-----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, SL6spP/XCABo2XAn0LJzTrmZAyoAe5cvQ0MPX0bzsh9wv/5Zb5y1wWacsnFBFmVd u2oORdVOytWaRY2abNK1/g== 0000811671-98-000006.txt : 19980326 0000811671-98-000006.hdr.sgml : 19980326 ACCESSION NUMBER: 0000811671-98-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING FINANCIAL CORP /PA/ CENTRAL INDEX KEY: 0000811671 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232449551 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-16276 FILM NUMBER: 98572792 BUSINESS ADDRESS: STREET 1: NORTH POINTE BANKING CORP STREET 2: 101 NORTH POINTE BLVD CITY: LANCASTER STATE: PA ZIP: 17605-4133 BUSINESS PHONE: 7175816030 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to _______________ Commission file number 0-16276 STERLING FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 23-2449551 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 North Pointe Boulevard Lancaster, Pennsylvania 17601-4133 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 581-6030 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $5.00 Per Share (Title of class) Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. | | Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The aggregate market value of the voting stock held by non-affiliates of the Registrant at February 27, 1998 was approximately $159,963,708. The number of shares of Registrant's Common Stock outstanding on February 27, 1998 was 6,161,006. Documents Incorporated by Reference Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of Shareholders are incorporated by reference into Part III of this report. Sterling Financial Corporation Table of Contents Page Part I Item 1. Business............................................. 3 Item 2. Properties........................................... 9 Item 3. Legal Proceedings.................................... 9 Item 4. Submission of Matters to a Vote of Security Holders.. 9 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.......................... 10 Item 6. Selected Financial Data.............................. 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 11 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.......................................... 28 Item 8. Financial Statements and Supplementary Data.......... 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 54 Part III Item 10. Directors and Executive Officers of the Registrant... 55 Item 11. Executive Compensation............................... 55 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................... 55 Item 13. Certain Relationships and Related Transactions....... 55 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................................... 56 Signatures...................................................... 57 PART I Item 1 - Business Sterling Financial Corporation Sterling Financial Corporation (the "Corporation") is a registered bank holding company and a Pennsylvania business corporation, headquartered in Lancaster, Pennsylvania. The Corporation was organized on February 23, 1987 as a bank holding company for The First National Bank of Lancaster County, now, by change of name, Bank of Lancaster County, N.A. (the "Bank"). The Corporation provides a wide variety of commercial banking and trust services through the Bank. A major source of operating funds for the Corporation is dividends provided by the Bank. The Corporation's expenses consist principally of operating expenses. Dividends paid to stockholders are, in part, obtained by the Corporation from dividends declared and paid to it by the Bank. As a bank holding company, the Corporation is registered with the Federal Reserve Board in accordance with the requirements of the Bank Holding Company Act of 1956, as amended, and is subject to regulation by the Federal Reserve Board and by the Pennsylvania Department of Banking. In addition, the Corporation owns all of the outstanding stock of Sterling Mortgage Services, Inc., a Pennsylvania corporation and a mortgage service company formed by the Corporation as a wholly owned subsidiary and is presently inactive. Bank of Lancaster County The Bank is a full service commercial bank operating under charter from the Comptroller of the Currency. On July 29, 1863, the Comptroller of the Currency authorized The First National Bank of Strasburg to commence the business of banking. On September 1, 1980, the name was changed to The First National Bank of Lancaster County. At the time of the holding company's organization, on June 30, 1987, the institution's name was changed to its present name, Bank of Lancaster County, N.A. At December 31, 1997, the Bank had total assets of $845,311,000 and total deposits of $720,480,000. The main office of the Bank is located at 1 East Main Street, Strasburg, Pennsylvania. In addition to its main office, the Bank had twenty-eight (28) branches in Lancaster County and one (1) branch in Chester County, Pennsylvania in operation at December 31, 1997. The Bank provides a full range of banking services. These include demand, savings and time deposit services, NOW (Negotiable Order of Withdrawal) accounts, money market accounts, safe deposit boxes, a VISA credit card, and a full spectrum of personal and commercial lending activities. The Bank maintains correspondent relationships with major banks in Philadelphia and Baltimore. Through these correspondent relationships, the Bank can offer a variety of collection and international services. With the installation of three automated teller machines (ATMs) in April, 1983, the Bank was the first financial institution in Lancaster County to join the MAC (Money Access Center) Network. The Bank now has 25 ATMs in Lancaster County. The Bank became a participating member of the Plus System in the Fall of 1984. This membership entitles the Bank's MAC/Plus cardholders to have access to a nationwide network of over 150,000 ATMs. The Bank introduced Discount Brokerage Service in July, 1983. This service is offered in coordination with Fiserv Investor Services, Inc., an affiliate of BHCM, Inc. and meets the needs of the commission-conscious investor. In 1992, the Bank began offering mutual funds to customers. The Bank is in the process of formalizing a product sales agreement with a third party marketer to sell fixed annuities. As required, the Bank has obtained an insurance license from the Commonwealth of Pennsylvania. The Bank expects to begin making this product available during the first quarter of 1998. Management believes these services are important additions to the Bank's product line and that these products make a statement about the Bank's progressive attitude towards the provision of the Bank's financial services in the future. The Bank was given permission to open a Trust Department by the Comptroller of the Currency on May 10, 1971. The Trust Department provides personal and corporate trust services. These include estate planning, administration of estates and the management of living and testamentary trusts and investment management services. Other services available are pension and profit sharing trusts and self-employed retirement trusts. Trust Department assets were over $379 million at December 31, 1997. On January 31, 1983, the Bank purchased Town & Country, Inc., a Pennsylvania corporation and a vehicle and equipment leasing company, operating in Pennsylvania and other states. Its principal office is located at 1097 Commercial Avenue, East Petersburg, PA. Town & Country, Inc. employs forty-two (42) people. The Bank's principal market area is Lancaster County, Pennsylvania. Lancaster County is the sixth largest county in Pennsylvania, in terms of population, behind Philadelphia, Allegheny, Montgomery, Delaware and Bucks. Lancaster County, with an area of 949 square miles, has a population of approximately 450,000 people. Lancaster's tradition of economic stability has continued, with agriculture, industry and tourism all contributing to the overall strength of the economy. Lancaster County has one of the strongest and most stable economies in the state. No single sector dominates the county's economy. One of the best agricultural areas in the nation, Lancaster County continues to be the top agricultural county in the state, leading Pennsylvania in production of most crops and all livestocks, with the exception of sheep. Lancaster County is also one of the leading industrial areas in the state. The county is considered a prime location for manufacturing, away from congested areas, yet close to major east coast markets. Diversification of industry has helped to maintain the economic stability of the county. The unemployment rate of the county in December 1997 was 2.9%, which was lower than the statewide rate (4.8%) and the national rate (4.7%). Lancaster County's December unemployment rate of 2.9% was the best among Pennsylvania's 14 metropolitan areas. Lancaster County, with its many historic sites, well-kept farmlands and the large Amish community has become very attractive to tourists and is one of the top tourist attractions in the United States. The Bank has no significant foreign sources and makes no significant foreign application of funds. The Bank is subject to regulation and periodic examination by the Comptroller of the Currency. The Bank's deposits are insured by the Federal Deposit Insurance Corporation, as provided by law. Competition The financial services industry in the Corporation's service area is extremely competitive. The Corporation's competitors within its service area include multi-bank holding companies, with resources substantially greater than those of the Corporation. Many competitor financial institutions have legal lending limits substantially higher than the Bank's legal lending limit. The Bank is subject to intense competition in all respects and areas of its business from banks and other financial institutions, including savings and loan associations, finance companies, credit unions and other providers of financial services. There are 14 full-service commercial banks with offices in Lancaster County. Some of these banks have branches located throughout Lancaster County and beyond. The institutions range in asset size from approximately $233 million to over $57 billion. Four (4) banks in the trade area exceed $5 billion in assets. Several banks are part of bank holding company systems. One bank is a subsidiary of a bank holding company that has assets in excess of $73 billion while two other banks are subsidiaries of bank holding companies with over $45 billion in assets. Due to the Bank's location, the Bank is in direct competition with the larger banks, as well as, a number of smaller banks. The increased competition has resulted from a changing legal and regulatory climate, as well as, from the economic climate. As of December 31, 1997, the Bank ranked, as measured by total deposits, as the third largest in market share within Lancaster County of the banks doing business in Lancaster County. The Bank is not, however, the third largest bank in Lancaster County. As of December 31, 1997, the Bank had total assets of over $845 million and ranked ninth on this basis among the commercial banks with offices located in Lancaster County. In September 1994, federal legislation was enacted that is expected to have a significant effect in restructuring the banking industry in the United States. See "Interstate Banking Legislation" herein. As a result, the Corporation expects the operating environment for Pennsylvania-based financial institutions to become increasingly competitive. Additionally, the manner in which banking institutions conduct their operations may change materially as the activities increase in which bank holding companies and their banking and nonbanking subsidiaries are permitted to engage, and funding and investment alternatives continue to broaden, although the long-range effects of these changes cannot be predicted, with reasonable certainty, at this time. These changes most probably will further narrow the differences and intensify competition between and among commercial banks, thrift institutions, and other financial service companies. See "Proposed Legislation and Regulations" herein. Neither the Corporation nor the Bank rely on a single customer or a few customers, including federal, state or local governments and agencies thereunder the loss of which would have a material adverse effect on the business of the Bank. Supervision and Regulation Bank Holding Company Regulation The Corporation is registered as a bank holding company and is subject to the regulations of the Board of Governors of the Federal Reserve System (the "Federal Reserve") under the Bank Holding Company Act of 1956, as amended ("BHCA"). Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. The Federal Reserve has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve, pursuant to such regulations, may require the Corporation to stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become "undercapitalized" (as defined by regulations) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency, up to specified limits. Under the BHCA, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. The BHCA prohibits the Corporation from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock or substantially all of the assets of any bank or merging or consolidating with another bank holding company without prior approval of the Federal Reserve. Such a transaction would also require approval of the Pennsylvania Department of Banking. Pennsylvania law permits Pennsylvania bank holding companies to control an unlimited number of banks. Additionally, the BHCA prohibits the Corporation from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a nonbanking business unless such business is determined by the Federal Reserve to be so closely related to banking as to be a proper incident thereto. The Federal Reserve can differentiate between nonbanking activities that are initiated by a bank holding company or subsidiary and activities that are acquired as a going concern. The BHCA does not place territorial restrictions on the activities of such nonbanking-related activities. The Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services. The activities that the Federal Reserve has determined by regulation to be permissible are: (1) making, acquiring, or servicing loans or other extensions of credit for its own account or for the account of others; (2) operating an industrial bank, Morris Plan bank, or industrial loan company, in the manner authorized by state law, so long as the institution is not a bank; (3) operating as a trust company in the manner authorized by federal or state law so long as the institution is not a bank and does not make loans or investment or accept deposits, except as may be permitted by the Federal Reserve; (4) subject to limitations, acting as an investment or financial advisor (i) to a mortgage or real estate investment trust, (ii) to certain registered investment companies, (iii) by providing portfolio investment advice to other persons, (iv) by furnishing general economic information and advice, general economic statistical forecasting services, and industry studies, (v) by providing financial advice to state and local governments, or (vi) by providing financial and transaction advice to corporations, institutions, and certain persons in connection with mergers, acquisitions, and other financial transactions; (5) subject to limitations, leasing real or personal property or acting as agent, broker, or adviser in leasing such property in accordance with prescribed conditions; (6) investing in corporations or projects designed primarily to promote community welfare; (7) providing to others data processing services and data transmission services, data bases, and facilities, within certain limitations; (8) subject to limitations, engaging in certain agency and underwriting activities with respect to credit insurance, and certain other insurance activities as permitted by the Federal Reserve; (9) owning, controlling, or operating a savings association, if the savings association engages only in deposit-taking activities and lending and other activities that are permissible for bank holding companies under Federal Reserve regulations; (10) providing courier services for certain financial documents; (11) subject to limitations, providing management consulting advice to nonaffiliated bank and nonbank depository institutions; (12) retail selling of money orders and similar consumer-type payment instruments having a face value of $1,000 or less, selling U.S. Savings Bonds, and issuing and selling traveler's checks; (13) performing appraisals of real estate and personal property; (14) subject to limitations, acting as intermediary for the financing of commercial or industrial income-producing real estate by arranging for the transfer of the title, control, and risk of such a real estate project to one or more investors; (15) providing certain securities brokerage services; (16) subject to limitations, underwriting and dealing in government obligations and certain other instruments; (17) subject to limitations, providing foreign exchange and transactional services; (18) subject to limitations, acting as a futures commission merchant for nonaffiliated persons; (19) subject to limitations, providing investment advice on financial futures and options to futures; (20) subject to limitations, providing consumer financial counseling; (21) subject to limitations, tax planning and preparation; (22) providing check guaranty services; (23) subject to limitations, operating a collection agency; and (24) operating a credit bureau. Federal Reserve approval may be required before the Corporation or its nonbank subsidiaries may begin to engage in any such activity and before any such business may be acquired. Dividend Restrictions The Corporation is a legal entity separate and distinct from the Bank and the Corporation's nonbank subsidiaries. The Corporation's revenues (on a parent Company only basis) result almost entirely from dividends paid to the Corporation by its subsidiaries. The right of the company, and consequently the right of creditors and shareholders of the Corporation, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of the Bank), except to the extent that claims of the Corporation in its capacity as a creditor may be recognized. Federal and state laws regulate the payment of dividends by the Corporation's subsidiaries. See "Supervision and Regulation - Regulation of the Bank" herein. Further, it is the policy of the Federal Reserve that bank holding companies should pay dividends only out of current earnings. Federal banking regulators also have the authority to prohibit banks and bank holding companies from paying a dividend if they should deem such payment to be an unsafe or unsound practice. Capital Adequacy Bank holding companies are required to comply with the Federal Reserve's risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half (4%) of the total capital is required to be "Tier 1 capital," consisting principally of common shareholders' equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, and minority interests in the equity accounts of consolidated subsidiaries, less certain intangible assets. The remainder ("Tier 2 capital") may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general loan loss allowance. In addition to the risk-based capital guidelines, the Federal Reserve requires a bank holding company to maintain a minimum "leverage ratio." This requires a minimum level of Tier 1 capital (as determined under the risk-based capital rules) to average total consolidated assets of 3% for those bank holding companies that have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are expected to maintain a ratio of at least 1% to 2% above the stated minimum. Further, the Federal Reserve has indicated that it will consider a "tangible Tier 1 capital leverage ratio" (deducting all intangibles) and other indicia of capital strength in evaluating proposals for expansion or new activities. The Federal Reserve has not advised the Corporation of any specific minimum leverage ratio applicable to the Corporation. Pursuant to FDICIA, the federal banking agencies have specified, by regulation, the levels at which an insured institution is considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized." Under these regulations, an institution is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage ratio of 5% or greater, and is not subject to any order or written directive to meet and maintain a specific capital level. The Corporation and the Bank, at December 31, 1997, qualify as "well capitalized" under these regulatory standards. FDIC Insurance The Bank is subject to Federal Deposit Insurance Corporation ("FDIC") assessments. The FDIC has adopted a risk-related premium assessment system for both the Bank Insurance Fund ("BIF") for banks and the Savings Association Insurance Fund ("SAIF") for savings associations. Under this system, FDIC insurance premiums are assessed based on capital and supervisory measures. Under the risk-related premium assessment system, the FDIC, on a semiannual basis, assigns each institution to one of three capital groups (well capitalized, adequately capitalized, or undercapitalized) and further assigns such institution to one of three subgroups within a capital group corresponding to the FDIC's judgment of its strength based on supervisory evaluations, including examination reports, statistical analysis, and other information relevant to gauging the risk posed by the institution. Only institutions with a total risk-based capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC") and to provide for repayment of the FICO (Financial Institution Collateral Obligation) bonds issued by the United States Treasury Department. The FDIC levied a one-time special assessment on SAIF deposits equal to 65.7 cents per $100 of the SAIF-accessible deposit base as of March 31, 1995. During 1997, 1998, and 1999, the Bank Insurance Fund ("BIF") will pay $322 million of FICO debt service, and SAIF will pay $458 million. During 1997, 1998, and 1999, the average regular annual deposit insurance assessment is estimated to be about 1.29 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institution's assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. After 1999, BIF and SAIF will share the FICO costs equally. Under current estimates, BIF and SAIF assessment bases would each be assessed at the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending the interest payment obligation. Regulation of the Bank The operations of the Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. The Bank's operations are also subject to regulations to the OCC, the Federal Reserve, and the FDIC. The OCC, which has primary supervisory authority over the Bank, regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. These examinations are designed for the protection of the Bank's depositors rather than the Corporation's shareholders. The Bank must furnish annual and quarterly reports to the OCC, which has the authority under the Financial Institutions Supervisory Act to prevent a national bank from engaging in an unsafe or unsound practice in conducting its business. Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may take, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of a bank with respect to mergers and consolidations, and the establishment of branches. Pennsylvania law permits statewide branching. Under the National Bank Act, as amended, the Bank is required to obtain the prior approval of the OCC for the payment of dividends if the total of all dividends declared by the Bank in one year would exceed the Bank's net profits (as defined and interpreted by regulation) for the two preceding years, less any required transfers to surplus. In addition, the Bank may only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed statutory bad debts (as defined by regulation). Under FDICIA, any depository institution, including the Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements. A subsidiary bank of a bank holding company, such as the Bank, is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries, and on taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve regulations also place certain limitations and reporting requirements on extensions of credit by a bank to the principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. The Bank, and the banking industry in general, are affected by the monetary and fiscal policies of government agencies, including the Federal Reserve. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors of the Federal Reserve exerts considerable influence over the cost and unavailability of funds for lending and investment. Interstate Banking Legislation In September 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act (the "Interstate Banking Act") was enacted. The Interstate Banking Act facilitates the interstate expansion and consolidation of banking organizations (i) by permitting bank holding companies that are adequately capitalized and adequately managed, beginning September 29, 1995, to acquire banks located in states outside their home states regardless of whether such acquisitions are authorized under the law of the host state; (ii) by permitting the interstate merger of banks after June 1, 1997, subject to the right of individual states to "opt in" or "opt out" of this authority before that date; (iii) by permitting banks to establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state; (iv) by permitting, beginning September 29, 1995, a bank to engage in certain agency relationships (i.e., to receive deposits, renew time deposits, close loans (but not including loan approvals or disbursements), service loans, and receive payments on loans and other obligations) as agent for any bank or thrift affiliate, whether the affiliate is located in the same state or a different state than the agent bank; and (v) by permitting foreign banks to establish, with approval of the regulators in the United States, branches outside their "home" states to the same extent that national or state banks located in the home state would be authorized to do so. One effect of this legislation will be to permit the Corporation to acquire banks and bank holding companies located in any state and to permit qualified banking organizations located in any state to acquire banks and bank holding companies located in Pennsylvania, irrespective of state law. In July 1995, the Pennsylvania Banking Code was amended to authorize full interstate banking and branching under Pennsylvania law. Specifically, the legislation (i) eliminates the "reciprocity" requirement previously applicable to interstate commercial bank acquisitions by bank holding companies, (ii) authorizes interstate bank mergers and reciprocal interstate branching into Pennsylvania by interstate banks, and (iii) permits Pennsylvania institutions to branch into other states with the prior approval of the Pennsylvania Department of Banking. Overall, this federal and state legislation has, as was predicted, had the effect of increasing consolidation and competition and promoting geographic diversification in the banking industry. Proposed Legislation and Regulations From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of the Corporation and the Bank, or otherwise change the business environment. Management cannot predict whether any of this legislation, if enacted, will have a material effect on the business of the Corporation. Employees As of December 31, 1997, there were 469 persons employed by the Bank, of which 350 were full-time and 119 were part-time employees. These figures do not include employees of Town & Country, Inc. which employed 42 persons. Item 2 - Properties The Bank, in addition to its main office, had, at December 31, 1997, a branch network of 29 offices and 2 off-site electronic MAC/ATM installations. All branches are located in Lancaster County with the exception of one office, located in Chester County. Branches at nineteen (19) locations are occupied under leases and at three branches, the Bank owns the building, but leases the land. One off-site MAC/ATM installation is occupied under lease. All other properties were owned in fee. All real estate and buildings owned by the Bank are free and clear of encumbrances. The Corporation owns no real estate. The leases expire intermittently over the years through 2022 and most are subject to one or more renewal options. During 1997, aggregate annual rentals for real estate did not exceed three percent of the Bank's operating expenses. On December 4, 1996, the Bank purchased a property located at 1097 Commercial Avenue, East Petersburg, PA, situated on 12.7 acres with a building containing approximately 123,000 square feet. The building is used to house the Bank's Administrative Service Center as well as other departments of the Bank. Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this building. The building is owned in fee by the Bank, free and clear of encumbrances. The Bank sold the building which previously housed the Administrative Service Center. Settlement took place on February 21, 1997. Town & Country, Inc. sold the building it formerly occupied on April 1, 1997. In 1995, the Bank completed construction of a new headquarters building including a branch banking office. The building also serves as headquarters for the Corporation. Occupancy took place in July of 1995. The three-story building contains approximately 53,000 square feet. The Bank and the Corporation occupy approximately 43,000 square feet. Nearly 10,000 square feet has been leased to other tenants. The building is owned in fee by the Bank, free and clear of encumbrances. Item 3 - Legal Proceedings As of December 31, 1997, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Corporation or its subsidiaries are a party or by which any of their property is the subject. Item 4 - Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1997. PART II Item 5 - Market for the Registrant's Common Equity and Related Stockholder Matters As of January 29, 1998, the common stock of the Corporation began trading on the NASDAQ National Market. The trading symbol for Sterling Financial Corporation is SLFI. There are 35,000,000 shares of common stock authorized and at February 27, 1998, 6,161,006 shares were outstanding. As of February 27, 1998, the Corporation had approximately 3,081 stockholders of record. There is no other class of stock authorized or outstanding. During 1997, the price range of the common stock known by management to have traded was $25.00 to $32.00 per share. A regular $.20 per share dividend, as well as a $.04 per share "Special Dividend," was declared in the third quarter of 1997 and is reflected in the table below. The Corporation is restricted as to the amount of dividends that it can pay to stockholders by virtue of the restrictions on the Bank's ability to pay dividends to the Corporation. See Note 19 to the 1997 Consolidated Financial Statements. The Corporation paid a 5% stock dividend in July 1996. The following table reflects the bid and asked prices reported for the Corporation's common stock at the end of the period indicated and the cash dividends declared on the common stock for the periods indicated. All information has been restated to give effect to the 5% stock dividend paid in 1996. In the absence of an active market, these prices may not reflect the actual market value of the Corporation's stock for the periods reported. 1997 Bid Ask Dividend First Quarter $25.25 $25.75 $.19 Second Quarter 25.375 25.625 .19 Third Quarter 25.75 26.125 .24 Fourth Quarter 30.50 32.00 .20 1996 Bid Ask Dividend First Quarter $25.18 $26.13 $.18 Second Quarter 26.36 26.60 .18 Third Quarter 26.25 26.75 .19 Fourth Quarter 25.25 26.25 .19 The prices used in the previous table represent bid and asked prices furnished by F.J. Morrissey & Company; Hopper Soliday & Co., Inc.; Legg Mason Wood Walker, Inc.; Prudential Securities; Ryan, Beck & Company; or The National Quotation Bureau. These quotations reflect inter-dealer prices, without retail markup, markdown or commission. The Corporation maintains a Dividend Reinvestment and Stock Purchase Plan for eligible stockholders who elect to participate in the plan. A copy of the Prospectus for this plan can be obtained by writing to: Bank of Lancaster County, N.A. Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard, Lancaster, Pennsylvania 17601-4133. Item 6 - Selected Financial Data The following selected financial data should be read in conjunction with the Corporation's consolidated financial statements and the accompanying notes presented elsewhere herein.
Summary of Operations (Dollars in thousands, except per share data) Years Ended 1997 1996 1995 1994 1993 Interest income.............. $ 56,499 $ 52,558 $ 48,850 $ 41,931 $ 40,092 Interest expense............. 25,326 22,823 21,153 14,926 15,042 ------ ------ ------ ------ ------ Net interest income.......... 31,173 29,735 27,697 27,005 25,050 Provision for loan losses.... 1,129 580 534 1,081 2,430 ------ ------ ------ ------ ------ Net interest income after provision for loan losses... 30,044 29,155 27,163 25,924 22,620 Other income................. 11,930 9,442 7,397 6,222 8,107 Other expenses............... 28,082 25,639 22,527 21,232 20,176 ------ ------ ------ ------ ------ Income before income taxes... 13,892 12,958 12,033 10,914 10,551 Applicable income taxes...... 3,491 3,147 3,039 2,637 2,749 ------ ------ ------ ------ ------ NET INCOME................... $ 10,401 $ 9,811 $ 8,994 $ 8,277 $ 7,802 ====== ====== ====== ====== ====== Per Common Share:* Net income (basic and diluted)$ 1.68 $ 1.57 $ 1.45 $ 1.35 $ 1.30 Cash dividends declared**.... .82 .74 .89 .58 .54 Book value................... 12.03 11.12 10.79 9.76 8.58 Book value (excluding SFAS 115)................. 11.56 10.86 10.51 9.69 8.58 Average shares outstanding 6,202,696 6,235,257 6,204,212 6,128,058 6,013,937 Ratios: Return on average assets.... 1.32% 1.34% 1.36% 1.38% 1.41% Return on average equity.... 14.89% 15.01% 15.02% 15.47% 16.90% Financial Condition at Year-End: Assets...................... $ 845,488 $ 764,072 $ 711,154 $ 633,395 $ 587,883 Loans (net of unearned)..... 511,637 473,832 426,312 392,649 359,365 Deposits.................... 718,661 647,036 610,105 537,002 505,680 Stockholders' Equity........ 73,987 69,179 63,909 57,285 49,467 Average Assets.............. 789,314 732,226 659,335 600,263 555,216 *Figures prior to 1996 were restated for stock dividends of 5% paid in 1996 and 5% paid in 1993, a two-for-one stock split paid on September 1, 1994 and for comparative purposes. **The 1997 dividend includes a $.04 per share "Special Dividend," declared in the third quarter. The 1995 dividend includes a $.25 per share "Special Dividend" declared in the second quarter.
