-----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, PnpMY2AZiBf1sXenh/x0F7YdVfYMWBSlBYD0m+EqFf+9diN+b2Fa6K8NlNl7o/wQ 2/NDmT4xQJRJhHQkoIPLDw== 0000950128-98-000659.txt : 19980325 0000950128-98-000659.hdr.sgml : 19980325 ACCESSION NUMBER: 0000950128-98-000659 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980324 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: SEC FILE NUMBER: 000-20715 FILM NUMBER: 98572027 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, 1997 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 17, 1998, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was $15.8 million. This figure is based on the reported closing bid in the NASDAQ system of $19.06 per share of the Registrant's Common Stock as of March 17, 1998. 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 17, 1998, there were outstanding 914,873 shares of the Registrant's Common Stock. DOCUMENTS INCORPORATED BY REFERENCE 1. Annual Report to Shareholders for the fiscal year ended December 31, 1997 (Parts I, Item I, II and IV). 2. Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1998 (Part I). ================================================================================ 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 debt and equity investments of $658,000, and deposits maintained at the Savings Bank. 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, 1997, the Company had total consolidated assets of $143.3 million, total consolidated deposits of $91.2 million, total consolidated liabilities (including deposits) of $127.6 million and total consolidated equity of $15.6 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 4 full-service offices located in Allegheny and Washington Counties, Pennsylvania. At December 31, 1997, the Savings Bank had total assets of $142.6 million, total deposits of $93.6 million, total liabilities (including deposits) of $130.0 million and total equity of $12.6 million. In February, 1998, the Savings Bank opened a branch office in Elizabeth, Pennsylvania. 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, commercial business loans, construction loans on residential and commercial 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. 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, tiered 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, 1997, by loan category and investment securities are shown on page 12 of the 1997 Annual Report to Shareholders. The gross interest expense of the Company on a consolidated basis for the fiscal year ending December 31, 2 3 1997 is shown on page 3 of the 1997 Annual Report to Shareholders. The amounts of the various deposit products of the Company (through its sole subsidiary, the Savings Bank) by category for the fiscal year ending December 31, 1997 is shown on pages 34 and 35 of the 1997 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. The Savings Bank operates four automated teller machines ("ATMs"), one at each of the branch offices, except the Elizabeth, Pennsylvania branch office. The Savings Bank is affiliated with a regional ATM network. The Savings Bank ended 1997 with a staff of 47 employees which comprised of 35 full-time and 12 part-time employees. Full-time equivalent employees averaged 35 in 1997. With the opening of the branch office in Elizabeth, Pennsylvania, full-time employees of the Savings Bank have risen to 39 and part-time employees have risen to 14. 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, 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 increase in competitors has resulted in a reduction in eligible mortgage loans which meet the underwriting criteria of the Savings Bank. This factor, together with the directive of management to increase commercial and consumer loans, has led to change in the composition of loan origination by the Savings Bank. Loan originations for one-to-four family residential mortgages constituted $12.0 million for 1994, or 79.6% of all loan origination for such year, compared to loan origination for one-to-four family residential mortgages of $14.0 million for 1997, or 34.7% of all loan origination for such year. 3 4 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. 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. Interstate branch banking is now permitted under Federal law 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. To date, the Savings Bank has not experienced increased competition from an out-of-state financial institution which has established a new branch in the Greater Pittsburgh area. Management of the Savings Bank and the Company cannot predict if out-of-state financial institutions will choose to open new branches in the primary market of the Savings Bank. POSSIBLE YEAR 2000 COMPUTER PROGRAM MATTERS A great deal of information has been disseminated about the global computer crash that may occur in the year 2000. Many computer programs that can only distinguish the final two digits of the year entered (a common programming practice in earlier years) are expected to read entries for the year 2000 as the year 1900 and compute payment, interest or delinquency based on the wrong date or are expected to be unable to compute payment, interest or delinquency. Rapid and accurate data processing is essential to our operations. Data processing is also essential to most other financial institutions and many other companies. Most of the data processing activity for the Savings Bank that could be affected by this problem is provided by third party service bureaus. These service bureaus have advised the Savings Bank that they expect to resolve these potential problems concerning data processing performed for the Savings Bank before the year 2000. In addition, these vendors have advised the Savings Bank that they will conduct tests concerning the impact of year 2000 problems before the end of 1998. Management will review the results of these testings at that time and determine if any changes in service providers, equipment or software will be necessary to meet year 2000 issues. Part of the function of the Technology Committee of the Savings Bank is to monitor and address year 2000 issues. The Committee has adopted a program to contact the vendor of each piece of computer hardware and software used on the premises of the Savings Bank to determine if any such hardware or software will recognize and function with the occurrence of January 1, 2000. Other equipment which utilizes calendars in operation will also be analyzed. To the extent computer hardware, equipment or software will not recognize the year 2000, a determination will be made whether to replace such computer hardware, equipment or software or to seek repairs to solve such problems. Management does not believe, at this time, that given the age and state of its computer hardware, equipment and software and the nature of the capital expenditure budget and capital improvement programs of the Savings Bank, that solutions to year 2000 problems for computer hardware, equipment and software on hand at the Savings Bank will have a material adverse effect on the net income of the Savings Bank. 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. In addition, if the Company acquired any non-savings institution subsidiaries, the OTS will have enforcement authority over such subsidiaries. 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. This regulatory authority granted to the OTS is intended primarily for the protection of the depositors of the Savings Bank and not for the benefit of the stockholders of the Company. 4 5 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 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 5 6 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, 1997, 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. 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 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. 6 7 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, 1997, the Savings Bank's largest aggregate amount of loans to any one borrower consisted of $1.2 million which was below the Savings Bank's loans to one borrower limit of $1.9 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. A savings association that fails the QTL Test must either convert to a bank charter or operate under certain restrictions. As of December 31, 1997, the Savings Bank maintained 88.58% 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 (i) 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. On November 24, 1997, the OTS published its final rule on changes to liquidity requirement calculations in order to conform with provisions of FIRREA, and reduced the liquidity base by modifying the definition of net withdrawable account to exclude accounts with maturities exceeding one year. Under the new rule, 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 7 8 certain mutual funds and certain corporate debt securities and commercial paper) equal to a monthly average of not less than 4.0% 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. The rule eliminates a separate limit that required each savings institution to maintain an average daily balance of short-term liquid assets equal to 1.0% 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, 1997 was 37.2%, which exceeded the new applicable requirements. The Savings Bank has never been subject to monetary penalties for failure to meet its liquidity requirements. Simply meeting the minimum liquidity requirement does not automatically mean a thrift institution has sufficient liquidity for safe and sound operation. The new final rule includes a separate requirement that each thrift must maintain sufficient liquidity to ensure safe and sound operation. Adequate liquidity may vary from institution to institution depending on a thrift's overall asset/liability structure, market conditions, the activities of financial service competitors and the requirements of its own deposit and loan customers. 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, 1997 and 1996 totaled $36,000 and $30,000, 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 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. Failure to maintain a satisfactory rating may establish a basis for the OTS to deny the application of the Savings Bank to open new branch offices or an application of the Savings Bank or the Company to undertake some other business opportunity. 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 8 9 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 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. 9 10 The Federal banking agencies have adopted a final regulation and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Safety and Soundness Guidelines") and a final rule which implements 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, 1997, the Savings Bank had no intangibles that 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 or 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. 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. 10 11 The risk-based capital standards of the OTS generally require savings institutions with more than a "normal" level of interest rate risk to maintain additional total capital. An institution's interest rate risk will be measured in terms of the sensitivity of its "net portfolio value" to changes in interest rates. Net portfolio value is defined, generally, as the present value of expected cash inflows from existing assets and off-balance sheet contracts less the present value of expected cash outflows from existing liabilities. A savings institution will be considered to have a "normal" level of interest rate risk exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates (whichever results in the greater decline) is less than two percent of the current estimated economic value of its assets. An institution with a greater than normal interest rate risk will be required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount (the "interest rate risk component") equal to one-half the difference between the institution's measured interest rate risk and the normal level of interest rate risk, multiplied by the economic value of its total assets. The OTS calculates the sensitivity of an institution's net portfolio value based on data submitted by the institution in a schedule to its quarterly Thrift Financial Report and using the interest rate risk measurement model adopted by the OTS. The amount of the interest rate risk component, if any, to be deducted from an institution's total capital will be based on the institution's Thrift Financial Report filed two quarters earlier. Savings institutions with less than $300 million in assets and a risk-based capital ratio above 12% are generally exempt from filing the interest rate risk schedule with their Thrift Financial Reports. However, the OTS may require any exempt institution that it determines may have a high level of interest rate risk exposure to file such schedule on a quarterly basis and may be subject to an additional capital requirement based upon its level of interest rate risk as compared to its peers. However, due to our net size and risk-based capital level, we are exempt from the interest rate risk component. At December 31, 1997, the Savings Bank met each of its capital requirements. For further information on the Savings Bank capital levels, see page 37 of the 1997 Annual Report to Shareholders. For further information on the application of the interest rate risk component, see pages 9, 10 and 11 of the 1997 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 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, 1997, 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 11 12 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 rates 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 ended December 31, 1997, the insurance fund assessment paid by the Savings Bank was 6.45 basis points which was 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 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 separate proposed legislation, Congress is considering the elimination of the federal thrift charter and elimination of the separate federal regulation of thrifts. As a result, the Savings Bank might have to convert to a different financial institution charter and be regulated under federal law as a commercial bank, including being subject to the more restrictive activity limitations imposed on national banks. Management cannot predict the impact of our conversion to, or regulation as, a commercial bank until the legislation requiring such change is enacted. 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 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, 1997, of $1.7 million. 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, 1997, 1996 and 1995, dividends from the FHLB to the Savings Bank amounted to $89,000, $46,000 and $49,000 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. 12 13 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 $44.9 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts greater than $44.9 million, the reserve requirement is $1.3 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 $44.9 million. The first $4.4 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 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. 13 14 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 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"). 14 15 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 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. 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, 1997, the Savings Bank had approximately $128,000 of applicable excess reserves. Approximately $21,300 of which will be recaptured on an annual basis. The Savings Bank has maintained the applicable residential loan requirement; and this recapture will commence with the 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 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, 1997. 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. 15 16 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 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 Company's and the Savings Bank's Federal income tax returns have been filed for taxable years through December 31, 1996 (a consolidated Federal income tax return has been filed by the Company and the Savings Bank for the taxable year ended December 31, 1996; and a consolidated return for the Company and the Savings Bank will be filed for each tax year commencing on and after January 1, 1997). Neither the Company nor the Savings Bank has 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, except for certain circumstances, the Savings Bank's returns for taxable years ending December 31, 1993 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 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 1997 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 12 and 13 of the 1997 Annual Report and is incorporated herein by reference. 16 17 II. Investment Portfolio. Information required by this section is presented on pages 28 through 33 of the 1997 Annual Report and is incorporated herein by reference. III. Loan Portfolio. Information required by this section is presented on pages 18 through 28 of the 1997 Annual Report and is incorporated herein by reference. IV. Summary of Loan Loss Experience. Information required by this section is presented on pages 25 through 28 of the 1997 Annual Report and is incorporated herein by reference. V. Deposits. Information required by this section is presented on pages 34 through 36 of the 1997 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 1997 Annual Report and is incorporated herein by reference. VII. Short-Term Borrowing. Information required by this section is presented on page 36 of the 1997 Annual Report and is incorporated herein by reference. EXECUTIVE OFFICERS OF THE COMPANY
NAME AGE POSITION WITH REGISTRANT ---- --- ------------------------ Robert S. Zyla........................ 50 President Patricia A. White..................... 51 Vice President, Secretary and Treasurer James M. Hein......................... 34 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.................. 1993-1997 President/CEO and Treasurer(1) Patricia A. White............... 1993-1997 Executive Vice President and Secretary James M. Hein................... 1993-1997 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. 17 18 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, 1997.
NET BOOK VALUE AMOUNT OF DESCRIPTION/ADDRESS LEASED/OWNED OF PROPERTY DEPOSITS ------------------- ------------ ----------- -------- (IN THOUSANDS) Corporate and Main Office: - -------------------------------------- 710 Old Clairton Road Owned $1,112 $37,374 Pleasant Hills, Pennsylvania 15236 Branch Offices: - -------------------------------------- 543 Brownsville Road Owned $ 441 $34,256 Mt. Oliver, Pennsylvania 15210 6257 Library Road Owned $ 171 $19,181 Bethel Park, Pennsylvania 15102 125 West Beau Street Leased N/A $ 345 Washington, Pennsylvania 15301
The Savings Bank completed the expansion and remodeling of the Corporate Headquarters of the Company and the Savings Bank in January 1998. The original project consisted of a 4,000 square foot expansion of the corporate offices and a renovation of existing space. The budget for this project was $600,000. An opportunity arose to obtain from a tenant at the corporate building a surrender of his lease. The Company took advantage of this situation and incorporated this leased space into the renovation and expansion project. Even with the expanded nature of the project, the Company finished the project within budget. 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 an office building on this parcel. No final decision has been made to start this project. On February 18, 1998, the Savings Bank opened a branch office at 603 Scenery Drive, Elizabeth, Pennsylvania. This branch office is located on leased property. 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, 1997, no matter was submitted to a vote of the security holders of the Company through the solicitation of proxies or otherwise. 18 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Pages 2-6 of the 1997 Annual Report to Shareholders is herein incorporated by reference. ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA Pages 2-6 of the 1997 Annual Report to Shareholders is herein incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Pages 7-18 of the 1997 Annual Report to Shareholders are herein incorporated by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Pages 10-11 of the 1997 Annual Report to Shareholders are herein incorporated by reference. ITEM 8. FINANCIAL STATEMENTS Pages 39-64 of the 1997 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 4-8 of the Registrant's definitive Proxy Statement dated March 23, 1998. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference to pages 9-13 of the Registrant's definitive Proxy Statement dated March 23, 1998. 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 2-4 and pages 5-7 of the Registrant's definitive Proxy Statement dated March 23, 1998. ITEM 13. CERTAIN TRANSACTIONS Information concerning certain relationships and transactions is incorporated herein by reference to pages 11-13 and pages 21 and 22 of the Registrant's definitive Proxy Statement dated March 23, 1998. 19 20 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 1997 Annual Report to Shareholders for the year ended December 31, 1997 is incorporated by reference from Item 8 hereof (see Exhibit 13).
