made in the normal course of business and were granted on substantially the same terms and conditions as loans to other individuals and businesses of comparable creditworthiness at the time. Total loans to these persons at December 31, 1996 and 1995, amounted to $419,236 and $192,018, respectively. An analysis of these related party loans is as follows:
1996 1995 --------- --------- Balance at January 1........................................ $ 192,018 $ 178,646 New loans................................................... 379,747 132,249 Payments.................................................... (152,529) (118,877) --------- --------- Balance at December 31...................................... $ 419,236 $ 192,018 ========= =========
Additionally, the Bank has an unfunded loan commitment for a director in the amount of $93,000. In addition, the Corporation from time to time has conducted business with certain directors, officers or companies in which they are related. During 1996, 1995 and 1994, such activity was as follows: 55 56 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 15. RELATED PARTY TRANSACTIONS:--CONTINUED - A member of the Board of Directors leases office space from the Corporation. The rental income was $11,100, $11,100 and $8,500 for the years ended December 31, 1996, 1995 and 1994, respectively. This director also provides professional services to the Bank and his fees were $4,950 for each of the three years ended December 31, 1996. - A member of that Board of Directors is employed by a law firm retained by the Corporation. Fees paid in 1996 approximated $156,000 relative to the stock conversion and another $38,300 for various bank and corporate legal matters. The firm's real estate closing service received approximately $109,700 as closing agent from third party borrowers pursuant to closings on Bank loans. A portion of this amount was used to purchase title insurance and pay miscellaneous closing fees relative to these closings. - The Corporation retained media services from a company owned by the brother of one of the Corporation's officers. The total costs for such services in 1996, 1995 and 1994 was $21,950, $24,765 and $26,320, respectively. - The Chairman of the Board of Directors is paid a fee of $2,500 per month, for a total fee of $30,000 paid in 1996 for providing from time to time advice and assistance to the officers of the Bank with respect to the operations and management of the Bank. 16. COMMITMENTS AND CONTINGENT LIABILITIES: The Corporation incurs off-balance sheet risks in the normal course of business in order to meet the financing needs of its customers. These risks derive from commitments to extend credit. Such commitments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the financial statements. Commitments to extend credit are obligations to lend to a customer as long as there is no violation of any condition established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses. A portion of the commitments is not expected to be drawn upon; thus, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The Bank's exposure to credit loss in the event of nonperformance by the other party to these commitments to extend credit is represented by their contractual amounts. The Bank uses the same credit and collateral policies in making commitments as for all other lending. The Bank has outstanding various commitments to extend credit approximating $5,400,000 and $1,500,000 as of December 31, 1996 and 1995, respectively. As of December 31, 1996, these commitments had fixed and variable rates which ranged from 8.00% to 10.00%, while as of December 31, 1995, $292,000 of these commitments had fixed rates which ranged from 6.75% to 8.00%. In the opinion of management, the funding of these credit commitments will not have a material adverse effect on the financial position or results of operations. Additionally, the Bank is also subject to asserted and unasserted potential claims encountered in the normal course of business. In the opinion of management and legal counsel, the resolution of these claims will not have a material adverse effect on the financial position or results of operations. 56 57 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 17. PARENT COMPANY FINANCIAL INFORMATION: Prestige Bancorp, Inc. (the Parent Company) functions primarily as a holding company for its sole subsidiary, the Bank. The following financial information relates only to the Parent Company activity from June 27, 1996 (date commencement of operations) to December 31, 1996: BALANCE SHEET December 31, 1996 ASSETS Cash and cash equivalents.............................................. $ 3,631,611 Investments securities available for sale.............................. 200,000 Investment in Prestige Bank, F.S.B..................................... 11,650,987 Other assets........................................................... 2,500 ----------- Total Assets........................................................... $15,485,098 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accrued expenses....................................................... $ 21,859 Income taxes payable................................................... 21,639 Deferred income tax payable............................................ 11,400 ----------- Total Liabilities...................................................... 54,898 Total Stockholders' Equity, net of ESOP loan of $755,490............... $15,430,200 ----------- Total Liabilities and Stockholders' Equity............................. $15,485,098 =========== STATEMENT OF INCOME For The Period From June 27, 1996 to December 31, 1996 Interest income........................................................ $ 93,695 ----------- Expenses: Legal fees........................................................... 24,262 Other................................................................ 8,988 ----------- Total Expenses......................................................... 33,250 Income before income taxes and equity in undistributed loss of subsidiary........................................................... 60,445 Provision for income taxes............................................. 21,639 Equity in undistributed loss of subsidiary............................. (35,736) ----------- Net income............................................................. $ 3,070 ===========