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides management's analysis of the consolidated financial condition and results of operations of the Corporation and its subsidiaries, the Bank and its subsidiary, Town & Country, Inc. and Sterling Mortgage Services, Inc. Management's discussion and analysis should be read in conjunction with the audited financial statements and footnotes appearing elsewhere in this report. (All dollar amounts presented in the tables are in thousands, except per share data.) Results of Operations Summary Net income for 1997 was $10,401,000, an increase of $590,000 or 6% over the $9,811,000 earned in 1996. The results of 1996 were $817,000 or 9.1% higher than the $8,994,000 reported in 1995. Basic earnings per share and diluted earnings per share on net income amounted to $1.68, $1.57 and $1.45 for the years ended 1997, 1996 and 1995, respectively. Basic earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding, which were 6,202,696, 6,235,257 and 6,204,212 for 1997, 1996 and 1995, respectively. The weighted number of common shares and dilutive potential common stock used in calculating the diluted earnings per share were 6,205,784, 6,235,330 and 6,204,212, respectively for 1997, 1996 and 1995. Figures prior to 1997 were restated to reflect a 5% stock dividend paid in July, 1996. Return on average total assets was 1.32% in 1997 compared to 1.34% in 1996 and 1.36% in 1995. Return on average stockholders' equity was 14.89%, in 1997 compared to 15.01% in 1996 and 15.02%, in 1995. Growth in earning assets was the primary factor contributing to the increased earnings in 1997 and 1996. As of December 31, 1997, earning assets were approximately $747 million compared to $673 million at December 31, 1996, and $629 million at December 31, 1995. Average earning assets for 1997 increased nearly $51 million, to approximately $699 million, up 7.9% from the prior year. Similarly, in 1996, average earning assets increased approximately $61 million, up 10.4% from 1995. The current year increase, as well as the increse in 1996, was primarily due to increases in both loans and investments. Average interest bearing liabilities increased nearly $48 million or 8.3% in 1997, compared to an increase of nearly $59 million, or 11.3% in 1996. The increase in average earning assets exceeded the increase in average interest-bearing liabilities in both 1997 and 1996. Provision for loan losses increased to $1,129,000 in 1997 from $580,000 in 1996. The provision in 1995 was $534,000. Non-interest income increased $2,488,000 in 1997, compared to an increase of $2,045,000 in 1996. In 1997, all categories of non-interest income increased over the previous year. Non-interest expenses increased $2,443,000 or 9.5% in 1997 compared to an increase of $3,112,000 or 13.8% in 1996 over 1995. The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on non-interest expenses, which tend to rise during periods of general inflation. The level of inflation over the last few years has been declining. During 1997, 1998 and 1999, the Federal Deposit Insurance Corporation (the "FDIC") estimates that the average regular annual deposit insurance assessment will be about 1.29 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institution's assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. Based on the above legislation, the Bank experienced an increase in the FDIC assessment in 1997 over 1996. The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act has not yet, but may have a significant impact upon the Corporation. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. Since September 1995, bank holding companies may acquire banks in other states without regard to state law. In addition, banks could merge with other banks in another state beginning in June 1997. States may adopt laws preventing interstate branching but, if so, no out-of-state bank can establish a branch in such state and no bank in such state may branch outside the state. Pennsylvania recently amended the provisions of its Banking Code to authorize full interstate banking and branching under Pennsylvania law and to facilitate the operations of interstate banks in Pennsylvania. As a result of legal and industry changes, management predicts that consolidation will continue as the financial services industry strives for greater cost efficiencies and market share. Management believes that such consolidation may enhance its competitive position as a community bank. There are numerous proposals before Congress to modify the financial services industry and the way commercial banks operate. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Except as specifically described above, management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources and results of operations of the Corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation, which if they were implemented, would have a material adverse effect upon the liquidity, capital resources or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have and in the future may have a negative impact on the Corporation's results of operations. In addition to historical information, this Annual Report on Form 10-K Annual Report contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Corporation files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed by the Corporation, and any Current Reports on Form 8-K filed by the Corporation. Management has initiated an enterprise-wide program to prepare the Corporation's computer systems and applications for the year 2000. In January 1997, the Corporation began converting its computer systems to be year 2000 compliant. On December 31, 1997, approximately 59 percent of the Corporation's systems were compliant, with all systems expected to be compliant by May of 1999. The Corporation continues to evaluate appropriate courses of corrective action, including replacement of certain systems whose associated costs would be recorded as assets and amortized. The total cost of the project is being funded through operating cash flows. Accordingly, the Corporation does not expect the amounts required to be expensed over the next two years to have a material effect on its financial position or results of operations. Aside from those matters described above, management does not believe that there are any trends or uncertainties which would have a material impact on future operating results, liquidity or capital resources nor is it aware of any current recommendations by the regulatory authorities which if they were to be implemented would have such an effect. Net Interest Income The primary component of the Corporation's net earnings is net interest income, which is the difference between interest and fees earned on interest-earning assets and interest paid on deposits and borrowed funds. For presentation and analytical purposes, net interest income is adjusted to a taxable equivalent basis. For purposes of calculating yields on tax-exempt interest income, the taxable equivalent adjustment equates tax-exempt interest rates to taxable interest rates as noted in Table 1. Adjustments are made using a statutory federal tax rate of 34% for 1997, 1996 and 1995. Table 1 presents average balances, taxable equivalent interest income and expense and the yields earned or paid on these assets and liabilities. The increase in net interest income during 1997 and 1996 resulted from increased volumes in average earning assets. Average earning assets increased 7.9% in 1997 and 10.4% in 1996. These increases were primarily funded with interest-bearing liabilities which increased 8.3% in 1997 and 11.3% in 1996. Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity Interest Rates and Interest Differential-Tax Equivalent Yields (Unaudited)
Years ended December 31, 1997 1996 1995 Average Annual Average Annual Average Annual Balance Interest Rate Balance Interest Rate Balance Interest Rate Assets Interest bearing deposits with banks..............$ 214 $ 13 5.90% $ 103 $ 6 5.72% $ 30 $ 2 6.78% Federal Funds sold......... 13,110 730 5.57% 7,376 398 5.39% 7,583 449 5.92% Investment securities: U.S. Treasury securities. 28,330 1,679 5.93% 28,789 1,686 5.86% 28,696 1,675 5.84% U.S. Government agencies. 33,508 2,100 6.27% 33,895 2,192 6.47% 27,999 1,761 6.29% State and Municipal securities.............. 60,324 4,702 7.79% 57,966 4,615 7.96% 48,884 4,083 8.35% Other securities......... 66,207 4,131 6.24% 57,189 3,535 6.18% 66,990 4,294 6.41% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total investment securities188,369 12,612 6.70% 177,839 12,028 6.76% 172,569 11,813 6.85% Loans: Commercial...............265,638 24,021 9.04% 245,018 22,276 9.09% 226,032 21,284 9.42% Consumer.................133,125 11,927 8.96% 130,044 11,401 8.77% 106,171 9,766 9.20% Mortgages................ 47,983 3,814 7.95% 41,046 3,330 8.11% 32,739 2,771 8.46% Leases................... 50,811 5,221 10.28% 46,420 4,865 10.48% 41,974 4,350 10.36% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total loans................497,557 44,983 9.04% 462,528 41,872 9.05% 406,916 38,171 9.38% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total earning assets.......699,250 58,338 8.34% 647,846 54,304 8.38% 587,098 50,435 8.59% Allowance for loan losses.. (7,863) (7,863) (7,155) Cash and due from banks.... 32,409 30,238 27,763 Other nonearning assets.... 65,518 62,005 51,629 ------- -------- -------- Total nonearning assets.... 90,064 84,380 72,237 ------- ------- ------ -------- -------- ------ -------- -------- ----- Total assets..............$789,314 $ 58,338 7.39% $732,226 $ 54,304 7.42% 659,335 $ 50,435 7.65% ======== ======= ====== ======== ======== ====== ======== ======= ====== Liabilities and Stockholders' Equity Deposits: Demand deposits Noninterest bearing....$ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00% $66,133 $ 0 0.00% Demand deposits Interest bearing........267,987 6,931 2.59% 257,622 6,726 2.61% 239,036 7,181 3.00% Savings deposits......... 58,149 1,188 2.04% 58,232 1,288 2.21% 54,982 1,333 2.42% Time deposits............262,681 14,805 5.64% 229,835 12,695 5.52% 194,512 10,579 5.44% ------- -------- ------ -------- ------- ------ -------- ------- ----- Total deposits.............663,149 22,924 3.46% 617,741 20,709 3.35% 554,663 19,093 3.44% Other borrowed funds....... 35,316 2,402 6.80% 30,578 2,114 6.91% 29,143 2,060 7.07% Other liabilities.......... 18,894 17,122 14,856 Stockholders' equity....... 71,955 66,785 60,673 ------- -------- ------ -------- ------- ------ -------- ------- ----- Total liabilities and Stockholders' equity....$789,314 $ 25,326 3.21% $732,226 $ 22,823 3.12% $659,335 $ 21,153 3.21% ======== ======== ====== ======== ======== ====== ======== ======= ===== Net interest income/ Average total assets...... $ 33,012 4.18% $ 31,481 4.30% $ 29,282 4.44% Net interest income/ Average earning assets.... $ 33,012 4.72% $ 31,481 4.86% $ 29,282 4.99%
Net interest income on a fully taxable equivalent basis increased by $1,531,000 in 1997 compared to an increase of $2,199,000 in 1996. Table 2 indicates that of the increase in 1997, $1,788,000 was the result of increased volumes. This figure was reduced by $257,000 due to changes in interest rates. The increase in 1996 resulted in $2,910,000 from increased volumes while a reduction of $711,000 was realized due to changes in interest rates. For the year 1997 compared to 1996, loan volumes, on average, increased over $35 million and income earned on loans increased $3,111,000, tax adjusted. This compares to a volume increase of nearly $56 million in 1996 over 1995 with an increase in income earned on loans amounting to $3,701,000. As a result of increased volumes in 1997, nearly $3.2 million contributed to the increase in income on loans. Rates charged on loans decreased in 1997. The decrease in rates reduced interest $60,000 in income earned on loans. Increased volume in loans in 1996 contributed over $5.2 million to the increase in income, while a decrease in interest rates reduced income earned on loans by $1.5 million. Total investment securities, on average, increased over $10.5 million in 1997 over 1996 compared to an increase of over $5.2 million in 1996 over 1995. Increased volume in both periods was primarily responsible for the increase in interest income on securities. Table 2 indicates that, of the increase in interest income in 1997, $712,000 was the result of increased volume while a decrease in interest rates caused a $128,000 reduction. Increased volume in securities in 1996 contributed nearly $361,000 to the increase while a decrease in rates caused a $146,000 reduction. Interest income on federal funds sold contributed $332,000 to the increase in net income in 1997 over 1996. Increased volume, as well as increased rates, combined to produce this increase. Interest bearing deposits, on average, grew over $43 million in 1997. The major portion of the increase in interest expense on deposits was generated on time deposits, as a result of increased volume and rates paid for these deposits. Although there were increased volumes on the other deposits, the decrease in rates paid on these deposits reduced the total interest expense by $163,000. Interest expense on interest bearing deposits increased over $1.6 million in 1996 over 1995. Increased volumes generated an increase of $2,558,000 while a reduction in income of $942,000 resulted from decreased rates. Interest expense on borrowed funds increased $288,000 in 1997 over 1996 compared to an increase of $54,000 in 1996 over 1995. The major portion of the increase in these periods was a result of increased volume. Table 2 - Analysis of Changes in Net Interest Income The rate-volume variance analysis set forth in the table below, which is computed on a tax equivalent basis, compares changes in net interest income for the periods indicated by their rate and volume components. ,caption> 1997 Versus 1996 1996 Versus 1995 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Volume Rate Total Volume Rate Total Interest Income Interest on deposits with banks...........$ 6 $ 1 $ 7 $ 5 $ (1) $ 4 Interest on federal funds sold........... 309 23 332 (12) (39) (51) Interest on investment securities........... 712 (128) 584 361 (146) 215 Interest and fees on loans................ 3,171 (60) 3,111 5,216 (1,515) 3,701 ------- -------- --------- -------- -------- ------- Total interest income...$ 4,198 $ (164) $ 4,034 $ 5,570 $ (1,701) $ 3,869 ------- -------- --------- -------- -------- ------- Interest Expense Interest on interest-bearing demand deposits......$ 271 $ (66) $ 205 $ 558 $ (1,013) $ (455) Interest on savings deposits...... (2) (97) (99) 79 (124) (45) Interest on time deposits......... 1,814 295 2,109 1,921 195 2,116 Interest on borrowed funds........ 327 (39) 288 102 (48) 54 ------- -------- -------- -------- -------- -------- Total interest expense..$ 2,410 $ 93 $ 2,503 $ 2,660 $ (990) $ 1,670 ------- -------- -------- -------- -------- -------- Net interest income.....$ 1,788 $ (257) $ 1,531 $ 2,910 $ (711) $ 2,199 ======= ======== ======== ======== ======== ========