PAGES IN ANNUAL REPORT SECTION ANNUAL REPORT --------------------- ------------- Independent Auditors' Report 39 Consolidated Balance Sheets 40 Consolidated Statements of Income 41 Consolidated Statements of Stockholders' Equity 42 Consolidated Statements of Cash Flows 43 Notes to Consolidated Financial Statements 44-64
(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 **** Pages 46 and 47 of Earnings the 1997 Annual Report
20 21
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 1997 is included as part of this integrated filing of 1997 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, 1997. 21 22 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. PRESTIGE BANCORP, INC. Date: March 23, 1998 By: /s/ ROBERT S. ZYLA ------------------------------- 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 23, 1998 Date: March 23, 1998 /s/ JOHN A. STIVER /s/ MARK R. SCHOEN - ------------------------------------ -------------------------------------- John A. Stiver Mark R. Schoen Chairman of the Board of Directors Director Date: March 23, 1998 Date: March 23, 1998 /s/ PATRICIA A. WHITE /s/ CHARLES P. MCCULLOUGH - ------------------------------------ -------------------------------------- Patricia A. White Charles P. McCullough Treasurer, Secretary and Director Director Date: March 23, 1998 Date: March 23, 1998 /s/ MARTIN W. DOWLING /s/ JAMES M. HEIN - ------------------------------------ -------------------------------------- Martin W. Dowling James M. Hein Director Controller Date: March 23, 1998 (Principal Financial and Accounting Officer) Date: March 23, 1998 22 EX-13 2 PRESTIGE BANCORP, INC. 1 Exhibit 13 PRESTIGE BANCORP, INC. 710 Old Clairton Road, Pittsburgh, PA 15236-4300 412-655-1190 - (Fax) 412-655-2114 March 23, 1998 To Our Stockholders & Friends: I am pleased to present the 1997 Annual Report for Prestige Bancorp, Inc., the parent company of Prestige Bank, a Federal Savings Bank. The Company reported net income of $784,000 for the year ended December 31, 1997 compared to $146,000 for the year ended December 31, 1996. There was a significant increase in the stock price from $13.50 at December 31, 1996 to $20.00 at December 31, 1997. Since becoming a public company and selling the initial stock for $10.00 per share, the price of the stock has increased 100%. At December 31, 1997, the Company's assets totaled $143.3 million compared to $114.6 million at December 31, 1996, an increase of 25%. Net loans receivable and investment securities increased $19.6 million or 25.7% and $6.9 million or 21.5%, respectively. Deposits from customers and advances from the Federal Home Loan Bank of Pittsburgh (FHLB) increased $7.4 million or 8.8% and $20.2 million or 139.5%, respectively. Management is committed to a leveraging strategy to enhance the use capital in order to promote further growth. Stockholders equity totaled $15.6 million, representing 10.91% of assets as of December 31, 1997. Management's operating strategy to increase profitability by making commercial business loans and commercial real estate loans to small or middle market businesses has increased the commercial loan portfolio from $2.0 million at December 31, 1996 to $11.1 million on December 31, 1997. Although such activities entail greater risks, management believes that there are lending opportunities that are appropriate for our institution that are not currently being fulfilled by other financial institutions. Management has also chosen to actively market our residential mortgage products. As a result, one-to-four family residential mortgages have risen from $65.1 million at December 31, 1996 to $72.2 million on December 31, 1997. We opened our first supermarket branch in October 1997 at the Shop 'N' Save located at 125 W. Beau Street, Washington, PA 15301. Our fifth branch located at 603 Scenery Drive (Route 48 & Simpson Howell Road) Elizabeth Twp., PA. 15037 opened in February 1998. Approval to establish our sixth branch location in Rostraver Twp, Belle Vernon, PA 15012 was received in July 1997 from the Office of Thrift Supervision. We anticipate this opening to be in the fourth quarter of 1998. Construction, renovation and expansion of the Corporate Offices located at 710 Old Clairton Road, Pleasant Hills, PA 15236 was completed in January 1998. This expansion has provided our employees with a more efficient and productive workplace. The Board of Directors, Officers, and Employees of Prestige Bancorp, Inc. are dedicated to enhancing the value of your company. I appreciate their commitment to this company and commend them for an outstanding year. 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. Any comparison herein of the Company's and the Savings Bank's performance to any period prior to June 27, 1996 is assumed to be a comparison to the performance of the Savings Bank for such period. 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 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"), debt and equity securities with a market value totaling $658,000 at December 31, 1997, and a money-market and checking 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 17, 1998 was 636. It is the policy of the Company to retain a substantial portion of its earnings to finance its business. On January 21, 1998, the Company increased its quarterly cash dividend from $.03 per share to $.05 per share 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 21, 1998, was $.05 per share and payable on March 20, 1998 to shareholders of record March 2, 1998. Information as to the high and low stock prices for each quarter of fiscal years 1997 and 1996 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, ----------------------------------------------------- 1997 1996(8) 1995(9) 1994(9) 1993(9) ---- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) SELECTED FINANCIAL DATA: Total assets................................ $143,263 $114,640 $91,841 $87,745 $82,522 Investment securities....................... 28,228 18,386 6,720 5,653 5,161 Mortgage-backed securities.................. 10,531 13,519 15,845 16,632 17,792 Loans receivable, net....................... 96,181 76,545 61,408 60,635 55,067 Cash and cash equivalents................... 2,213 2,148 4,394 1,540 2,045 Deposits.................................... 91,156 83,821 80,731 75,313 74,727 FHLB of Pittsburgh advances................. 34,677 14,477 2,977 4,261 461 Stockholders' equity(1)..................... 15,630 15,430 7,178 7,049 6,521 Nonperforming assets(2)..................... 611 391 348 391 351 SELECTED OPERATING DATA: Interest income............................. $ 9,371 $ 6,748 $ 5,719 $ 5,314 $ 5,410 Interest expense............................ 5,240 3,683 3,406 2,620 2,634 -------- -------- ------- ------- ------- Net interest income......................... $ 4,131 $ 3,065 $ 2,313 $ 2,694 $ 2,776 Provision for loan losses................... 104 44 36 36 36 -------- -------- ------- ------- ------- Net interest income after provision for loan losses.................................... $ 4,027 $ 3,021 $ 2,277 $ 2,658 $ 2,740 Other income................................ 373 297 222 294 310 Other expenses.............................. 3,123 3,102(5) 2,255 2,058 1,913 -------- -------- ------- ------- ------- Income before income tax expense............ $ 1,277 $ 216 $ 244 $ 894 $ 1,137 Income tax expense.......................... 493 70 83 346 452 -------- -------- ------- ------- ------- Net income.................................. $ 784 $ 146(6) $ 161 $ 548 $ 685 ======== ======== ======= ======= ======= SELECTED OPERATING RATIOS(3): Return on average assets.................... .59% .14% .18% .64% .85% Return on average equity.................... 5.13 1.22 2.26 8.08 11.11 Average yield earned on interest-earning assets.................................... 7.21 6.93 6.66 6.41 6.88 Average rate paid on interest-bearing liabilities............................... 4.47 4.21 4.22 3.38 3.58 Average interest rate spread(4)............. 2.74 2.72 2.44 3.03 3.30 Net interest margin(4)...................... 3.18 3.15 2.69 3.25 3.53 Ratio of interest-earning assets to interest-bearing liabilities.............. 110.99 111.31 106.34 107.03 106.75 Operating expenses as a percent of average assets.................................... 2.33 3.09 2.54 2.41 2.37 Average equity to average assets............ 11.42 11.86 8.02 7.97 7.63 Dividend payout ratio....................... 13.04 N/A N/A N/A N/A ASSET QUALITY RATIOS(3): Nonperforming loans as a percent of total loans..................................... .63% .44% .50% .64% .63% Nonperforming assets as a percent of total assets.................................... .43 .34 .38 .45 .43 Allowance for loan losses as a percent of total loans............................... .42 .40 .46 .49 .48 Charge-offs to average loans receivable outstanding during the period............. .01 .04 .09 .00 .01 PER SHARE DATA: Basic Earnings Per Share.................... $ 0.92 $ 0.00(7) N/A N/A N/A Diluted Earnings Per Share.................. 0.92 0.00(7) N/A N/A N/A Per Share Book Value........................ 17.08 16.02 N/A N/A N/A Per Share Market Value...................... 20.00 13.50 N/A N/A N/A NUMBER OF OFFICES: Full-service offices at period end.......... 4 3 3 3 3
3 4 - --------- (1) For years ending December 31, 1995, 1994, and 1993 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 31, 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. (8) Based on the business activities of the Savings Bank prior to June 27, 1996, and on the business activities of the Savings Bank and the Company on and after June 27, 1996. (9) Based solely on the business activities of the Savings Bank. 4 5 SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA The following table sets forth certain unaudited quarterly consolidated financial data regarding the Company:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- ------- ------------ ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 QUARTER ENDED Interest income............................... $2,133 $2,303 $2,467 $ 2,468 Non-interest income........................... 74 96 84 120 ------ ------ ------ ------- Total operating income........................ 2,207 2,399 2,551 2,588 Interest expense.............................. 1,152 1,265 1,401 1,423 Provision for loan losses..................... 17 27 30 30 Non-interest expense.......................... 709 746 795 873(1) ------ ------ ------ ------- Income before income taxes.................... 329 361 325 262 Provision for income taxes.................... 125 137 123 108 ------ ------ ------ ------- Net income.................................... $ 204 $ 224 $ 202 $ 154 ====== ====== ====== ======= Basic earnings per common share............... $ .23 $ .27 $ .24 $ .18 Basic average number of common shares outstanding................................. 884,984 840,984 840,878 841,711 Diluted earnings per common share(2).......... $ .23 $ .27 $ .24 $ .18 Diluted average number of common shares outstanding................................. 884,984 841,278 842,738 851,002 Stock prices(3) High........................................ $16.50 $16.50 $18.88 $ 20.00 Low......................................... $13.00 $15.50 $15.63 $ 18.00 Cash dividends declared per common share...... $ .03 $ .03 $ .03 $ .03
MARCH 31(4) JUNE 30(5) SEPTEMBER 30(6) DECEMBER 31(6) ----------- ---------- --------------- -------------- (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 ====== ====== ====== ======= Basic earnings (loss) per common share........ N/A N/A $ (.16)(7) $ .17 Basic average number of common shares outstanding................................. N/A N/A 885,982 886,063 Stock prices(3) High........................................ N/A $10.75(8) $12.25 $ 13.75 Low......................................... N/A $10.00(8) $ 9.75 $11.875 Cash dividends declared per common share(9)... N/A None None None
- --------- (1) The increase in non-interest expense from $795,000 for the quarter ended September 30, 1997 to $873,000 for the quarter ended December 31, 1997 was primarily attributable to the opening of our supermarket branch located in Washington, PA. (2) Prior to April 23, 1997, the Company had a simple capital structure with no difference between basic and diluted earnings per share. (3) Stock prices are based on the closing bid prices reported on NASDAQ. (4) Applies solely to business operations of the Savings Bank. 5 6 (5) Reflects business activity of the Savings Bank and activities of the Company since June 27, 1996. (6) Reflects business activities of the Savings Bank and the Company for such quarter. (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. (8) The common stock of the Company commenced trading on June 27, 1996 with an opening price of $10.00. (9) 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. 6 7 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. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 In addition to historical information, forward-looking statements are contained herein that are subject to risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause future results to vary from current expectations, include, but are not limited to, the impact of economic conditions (both generally and more specifically in the markets in which the Company and the Savings Bank operate), the impact of competition for the customers of the Savings Bank from other providers of financial services, the impact of government legislation and regulation (which changes from time to time and over which the Company and the Savings Bank have no control), and other risks detailed in this Annual Report and in the Company's other Securities and Exchange Commission filings. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements, to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed by the Company in 1998 and any Current Reports on Form 8-K filed by the Company. CHANGES IN FINANCIAL CONDITION The Company's consolidated assets increased by $28.7 million or 25.0% from $114.6 million at December 31, 1996 to $143.3 million at December 31, 1997. The increase in total assets was primarily attributable to an increase in total loans receivable and investment securities. Premises and equipment increased $793,000 in 1997 primarily due to the expansion of the corporate office. The increase in total assets was funded by an increase in deposits and the leverage of the balance sheet through loans from the Federal Home Loan Bank of Pittsburgh ("FHLB of Pittsburgh"). Total deposits increased from $83.8 million at December 31, 1996 to $91.2 million at December 31, 1997, and advances from the FHLB of Pittsburgh rose from $14.5 million at December 31, 1996 to $34.7 million at December 31, 1997. The Savings Bank's total loans receivable increased by $21.0 million or 27.1% from $77.4 million at December 31, 1996 to $98.4 million at December 31, 1997. This rise in total loan receivables can be traced to three main areas of growth. One-to-four family residential mortgages increased $7.1 million or 10.9%, as the Savings Bank expanded its efforts to contact realtors and priced its mortgage rates to attract new business. Consumer loans increased $3.5 million or 37.7%, 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 from $2.0 million at December 31, 1996 to $11.1 million at December 31, 1997 as the Savings Bank used contacts and referrals to build its commercial and commercial real estate loan portfolio. Investment securities increased from $31.9 million at December 31, 1996 to $38.8 million at December 31, 1997. The increase occurred as the Company proceeded to leverage its strong capital position by primarily investing in U.S. Government agency securities with funds received by the FHLB of Pittsburgh. The Savings Bank's total deposits increased $7.4 million or 8.8% from $83.8 million at December 31, 1996 to $91.2 million at December 31, 1997. The growth in deposits during fiscal 1997 was primarily a result of competitive rates and fees that continue to be offered by the Savings Bank. Borrowings by the Savings Bank from the FHLB of Pittsburgh rose by $20.2 million, or 139.3%, from $14.5 million at December 31, 1996 to 7 8 $34.7 million at December 31, 1997. Total equity increased $200,000 or 1.3% to $15.6 million at December 31, 1997, a result of the net income for fiscal 1997 and the impact of the valuation of available-for-sale securities pursuant to Statement of Financial Accounting Standards ("SFAS") No. 115 which was offset by a 5% stock buyback program initiated and completed during 1997 in the amount of $776,000 and dividends paid of $111,000. The Savings Bank's 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 (includes assets of the Company on a consolidated basis). 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 Savings Bank'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, mainly attributable to three main areas of growth. One-to-four family residential mortgages increased $9.8 million or 17.6%, consumer loans increased $3.7 million or 67.2%, and 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. Cash and cash equivalents decreased by $2.2 million or 51.1% between December, 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 increase in deposits during fiscal 1996 was primarily as a result of competitive rates offered by the Savings Bank. Borrowings by the Savings Bank's 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, as 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 SFAS No. 115. OPERATING STRATEGY 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 continued to experience 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 $51.0 million or 61.8% of total assets at December 31, 1993, was $72.2 million at December 31, 1997 but had declined as a percentage of total assets to 50.4%. During the same period, the Savings Bank's total loans receivable attributable to commercial business, commercial real estate, construction and consumer loans, which amounted to $4.6 million or 5.6% of total assets at December 31, 1993, had increased to $26.2 million at December 31, 1997 or 18.3% of total assets. At the same time, investment and mortgage-backed securities, which amounted to $23.0 million, or 27.9% of total assets, at December 31, 1993 had increased to $38.8 million, or 27.1% of total assets, at December 31, 1997. Management attributes this shift in asset composition to an increase in deposits and borrowings over the same period (from $75.2 million at December 31, 1993 to $125.8 million at December 31, 1997) 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's percentage of adjustable rate mortgages in its mortgage portfolio has declined due to lack of demand. As fixed loan rates have fallen recently, the adjustable rate mortgage has become less attractive to potential customers. As of December 31, 1997, adjustable rate mortgages constituted 33.7% of the Savings Bank's one-to-four family residential mortgage portfolio and fixed rate mortgages made up the remaining portion 8 9 of the Savings Bank's one-to-four family residential mortgage portfolio. In contrast, as of December 31, 1996, adjustable rate mortgages composed 42.0% 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 realizes the importance of adjustable rate mortgages to interest rate risk management but believes that under this current rate environment it would be difficult to profitably produce adjustable rate mortgages. Therefore, 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. In striving to increase deposit balances, the Savings Bank has opened its fourth branch and first supermarket branch in October 1997 at the Shop 'N' Save located at 125 W. Beau Street, Washington, PA 15301. However, due to 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 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 the loan demand. As of December 31, 1996, outstanding borrowings from the FHLB of Pittsburgh stood at $14.5 million and as of December 31, 1997 such borrowings have increased to $34.7 million. This increased borrowing occurred as part of Management's plan to increase the assets of the Savings Bank and increase the debt to equity leverage ratio due to 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 rate risk. In the event the Savings Bank needs cash to fund additional consumer loans, commercial business 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 business 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. However, due to the heavy demand for 30 year fixed rate mortgages, management has started to promote this product. Management is cognizant of the increased interest rate risk this product presents and takes necessary steps to control the risk. Such steps include limiting new loan volume and funding the loans with longer-term borrowings. Adjustable rate mortgage loans ("ARMs") for one-to-four family residential mortgages continue to be offered. 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 that combine higher yields and a shorter loan term. Consumer and commercial business loans have grown from $9.3 million and $1.0 million, respectively, at December 31, 1996 to $12.8 million and $9.6 million, respectively, at December 31, 1997. 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 subject to change. 9 10 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 in June of 1996, 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. The Company seeks, through the Asset Liability Committee ("ALCO"), to reduce the vulnerability of its operations to changes in interest rates and to manage the difference between amounts of interest-rate sensitive assets and interest-rate sensitive liabilities within specified maturities or repricing dates. The difference, or the interest rate repricing "gap", provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets during a given time period. Generally, during a period of rising interest rates, a negative gap within shorter maturities would adversely affect net interest income, while a positive gap within shorter maturities would result in an increase in net interest income, and during a period of falling interest rates, a negative gap within shorter maturities would result in an increase in net interest income while a positive gap within shorter maturities would have the opposite effect. As of December 31, 1997, the amount of the Company's interest-bearing liabilities which were estimated to mature or reprice within one year exceeded the Company's interest-earning assets with the same characteristics by $24.5 million or 17.2% of the Company's total assets. In addition, ALCO reviews, among other things, the sensitivity of the Savings Bank's assets, liabilities, and net interest income 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, current market conditions and interest rates, and pricing of its deposit and loan products. 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, 1997, as calculated by the OTS in accordance with its model, based on information provided to the OTS by the Savings 10 11 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..................................... $ 7,238 $-9,855 -58% 5.37% -625 bp +300..................................... 9,806 -7,288 -43 7.11 -451 bp +200..................................... 12,371 -4,723 -28 8.77 -285 bp +100..................................... 14,844 -2,250 -13 10.29 -133 bp 0....................................... 17,094 11.62 - -100..................................... 19,017 1,923 +11 12.70 +108 bp - -200..................................... 20,480 3,387 +20 13.49 +187 bp - -300..................................... 22,020 4,926 +29 14.29 +267 bp - -400..................................... 24,120 7,026 +41 15.37 +375 bp
- --------- (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. 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 that 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 increase in prevailing rates changed from a negative 29 at December 31, 1996 to a negative 28 at December 31, 1997. 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, 1997. Management uses the NPV and the IRR rule as an additional tool to evaluate the Savings Bank's asset and liability position. 11 12 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, all information presented is based solely on the business operations of the Savings Bank.