57 58 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 17. PARENT COMPANY FINANCIAL INFORMATION:--CONTINUED STATEMENT OF CASH FLOWS For The Period From June 27, 1996 to December 31, 1996 Operating Activities: Net income........................................................... $ 3,070 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed loss of subsidiary........................... 35,736 Change in other assets and liabilities............................ 45,389 ----------- Net cash provided by operating activities....................... 84,195 Investing and Financing Activities: Net proceeds from sale of stock, net of ESOP loan of $770,410........ 8,188,394 Repayment received from ESOP......................................... 14,924 Purchase of available for sale investment securities................. (171,500) Investment in Prestige Bank, F.S.B................................... (4,484,402) ----------- Net cash provided by investing and financing activities......... 3,547,416 ----------- Ending Cash and Cash Equivalents....................................... $ 3,631,611 ===========
The ability of the Bank to upstream cash to the Parent Company is restricted by regulations. Federal law prevents the Parent Company from borrowing from its subsidiary banks unless the loans are secured by specific assets. Further such secured loans are limited in amount to ten percent of the subsidiary bank's capital and surplus. In addition, the subsidiary bank is subject to legal limitations on the amount of dividends that can be paid to their shareholder. On the date of the conversion, as required by regulatory pronouncements, the Bank established a liquidation account in the amount of $7,085,000 which is equal to retained earnings reflected in the Bank's statement of financial condition. The liquidation account will be maintained for the benefit of eligible savings account holders and supplemental eligible account holders who continue to maintain their accounts at the Bank after the conversion in accordance with supervisory regulations. In the event of a complete liquidation (and only in such event), each eligible savings account holder will be entitled to receive a liquidation distribution from the liquidation account in the amount of the then current adjusted balance of deposit accounts held, before any liquidation distribution may be made with respect to the common shares. Except for the repurchase of stock and payment of dividends by the Bank, the existence of the liquidation account will not restrict the use or further application of such retained earnings. The Bank may not declare or pay a cash dividend on, or repurchase any of its common shares if the effect thereof would cause the Bank's equity to be reduced below either the amount required for the liquidation account or the regulatory capital requirements for insured institutions. 18. SUBSEQUENT EVENT: On March 3, 1997, the Corporation announced a plan to repurchase at market value by the Corporation of up to 5% of its outstanding shares of common stock through the use of its existing cash and cash equivalents. This stock repurchase program is to be completed by June 27, 1997. 58 59 CORPORATE INFORMATION CORPORATE OFFICERS ROBERT S. ZYLA President PATRICIA A. WHITE Treasurer and Secretary JAMES M. HEIN Controller BOARD OF DIRECTORS JOHN A. STIVER Chairman of the Board Certified Public Accountant John A. Stiver, C.P.A. ROBERT S. ZYLA President Prestige Bancorp, Inc. President and Chief Executive Officer Prestige Bank, A Federal Savings Bank PATRICIA A. WHITE Treasurer and Secretary Prestige Bancorp, Inc. Executive Vice President and Secretary Prestige Bank, A Federal Savings Bank MARTIN W. DOWLING President and Owner Jefferson Hills Real Estate, Inc. MICHAEL R. MACOSKO Pharmacist Thrift Drug, Inc. CHARLES P. MCCULLOUGH Attorney at Law Tucker Arensberg, P.C. MARK R. SCHOEN Assistant Vice President Federated Investors CORPORATE OFFICE 710 Old Clairton Road Pittsburgh, Pennsylvania 15236 412-655-1190 BRANCH OFFICES Pleasant Hills 710 Old Clairton Road Pittsburgh, Pennsylvania 15236 412-655-2110 Bethel Park 6257 Library Road Bethel Park, PA 15102 412-831-8440 Mt. Oliver 543 Brownsville Road Pittsburgh, PA 15210 412-431-3374 MARKET MAKERS Friedman Billings Ramsey & Co. Rodman & Renshaw Inc. Herzog, Heine, Geduld, Inc. Sandler O'Neill & Partners Ryan Beck & Co. Inc. Legg Mason Wood Walker Inc. Parker/Hunter Inc. TRANSFER AGENT ChaseMellon Shareholder Services LLC CORPORATE COUNSEL Tucker Arensberg, P.C. Pittsburgh, Pennsylvania INDEPENDENT AUDITORS Arthur Andersen LLP Pittsburgh, Pennsylvania STOCK LISTING NASDAQ Stock Market Symbol: PRBC GENERAL INQUIRIES & REPORTS Prestige Bancorp is required to file an annual report on Form 10-K for its fiscal year ended December 31, 1996, with the Securities and Exchange Commission. Copies of this annual report and quarterly reports may be obtained without charge by contacting: James M. Hein Controller 412-655-1190 Corporate Office EX-27 4 PRESTIGE BANCORP, INC.
9 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 736 1,412 0 0 11,443 20,462 20,365 76,545 307 114,640 83,821 0 911 14,477 0 0 8,208 7,222 114,640 5,078 1,579 91 6,748 3,407 3,683 3,065 44 0 3,104 215 215 0 0 146 0 0 6.93 341 0 0 0 287 24 0 307 241 0 66
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