Provision for Loan Losses The provision for loan losses charged against earnings was $1,129,000 in 1997 compared to $580,000 in 1996 and $534,000 in 1995. The provision reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Net charge-offs amounted to $1,199,000 in 1997, $560,000 in 1996 and $394,000 in 1995. Gross charge-offs for 1997 were $1,502,000, an increase over the $703,000 reported in 1996. The increases in the provision for loan losses, gross and net charge-offs were a result of a reduction in asset quality in the consumer loan portfolio, particularly the installment and credit card portfolios. Personal bankruptcies played a significant role in the losses. Management has instituted certain changes in underwriting criteria in an effort to reduce the risk of similar increases in the future. Management does not expect to experience a similar increase in losses in 1998 in the consumer portfolio. Management believes that despite the increase in the losses in 1997, the percentage of net losses to average loans and leases is comparable to the Bank's peers. The allowance for loan losses as a percent of loans at December 31, 1996 was 1.65%, while at December 31, 1997 it was 1.51%. Non-Interest Income Table 3 - Non-Interest Income
1997/1996 1996/1995 Increase Increase (Decrease) (Decrease) 1997 Amount % 1996 Amount % 1995 Income from fiduciary activities.$ 1,513 $ 374 32.8% $1,139 $ 283 33.1% $ 856 Service charges on deposit accounts....................... 2,909 424 17.1% 2,485 475 23.6% 2,010 Other service charges, commissions and fees....................... 1,456 512 54.2% 944 124 15.1% 820 Mortgage banking income........... 1,305 113 9.5% 1,192 667 127.0% 525 Other operating income............ 4,539 1,015 28.8% 3,524 338 10.6% 3,186 Investment securities gains or (losses)....................... 208 50 31.7% 158 158 .0% 0 ------ ------ ------ ------ ------- ------ ------ Total............................$11,930 $ 2,488 26.4% $9,442 $ 2,045 27.7% $7,397 ======= ======= ====== ====== ======= ====== ======
Non-interest income, recorded as other operating income, consists of income from fiduciary activities, service charges on deposit accounts, other service charges, commissions and fees, mortgage banking income and other income such as safe deposit box rents and income from operating leases. Income from fiduciary activities in the amount of $1,513,000 in 1997 was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996. Income in 1996 was $283,000 or 33.1% greater than the $856,000 recorded in 1995. Fees increased primarily due to increased transaction volumes. Service charges on deposit accounts increased to $2,909,000, an increase of $424,000 or 17.1% over the $2,485,000 reported for 1996. Service charges on deposit accounts in 1996 were $475,000 more than the $2,010,000 reported for 1995. General increases in service charges on various accounts, as well as, transaction volume produced the increases for the periods reported. Management continuously monitors fee structure and makes changes where they believe appropriate. Other service charges, commissions and fees were $1,456,000 in 1997 compared to $944,000 in 1996 and $820,000 in 1995. The increase in 1997 over 1996 was $512,000 or 54.2%. The significant increase in 1997 is attributable to the introduction of ATM charges. Other contributors to the increase were fees received on mutual fund transactions and fees on the Bank's debit card. Income from mortgage banking activities increased to $1,305,000 in 1997 from $1,192,000 in 1996. Mortgages sold in the secondary market in 1997 increased to approximately $40.9 million from $33.2 million in 1996. All mortgages sold were originated by the Bank's mortgage department or the branch network. No mortgages were acquired from third parties, nor have servicing rights been purchased from third parties. A low interest rate environment in 1997, as well as an expansion in mortgage products and services resulted in the increase in volume in 1997. The Bank retains mortgage servicing rights on the majority of mortgages originated and sold on the secondary market. The Bank's mortgage servicing portfolio was $175 million as of December 31, 1997 compared to $155 million on December 31, 1996. Another component of the mortgage banking increase in profit was caused by implementation of FASB 122 (subsequently replaced by FASB 125) which required that mortgage servicing rights be recognized for their economic value, as of January 1, 1996. Mortgage servicing has a value because of the value of the future servicing income to be recieved over the life of a mortgage. The value of servicing rights is available through third party purchasers in private transactions. The Bank has developed business relationships with a third party mortgage company, which sets the values of mortgage servicing rights based upon the mortgage company's price offerings. The Bank recognized $470,805 in mortgage servicing values in 1996 for its originated servicing portfolio, when in previous years no value was recognized. In 1997, the amount recognized was $549,756. Mortgage servicing rights are recorded as an asset and recognized directly to income as if the servicing had been sold. The asset is amortized as a charge to earnings over the estimated servicing life of the associated mortgage. Mortgage servicing assets, as of December 31, 1997, and 1996 were $892,000 and $442,000, respectively. Actual pay-off of mortgages serviced with a recorded asset value are immediately charged against earnings. Other operating income increased $1,015,000 to $4,539,000 in 1997 from $3,524,000 in 1996. Other income was $3,186,000 in 1995. Income generated from operating leases was a major contributor to this increase. Income on operating leases increased approximately $400,000 in 1997 over 1996. Gains realized on the sale of real estate and equipment, which amounted to $456,000, also added to the increase. Investment securities transactions reflect a gain of $208,000 in 1997 compared to a gain of $158,000 in 1996 on securities sold from the available-for-sale securities. There were no securities sold in 1995. The Bank does not engage in trading activities. Therefore, the adoption of SFAS 115 did not impact current year earnings. As a result of these changes in the components of non-interest income, total other operating income increased $2,488,000 in 1997 over 1996 compared to an increase of $2,045,000 in 1996 over 1995. Non-Interest Expense Table 4 - Non-Interest Expense
1997/1996 1996/1995 Increase Increase (Decrease) (Decrease) 1997 Amount % 1996 Amount % 1995 Salaries and employee benefits...$16,398 $ 1,371 9.1% $15,027 $1,987 15.2% $13,040 Net occupancy expense............. 2,290 181 8.6% 2,109 388 22.5% 1,721 Furniture & equipment expense..... 2,480 436 21.3% 2,044 439 27.4% 1,605 FDIC insurance assessment......... 81 79 --- 2 (620) (99.7%) 622 Other operating expense........... 6,833 376 5.8% 6,457 918 16.6% 5,539 ----- ------ ----- ------ ----- ----- ------- Total............................$28,082 $ 2,443 9.5% $25,639 $3,112 13.8% $22,527 ======= ======= ===== ====== ====== ===== =======
Non-interest expense consists of salaries and employee benefits, net occupancy expense, furniture and equipment expense and other operating expenses. Total operating expenses for 1997 were $28,082,000 compared to $25,639,000 in 1996. This represents an increase of $2,443,000 or 9.5%. This compares to an increase of $3,112,000 of 13.8% in 1996. The largest component of the Corporation's other operating expense is salaries and employee benefits, which increased to $16,398,000 in 1997 or $1,371,000 (9.1%) over the $15,027,000 reported in 1996. In 1996, expenses increased $1,987,000 (15.2%) over the $13,040,000 reported in 1995. The increases in 1997 and 1996 were primarily due to increases in staff as well as increases in wages and the increased cost of employee benefits. During 1996, four branch offices were opened. In December 1995, two branch offices were acquired from another financial institution. Each of these acquisitions contributed to the increase in 1996. Three of the branches opened in 1996 were opened in the last quarter of 1996. Occupancy expense increased $181,000 or 8.6% to $2,290,000 in 1997 from $2,109,000 in 1996. By comparison, during 1996, there was an increase of $388,000 or 22.5%. Three new branch offices were opened in the last quarter of 1996. In addition, on December 4, 1996, the Bank purchased property located at 1097 Commercial Avenue, East Petersburg, Pennsylvania situated on 12.7 acres with a building containing approximately 123,000 square feet. The building now houses the Bank's Administrative Service Center, as well as other departments of the Bank. Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this building. These additions contributed to the increase in occupancy expense in 1997. As noted, the Bank added four branch facilities to its network in 1996. In addition, the Bank completed construction of a new headquarters building in 1995 that also includes branch banking facilities and two branch offices were acquired from another financial institution in December 1995. These additions and expenses relating to occupancy such as real estate taxes, insurance, utilities, maintenance and janitor services contributed to the increase in occupancy expense. Furniture and equipment expenses were $2,480,000 in 1997 and $2,044,000 in 1996. This represents an increase of $436,000 or 21.3%. The increase in 1996 over 1995 was $439,000 or 27.4%. Reflected in this increase is a $244,000 increase in depreciation expense in 1997. Service contracts on equipment also contributed to the increase in 1997. The FDIC insurance assessment reflects an increase of $79,000 in 1997 over 1996. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC") and to provide for repayment of the FICO (Financial Institution Collateral Obligation) bonds issued by the United States Treasury Department. The FDIC levied a one-time special assessment on SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base as of March 31, 1995. During 1997, 1998 and 1999, the Bank Insurance Fund ("BIF") will pay $322 million of FICO debt service, and SAIF will pay $458 million. During 1997, 1998 and 1999, the average regular annual deposit insurance assessment is estimated to be about 1.29 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institution's assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. After 1999, BIF and SAIF will share the FICO costs equally. Under current estimates, BIF and SAIF assessment bases would each be assessed at the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending the interest payment obligation. The legislation caused the Bank to experience an increase in the 1997 FDIC assessment over the 1996 assessment. Other operating expense increased $376,000 or 5.8% in 1997 compared to an increase of $918,000 in 1996. The 1997 increase is consistent with rising costs associated with the acquisition of services in this category of expense. Expenses in this category include postage, Pennsylvania Shares Tax, advertising and marketing, professional services, telephone, stationery and forms, ATM fees, insurance premiums, expense of other real estate owned and other expense categories not specifically identified on the income statement. Contributing to the increase in 1997 were increases in Pennsylvania Shares Tax, professional services, postage, MAC fees and telephone expense. Income Taxes Income tax expense was $3,491,000 in 1997 compared to $3,147,000 in 1996 and $3,039,000 in 1995. These increases were a result of higher levels of taxable income and increased earnings each year. The Corporation's effective tax rate was 25.1%, in 1997, compared with 24.3%, in 1996, and 25.3%, in 1995. Use of tax credits in 1997 and 1996 resulted in a lower effective tax rate than 1995 even though income before taxes increased. Additional information relating to income taxation is presented in the Notes to Consolidated Financial Statements. Financial Condition Investment Portfolio Table 5 - Investment Securities at Cost The following table shows the amortized cost of the held-to-maturity securities owned by the Corporation as of the dates indicated. Investment securities are stated at cost adjusted for amortization of premiums and accretion of discounts. December 31, 1997 1996 1995 U.S. Treasury securities................$ 6,537 $ 12,888 $ 18,837 Obligations of other U.S. Government agencies and corporations............. 9,696 11,607 18,473 Obligations of states and political subdivisions.......................... 45,816 37,584 40,212 Mortgage-backed securities.............. 1,575 2,076 3,854 Other bonds, notes and debentures....... 18,574 27,269 38,944 --------- --------- --------- Subtotal................................ 82,198 91,424 120,320 Non-marketable securities............... 2,957 2,798 2,565 --------- --------- --------- Total...................................$ 85,155 $ 94,222 $ 122,885 ========= ========= ========= The following table shows the amortized cost and fair value of the available-for-sale securities owned as of the dates indicated.