AT YEAR ENDED DECEMBER 31, DECEMBER 31, ------------------------------------------------------------- 1997 1997 1996 ------------ ----------------------------- ----------------------------- AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ---- ------- -------- ---- ------- -------- ---- (DOLLARS IN THOUSANDS) Interest-earning assets: Investment securities(1)..... 6.65% $ 25,918 $1,706 6.58% $ 11,609 $ 657 5.66% Loans receivable(2) Commercial................. 9.44 7,680 $ 737 9.60 574 $ 51 8.89 Real estate loans.......... 7.42 70,445 5,160 7.32 62,537 4,568 7.31 Consumer................... 8.11 11,178 889 7.95 6,147 459 7.47 -------- ------ -------- ------ Total Loans Receivable....... 7.73 89,303 6,786 7.60 69,258 5,078 7.33 Mortgage-backed securities(1).............. 6.29 12,080 773 6.40 14,619 922 6.31 Other interest-earning assets..................... 5.15 2,750 106 3.85 1,867 91 4.87 -------- ------ -------- ------ Total interest-earning assets................... 7.36% $130,051 $9,371 7.21% $ 97,353 $6,748 6.93% Non-interest-earning assets.... 3,896 3,086 -------- -------- Total assets............... $133,947 $100,439 ======== ======== Interest-bearing liabilities: Deposits..................... 4.14% $ 88,617 $3,650 4.12% $ 82,294 $3,407 4.14% FHLB advances................ 5.78 28,554 1,590 5.57 5,169 276 5.34 -------- ------ -------- ------ Total interest-bearing liabilities.............. 4.62% $117,171 $5,240 4.47% $ 87,463 $3,683 4.21% Non-interest-bearing liabilities.................. 1,480 1,067 -------- -------- Total liabilities.......... $118,651 $ 88,530 Equity......................... 15,296 11,909 -------- -------- Total liabilities and equity................... $133,947 $100,439 ======== ======== Net interest-earning assets.... $ 12,880 $ 9,980 ======== ======== Net interest income/interest rate spread.................. 2.74% $4,131 2.74% $3,065 2.72% ==== ====== ====== ====== ====== Net yield on interest-earning assets(3).................... 3.18% 3.15% ====== ====== Ratio of average interest-earning assets to average interest-bearing liabilities.................. 110.99% 111.31% ====== ====== YEAR ENDED DECEMBER 31, ---------------------------- 1995 ---------------------------- AVERAGE AVERAGE YIELD/ BALANCE INTEREST RATE ------- -------- ---- (DOLLARS IN THOUSANDS) Interest-earning assets: Investment securities(1)..... $ 6,562 $ 335 5.11% Loans receivable(2) Commercial................. -- -- -- Real estate loans.......... 56,655 3,937 6.95 Consumer................... 4,983 352 7.06 ------- ------ Total Loans Receivable....... 61,638 4,289 6.96 Mortgage-backed securities(1).............. 16,363 1,015 6.20 Other interest-earning assets..................... 1,345 80 5.95 ------- ------ Total interest-earning assets................... $85,908 $5,719 6.66% Non-interest-earning assets.... 2,962 ------- Total assets............... $88,870 ======= Interest-bearing liabilities: Deposits..................... $77,711 $3,214 4.14% FHLB advances................ 3,078 192 6.24 ------- ------ Total interest-bearing liabilities.............. $80,789 $3,406 4.22% Non-interest-bearing liabilities.................. 952 ------- Total liabilities.......... $81,741 Equity......................... 7,129 ------- Total liabilities and equity................... $88,870 ======= Net interest-earning assets.... $ 5,119 ======= Net interest income/interest rate spread.................. $2,313 2.44% ====== ====== Net yield on interest-earning assets(3).................... 2.69% ====== Ratio of average interest-earning assets to average interest-bearing liabilities.................. 106.34% ======
- --------- (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 that 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 attributable to (i) changes in 12 13 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, ----------------------------------------------------------------------------------- 1997 VS. 1996 1996 VS. 1995 ---------------------------------------- ---------------------------------------- INCREASE INCREASE (DECREASE) (DECREASE) DUE TO TOTAL DUE TO TOTAL -------------- RATE/ INCREASE -------------- RATE/ INCREASE RATE VOLUME VOLUME (DECREASE) RATE VOLUME VOLUME (DECREASE) ---- ------ ------ ---------- ---- ------ ------ ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable, net..... $ 46 $1,586 $ 76 $1,708 $222 $ 491 $ 76 $ 789 Mortgage-backed securities.............. 14 (160) (2) (148) 17 (108) (2) (93) Investment securities..... 107 810 132 1,049 36 258 28 322 Other interest-earning assets.................. (19) 43 (9) 15 (15) 31 (5) 11 ---- ------ ---- ------ ---- ----- ---- ------ Total interest-earning assets.................. $148 $2,279 $197 $2,624 $260 $ 672 $ 97 $1,029 ---- ------ ---- ------ ---- ----- ---- ------ Interest-bearing liabilities Deposits.................. $(17) $ 262 $ (1) $ 244 $ 3 $ 190 $ 0 $ 193 FHLB advances............. 12 1,249 53 1,314 (27) 130 (19) 84 ---- ------ ---- ------ ---- ----- ---- ------ Total interest-bearing liabilities............. (5) 1,511 52 1,558 (24) 320 (19) 277 ---- ------ ---- ------ ---- ----- ---- ------ Increase in net interest income.................... $153 $ 768 $145 $1,066 $284 $ 352 $116 $ 752 ==== ====== ==== ====== ==== ===== ==== ======
NET INCOME. The Company reported consolidated net income of $784,000, $146,000 and $161,000 for the fiscal years ended December 31, 1997, 1996 and 1995, respectively. Results for fiscal 1996 were affected by a $502,000 before tax ($308,000 after tax) FDIC special assessment to recapitalize the Savings Association Insurance Fund ("SAIF"). But for this special assessment, earnings for the year ended December 31, 1996 would have been $454,000. The $330,000 or 72.7% increase in net income for fiscal 1997 when compared to fiscal 1996, without the special assessment, was attributable to a $1.1 million or 34.7% increase in net interest income and a $75,000 or 25.3% increase in other income, which was partially offset by an increase of $520,000 or 20.0% in non-interest expense and an increase of $230,000 in income tax expense, net of the benefit from the SAIF assessment. For fiscal 1996, the $15,000 decrease in net income compared to 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 which included the $502,000 FDIC special assessment. 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. NET INTEREST INCOME. Net interest income before provision for loan losses amounted to $4.1 million during fiscal 1997, compared to $3.1 million during fiscal 1996 and compared to $2.3 million during fiscal 1995. During fiscal 1997, the $1.0 million or 32.3%, increase in net interest income compared with fiscal 1996 was attributable to a $32.7 million, or 33.6%, increase in the average balance of interest-earning assets which was partially offset by an increase of $29.7 million, or 33.9%, increase in average interest-bearing liabilities. The increase in both average assets and liabilities was due directly to management's intent to leverage the Company's excess capital by funding the accelerated growth in assets with primarily FHLB advances. The increase in average interest- earning assets over average interest-bearing liabilities of $3.0 million in 1997 was primarily attributable from having the proceeds from the Company's stock offering on June 27, 1996 for a full year. Another contributing factor was an increase in the average yield earned on interest-earning assets to 7.21% in 1997 from 6.93% in 1996, due primarily to increases in yields earned on loans receivable and investment securities. The increases in both average balances and yield on earning assets, during fiscal 1997, increased interest income $2.6 million, or 38.9%, which more than offset a $1.6 million or 42.3% increase in total interest expense. The $2.6 million increase in total interest income during the year ended December 31, 1997 over the prior comparable period was primarily due to a $1.7 million or 33.6% increase in interest and fees on loans and a 13 14 $1.0 million or 159.7%, 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 1997 was primarily due to a rise in average balances of loans receivable and on investment securities of $20.0 million, or 28.9%, and $14.3 million, or 123.3%, respectively. Management continued to grow its traditional one-to-four family residential loans from $65.1 million at December 31, 1996 to $72.2 million at December 31, 1997, but in addition was able to grow its commercial business loans from $1.0 million at December 31, 1996 to $9.6 million at December 31, 1997. In addition, an increase in the average yield earned on loans receivables and investment securities from 7.33% and 5.66%, respectively, in 1996 to 7.60% and 6.58%, respectively, in 1997 accounted for a portion of the increase in interest income. The increase in interest expense in 1997, compared with 1996, was primarily a result of an increase in the Savings Bank's average interest bearing liabilities from $87.5 million to $117.2 million. This increase resulted from an increased volume of average deposits of $6.3 million or 7.7% and a $23.4 million increase in average borrowings. The increase in average borrowings was due to funding the accelerated growth in assets of the Company through increased borrowings provided by the FHLB of Pittsburgh. Net interest income before provision for loan losses amounted to $3.1 million during fiscal 1996, compared to $2.3 million during fiscal 1995. 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, or 8.1%, increase in total interest expense. 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%. 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, 1997, the provision for loan losses was $104,000. For the two years ended December 31, 1996 and 1995, provisions for loan losses were $44,000 and $36,000, respectively. The increase in provision for loan losses in 1997 represents management's intent to raise the level of provision in relation to the increased loan types and volume during fiscal 1997. During fiscal 1997, the Savings Bank charged off $8,000 in credit card loans. At December 31, 1997, the Savings Bank's allowance for loan losses amounted to 65.96% of total non-performing loans and .42% of total loans receivable. Management and the directors of the Company and the Savings Bank believe that the allowance for loan losses is adequate. 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 14 15 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 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 March 31, 1997. OTHER INCOME. Total other income amounted to $372,000 for the year ended December 31, 1997, an increase of $75,000 or 25.3% from the $297,000 earned in fiscal 1996. Increased transaction fees accounted primarily for the rise in total other income. The increase in transaction fees occurred due to an increase in transaction accounts, which include NOW and non-interest bearing accounts, from $11.1 million at December 31, 1996 to $13.9 million at December 31, 1997. The additional transaction fees have resulted in increased costs due to higher employee manhours to administer such transactions. 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. OTHER EXPENSES. Total other expenses amounted to $3.1 million for the year ended December 31, 1997, an increase of $520,000 or 20.0% from the $2.6 million incurred in fiscal 1996, without the SAIF special assessment. One of the reasons for the increase was a $347,000 or 28.4% increase in salaries and employee benefits. This is attributable to the hiring of five full time equivalent employees to staff the newly formed supermarket branch, an $88,000 expense associated with the implementation of a Management Recognition and Retention plan, additional ESOP compensation expense of $54,000, an increase in expenses related to commercial loan administration, and salary increases for its existing employees. The increase is also attributable to a rise in other expenses, which increased $198,000 or 53.6% during 1997. 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 for an entire year and additional costs associated with the first annual meeting. 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 an employee stock ownership plan. The increase is also attributable to a rise in other expenses that 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. INCOME TAXES. For the fiscal years ended December 31, 1997, 1996 and 1995, the Savings Bank incurred income tax expense of $493,000, $69,000 and $83,000. The effective tax rate was 38.6% during the year ended December 31, 1997, compared to 32.3% during the year ended 1996, and 34.1% in fiscal 1995. The increased income tax expense incurred in 1997 was due to increased taxable income. 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. 15 16 During the years ended December 31, 1997 and 1996, the Company's or the Savings Bank's operating activities provided net cash of approximately $1.5 million and $79,000, respectively. The primary reasons for the $1.5 million net cash provided during the year ended December 31, 1997 were $784,000 in net income, a $287,000 increase in other liabilities, and $189,000 in depreciation of premises and equipment, which was partially offset by a $222,000 increase in accrued interest receivable. During the year ended December 31, 1996, the $79,000 net cash provided by operating activities was the result of $146,000 in net income and $171,000 in depreciation of premises and equipment, which was partially offset by a $237,000 increase in accrued interest receivable. Net cash used by investing activities was $28.1 million for the year ended December 31, 1997. During the year ended December 31, 1997, the Savings Bank originated $19.7 million in new loans in excess of principal payments received on existing loans and purchased $17.7 million of investment securities designated held to maturity due to their longer term maturity structure. In addition, $8.5 million held to maturity securities were called during fiscal 1997. This compares with the year ended December 31, 1996 when the Savings Bank had approximately $15.2 million in new loans in excess of principal payments received on existing loans, purchased $4.7 million of investment securities designated available for sale due to the Savings Bank needing more flexibility as it prepared for its conversion from a mutual chartered savings association to a stock chartered savings association on June 27, 1996, and purchased $8.7 million of investment securities designated held to maturity due to their longer term maturity structure. Net cash provided by financing activities for the year ended December 31, 1997, was approximately $26.7 million, attributable to increases in core deposits and certificate accounts of $5.2 million and $2.1 million, respectively, and increases in net Federal Home Loan Bank advances of $20.2 million. During the same period last year, the Savings Bank experienced a $22.8 million increase in net cash provided by financing activities primarily due to $8.2 million of capital raised in connection with the conversion of the Savings Bank from a mutual chartered savings association to a stock chartered savings association on June 27, 1996, a $5.2 million increase in core deposits and increases in net Federal Home Loan Bank advances of $11.5 million. The primary sources of funds for the Savings Bank are deposits, advances from the FHLB of Pittsburgh, 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, interest and dividends on debt and 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. At December 31, 1997, the Savings Bank had a line of credit of $8.2 million from the FHLB of Pittsburgh that will expire March 24, 1998. The Company will not renew this line of credit and will instead rely on other loan products made available by the FHLB of Pittsburgh. The maximum borrowing capacity of the Savings Bank with the FHLB of Pittsburgh at December 31, 1997 was $91.0 million of which $34.7 million was borrowed 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, 1997, 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 one-to-four family mortgage 16 17 loan, commercial loan and consumer loan portfolios. The Savings Bank has outstanding loan commitments (i.e. one-to-four family and home equity loan commitments, credit card limits and commercial loan commitments) to extend credit approximating $6.7 million as of December 31, 1997. Certificates of deposit scheduled to mature in one year or less at December 31, 1997 totaled $34.1 million. Consolidated cash and cash equivalents increased by $65,000 or 3.0% between December 31, 1996 and December 31, 1997. As of December 31, 1997, the consolidated cash and cash equivalents of the Company amounted to $2.2 million or 1.5% of assets, of which $1.3 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 had an increase in dollar amount over the last few years, from $31.9 million or 27.8% of total assets at December 31, 1996 to $38.8 million or 27.1% of assets at December 31, 1997. As of December 31, 1997, $3.1 million of such investment securities (including mortgage-backed securities) of the Company and the Savings Bank mature within one year or less and $8.0 million have maturities of five years or less. The Company's consolidated net interest margin has increased from 3.15% for the year ended December 31, 1996 to 3.18% for the year ended December 31, 1997. 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 (as defined in OTS regulations) in an amount equal to 4.0% 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 at December 31, 1997 was 37.2%. 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, debt and equity investments with an aggregate market value of $658,000 at December 31, 1997 and deposits maintained with the Savings Bank. Its sources of income will consist of earnings from the investment in such debt and equity securities, interest on such deposits and interest from the ESOP obligation. The only expenses of the Company relate to its reporting obligations to the OTS, its reporting obligations under the Exchange Act and related expenses to operate 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. 17 18 RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This standard establishes reporting requirements for a new statement of comprehensive income and its components to be included with the financial statements currently required. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company will adopt SFAS No. 130 in the fiscal year ending December 31, 1998. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This standard establishes requirements for reporting information about operating segments. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company will adopt SFAS No. 131 in the fiscal year ending December 31, 1998. EARNINGS PER COMMON SHARE During the fourth quarter of 1997, the Company adopted SFAS No. 128, "Earnings Per Share". Under SFAS No. 128, earnings per share are classified as basic earnings per share and diluted earnings per share. Basic earnings per share includes only the weighted average common shares outstanding. Diluted earnings per share includes the weighted average common shares outstanding and any dilutive common stock equivalent shares in the calculation. All prior periods have been restated to reflect this adoption. Treasury shares are treated as retired for earnings per share purposes. The following table reflects the calculation of earnings per share under SFAS No. 128.