December 31, 1997 1996 1995 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- --------- -------- -------- ----------- -------- U.S. Treasury securities............$ 24,435 $ 24,625 $ 13,611 $ 13,598 $ 11,046 $ 11,155 Obligations of other U.S. Government agencies and corporations.......... 26,821 27,008 18,800 18,718 15,489 15,632 Obligations of states and political subdivisions....................... 21,840 22,571 20,488 20,819 19,622 19,945 Mortgage-backed securities........... 832 829 1,125 1,117 1,249 1,242 Other bonds, notes and debentures.... 42,955 43,178 22,752 22,771 19,013 19,247 -------- --------- -------- -------- --------- -------- Subtotal............................. 116,883 118,211 76,776 77,023 66,419 67,221 Equity securities.................... 174 3,263 171 2,352 88 1,746 -------- --------- -------- -------- --------- -------- Total................................$117,057 $ 121,474 $ 76,947 $ 79,375 $ 66,507 $ 68,967 ======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields) The following table shows the maturities of held-to-maturity debt securities at amortized cost as of December 31, 1997 and approximate weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru 1 Year and less 5 Years 10 Years Over 10 Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury securities....$ 3,999 5.71% $ 2,538 5.99% $ --- ---% $ --- ---% $ 6,537 5.82% Obligations of other U.S. Government agencies and corporations.. 5,452 5.79% 3,256 6.06% 988 6.48% --- ---% 9,696 5.95% Obligations of states and political sub- divisions..... 3,966 5.96% 11,264 7.40% 21,463 7.62% 9,123 7.58% 45,816 7.41% Mortgage-backed securities.... 60 8.62% 1,102 8.68% 226 8.55% 187 7.61% 1,575 8.53% Other bonds, notes and debentures.... 9,476 6.15% 9,098 6.53% --- ---% --- ---% 18,574 6.34% ------- ----- -------- ------ -------- ------ ------- ------ -------- ----- $22,953 5.96% $27,258 6.87% $ 22,677 7.58% $ 9,310 7.58% $82,198 6.89% ======= ===== ======= ====== ======== ===== ======= ====== ======== =====
The following table shows the maturities of available-for-sale debt securities at amortized cost as of December 31, 1997 and approximate weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru 1 Year and less 5 Years 10 Years Over 10 Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury securities....$ 4,500 4.17% $ 19,622 6.13%$ 313 6.21% $ --- ---% $ 24,435 5.77% Obligations of other U.S. Government agencies and corporations.. 1,299 5.98% 19,876 6.26% 5,646 6.66% --- ---% 26,821 6.33% Obligations of states and political sub- divisions..... 603 7.93% 4,119 7.14% 15,308 7.91% 1,810 7.91% 21,840 7.77% Mortgage-backed securities.... 278 5.85% 554 5.91% --- ---% --- ---% 832 5.89% Other bonds, notes and debentures.... 4,952 6.13% 38,003 6.49% --- ---% --- ---% 42,955 6.45% ------- ------ ------- ------ ------- ----- ------- ----- -------- ------ $11,632 5.44% $82,174 6.38% $21,267 7.55% $ 1,810 7.91% $116,883 6.52% ======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans Table 7 - Loan Portfolio The following table sets forth the composition of the Corporation's loan portfolio as of the dates indicated:
December 31, 1997 1996 1995 1994 1993 Commercial, financial and agricultural..............$ 271,605 $ 239,701 $ 228,058 $ 208,918 $ 191,431 Real estate-construction... 6,045 5,608 6,378 8,542 10,265 Real estate-mortgage....... 49,438 45,373 33,124 30,505 22,335 Consumer................... 132,778 136,989 116,210 106,921 101,256 Lease financing (net of unearned income)......... 52,207 47,346 43,904 38,771 35,443 ---------- ---------- ---------- ---------- --------- Total loans.................$ 512,073 $ 475,017 $ 427,674 $ 393,657 $ 360,730 ========== ========== ========== ========== =========
Table 8 - Loan Maturity and Interest Sensitivity The following table sets forth the maturity and interest sensitivity of the loan portfolio as of December 31, 1997:
After one Within but within After one year five years five years Total Commercial, financial and agricultural..$ 121,240 $ 129,905 $ 20,460 $ 271,605 Real estate-construction................ 1,009 5,036 none 6,045 --------- --------- -------- -------- $ 122,249 $ 134,941 $ 20,460 $ 277,650 ========= ========= ========= =========
Loans due after one year totaling $94,632,000 have variable interest rates. The remaining $60,769,000 in loans have fixed rates. Table 9 - Nonaccrual, Past Due and Restructured Loans The following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans:
December 31, 1997 1996 1995 1994 1993 Nonaccrual loans...........$ 1,314 $ 1,193 $ 1,010 $ 2,127 $ 2,960 Accruing loans, past due 90 days or more......... 787 737 330 1,127 522 Restructured loans........ 2,105 none none none none -------- -------- -------- -------- -------- Total nonperforming loans.. 4,206 1,930 1,340 3,254 3,482 Other real estate owned.... 341 81 252 759 251 -------- -------- -------- -------- -------- Total nonperforming assets.$ 4,547 $ 2,011 $ 1,592 $ 4,013 $ 3,733 ======== ======== ======= ======== ======== Ratios: Non-performing loans to total loans.......... .82% .41% .31% .83% .97% Non-performing assets to total loans and other real estate owned.... .89% .42% .37% 1.02% 1.04% Non-performing assets to total assets.......... .54% .26% .22% .63% .63% Allowance for loan losses to non-performing loans.. 183.8% 404.1% 580.6% 234.8% 206.2%
The economic conditions within the Corporation's market area remained healthy in 1997. The unemployment rate for Lancaster County, which is the Bank's primary market area was 2.9%. The jobless rate during 1997 hovered close to 3%, which was the lowest or second lowest in the state. Lancaster County's unemployment rate has historically been and continues to be one of the lowest among Pennsylvania's 14 metropolitan regions. It also remains well below the state unemployment rate of 4.80%, as reported for December 1997. Management believes that the unemployment rate for 1998 is expected to mirror that of 1997 with little movement in either direction. Management believes that Lancaster's labor market is expected to remain one of the tightest in the state. Lancaster County also was strong compared to the national unemployment levels. The U.S. unemployment rate was at 4.70% in December 1997 compared to 5.3% in December 1996. The average for the year of 4.9% was the best since 1973. Unemployment hasn't been lower since 1969. Economists do not anticipate much change this year in the health of labor markets and believe the unemployment rate will drift toward 4.5% or a shade lower before rising late in the year toward 5%. The Bank's loan delinquency, as a percent of loans outstanding, declined during 1997. At December 31, 1997, the rate was at .83% compared to .96% and .58% for December 31, 1996 and December 31, 1995, respectively. The average delinquency rate of .99% for 1997 did increase compared to .77% in 1996. The increase in the average delinquency rate is primarily attributable to increases in the retail portfolio, particularly in the installment and credit card portfolios. The Bank is not immune to the continued rise in the number of bankruptcies that occurred in 1997 and 1996 nationwide. While management believes delinquency rates could continue an upward trend during 1998, management does not expect that they will approach the national delinquency rates. The .83% remains well below the accepted level established by management and below that of the Bank's peers. During the year, total nonaccrual loans and other real estate owned increased to $1,655,000 from $1,274,000 at December 31, 1996. Total non-performing assets increased to $4,547,000 compared to $2,011,000 for December 31, 1996, representing a 126.1% increase. The increase in the total non-performing assets is primarily attributed to the restructure of a series of loans to one borrower involving $2,105,000. There are no commitments to lend additional funds to this borrower in relation to the restructured loans. A loan is categorized as restructured if the original interest rate on the loan, repayment terms or both are restructured due to a deterioration in the financial condition of the borrower. In the case of the above referenced loans, the Bank is secured by real estate. The loans are current and have performed in accordance with the contractural terms, both prior to and after the restructure. Accrual of interest on these loans continues. The Bank's reserve coverage declined during the year. Reserves, as a percent of non-performing loans, declined to 184% compared with 404% for December 31, 1996, and 581% for December 31, 1995. This decline in reserve coverage is a result of the restructured loans in 1997 which were not present in 1996 and 1995. A portion of the Bank's loan portfolio consists of loans to agricultural-related borrowers. These loans are made for a variety of purposes within the industry. Lancaster County continues to be the top agricultural county in the state, leading Pennsylvania in production of most crops and all livestock with the exception of sheep. Dairy production remains Lancaster County's number one agricultural industry. The Lancaster County dairy industry suffered in 1997 due to a steep drop in milk prices. During the later part of 1997, milk prices edged up slightly. Management hopes that this portion of the loan portfolio will continue to show growth, but notes that agricultural loans are susceptible to a variety of external factors such as adverse climate, economic conditions, etc., in addition to factors common to other industries. In 1997, Lancaster County's residental real estate market enjoyed a strong year. Through November 1997, houses sold countywide were up 5.4% during the same 11-month period in 1996. Residential construction contracts, however, dropped 6% between 1996 and 1997,. Reasonably low interest rates, a continuing strong economy and minimal inflation accounted for the sales performance. Strong home sales are predicted through at least the first half of 1998. Non-residential contracts increased by 25% over 1996. The year 1998 is expected to be equivalent to 1997. Most of the Bank's business activity is with customers located within the Bank's defined market area. The majority of the Bank's real estate loans are located within this area, therefore both a debtor's ability to honor his obligations and increases and decreases in the market value of the real estate collateralizing loans are affected by the level of economic activity in Lancaster County. The Bank's general policy is to cease accruing interest on loans when management determines that a reasonable doubt exists as to the collectibility of additional interest. Interest income on these loans is only recognized to the extent payments are received. Loans on a nonaccrual status were $1,314,000 at December 31, 1997, compared to $1,193,000 at December 31, 1996. If interest income had been