AT DECEMBER 31, -------------------- 1997 1996 ---- ---- Basic earnings per share: Net income(1)....................................... $784,487 $ 3,070 Average shares outstanding (1)...................... 851,976 886,755 Earnings per share(2)............................... $ 0.92 -- Diluted earnings per share: Net income(1)....................................... $784,487 $ 3,070 Average shares outstanding(1)....................... 851,976 886,755 Stock options....................................... 2,817 N/A -------- -------- Diluted average shares outstanding(1)............... 854,793 886,755 Earnings per share(2)............................... $ 0.92 --
- --------- (1) Net income and weighted shares outstanding for 1996 are for the period from June 27, 1996 to December 31, 1996. (2) Earnings per share information for 1996 represents the period subsequent to initial issuance of common stock on June 27, 1996. 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 also owns a loan receivable from the ESOP and holds debt and equity investments with a market value totaling $658,000 at December 31, 1997 and maintains deposit accounts 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 18 19 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, 1997, the Savings Bank's total loan portfolio amounted to $98.4 million, or 68.7% 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, $72.2 million or 73.3% of the Savings Bank's total loan portfolio consisted of one-to-four family residential loans at December 31, 1997. Management intends that one-to-four family residential mortgage loans will be the primary lending activity of the Savings Bank but the percentage of one-to-four family mortgages against the total loan portfolio will not be as high as it was at December 31, 1996. Although one-to-four family residential mortgages advanced by the Savings Bank have increased from $65.1 million at December 31, 1996 to $72.2 million at December 31, 1997, the percentage of one-to-four family mortgages to total loan portfolio has dropped from 84.2% at December 31, 1996 to 73.3% at December 31, 1997. This decline in percentage can be traced to the increases in commercial business loans, construction loans, and consumer loans booked in 1997. Management is committed to aggressively market the residential mortgage products of the Savings Bank, but management does not intend to pursue a policy to return the Savings Bank's loan portfolio to a position where one-to-four family mortgages account for 80% or more of the total loan portfolio. Consumer loans, which are of shorter maturity and at higher margins above cost of funds, have risen from $9.3 million at December 31, 1996, to $12.8 million at December 31, 1997. 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 $4.6 million at December 31, 1996 to $7.5 million at December 31, 1997. 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 12.0% at December 31, 1996, to 13.0% at December 31, 1997. 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 $2.0 million at December 31, 1996, to $11.1 million at December 31, 1997 and are expected to continue to increase in 1998. Each of the foregoing figures shows gross loan receivables with no allocation for bad debt reserve or other contra accounts. The percentage of commercial loans and commercial real estate loans against total loan receivables has changed from 2.6% at December 31, 1996 to 11.2% at December 31, 1997. Management has set a goal to grow the commercial loan portfolio to approximately $20.0 million by December 31, 1998. No special goals have been set on the growth of the commercial real estate portfolio. By statute, the Savings Bank must limit its commercial business loans to 20% of its total assets provided that amounts in excess of 10% of total assets may be used only for small business loans. As of December 31, 1997, the total asset size of the Savings Bank was $142.6 million and 20% of such number is $28.5 million and 10% of such number is $14.2 million. At December 31, 1997, the Savings Bank had $9.6 million in commercial business loans of which $3.8 million was considered small business loans. The statutory ceiling on commercial real estate loans is substantially higher, i.e. 400% of the Savings Bank's capital, or at December 31, 1997 $50.2 million. At December 31, 1997, the Savings Bank had $1.4 million in commercial real estate loans. Management intends to continue to pursue commercial loans that carry a partial U.S. Government guarantee of the payment of principal and interest. Included in the Savings Bank's loan portfolio at December 31, 1997 are $4.0 million of new commercial loans that are 80% guaranteed by the United States Government. 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. 19 20 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, ------------------------------------------------------------ 1997 1996 1995 --------------- --------------- ---------------- AMOUNT % AMOUNT % AMOUNT % ------- ----- ------- ----- ------- ------ (DOLLARS IN THOUSANDS) Real estate loans One-to-four family(1)............. $72,198 73.34% $65,117 84.17% $55,367 89.68% Construction...................... 2,449 2.49 925 1.20 0 0.00 Commercial real estate............ 1,425 1.45 1,023 1.32 793 1.28 ------- ----- ------- ----- ------- ------ Total.......................... $76,072 77.28% $67,065 86.69% $56,160 90.96% ------- ----- ------- ----- ------- ------ Commercial loans(1)................. $ 9,565 9.72% $ 1,010 1.30% $ 22 0.04% ------- ----- ------- ----- ------- ------ Consumer loans Home equity loans & lines......... $ 7,535 7.66% $ 4,562 5.90% $ 2,053 3.33% Student loans..................... 2,215 2.25 2,228 2.88 2,220 3.60 Automobile loans.................. 1,967 2.00 1,515 1.96 713 1.15 Other consumer loans(1)........... 1,076 1.09 984 1.27 569 0.92 ------- ----- ------- ----- ------- ------ Total.......................... $12,793 13.00% $ 9,289 12.01% $ 5,555 9.00% ------- ----- ------- ----- ------- ------ Total loans receivable(1)........... $98,430 100% $77,364 100% $61,737 100.00% ======= ===== ======= ===== ======= ====== Less: Allowance for loan losses......... $ 403 $ 307 $ 287 Loans in process.................. 1,857 515 0 Deferred loan (costs) fees........ (11) (3) 42 ------- ------- ------- Loans receivable, net............... $96,181 $76,545 $61,408 ======= ======= =======
- --------- (1) Includes non-performing loans. CONTRACTUAL MATURITIES. The following table sets forth the scheduled contractual maturities of the Savings Bank's loan portfolio at December 31, 1997. 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, 1997 -------------------------------------------------------------------- ONE-TO-FOUR COMMERCIAL FAMILY(1) REAL ESTATE(2) COMMERCIAL CONSUMER TOTAL ----------- --------------- ----------- -------- ------- (IN THOUSANDS) 1 year or less.................. $ 1,205 $1,455 $1,309 $ 1,525 $ 5,494 After 1 year through 5 years.... 5,199 99 2,225 4,285 11,808 More than 5 years............... 66,788 1,326 6,031 6,983 81,128 ------- ------ ------ ------- ------- Total amounts due............... $73,192 $2,880 $9,565 $12,793 $98,430 ======= ====== ====== ======= ======= Interest rate terms on amounts due after 1 year: Fixed......................... $47,307 $ 452 $5,399 $ 7,141 $60,299 ======= ====== ====== ======= ======= Adjustable/Floating........... $24,680 $ 973 $2,857 $ 4,127 $32,637 ======= ====== ====== ======= =======
- --------- (1) Includes construction loans of $994,000 for the construction of one-to-four family homes. At the completion of the construction period (scheduled to be less than one year), the loans will convert automatically to a traditional mortgage with maturities in excess of five years. 20 21 (2) Includes a construction loan of $1,455,000 for the construction of a commercial real estate property. At the completion of the construction period (scheduled to be less than one year), the loan will convert automatically to a commercial real estate 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. 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, ----------------------- 1997 1996 ---- ---- (IN THOUSANDS) Total loans at beginning of period.......................... $ 77,364 $ 61,737 Loan originations: Real estate One-to-four family..................................... $ 13,982 $ 17,100 Construction........................................... 2,948 512 Commercial real estate................................. 475 925 -------- -------- Total real estate loans originated................... $ 17,405 $ 18,537 -------- -------- Commercial loans.......................................... $ 14,174 $ 1,173 -------- -------- Consumer loans Home equity loans and lines of credit.................. $ 5,762 $ 3,868 Student loans.......................................... 353 482 Automobile loans....................................... 1,323 1,242 Other consumer loans................................... 1,267 1,284 -------- -------- Total consumer loans originated...................... $ 8,705 $ 6,876 -------- -------- Total loans originated................................. $ 40,284 $ 26,586 -------- -------- Deduct: Principal loan repayments and prepayments................. $(19,218) $(10,949) Transferred to real estate owned.......................... (0) (10) -------- -------- Subtotal:................................................... $(19,218) $(10,959) -------- -------- Net increase in loans..................................... $ 21,066 $ 15,627 -------- -------- Total loans at end of period.............................. $ 98,430 $ 77,364 ======== ========
Applications for residential mortgage and consumer loans are taken at any of the Savings Bank's offices, while commercial business loan, commercial real estate loan and construction loan applications are referred to the appropriate loan officer 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 primarily from referrals. 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 that consists of a 21 22 member of management and three 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 $500,000, 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 $500,000. 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 $1.9 million at December 31, 1997. 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 had 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 at other financial institutions that have previously done business with the Savings Bank. At December 31, 1997, none of the Savings Bank's total loans receivable consisted of participation interests. 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, 1997, $72.2 million or 73.3% 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 22 23 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, 1997, approximately $48.5 million or 66.3% 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. 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 flood insurance when required by the United States Department of Housing and Urban Development as researched by a third party vendor. 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. The Savings Bank originates mortgage loans for the acquisition and refinancing of commercial real estate properties (including multi-family complexes). At December 31, 1997, $1.4 million or 1.45% of the Savings Bank's total loan portfolio consisted of loans secured by existing commercial real estate properties. At December 31, 1997, the Savings Bank's commercial real estate loan portfolio consisted of eight loans with an average principal balance of $178,000. The Savings Bank's commercial real estate loans are secured by apartment complexes, developed residential lots and small retail establishments located in Pennsylvania. Although terms vary, commercial real estate loans generally are amortized over a maximum period of 15 years. The Savings Bank originates these loans either with fixed interest rates or with interest rates that 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, 1997, $9.6 million or 9.72% 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 23 24 Bank's primary market area. At December 31, 1997, $2.4 million or 2.5% 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 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 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 $2.0 million or 2.0% of the total loans receivable at December 31, 1997. Home equity loans and lines of credit amounted to $7.5 million or 7.7% of the total loans receivable at December 31, 1997. The student loan balance amounted to $2.2 million or 2.3% of the total loans receivable as of such date, deposit account secured loans had outstanding balances of $517,000 or .5% of total loans receivables as of such date and unsecured personal loans (including credit card balances outstanding) stood at $558,000 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, 1997, 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 including transfer fees and taxes. 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 $419,000 or .4% of the total loans receivable at December 31, 1997. 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 1997, the Savings Bank wrote-off three credit card loan balances with aggregate outstandings of $8,000. At December 31, 1997, $15,000 of the remaining consumer loans were classified as non-performing. 24 25 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 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, 1997, 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, 1997 DECEMBER 31, 1996 --------------------------------------------------------- -------------------------- 90 DAYS OR 60-89 30-59 DAYS 60-89 DAYS GREATER 30-59 DAYS DAYS ----------------- ----------------- ----------------- ----------------- ------ PERCENT PERCENT PERCENT PERCENT OF LOAN OF LOAN OF LOAN OF LOAN AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT ------ -------- ------ -------- ------ -------- ------ -------- ------ (DOLLARS IN THOUSANDS) Real estate loans: One-to-four family residences......... $2,636 3.65% $ 188 .26% $ 589 .82% $1,738 2.67% $ 75 Commercial.......... 0 0 0 0 7 .07 0 0 0 Consumer loans:...... 92 .72 8 .06 $ 15 .12 $ 6 .06 $ 15 ------ ------ ------ ------ ------ Total............. $2,728 $ 196 $ 611 $1,744 $ 90 ====== ====== ====== ====== ======
90 DAYS OR GREATER ----------------- PERCENT PERCENT OF LOAN OF LOAN CATEGORY AMOUNT CATEGORY -------- ------ -------- Real estate loans: One-to-four family residences......... .12% $ 339 .52% Commercial.......... 0 0 0 Consumer loans:...... .16 $ 2 .02 ------ Total............. $ 341 ======
25 26 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, ----------------------- 1997 1996 1995 ---- ---- ---- (DOLLARS IN THOUSANDS) Non-accruing loans: One-to-four family residential(1)........................... $589 $339 $306 Consumer loans(2)........................................... 15 2 0 Commercial loans(3)......................................... 7 0 0 ---- ---- ---- Total nonperforming loans................................. 611 341 306 Real estate owned........................................... 0 50 42 ---- ---- ---- Total nonperforming assets................................ $611 $391 $348 ==== ==== ==== Total nonperforming loans as a percentage of total loans.... .63% .44% .50% ==== ==== ==== Total nonperforming assets as a percentage of total assets.................................................... .43% .34% .38% ==== ==== ====
- --------- (1) Consists of an aggregate of 11, 6 and 8 loans at December 31, 1997, 1996 and 1995, respectively. (2) Consists of nine loans at December 31, 1997 and one loan at December 31, 1996. (3) Consists of 1 loan at December 31, 1997. The Savings Bank's total non-performing assets have increased from $391,000 or .34% of total assets at December 31, 1996 to $611,000 or .43% of total assets at December 31, 1997. The $220,000 increase in total non-performing assets between December 31, 1996 and 1997 principally reflects increases in non-performing loans. At December 31, 1997 and at December 31, 1996, approximately $46,000 and $15,000 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. 26 27 The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods presented.
DECEMBER 31, ----------------------------- 1997 1996 1995 ---- ---- ---- (DOLLARS IN THOUSANDS) Average total loans................................... $89,303 $69,258 $61,638 ======= ======= ======= Allowance for loan losses, beginning of year.......... $ 307 $ 287 $ 303 Charged-off loans(1).................................. (8) (24) (53) Recoveries on loans previously charged off............ 0 0 1 Provision for loan losses............................. 104 44 36 ------- ------- ------- Allowance for loan losses, end of period.............. $ 403 $ 307 $ 287 ======= ======= ======= Net loans charged-off to average loans................ .01% .04% .09% ======= ======= ======= Allowance for loan losses to total loans.............. .42% .40% .46% ======= ======= ======= Allowance for loan losses to nonperforming loans...... 65.96% 89.88% 93.79% ======= ======= =======
- --------- (1) Consists of $8,000 of consumer loans in 1997; consists of $18,000 of one-to-four family residential mortgage loans and $6,000 of consumer loans in 1996; and consists of $23,000 of commercial real estate loans and $30,000 of one-to-four family residential loans in 1995. 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, --------------------------------------------------------- 1997 1996 1995 ----------------- ----------------- ----------------- % 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................ $247 61.29% $227 73.94% $207 72.13% Commercial Loan: Working capital and term loans for business uses........................ 89 22.08 5 1.63 0 0 Consumer: Automobile, home equity, student, share and other consumer............. 67 16.63 75 24.43 80 27.87 ---- ------ ---- ------ ---- ------ Total............................. $403 100.00% $307 100.00% $287 100.00% ==== ====== ==== ====== ==== ======
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 27 28 remaining portion of an institution's loan portfolio. Specifically, the Policy Statement sets forth the following quantitative measures which examiners may use to 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, 1997, the Savings Bank had $611,000 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 Company's Board of Directors has given authority to the Investment Committee of the Savings Bank to manage the investment activities of the Company. Investment activity at the Company is minimal. The Company has chosen to invest in several debt and equity securities. The aggregate market value of these investments, at December 31, 1997, is $658,000. These investments were selected on management's belief that the value would appreciate. These debt and equity investments represent .5% of the total consolidated assets of the Company and 1.7% 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 Investment Committee 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 increased by $65,000 or 3.0% from fiscal 1996 to fiscal 1997. At December 31, 1997, cash and cash equivalents of the Savings Bank amounted to $2.2 million or 1.5% of total assets. The largest component in this category is interest-bearing 28 29 deposits in banks, which amounted to $1.3 million at December 31, 1997. 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 that 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 debt and equity securities with a market value totaling $658,000 at December 31, 1997 and to deposit the remaining funding of the Company in a money market and checking 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 is 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 monthly. 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. 29 30 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, -------------------------------------------------------------------- 1997 1996 1995 ------------------ ------------------ ------------------ AMORTIZED % OF AMORTIZED % OF AMORTIZED % OF COST TOTAL COST TOTAL COST TOTAL --------- ------ --------- ------ --------- ------ (DOLLARS IN THOUSANDS) HELD TO MATURITY Investment securities: U.S. Government securities............... $ 2,001 10.15% $ 2,002 19.00% $ 3,502 100.00% Federal agency obligations.............. 17,720 89.85 8,533 81.00 0 0 --------- ------ --------- ------ --------- ------ Total investment securities............. $ 19,721 100.00% $ 10,535 100.00% $ 3,502 100.00% ========= ====== ========= ====== ========= ====== Average remaining contractual life of investment 10.38 securities.................. yrs. 8.01 yrs. 2.50 yrs. ========= ========= ========= Mortgage-backed securities: GNMA........................ $ 1,158 14.44% $ 1,361 13.71% $ 1,584 13.69% FHLMC....................... 6,775 84.47 8,453 85.16 9,841 85.04 FNMA........................ 87 1.09 113 1.13 147 1.27 --------- ------ --------- ------ --------- ------ Total mortgage-backed securities............. $ 8,020 100.00% $ 9,927 100.00% $ 11,572 100.00% ========= ====== ========= ====== ========= ======
30 31
DECEMBER 31, -------------------------------------------------------------------- 1997 1996 1995 ------------------ ------------------ ------------------ AMORTIZED % OF AMORTIZED % OF AMORTIZED % OF COST TOTAL COST TOTAL COST TOTAL --------- ------ --------- ------ --------- ------ (DOLLARS IN THOUSANDS) AVAILABLE FOR SALE Investment securities: Federal agency obligations.............. $ 6,602 78.75% $ 6,503 80.91% $ 1,999 60.83% Marketable equity securities............... 1,781 21.25 1,535 19.09 1,287 39.17 --------- ------ --------- ------ --------- ------ Total investment securities............. $ 8,383 100.00% $ 8,038 100.00% $ 3,286 100.00% ========= ====== ========= ====== ========= ====== Average remaining contractual life of investment securities.................. 6.52 yrs. 8.31 yrs. 2.75 yrs. ========= ========= ========= Mortgage-backed securities: FHLMC....................... $ 1,329 52.76% $ 2,356 63.93% $ 2,930 67.87% FNMA........................ 1,191 47.24 1,329 36.07 1,387 32.13 --------- ------ --------- ------ --------- ------ Total mortgage-backed securities............. $ 2,520 100.00% $ 3,685 100.00% $ 4,317 100.00% ========= ====== ========= ====== ========= ======
The composition and maturities of the investment securities portfolio by contractual maturity are indicated in the following table:
DECEMBER 31, 1997 ------------------------------------------------------------------------------ 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.................... $2,000 $3,101 $ 0 $21,222 $26,323 $26,308 $26,281 Marketable equity securities............ 1,781 0 0 0 1,781 1,947 1,947 ------ ------ ------ ------- ------- ------- ------- Total investment securities............. $3,781 $3,101 $ 0 $21,222 $28,104 $28,255 $28,228 ====== ====== ====== ======= ======= ======= ======= Weighted average yield.................. 4.80% 5.99% N/A 7.26% 6.79% 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. The actual maturity of the Company's consolidated investment securities may differ from contractual maturity since certain of the Company's consolidated investment securities are subject to call provisions that allow the issuer to accelerate the maturity date of the security. The Savings Bank's investment securities portfolio at December 31, 1997 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. 31 32 The following table sets forth the contractual maturities of the Company's and the Savings Bank's mortgage-backed securities at December 31, 1997.
DUE IN ----------------------------------------------------------------------------------------------------- LESS THAN 1 TO 3 3 TO 5 5 TO 10 10 TO 20 OVER 20 DECEMBER 31, 1997 1 YEAR YEARS YEARS YEARS YEARS YEARS AMORTIZED COST --------- ------------ ------------ ------------- --------- --------- ------------------- AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR COST COST COST COST COST COST COST VALUE ---- ---- ---- ---- ---- ---- ---- ----- (DOLLARS IN THOUSANDS) GNMA..................... $ 0 $ 0 $ 0 $ 0 $ 157 $1,001 $ 1,158 $ 1,189 FHLMC.................... 1,043 557 0 0 6,218 286 8,104 8,184 FNMA..................... 87 282 909 0 0 0 1,278 1,260 ------ ------ ------ ------ ------ ------ ------- ------- Total.................... $1,130 $ 839 $ 909 $ 0 $6,375 $1,287 $10,540 $10,633 ====== ====== ====== ====== ====== ====== ======= ======= Weighted Average Yield... 5.23% 6.16% 5.00% N/A 6.54% 7.27% 6.32% N/A ====== ====== ====== ====== ====== ====== ======= =======
CARRYING VALUE -------- GNMA..................... $ 1,158 FHLMC.................... 8,114 FNMA..................... 1,259 ------- Total.................... $10,531 ======= Weighted Average Yield... N/A =======
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 Company's and the Savings Bank's securities classified as held to maturity at December 31, 1997.
DECEMBER 31, 1997 TOTAL MORTGAGE- BACKED DUE IN SECURITIES --------------------------------------------------------------------------------- ------------------ DUE 1 YEAR 1 TO 3 3 TO 5 5 TO 10 10 TO 20 OVER 20 OR LESS YEARS YEARS 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 $2,001 $ 0 $11,514 $ 6,206 $ 0 $19,721 $19,749 $19,721 FHLMC Certificates... 0 557 0 0 6,218 0 6,775 6,844 6,775 GNMA Certificates.... 0 0 0 0 157 1,001 1,158 1,189 1,158 FNMA Certificates.... 87 0 0 0 0 0 87 89 87 ------ ------ --- ------- ------- ------ ------- ------- ------- Total................ $ 87 $2,558 $ 0 $11,514 $12,581 $1,001 $27,741 $27,871 $27,741 ====== ====== === ======= ======= ====== ======= ======= ======= Weighted Average Yield.............. 8.00% 6.01% N/A 7.31% 6.97% 7.07% 7.03% 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. The actual maturity of the Company's consolidated investment securities may differ from contractual maturity since certain of the Company's consolidated investment securities are subject to call provisions that allow the issuer to accelerate the maturity date of the security. 32 33 The following table sets forth the contractual maturities of the Company's and Savings Bank's securities classified as available for sale at December 31, 1997.
DECEMBER 31, 1997 TOTAL MORTGAGE- BACKED DUE IN SECURITIES --------------------------------------------------------------------------------- ------------------ DUE 1 YEAR 1 TO 3 3 TO 5 5 TO 10 10 TO 20 OVER 20 OR LESS YEARS YEARS YEARS YEARS YEARS AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED AMORTIZED FAIR CARRYING COST COST COST COST COST COST COST VALUE VALUE --------- --------- --------- --------- --------- --------- --------- ------- -------- Marketable Equity Securities......... $1,781 $ 0 $ 0 $ 0 $ 0 $ 0 $ 1,781 $ 1,947 $ 1,947 U.S. Gov't & Agency Securities......... 2,000 1,100 0 1,502 2,000 0 6,602 6,559 6,559 FHLMC Certificates... 1,043 0 0 0 0 286 1,329 1,340 1,340 GNMA Certificates.... 0 0 0 0 0 0 0 0 0 FNMA Certificates.... 0 282 909 0 0 0 1,191 1,171 1,171 ------ ------ ----- ------ ------ ----- ------- ------- ------- Total................ $4,824 $1,382 $ 909 $1,502 $2,000 $ 286 $10,903 $11,017 $11,017 ====== ====== ===== ====== ====== ===== ======= ======= ======= Weighted Average Yield.............. 4.84% 6.06% 5.00% 6.55% 7.05% 8.00% 5.73% 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. The actual maturity of the Company's consolidated investment securities may differ from contractual maturity since certain of the Company's consolidated investment securities are subject to call provisions that allow the issuer to accelerate the maturity date of the security. At December 31, 1997, 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 6.31%. 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 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, 1997, of the $10.5 million of mortgage-backed securities, an aggregate of $7.5 million were secured by fixed-rate mortgage loans and an aggregate of $3.0 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, 1997 and has no present intention to invest in such products. 33 34 SOURCES OF FUNDS GENERAL. The principal source of funds for the Company is the repayment of the loan to the ESOP, interest and dividends on its debt and 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 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, tiered 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. In October 1997, the Savings Bank opened its fourth branch and first supermarket branch at the Shop 'N' Save located at 125 W. Beau Street, Washington, PA 15301. 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 fee structures on transaction accounts, 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, 1997. The Savings Bank presently operates four automated teller machines ("ATMs"), one at each of the branch offices maintained by the Savings Bank as of December 31, 1997. 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. 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, --------------------------------------------------------------- 1997 1996 1995 ----------------- ----------------- ----------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- ------ ------- (DOLLARS IN THOUSANDS) Passbook and club accounts........... $15,298 16.78% $15,476 18.46% $16,396 20.32% Money market......................... 16,122 17.68 13,513 16.12 9,085 11.25 Certificates of deposit.............. 45,803 50.25 43,683 52.12 45,842 56.78 NOW accounts......................... 9,933 10.90 8,595 10.25 7,325 9.07 Non-interest bearing................. 4,000 4.39 2,554 3.05 2,083 2.58 ------- ------ ------- ------ ------- ------ Total deposits..................... $91,156 100.00% $83,821 100.00% $80,731 100.00% ======= ====== ======= ====== ======= ======
34 35 The following table presents, by various interest rate categories, the amount of certificates of deposit at December 31, 1997 and the amounts at December 31, 1997 that mature during the periods indicated.
TOTAL AS OF DECEMBER 31, AMOUNTS AT DECEMBER 31, 1997 1997 MATURING WITHIN ------------ ------------------------------------ AFTER ONE BUT WITHIN ONE THREE CERTIFICATES OF DEPOSIT YEAR YEARS THEREAFTER ----------------------- ---- ----- ---------- (DOLLARS IN THOUSANDS) 4.01% to 6.00%................................... $35,737 $28,267 $4,959 $2,511 6.01% to 8.00%................................... 10,066 5,837 4,050 179 ------- ------- ------ ------ Total certificate accounts..................... $45,803 $34,104 $9,009 $2,690 ======= ======= ====== ======
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, --------------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID ------- --------- ------- --------- ------- --------- (DOLLARS IN THOUSANDS) Passbook and club accounts....... $15,587 2.53% $16,112 2.55% $16,882 2.54% Money market..................... 15,014 3.56 10,649 3.15 9,914 2.97 Certificates of deposit.......... 45,579 5.62 45,522 5.54 42,456 5.58 NOW accounts..................... 9,272 1.74 8,009 1.73 7,017 1.72 Non-interest bearing............. 3,165 0.00 2,002 0.00 1,442 0.00 ------- ---- ------- ---- ------- ---- Total deposits................... $88,617 4.12% $82,294 4.14% $77,711 4.14% ======= ==== ======= ==== ======= ====
The following table sets forth the Savings Bank's net savings flows during the periods indicated.
YEAR ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 ---- ---- ---- (IN THOUSANDS) Beginning balance........................................... $83,821 $80,731 $75,313 Increase (decrease) before interest credited................ 3,685 (317) 2,201 Interest credited........................................... 3,650 3,407 3,217 ------- ------- ------- Net savings increase........................................ 7,335 3,090 5,418 ------- ------- ------- Ending balance.............................................. $91,156 $83,821 $80,731 ======= ======= =======
The following table sets forth maturities of the Savings Bank's certificates of deposit of $100,000 or more at December 31, 1997 by time remaining to maturity.
IN THOUSANDS ------------ Three months or less........................................ $ 306 Over three months through six months........................ 2,401 Over six months through 12 months........................... 1,414 Over 12 months.............................................. 1,251 ------ Total..................................................... $5,372 ======
35 36 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, ---------------------------------- 1997 1996 1995 ---- ---- ---- (DOLLARS IN THOUSANDS) Amount Outstanding At Year End............................. $34,677 $14,477 $2,977 ======= ======= ====== Maximum Balance............................................ $34,977 $15,077 $4,861 ======= ======= ====== Average Balance............................................ $28,554 $ 5,169 $3,078 ======= ======= ====== Weighted Average Interest Rate: At end of year........................................... 5.78% 5.96% 6.25% ======= ======= ====== During Year.............................................. 5.57% 5.34% 6.24% ======= ======= ======
The Savings Bank utilized the increased borrowings during 1997 to meet increased loan demand. As of December 31, 1997, the Savings Bank also had a revolving credit commitment from the FHLB of Pittsburgh of $8.2 million all of which remained available for borrowing. 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. 36 37 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. At December 31, 1997, 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, 1997 and as of December 31 of each of the preceding four years.
AS OF AS OF AS OF AS OF DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994 -------------------- -------------------- ------------------- ------------------- PERCENT OF PERCENT OF PERCENT OF PERCENT OF AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) ------ --------- ------ --------- ------ --------- ------ --------- (DOLLARS IN THOUSANDS) Tangible capital:(1) Requirement........ $ 2,139 1.50% $ 1,719 1.50% $1,378 1.50% $1,316 1.50% Actual............. 12,592 8.83 11,787 10.28 7,228 7.87 7,049 8.03 Excess............. $10,453 7.33% $10,068 8.78% $5,850 6.37% $5,733 6.53% Core capital:(1)(2) Requirement........ $ 4,279 3.00% $ 3,438 3.00% $2,757 3.00% $2,632 3.00% Actual............. 12,592 8.83 11,787 10.28 7,228 7.87 7,049 8.03 Excess............. $ 8,313 5.83% $ 8,349 7.28% $4,471 4.87% $4,417 5.03% Risk-based capital:(1) Requirement(4)..... $ 5,537 8.00% $ 4,064 8.00% $3,101 8.00% $2,985 8.00% Actual(3).......... 12,995 18.78 12,094 23.81 7,515 19.39 7,352 19.70 Excess............. $ 7,458 10.78% $ 8,030 15.81% $4,414 11.39% $4,367 11.70%
AS OF DECEMBER 31, 1993 ------------------- PERCENT OF AMOUNT ASSETS(2) ------ --------- Tangible capital:(1) Requirement........ $1,238 1.50% Actual............. 6,500 7.90 Excess............. $5,262 6.40% Core capital:(1)(2) Requirement........ $2,476 3.00% Actual............. 6,500 7.90 Excess............. $4,024 4.90% Risk-based capital:(1) Requirement(4)..... $2,682 8.00% Actual(3).......... 6,800 20.30 Excess............. $4,118 12.30%
- --------- (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. As of December 31, 1997, the difference between capital under generally accepted accounting principles ("GAAP") and regulatory tangible and core capital is attributable to $30,000 for the Savings Bank's net unrealized holding losses on available-for-sale securities to arrive at regulatory tangible and core capital of $12,592,000. (2) To be "adequately capitalized" for purposes of the OTS' Prompt Corrective Action regulations, core capital generally must be at least 4.0%. (3) As of December 31, 1997, 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 $403,000 for the allowance for loan loss and $30,000 for the Savings Bank's net unrealized holding gains (losses) on available-for-sale securities to arrive at regulatory risk-based capital of $12,995,000. (4) Calculated based on the OTS requirement of 8.0% of risk-weighted assets. 37 38 DIRECTOR AND EXECUTIVE OFFICER BIOGRAPHICAL INFORMATION Set forth below are the directors and executive officers of the Company and the Savings Bank together with information concerning the principal occupations during the last five years for such directors and executive officers. MARTIN W. DOWLING has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1992. Mr. Dowling is the director and owner of Jefferson Hills Real Estate, Inc. He is also President of Martin W. Dowling, Inc., a building and remodeling company, and President of Town Hall Estates, Inc., and Meadow Green Corp., both companies being in the business of real estate development. Mr. Dowling also serves as director of Jefferson Hospital and other healthcare-related organizations. JAMES M. HEIN is the Chief Financial Officer of the Savings Bank and has performed as such since January 1996. Prior to that time Mr. Hein acted as the Controller of the Savings Bank. In connection with the formation of the Company and the Conversion of the Savings Bank, Mr. Hein was appointed the Controller of the Company. MICHAEL R. MACOSKO has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1992. Mr. Macosko is a pharmacist with Eckerd Drug, Inc., and has performed as such since 1995 with Eckerd Drug, Inc. and its predecessor Thrift Drug, Inc. From 1974 until 1995 he was pharmacist, owner and President of Woody's Drug Store, Inc. CHARLES P. MCCULLOUGH has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1995. Mr. McCullough is an attorney and a shareholder with Tucker Arensberg, P.C., and has performed as an attorney at Tucker Arensberg, P.C. since November of 1995. Prior to his employment by Tucker Arensberg, P.C., Mr. McCullough was a solo practitioner attorney at law. MARK R. SCHOEN has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1994. Mr. Schoen is an Assistant Vice President of Business Development for Federated Investors, a company servicing the mutual fund industry. Mr. Schoen has performed in this capacity since 1997. Prior to 1997, Mr. Schoen was employed as an Assistant Vice President of Product Administration for Federated Investors and had performed as such since 1992. JOHN A. STIVER has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1986. Mr. Stiver is a CPA licensed to practice in Pennsylvania since 1972 and has been a self employed CPA since 1980. Mr. Stiver serves as Chairman of the Board of Directors of the Company and the Savings Bank. He is also President and owner of C & J Leasing Co., an equipment leasing company, President and owner of Jackson Group, Ltd., an investment company, and President and owner of Miller's Mini Storage, Inc., a self-storage company. PATRICIA A. WHITE has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1989. Ms. White is the Executive Vice President of the Savings Bank, and has performed as such since 1989. She is also the Corporate Secretary of the Savings Bank and has performed as such since 1986. Her main duties include oversight of the marketing, compliance, security and loan origination areas of the Savings Bank. In connection with the formation of the Company and the Conversion, Ms. White was appointed Treasurer and Secretary of the Company. ROBERT S. ZYLA has been a director of the Company since its formation in 1996 and a director of the Savings Bank since 1984. Mr. Zyla is the President, Chief Executive Officer and Treasurer of the Savings Bank. Mr. Zyla was appointed President of the Savings Bank in 1989. Mr. Zyla received the title of Chief Executive Officer and Treasurer of the Savings Bank in 1995. In connection with the formation of the Company and the Conversion, Mr. Zyla was appointed the President of the Company. 38 39 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, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Pittsburgh, Pennsylvania, January 14, 1998 39 40 PRESTIGE BANCORP, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
1997 1996 ---- ---- ASSETS Cash and due from banks..................................... $ 927,362 $ 735,951 Interest-bearing deposits with banks........................ 1,286,099 1,411,727 Investment securities: Available for sale........................................ 11,017,858 11,442,549 Held to maturity (market value $27,870,426 and $20,364,934, respectively)............................. 27,741,398 20,461,927 Loans....................................................... 98,429,871 77,364,459 Less--Unearned income (deferred costs), net................. (10,856) (2,735) Allowance for loan losses............................ 402,964 306,926 Loans in process..................................... 1,856,802 515,115 ------------ ------------ Net loans......................................... 96,180,961 76,545,153 ------------ ------------ Federal Home Loan Bank stock, at cost....................... 1,748,900 753,900 Premises and equipment, net................................. 2,673,794 1,880,919 Accrued interest receivable................................. 1,033,261 810,884 Deferred tax asset.......................................... -- 35,726 Other assets................................................ 653,077 561,413 ------------ ------------ Total assets................................................ $143,262,710 $114,640,149 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Noninterest-bearing deposits.............................. $ 4,000,085 $ 2,554,148 Interest-bearing deposits................................. 87,155,740 81,267,320 ------------ ------------ Total deposits.................................... 91,155,825 83,821,468 Federal Home Loan Bank advances........................... 34,677,000 14,477,000 Advance payments by borrowers for taxes and insurance..... 856,881 622,057 Income taxes payable...................................... 178,068 24,360 Deferred tax liability.................................... 77,927 -- Accrued interest payable.................................. 153,336 37,954 Other liabilities......................................... 533,862 227,110 ------------ ------------ Total liabilities................................. 127,632,899 99,209,949 ------------ ------------ Stockholders' Equity: Preferred stock, $1.00 par value; 5,000,000 shares authorized, none issued............................................ -- -- Common stock, $1.00 par value; 10,000,000 shares authorized, 963,023 shares issued...................... 963,023 963,023 Treasury stock, 48,150 shares on December 31, 1997, at cost; none at December 31, 1996.............................. (775,881) -- Additional paid in capital................................ 8,033,296 8,000,176 Unearned ESOP shares...................................... (724,050) (755,490) Retained earnings......................................... 8,064,202 7,390,945 Net unrealized holding gains (losses) on available for sale securities, net of taxes.......................... 69,221 (168,454) ------------ ------------ Total stockholders' equity........................ 15,629,811 15,430,200 ------------ ------------ Total liabilities and stockholders' equity.................. $143,262,710 $114,640,149 ============ ============
The accompanying notes are an integral part of these statements 40 41 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ---- ---- ---- INTEREST INCOME: Interest and fees on loans................................. $6,786,131 $5,078,301 $4,289,258 Interest on mortgage-backed securities..................... 773,171 922,491 1,014,922 Interest and dividends on other investment securities...... 1,706,379 656,991 334,581 Interest on deposits in other financial institutions....... 105,621 90,584 80,180 ---------- ---------- ---------- Total interest income............................... 9,371,302 6,748,367 5,718,941 ---------- ---------- ---------- INTEREST EXPENSE: Interest on deposits....................................... 3,650,221 3,406,804 3,213,488 Advances from Federal Home Loan Bank....................... 1,590,207 276,022 192,148 ---------- ---------- ---------- Total interest expense.............................. 5,240,428 3,682,826 3,405,636 ---------- ---------- ---------- Net interest income................................. 4,130,874 3,065,541 2,313,305 ---------- ---------- ---------- PROVISION FOR LOAN LOSSES.................................. 104,000 44,000 36,000 ---------- ---------- ---------- Net interest income after provision for loan losses............................................ 4,026,874 3,021,541 2,277,305 ---------- ---------- ---------- OTHER INCOME: Fees and service charges................................... 321,727 260,685 217,937 Gain on sale of investments................................ 20,704 -- -- Other income, net.......................................... 29,932 36,327 3,893 ---------- ---------- ---------- Total other income.................................. 372,363 297,012 221,830 ---------- ---------- ---------- OTHER EXPENSES: Salaries and employee benefits............................. 1,567,942 1,221,432 1,016,382 Premises and occupancy costs............................... 332,882 326,200 314,513 Federal deposit insurance premiums......................... 56,508 175,984 174,225 Special SAIF assessment.................................... -- 501,727 -- Data processing costs...................................... 204,757 171,485 154,063 Advertising costs.......................................... 108,280 86,157 93,740 Transaction processing costs............................... 191,773 159,213 141,418 ATM transaction fees....................................... 92,515 92,174 86,243 Other expenses............................................. 567,173 369,282 274,623 ---------- ---------- ---------- Total other expenses................................ 3,121,830 3,103,654 2,255,207 ---------- ---------- ---------- Income before income tax expense........................... 1,277,407 214,899 243,928 INCOME TAX EXPENSE......................................... 492,920 69,386 83,069 ---------- ---------- ---------- NET INCOME................................................. $ 784,487 $ 145,513 $ 160,859 ========== ========== ========== PER COMMON SHARE DATA: Basic: Net Income(1).......................................... $ 0.92 $ -- N/A ========== ========== ========== Average number of common shares outstanding(2)......... 851,976 886,755 N/A ========== ========== ========== Diluted: Net Income(1).......................................... $ 0.92 $ -- N/A ========== ========== ========== Average number of common shares outstanding(2)......... 854,793 886,755 N/A ========== ========== ========== Cash Dividends Declared(1)............................... $ 0.12 -- N/A ========== ========== ==========
- --------- (1) Earnings per share and cash dividends declared information for 1996 represents the period subsequent to initial issuance of common stock on June 27, 1996. (2) Weighted shares outstanding for 1996 represent the weighted shares outstanding from June 27, 1996 to December 31, 1996. The accompanying notes are an integral part of these statements 41 42 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NET UNREALIZED HOLDING GAINS (LOSSES) ON ADDITIONAL AVAILABLE FOR COMMON STOCK TREASURY PAID-IN UNEARNED RETAINED SALE SECURITIES, $1.00 PAR VALUE STOCK CAPITAL ESOP SHARES EARNINGS NET OF TAXES TOTAL --------------- ----- ------- ----------- -------- ------------ ----- BALANCE, December 31, 1994..................... $ -- $ -- $ -- $ -- $7,084,573 $ (35,463) $ 7,049,110 Net income................. -- -- -- -- 160,859 -- 160,859 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 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 Net income................. -- -- -- -- 784,487 -- 784,487 Allocation of 3,144 ESOP shares................... -- -- 33,120 31,440 -- -- 64,560 Net unrealized gains on available for sale securities, net of tax... -- -- -- -- -- 237,675 237,675 Cash dividends declared.... -- -- -- -- (111,230) -- (111,230) Treasury stock purchases, 48,150 shares............ -- (775,881) -- -- -- -- (775,881) -------- --------- ---------- --------- ---------- --------- ----------- BALANCE, December 31, 1997..................... $963,023 $(775,881) $8,033,296 $(724,050) $8,064,202 $ 69,221 $15,629,811 ======== ========= ========== ========= ========== ========= ===========
The accompanying notes are an integral part of these statements 42 43 PRESTIGE BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES: Net income.................................................. $ 784,487 $ 145,513 $ 160,859 ------------ ----------- ----------- Adjustments to reconcile net income to net cash provided (used) by operating activities-- Depreciation of premises and equipment.................. 188,779 171,044 155,618 Amortization of premiums and discounts, net............. (31,805) (4,354) (2,791) Non cash compensation expense related to MRP Plan....... 88,307 -- -- Non cash compensation expense related to ESOP benefit... 84,484 30,071 -- Loss on sale of mutual funds............................ 3,200 -- -- Loss on sale of available for sale mortgage-backed securities............................................. 792 -- -- Gain on call of held to maturity investment securities............................................. (24,696) -- -- Loss on sale of premises and equipment.................. -- -- 32,675 Provision for loan losses............................... 104,000 44,000 36,000 Increase (decrease) in other liabilities................ 286,828 25,524 (185,828) Increase (decrease) in accrued interest payable......... 115,382 (37,978) 46,355 Increase (decrease) in income taxes payable............. 108,912 (60,524) (81,736) Increase in accrued interest receivable................. (222,377) (237,334) (63,991) Decrease (increase) in other assets..................... 30,435 1,584 (88,230) Other, net.............................................. -- 1,783 (13,862) ------------ ----------- ----------- Total adjustments................................... 732,241 (66,184) (165,790) ------------ ----------- ----------- Net cash provided (used) by operating activities.... 1,516,728 79,329 (4,931) ------------ ----------- ----------- INVESTING ACTIVITIES: Loan originations........................................... (38,985,258) (26,118,053) (8,875,462) Principal payments on loans................................. 19,245,450 10,935,360 8,080,275 Proceeds from calls and maturities of held to maturity investment securities..................................... 8,524,696 1,700,000 500,000 Proceeds from sale of available for sale mutual funds....... 101,000 -- -- Proceeds from sale of available for sale mortgaged-backed securities................................................ 633,274 -- -- Proceeds from call of available for sale investment securities................................................ 1,000,000 -- -- Return of capital on investment securities.................. 29,100 -- -- Purchases of held to maturity investment securities......... (17,672,530) (8,735,000) (1,502,422) Purchases of available for sale securities.................. (1,479,908) (4,747,900) (67,785) Principal payments on available for sale mortgage-backed securities................................................ 543,835 637,010 -- Principal payments on held to maturity mortgage-backed securities................................................ 1,914,386 1,643,112 1,719,761 Purchases of held to maturity mortgage-backed securities.... -- -- (978,469) Purchases of premises and equipment......................... (981,654) (183,397) (275,007) Proceeds from sale of premises and equipment................ -- -- 90,053 Purchase of land............................................ -- (265,717) -- Purchase of Federal Home Loan Bank stock.................... (995,000) (20,200) (40,000) ------------ ----------- ----------- Net cash used by investing activities............... (28,122,609) (25,154,785) (1,349,056) ------------ ----------- ----------- FINANCING ACTIVITIES: Increase in advance payments by borrowers for taxes and insurance................................................. 234,824 50,277 74,635 Purchases of MRP shares..................................... (210,406) -- -- Proceeds from Federal Home Loan Bank advances............... 88,607,500 44,850,000 2,027,000 Payments on Federal Home Loan Bank advances................. (68,407,500) (33,350,000) (3,311,400) Net increase (decrease) in money market, NOW and passbook savings accounts.......................................... 5,214,353 5,249,401 (2,519,341) Net increase (decrease) in certificate accounts............. 2,120,004 (2,158,605) 7,936,529 Purchases of treasury stock................................. (775,881) -- -- Common stock dividends paid................................. (111,230) -- -- Net proceeds from stock offering............................ -- 8,188,394 -- ------------ ----------- ----------- Net cash provided by financing activities........... 26,671,664 22,829,467 4,207,423 ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents......................................... 65,783 (2,245,989) 2,853,436 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 2,147,678 4,393,667 1,540,231 ------------ ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 2,213,461 $ 2,147,678 $ 4,393,667 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for income taxes.................. $ 381,000 $ 132,000 $ 129,770 ============ =========== =========== Cash paid during the year for interest on deposits and borrowings................................................ $ 5,125,044 $ 3,682,828 $ 3,408,936 ============ =========== =========== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITY: Loans transferred to real estate owned...................... $ -- $ 10,000 $ 80,716 ============ =========== =========== Investment securities transferred from held to maturity to available for sale........................................ $ -- $ -- $ 6,316,596 ============ =========== ===========
The accompanying notes are an integral part of these statements 43 44 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 AND 1996 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., (the Corporation), a Pennsylvania 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 of 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 four 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, 1997 and 1996 included $164,000 and $77,000, respectively, of reserves required to be maintained under Federal Reserve Bank regulations. INVESTMENT SECURITIES The Bank follows 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 accretion of discount using the interest method. 44 45 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED 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 by its Board of Directors 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 multiple 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. 45 46 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 defined benefit 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, 1997 and 1996, 72,405 and 75,549 shares, respectively, remain unearned. On April 23, 1997, the Board of Directors and shareholders formally approved the Corporation's Stock Option Plan (the Option Plan) and Management Recognition and Retention Plan and Trust (the MRP Plan). See notes 12, 13 and 14 for additional information. 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 COMMON SHARE During the fourth quarter of 1997, the Company adopted SFAS No. 128, "Earnings Per Share". Under SFAS No. 128, earnings per share are classified as basic earnings per share and diluted earnings per share. Basic earnings per share includes only the weighted average common shares outstanding. Diluted earnings per share includes the weighted average common shares outstanding and any dilutive common stock equivalent shares in the calculation. All prior periods have been restated to reflect this adoption. Treasury shares are treated as retired for earnings per share purposes. 46 47 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED The following table reflects the calculation of earnings per share under SFAS No. 128.
AT DECEMBER 31, ------------------- 1997 1996 -------- -------- Basic earnings per share: Net income (1)............................................ $784,487 $ 3,070 Average shares outstanding (1)............................ 851,976 886,755 Earnings per share (2).................................... $ .92 -- Diluted earnings per share: Net income (1)............................................ $784,487 $ 3,070 Average shares outstanding (1)............................ 851,976 886,755 Stock options............................................. 2,817 -- -------- -------- Diluted average shares outstanding (1).................... 854,793 886,755 Earnings per share (2).................................... $ .92 --
- --------- (1) Net income and weighted shares outstanding for 1996 are for the period from June 27, 1996 to December 31, 1996. (2) Earnings per share information for 1996 represents the period subsequent to initial issuance of common stock on June 27, 1996. 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. 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. 47 48 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--CONTINUED FUTURE ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This standard establishes reporting requirements for a new statement of comprehensive income and its components to be included with the financial statements currently required. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This standard establishes disclosure requirements for reporting information about operating segments. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. 3. INVESTMENT SECURITIES: The cost and market values of investment securities are summarized as follows: Investment securities held to maturity:
DECEMBER 31, 1997 --------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------- -------- -------- ----------- U.S. government and government agency obligations: Due after one and within five years......................... $ 2,001,480 $ 15,763 $ 10,518 $ 2,006,725 Due within ten years............ 11,514,303 36,587 3,280 11,547,610 Due after ten years............. 6,205,592 -- 11,500 6,194,092 Federal Home Loan Mortgage Corporation (FHLMC) certificates: Due after one and within five years......................... 556,615 7,494 -- 564,109 Due after ten years............. 6,217,776 62,247 -- 6,280,023 Government National Mortgage Association (GNMA) certificates due after 10 years..................... 1,158,357 30,793 -- 1,189,150 Federal National Mortgage Association (FNMA) certificates due within one year........................... 87,275 1,442 -- 88,717 ----------- -------- -------- ----------- $27,741,398 $154,326 $ 25,298 $27,870,426 =========== ======== ======== ===========
The maturities within the table above are based upon contractual maturity. 48 49 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 3. INVESTMENT SECURITIES:--CONTINUED Investment securities available for sale:
DECEMBER 31, 1997 --------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ----------- -------- -------- ----------- U.S. government and government agency obligations: Due within one year............. $ 2,000,000 $ -- $ 13,740 $ 1,986,260 Due after one and within five years......................... 1,100,344 -- 539 1,099,805 Due within ten years............ 1,501,819 -- 13,694 1,488,125 Due after ten years............. 2,000,000 -- 14,680 1,985,320 Federal Home Loan Mortgage Corporation (FHLMC) certificates: Due within one year............. 1,042,500 880 3,116 1,040,264 Due after ten years............. 286,050 13,719 -- 299,769 Federal National Mortgage Association (FNMA) certificates due after one and within five years.............. 1,190,371 -- 19,059 1,171,312 Mutual fund investment............... 1,325,890 -- 36,609 1,289,281 Common stock portfolio............... 455,427 202,295 -- 657,722 ----------- -------- -------- ----------- $10,902,401 $216,894 $101,437 $11,017,858 =========== ======== ======== ===========
The maturities within the table above are based upon contractual maturity. 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 =========== ======= ======== ===========
49 50 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 3. INVESTMENT SECURITIES:--CONTINUED 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. Mortgage-backed securities include net unamortized discounts of $29,321 and $48,910 at December 31, 1997 and 1996, respectively. 50 51 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 4. LOANS RECEIVABLE: Loans receivable at December 31, 1997 and 1996, are summarized as follows:
1997 1996 ---- ---- Commercial, including commercial secured by real estate................................................. $10,989,872 $ 2,032,794 Construction............................................. 1,455,000 -- Less--Undisbursed loan proceeds........................ (1,315,560) -- ----------- ----------- Total commercial......................................... 11,129,312 2,032,794 Real estate loans: 1-4 family............................................. 72,197,618 65,117,008 Construction........................................... 993,981 925,100 ----------- ----------- 73,191,599 66,042,108 Less--Undisbursed loan proceeds........................ (541,242) (515,115) Deferred loan costs/(fees)...................... 10,856 2,735 ----------- ----------- 72,661,213 65,529,728 ----------- ----------- Consumer loans: Home equity............................................ 7,535,275 4,562,094 Student................................................ 2,214,946 2,228,756 Automobile............................................. 1,967,348 1,515,015 Share.................................................. 517,215 486,695 Credit cards........................................... 419,142 398,840 Personal unsecured/other............................... 139,474 98,157 ----------- ----------- 12,793,400 9,289,557 ----------- ----------- 96,583,925 76,852,079 Less--Allowance for loan losses........................ (402,964) (306,926) ----------- ----------- $96,180,961 $76,545,153 =========== ===========
The credit cards are currently being serviced by a third party. At December 31, 1997 and 1996, the majority of the loan portfolio was secured by properties located in Western Pennsylvania. As of December 31, 1997, 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, 1997 and 1996, the Bank had approximately $611,000 and $341,000 of nonaccrual loans. The Bank does not have any other significant off-balance sheet risk except for the commitments referenced in Note 16. Deferred loan costs in 1997 and 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:
1997 1996 1995 ---- ---- ---- Balance at beginning of year....................... $306,926 $287,060 $303,312 Provision for loan losses.......................... 104,000 44,000 36,000 Charge-offs........................................ (8,446) (24,294) (52,884) Recoveries......................................... 484 160 632 -------- -------- -------- Balance at end of year............................. $402,964 $306,926 $287,060 ======== ======== ========
51 52 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 5. ALLOWANCE FOR LOAN LOSSES:--CONTINUED 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, 1997 and 1996, the Bank had loans totaling $611,000 and $341,000, 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 1997 and 1996 were $467,000, and $267,000, 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 no real estate owned assets at December 31, 1997 and $49,872 at December 31, 1996. 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, 1997 and 1996, are summarized by major classification as follows:
1997 1996 ---- ---- Land....................................................... $ 224,817 $ 224,817 Building and improvements.................................. 2,359,684 1,776,892 Furniture, fixtures and equipment.......................... 1,275,127 876,264 ---------- ---------- Total, at cost........................................ 3,859,628 2,877,973 Less--Accumulated depreciation............................. 1,185,834 997,054 ---------- ---------- Premises and equipment, net................................ $2,673,794 $1,880,919 ========== ==========
Depreciation and amortization expense was $188,779, $171,044 and $155,618 for the fiscal years ended December 31, 1997, 1996 and 1995, respectively. 52 53 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 8. DEPOSITS: The aggregate amount of short-term jumbo certificates of deposit, each with a minimum denomination of $100,000, was approximately $5,372,000 and $4,431,000 at December 31, 1997, and 1996, respectively. At December 31, 1997 the scheduled maturities of the certificate accounts are as follows: 1998................................................. $34,103,528 1999................................................. 3,212,594 2000................................................. 5,796,419 2001................................................. 1,458,445 2002 and thereafter.................................. 1,232,213 ----------- $45,803,199 ===========
Interest expense associated with deposits for each of the years ended is as follows:
1997 1996 1995 ---- ---- ---- Interest on certificates of deposit........... $2,572,048 $2,530,750 $2,379,871 Interest on savings accounts.................. 394,893 410,460 428,583 Money market demand accounts.................. 534,917 334,873 294,353 Interest on NOW accounts...................... 160,531 138,772 121,322 Early withdrawal penalties.................... (12,168) (8,051) (10,641) ---------- ---------- ---------- $3,650,221 $3,406,804 $3,213,488 ========== ========== ==========
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, 1997 - ------------------------------------ WEIGHTED MATURITY AVERAGE RATE BALANCE - -------- ---- ----------- 1998 6.07% $ 1,700,000 1999 6.32 5,000,000 2000 5.92 2,977,000 2002 5.64 25,000,000 ----------- $34,677,000 ===========
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 ===========
53 54 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 9. FEDERAL HOME LOAN BANK ADVANCES:--CONTINUED As of December 31, 1997 and 1996, the Bank had an available balance under its line of credit of approximately $8,185,000 and $6,512,000, 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, 1997 and 1996. 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. Of the outstanding FHLB advances, $9,000,000 was adjustable rate notes with a weighted average rate 6.06%. At December 31, 1997, there are $23.0 million of advances that are convertible to quarterly adjustable rate advances at varying convertible dates two years or less. All of these advances have final maturity dates in the year 2002. 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 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. 54 55 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:--CONTINUED 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, 1997 and 1996 are as follows:
1997 1996 ------------------------- ------------------------- ESTIMATED RECORDED ESTIMATED RECORDED FAIR VALUE BALANCE FAIR VALUE BALANCE ----------- ----------- ----------- ----------- Cash and short term deposits.... $ 2,213,461 $ 2,213,461 $ 2,147,678 $ 2,147,678 Investment securities........... 38,888,284 38,759,256 31,807,483 31,904,476 Net loans....................... 97,688,000 96,180,961 76,278,000 76,545,153 Accrued interest receivable..... 1,033,261 1,033,261 810,884 810,884 Deposits with no stated maturities.................... 45,352,626 45,352,626 40,138,273 40,138,272 Deposits with stated maturities.................... 45,704,000 45,803,199 43,590,000 43,683,196 Federal Home Loan Bank advances...................... 34,815,000 34,677,000 14,457,000 14,477,000 Commitments to originate loans......................... 6,716,000 6,716,000 5,400,000 5,400,000
11. INCOME TAXES: The provision (benefit) for income taxes for each of the years ended is as follows:
1997 1996 1995 ---- ---- ---- Federal: Current........................................... $449,181 $ 67,249 $30,940 Deferred.......................................... (44,797) (13,735) 43,615 -------- -------- ------- 404,384 53,514 74,555 State: Current........................................... 88,536 15,872 8,514 -------- -------- ------- Total income tax expense............................ $492,920 $ 69,386 $83,069 ======== ======== =======
55 56 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:
1997 1996 1995 ---- ---- ---- Deferred tax expense (benefit): Deferred loan costs/fees.......................... $ 10,259 $ 1,845 $17,706 Prepaid pension................................... (6,603) (796) 35,206 Vacation accrual.................................. (1,417) (700) (3,670) MRP accrual....................................... (30,024) -- -- Provision for loan losses......................... (35,360) (14,960) (8,097) Tax depreciation in excess of book depreciation... 17,000 5,950 5,192 Other, net........................................ 1,348 (5,074) (2,722) -------- -------- ------- $(44,797) $(13,735) $43,615 ======== ======== =======
The special tax benefit afforded to thrift institutions that 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 1996 and 1997. The Bank has maintained the applicable residential loan requirement and this recapture will commence with the taxable year beginning January 1, 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 are 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 January 1, 1988, there is an unrecognized deferred tax liability of approximately $565,000 at December 31, 1997. 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. 56 57 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:
1997 1996 1995 ---- ---- ---- Statutory federal tax rate................................. 34.0% 34.0% 34.0% State income taxes, net of Federal income tax benefit...... 6.9 7.4 2.3 Effect of graduated federal tax rates...................... (1.5) (5.6) (2.2) Other...................................................... (.8) (3.5) -- ---- ---- ---- 38.6% 32.3% 34.1% ==== ==== ====
Net deferred tax liabilities (assets) as of December 31, 1997 and 1996 are as follows:
1997 1996 ---- ---- Prepaid pension............................................. $ 20,486 $ 27,088 Vacation accrual............................................ (15,980) (14,563) Allowance for loan losses................................... (20,525) 14,835 Valuation allowance for investments......................... 46,173 (112,279) Tax depreciation in excess of book depreciation............. 69,419 52,422 Deferred loan costs/fees.................................... 12,104 1,845 MRP accrual................................................. (30,024) -- Other, net.................................................. (3,726) (5,074) -------- -------- Net deferred tax liability (asset).......................... $ 77,927 $(35,726) ======== ========
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 balance sheets at December 31, 1997 and 1996, respectively.
1997 1996 ---- ---- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $467,069 and $372,130.................... $ 478,461 $ 380,136 ========= ========= Projected benefit obligation for service rendered to date... $(921,563) $(746,125) Plan assets at fair value................................... 806,833 619,396 --------- --------- Projected benefit obligation in excess of plan assets....... (114,730) (126,729) Unrecognized net obligation at transition................... 54,428 59,200 Unrecognized net loss....................................... 120,554 147,201 --------- --------- Prepaid pension cost........................................ $ 60,252 $ 79,672 ========= =========
Approximately 98% of the plan's assets are 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. 57 58 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:
1997 1996 1995 ---- ---- ---- Service cost........................................ $ 66,227 $ 51,209 $ 43,078 Interest cost....................................... 54,094 45,200 39,991 Actual return on plan assets........................ (124,939) (76,604) (63,071) Amortization of transition asset.................... 88,735 44,656 49,037 -------- -------- -------- Net periodic pension cost........................... $ 84,117 $ 64,461 $ 69,035 ======== ======== ========
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, 1997, 1996 and 1995. The expected long-term rate of return on assets was 7.25% for each of the years ended December 31, 1997, 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 $724,050 and $755,490 at December 31, 1997 and 1996, respectively, as reflected in shareholders' equity, will be amortized to compensation over the remaining 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 incurred in 1997 and 1996 for allocated ESOP shares was $84,484 and $30,071, respectively. 14. CAPITAL STOCK PLANS: On April 23, 1997, at the annual stockholders meeting, the Board of Directors and shareholders formally approved the Corporation's Stock Option Plan (the Option Plan) and the Management Recognition and Retention Plan and Trust (the MRP Plan; the Option Plan and MRP Plan herein are referred to as the Plans). The aforementioned approval of the MRP Plan made 38,521 shares of common stock available for awards to officers, key employees of the Corporation and Bank and non-employee directors thereof. As of December 31, 1997, the Corporation has granted 34,885 shares. However, such shares are vested over a five year period. In connection with the MRP Plan's approval, the Bank established a trust whose purpose is to purchase shares on the open market. During the year ended December 31, 1997, the Corporation incurred compensation 58 59 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 14. CAPITAL STOCK PLANS:--CONTINUED expense of $88,307, based on the estimated cost to incur to purchase the currently vesting shares in the open market. The Bank may incur additional costs related to funding the trust based on the market cost of the shares being acquired. During the year ended December 31, 1997, the Bank funded $210,406 to the trust toward the purchase of shares. As of December 31, 1997, the trust had purchased 11,000 shares. The aforementioned approval of the Option Plan made 96,302 options available for grant to employees and others who perform substantial services to the Corporation. As of December 31, 1997, the corporation has granted 76,741 options. As permitted by Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," the Corporation accounts for the Option Plan under APB Opinion No. 25, "Accounting for Stock Issued to Employees" whereby no compensation cost has been recorded in accordance with certain valuation models, such as the Black Scholes model. Under the provisions of SFAS No. 123, the per share compensation expense in connection with the MRP Plan is fixed on the date of grant. Had such valuation models been used in connection with the Option Plan and had compensation per share for the MRP Plan been set on the date of grant, the Corporation's net income and earnings per share would have had a net reduction to the following pro forma amounts:
FOR THE YEAR ENDED DECEMBER 31, 1997 ------------------- Net income: As reported............................................... $784,487 Pro forma................................................. 774,133 Basic earnings per share: As reported............................................... $ 0.92 Pro forma................................................. 0.91 Diluted earnings per share: As reported............................................... $ 0.92 Pro forma................................................. 0.91
A summary of the status of the Corporation's Stock Option Plan at December 31, 1997, and changes during the year ended is presented in the table and narrative following:
WEIGHTED AVERAGE EXERCISE SHARES PRICE ------- -------- Outstanding at beginning of period.......................... -- $ -- Granted................................................... 76,741 16.59 Exercised................................................. -- -- Forfeited................................................. -- -- Outstanding at end of period................................ 76,741 16.59 Exercisable at end of period................................ -- -- Weighted average fair value of options granted.............. -- $ 5.51
The options are exercisable beginning one year from the grant date in equal annual installments over a period of five years. The maximum term of any option granted under the Plan cannot exceed 10 years. The 76,741 options outstanding at December 31, 1997, have a weighted average exercise price of $16.59 and a weighted average remaining contractual life of 9.6 years. None of these options are exercisable. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the 59 60 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 14. CAPITAL STOCK PLANS:--CONTINUED following assumptions used for grants in 1997: weighted average risk-free interest rate of 6.41%, weighted average expected dividend yield of 1.21%, expected life of 7.0 years and expected volatility of 19.00%. Additionally, on March 3, 1997, the Corporation initiated a plan to repurchase, at market value, up to 5% (48,150 shares) of its outstanding shares of common stock through the use of its existing cash and cash equivalents. This repurchase program was completed on April 28, 1997. 15. RETAINED EARNINGS AND REGULATORY CAPITAL: The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. 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 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, 1997, that the Corporation and the Bank meet all capital adequacy requirements to which it is subject. As of December 31, 1997, 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 below. There are no conditions or events since that notification that management believes have changed the Bank'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, 1997.......... $12,995 18.78% $$5,537 $8.0% $$6,921 $10.0% As of December 31, 1996.......... $12,094 23.81% $$4,064 $8.0% $$5,080 $10.0% Tier 1 Capital (to Risk Weighted Assets): As of December 31, 1997.......... $12,592 18.19% $$2,768 $4.0% $$4,153 $6.0% As of December 31, 1996.......... $11,787 23.20% $$2,032 $4.0% $$3,048 $6.0% Tier 1 Capital (to Average Assets): As of December 31, 1997.......... $12,592 9.43% $$5,340 $4.0% $$6,676 $5.0% As of December 31, 1996.......... $11,787 11.74% $$4,016 $4.0% $$5,019 $5.0%
60 61 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 16. 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, 1997 and 1996, amounted to $182,175 and $419,236, respectively. An analysis of these related party loans is as follows:
1997 1996 ---- ---- Balance at January 1........................................ $ 419,236 $ 192,018 New loans................................................... 13,000 379,747 Payments.................................................... (250,061) (152,529) --------- --------- Balance at December 31...................................... $ 182,175 $ 419,236 ========= =========
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 1997, 1996 and 1995, such activity was as follows: - A member of the Board of Directors leases office space from the Corporation. The rental income was $11,100 for each of the three years ended December 31, 1997. This director also provides professional services to the Bank and his fees were $5,500, $4,950, $4,950 for the years ended December 31, 1997, 1996 and 1995, respectively. - A member of the Board of Directors is employed by a law firm retained by the Corporation. Fees paid in 1997 and 1996 relative to various bank and corporate matters totaled $82,088 and $38,300, respectively. During 1996, additional fees of approximately $156,000 were paid relative to the stock conversion. No such fees occurred relative to the conversion during 1997. The firm's real estate closing service rendered gross proceeds of approximately $232,800 and $109,700, respectively, during 1997 and 1996 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 1997, 1996 and 1995 was $21,070, $21,950 and $24,765, respectively. - The Chairman of the Board of Directors, John A. Stiver, is paid a fee of $8,000 per month for a total of $96,000 paid in 1997 for providing advice and assistance to the officers of the Bank with respect to the operations and management of the Bank. In addition, Mr. Stiver has expanded the commercial loan portfolio which is in excess of $11 million as of December 31, 1997. - The Chairman of the Board of Directors was 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. 17. 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 61 62 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 17. COMMITMENTS AND CONTINGENT LIABILITIES:--CONTINUED 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 $6,716,000 and $5,400,000 as of December 31, 1997 and 1996, respectively. As of December 31, 1997 and 1996, these commitments had fixed and variable rates which ranged from 6.9% to 12.9% and 8.0% to 10.0%, respectively. In the opinion of management, the funding of the credit commitments will not have a material adverse effect on the Bank's 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 Bank's financial position or results of operations. 18. PARENT COMPANY FINANCIAL INFORMATION: Prestige Bancorp, Inc. (the Parent Company) began operations on June 27, 1996 and functions primarily as a holding company for its sole subsidiary, the Bank. The Parent Company's balance sheets as of December 31, 1997 and 1996 and related statements of income and cash flows are as follows: BALANCE SHEETS December 31, 1997 and 1996
1997 1996 ---- ---- ASSETS Cash and cash equivalents................................ $ 2,480,815 $ 3,631,611 Investments securities available for sale................ 657,721 200,000 Investment in Prestige Bank, F.S.B. ..................... 12,561,900 11,650,987 Other assets............................................. 2,783 2,500 ----------- ----------- Total Assets............................................. $15,703,219 $15,485,098 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Total Liabilities........................................ $ 73,408 $ 54,898 Total Stockholders' Equity, net of ESOP loan of $724,050 at December 31, 1997; $755,490 at December 31, 1996.... 15,629,811 15,430,200 ----------- ----------- Total Liabilities and Stockholders' Equity............... $15,703,219 $15,485,098 =========== ===========
62 63 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 18. PARENT COMPANY FINANCIAL INFORMATION:--CONTINUED STATEMENTS OF INCOME For The Year Ended December 31, 1997 and The Period From June 27, 1996 to December 31, 1996
1997 1996 ---- ---- Interest income........................................... $ 194,541 $ 93,695 Expenses: Legal fees.............................................. 80,435 24,262 Other................................................... 105,795 8,988 ----------- ----------- Total expenses............................................ 186,230 33,250 ----------- ----------- Income before income taxes and equity in undistributed gain/loss of subsidiary................................. 8,311 60,445 Provision for income taxes................................ 1,338 21,639 Equity in undistributed gain (loss) of subsidiary......... 777,514 (35,736) ----------- ----------- Net income................................................ $ 784,487 $ 3,070 =========== ===========
STATEMENTS OF CASH FLOWS For The Year Ended December 31, 1997 and The Period From June 27, 1996 to December 31, 1996
1997 1996 ---- ---- Operating Activities: Net income.............................................. $ 784,487 $ 3,070 Adjustments to reconcile net income to net cash (used) provided by operating activities: Equity in undistributed (gain) loss of subsidiary.... (777,514) 35,736 Change in other assets and liabilities............... (18,164) 45,389 ----------- ----------- Net cash (used) provided by operating activities..... (11,191) 84,195 Investing Activities: Purchase of available for sale investment securities.... (283,927) (171,500) Investment in Prestige Bank, F.S.B. .................... -- (4,484,402) ----------- ----------- Net cash used by investing activities................ (283,927) (4,655,902) Financing Activities: Common stock dividends paid............................. (111,230) -- Purchase of treasury stock.............................. (775,881) -- Net proceeds from sale of stock, net of ESOP loan of $770,410............................................. -- 8,188,394 Repayment received from ESOP............................ 31,433 14,924 ----------- ----------- Net cash (used) provided by financing activities..... (855,678) 8,203,318 ----------- ----------- Net (decrease) increase in cash and cash equivalents...... (1,150,796) 3,631,611 Cash and Cash Equivalents, Beginning...................... 3,631,611 -- ----------- ----------- Cash and Cash Equivalents, Ending......................... $ 2,480,815 $ 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 63 64 PRESTIGE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED 18. PARENT COMPANY FINANCIAL INFORMATION:--CONTINUED 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. 64 65 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 Director and Owner Jefferson Hills Real Estate, Inc. MICHAEL R. MACOSKO Pharmacist Eckerd 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 Fax 412-655-2114 www.prestigebank.com BRANCH OFFICES Pleasant Hills 710 Old Clairton Road Pittsburgh, PA 15236 412-655-2110 Bethel Park 6257 Library Road Bethel Park, PA 15102 412-831-8440 Elizabeth Township 603 Scenery Drive Elizabeth, PA 15037 412/754-2661 Mt. Oliver 543 Brownsville Road Pittsburgh, PA 15210 412-431-3374 Washington Located in Shop'n Save 125 West Beau Street Washington, PA 15301 724/228-1314 MARKET MAKERS Friedman Billings Ramsey & Co. Tucker, Anthony 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 www.chasemellon.com 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, 1997, 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 3 PRESTIGE BANCORP, INC.
9 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 927 1,286 0 0 11,018 27,741 27,870 96,181 403 143,263 91,156 0 1,800 34,677 0 0 7,496 8,134 143,263 6,786 2,480 105 9,371 3,650 5,240 4,131 104 21 3,122 1,277 1,277 0 0 784 .92 .92 3.18 611 0 0 0 307 8 0 403 344 0 59
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