recorded on all such loans for the years indicated, such interest income would have been increased by approximately $152,755 and $116,567 for 1997 and 1996 respectively. Interest income recorded on nonaccrual loans was $20,020 and $27,532 for 1997 and 1996, respectively. Potential problem loans are included as performing loans, and are loans with respect to which possible credit problems of the borrower cause management to doubt the ability of the borrower to comply with present repayment terms. These loans may eventually result in disclosure as non-performing loans. At December 31, 1997, the Bank had no loans to disclose as potential problem loans. The Corporation implemented SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures," an amendment of SFAS No. 114, at the beginning of 1995. The Bank defined impaired loans as all loans on nonaccrual status and restructured, except those specifically excluded from the scope of SFAS No. 114, regardless of the credit grade assigned by loan review committee. All impaired loans are measured using the fair value of the collateral for each loan. When an impaired loan is measured as less than the recorded investment in the loan, the Bank compares the impairment measured to the existing allowance assigned to the loan. If the impairment is greater than the allowance, the Bank adjusts the existing allowance to reflect the greater amount or takes a charge to the provision for loan losses in that amount. If the impairment is less than the existing allowance for a particular loan, no adjustment to the allowance or to the provision for loan and lease losses is made. The Bank was not required to adjust for impaired loans for the periods indicated. The following table presents information concerning impaired loans at December 31: 1997 1996 Gross impaired loans which have allowances..........$3,419 $1,193 Less: Related allowances for loan losses......... (410) (179) ------ ------ Net impaired loans..................................$3,009 $1,014 ====== ====== The increase in impaired loans is primarily attributable to the restructure of a series of loans to one borrower involving $2,105,000. A loan is categorized as restructured if the original interest rate on the loan, repayment terms or both are restructured due to a deterioration in the financial condition of the borrower that otherwise would not have been granted. In the case of the above referenced loans, the Bank is fully secured with real estate. The loans are current and have performed in accordance with the contractural terms, both prior to and after the restructure. Accrual of interest on these loans continue. At December 31, 1997, there were no concentrations exceeding 10% of total loans. A concentration is defined as amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by changes in economic or other conditions. There were no foreign loans outstanding at December 31, 1997. Allowance for Loan Losses Table 10 - Summary of Loan Loss Experience Years ended December 31, 1997 1996 1995 1994 1993 Allowance for Loan Losses: Beginning balance.............$ 7,800 $ 7,780 $ 7,640 $ 7,180 $ 5,400 Loans charged off during year: Commercial, financial and agricultural.............. 43 37 50 157 194 Real estate mortgage........ 419 184 252 235 392 Consumer.................... 919 458 360 360 290 Lease financing............. 121 24 14 10 14 ------- ------- ------- ------- ------- Total charge-offs........... 1,502 703 676 762 890 ------- ------- ------- ------- ------- Recoveries: Commercial, financial and agricultural.............. 4 5 117 61 157 Real estate mortgage........ 112 42 72 2 8 Consumer.................... 122 88 91 77 63 Lease financing............. 65 8 2 1 12 ------- ------- ------- ------- ------- Total recoveries............ 303 143 282 141 240 ------- ------- ------- ------- ------- Net loans charged off......... 1,199 560 394 621 650 Additions charged to operations.................. 1,129 580 534 1,081 2,430 ------- ------- ------- ------- ------- Balance at end of year........$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180 ======= ======= ======= ======= ======= Ratio of net loans charged off to average loans outstanding................. .24% .12% .10% .17% .18% Ratio of net loans charged off to loans at end of year. .23% .12% .09% .16% .18% Net loans charged off to allowance for loan losses.. 15.51% 7.18% 5.06% 8.13% 9.05% Net loans charged off to provision for loan losses.. 106.20% 96.55% 73.78% 57.45% 26.75% Allowance for loan losses as a percent of average loans... 1.55% 1.69% 1.91% 2.04% 2.01% Allowance for loan losses as a percent of loans at end of year................ 1.51% 1.65% 1.82% 1.95% 2.00% Allowance for loan losses as a percent of nonperforming loans........ 183.8% 404.1% 580.6% 234.8% 206.2% The Corporation experienced a 113.7% increase in gross charge-offs in 1997. Net charge-offs increased 114.1% in 1997. The increase in charge offs was a result of a reduction in asset quality in the consumer loan portfolios, particularly the installment and credit card portfolios. Personal bankruptcies played a significant role in the losses. Management has instituted certain changes in underwriting criteria in an effort to reduce the risk of increases in the future. For the year, the Corporation recorded net charge-offs of $1,199,000 or .24% of average loans outstanding, compared to $560,000 or .12% of average loans in 1996 and $394,000 or .10% of average loans in 1995. The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present risk and inherent risk in the loan portfolio. Management performs a quarterly assessment of the loan portfolio to determine the appropriate level of the allowance. The factors considered in this evaluation include, but are not limited to, estimated loan losses identified through a loan review process, general economic conditions, deterioration in pledged collateral, past loan experience and trends in delinquencies and nonaccruals. Management uses available information to determine the appropriate level of the allowance for possible loan losses. However, the allowance may be affected in the future based upon changes in the economic conditions and other factors. While there can be no assurance that material amounts of additional loan loss provisions will not be required in the future, management believes that, based upon information presently available, the amount of the allowance for possible loan losses is adequate. Management has not targeted any specific coverage ratio of non-performing loans by the allowance for loan losses and the coverage ratio may fluctuate based on loans placed into or removed from non-performing status. Table 11 - Allocation of Allowance for Loan Losses December 31, 1997 1996 Commercial, financial and agricultural..........$ 3,529 $ 3,471 Real estate - mortgage.......................... 25 5 Consumer........................................ 910 590 Leases.......................................... 599 620 Unallocated..................................... 2,667 3,114 ------- ------- Total...........................................$ 7,730 $ 7,800 ======= ======= Deposits Table 12 - Average Deposit Balances and Rates Paid The average amounts of deposits and rates paid for the years indicated are summarized below:
1997 1996 1995 Amount Rate Amount Rate Amount Rate Demand deposits.....................$ 74,332 --- $ 72,052 --- $ 66,133 --- Interest-bearing demand deposits.... 267,987 2.59% 257,622 2.61% 239,036 3.00% Savings deposits.................... 58,149 2.04% 58,232 2.21% 54,982 2.42% Time deposits....................... 262,681 5.64% 229,835 5.52% 194,512 5.44% -------- ----- -------- ----- -------- ----- $663,149 3.46% $617,741 3.35% $554,663 3.44% ======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity The maturities of time deposits of $100,000 or more are summarized below: December 31, 1997 1996 Three months or less..........................$ 11,058 $ 6,095 Over three thru six months.................... 6,541 6,112 Over six thru twelve months................... 9,209 9,026 Over twelve months............................ 10,357 5,963 ------- ------- Total.........................................$ 37,165 $ 27,196 ======= ======= Capital Total stockholders' equity increased over $4.8 million or 7% in 1997 to $73,987,000. Total stockholders' equity at December 31, 1996 of $69,179,000 represented an increase of nearly $5.3 million or 8.3% over the $63,909,000 reported at December 31, 1995. The increase for 1997 was the difference between net income of $10.4 million less dividends declared of approximately $5.1 million. Adding to the increase in stockholders' equity was an increase in net unrealized gains on available-for-sale securities in the amount of $1.3 million. These increases were to some degree offset by the repurchase of outstanding common stock throughout the year. Treasury stock purchased during the period was $3.3 million. The Corporation issued $1.5 million in treasury shares. The major portion of the increase in 1996 was due to net income of $9.8 million less dividends declared $4.5 million. During 1997, the Corporation announced that the Board of Directors authorized the repurchase of up to 140,000 shares of the outstanding common stock. During 1997, the Corporation repurchased 127,751 shares for $3.3 million. The Corporation used, during 1997, 55,868 shares of treasury stock for the Dividend Reinvestment Plan and 1,600 shares for the Director's Compensation Plan. Federal regulatory authorities promulgate risk-based capital guidelines that are applicable to banks and bank holding companies in an effort to make regulatory capital more responsive to the risk exposure related to various categories of assets and off-balance sheet items. These guidelines require that banking organizations meet a minimum risk-based capital, define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of capital requirements. The components of total capital are called Tier 1 and Tier 2 capital. In the case of the Bank, Tier 1 capital is the shareholders' equity and Tier 2 capital is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-weighted assets. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet items. Regulatory authorities have decided to exclude the net unrealized holding gains and losses on available-for-sale securities from the definition of common stockholders' equity for regulatory capital purposes. However, national banks will continue to deduct unrealized losses on equity securities in their computation of Tier 1 capital. Therefore, national banks will continue to report the net unrealized gains and loses on available-for-sale securities in the reports of condition and income submitted to federal regulators as required by SFAS 115 and the financial reports prepared in accordance with generally accepted accounting principles, but will exclude these amounts from calculations of Tier 1 capital. In addition, national banks should use the amortized cost of available-for-sale debt securities (as opposed to fair value) to determine the average total assets as well as the risk-weighted assets used in the calculations of the leverage and risk-based capital ratios. The ratios below and in Table 14 reflect the above definition of common stockholders' equity which includes common stock, capital surplus and retained earnings, less net unrealized holding losses on available-for-sale equity securities with readily determinable fair values. The Bank's ratios at December 31, 1997, 1996 and 1995 were above the final risk-based capital standards that require Tier 1 capital of at least 4% and total risk-based capital of 8% of risk-weighted assets. The Tier 1 capital ratio at December 31, 1997 was 10.23% and the total risk-based capital ratio was 11.38%, which exceeds the minimum capital guidelines. Tier 1 capital ratio was 10.68% and the total risk-based capital ratio was 11.93% at December 31, 1996 while Tier 1 capital ratio was 10.95% and the total risk-based capital ratio was 12.21% at December 31, 1995. At December 31, 1997, the Corporation and the Bank, exceeded all capital requirements and are considered to be "well capitalized." Table 14 - Capital and Performance Ratios The following are selected ratios for the years ended December 31: 1997 1996 1995 Return on average assets...................... 1.32% 1.34% 1.36% Return on average equity...................... 14.89% 15.01% 15.02% Dividend payout ratio......................... 48.79% 45.95% 58.48% Average total equity to average assets........ 8.89% 8.95% 9.10% Total equity to assets at year end............ 8.45% 8.87% 8.79% Primary capital ratio......................... 9.28% 9.80% 9.78% Tier 1 risk-based capital ratio............... 10.23% 10.68% 10.95% Total risk-based capital ratio................ 11.38% 11.93% 12.21% Liquidity Liquidity is the ability to meet the requirements of customers for loans and deposit withdrawals in the most economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost. Liquidity from asset categories is provided through cash, noninterest-bearing and interest-bearing deposits with banks, federal funds sold and marketable investment securities maturing within one year. Investment securities maturing within one year were $34,585,000 at December 31, 1997 compared to $27,169,000 at December 31, 1996. Interest-bearing deposits with banks were $643,498 at December 31, 1996 compared to $14,565 at December 31, 1997. Federal funds sold totaled $28,150,000 at December 31, 1997 compared to $24,150,000 at December 31, 1996. Securities available-for-sale as of December 31, 1997 were $121,474,497 compared to $79,374,627 as of December 31, 1996. The loan portfolio also provides an additional source of liquidity due to the Bank's participation in the secondary mortgage market. Sales of residential mortgages in the secondary market were approximately $40.9 million in 1997 and $33.2 million in 1996, which allowed the Bank to meet the needs of customers for new mortgage financing. The loan portfolio also provides significant liquidity through repayment of loans by maturity or scheduled amortization payments. On the liability side, liquidity is available through customer deposit growth and short term borrowings. Federal Home Loan Bank available borrowing capacity as of December 31, 1997 was $16,800,000 with existing capital stock ownership. Federal funds purchased lines are also in place. Management monitors liquidity daily because customer deposit levels fluctuate daily and loan fundings, maturities and investment purchases occur with irregularity. The amount of liquidity needed is determined by the changes in levels of deposits and in the demand for loans. Management believes that these mentioned sources of funds provide sufficient liquidity. New Financial Accounting Standard In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 125 - "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This Statement amends and extends to all servicing assets and libilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities," and supercedes FASB Statement No. 122, "Accounting for Mortgage Servicing Rights." SFAS No. 125 establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on the consistent application of the financial-components approach. This approach requires the recognition of financial assets and servicing assets that are controlled by the reporting entity, the derecognition of financial assets when control is surrendered and the derecognition of liabilities when they are extinguished. Specific criteria are established for determining when control has been surrendered in the transfer of financial assets. Liabilities incurred and deriviatives obtained by transferors in connection with the transfer of financial assets are measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are measured by allocating any prior carrying amount between the assets sold, if any, and the interest retained, if any, based on the relative fair values of the assets at the date of transfer. Servicing assets retained are then subject to amortization and assessment for impairment. As issued, this Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The FASB became aware that the volume and variety of certain transactions and the related changes to information systems and accounting processes necessary to comply with the requirements of SFAS No. 125 would make it extremely difficult, if not impossible, for some affected companies to comply by January 1, 1997. As a result, in December 1996, the FASB issued FASB No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" that defers, for one year, the effective date of certain provisions, as well as accounting for transfers and servicing for repurchase agreements, dollar-roll, securities lending and similar transactions. Therefore, this Statement shall be effective for such transfers of financial assets after December 31, 1997. Management does not expect the adoption of SFAS No. 127 to have a material effect on the financial position or results of operations of the Corporation. In February 1997, the FASB issued SFAS No. 128 - "Earnings per Share," effective for periods ending after December 15, 1997. SFAS No. 128 is designed to simplify the computation of earnings per share and requires disclosure of "basic earnings per share" and, if applicable, "diluted earnings per share." Earlier application is not permitted. The Statement requires restatement of all prior period earnings per share data when adopted. Management does not expect SFAS No. 129 to material impact on the Corporation's reported earnings per share. In February 1997, SFAS No. 129 - "Disclosure of Information about Capital Structure" was issued by the FASB, which establishes standards for disclosing information about an entity's capital structure. It consolidates the disclosure requirements that were previously covered in APB-10, APB-15 and FAS-47. The Statement is effective for periods ending after December 15, 1997. Managemnt does not expect SFAS No. 129 to have a material impact on the Corporation. In June 1997, the FASB issued Statement No. 130 - "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Statement No. 130 requires that all items that are required to be recognized as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Statement No. 130 is effective for fiscal years beginning after December 15, 1997. This Statement will require the Corporation to set forth additional disclosures in the Corporation's financial statements. In June 1997, the FASB issued SFAS No. 131 - "Disclosures about Segments of an Enterprise and Related Information." This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. The Statement also establishes standards for related disclosures about products and services, geographic areas and major customers. This Statement supersedes FASB No. 14, - - "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends FASB Statement No. 94 - "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. The Statement is effective for fiscal years beginning after December 15, 1997. This Statement will require the Corporation to set forth additional disclosures in the Corporation's financial statements. Item 7A - Quantitative and Qualitative Disclosures About Market Risk Discussion of Market Risk and Interest Rate Sensitivity As a financial institution, the primary component of the Bank's market risk is interest rate volatility. Changes in interest rates will ultimately impact the Bank's interest income from earning assets and the interest expense from funding sources (deposits and debt). Based upon the Bank's nature of operations, the Bank is not subject to foreign currency exchange or commodity price risk. The Bank's market area for loans and deposits is concentrated in Lancaster County, Pennsylvania and as such is subject to risks associated with the local economy. The Bank does not own any trading assets. The Bank does not have any hedging transactions in place such as interest rate swaps and caps. Management endeavors to control the exposure of earnings to changes in interest rates. The Bank's asset/liability committee manages interest rate risk by various means including '"Gap" management and internally developed models and reports. In 1997, the Bank also utilized Sheshunoff Interest Rate Risk management services and IBAA investment portfolio valuation services to enhance risk exposure review. Interest repricing of assets and liabilities is measured over future time periods (interest rate sensitivity gaps). While all time gaps are measured, management's primary focus is the cumulative gap through six months, as this time frame directly impacts net interest income in the near term time horizon and is most difficult to make reactive adjustment to actual rate movements. The Bank has various investments structured to change investment yield with current market conditions. Assets subject to repricing include federal funds sold (repricing daily), loans floating to "treasury bill" indexes (repricing monthly) and loans tied to "prime" or other indexes subject to immediate change. Other factors effecting income are maturing and contracted repayments and\ prepayments of existing loans and investments. These cash flows will be re-invested at current market yields. The Bank's funding liabilities (customer deposits and borrowed funds) have more complex repricing characteristics, since interest bearing deposits are subject to rate change but are not specifically indexed to "prime" or "treasury" indexes. Time certificates and borrowed money are subject to interest rate change at maturity. The Bank's deposit funding is essentially comprised of "core" deposits that have been historically loyal and stable, and these deposits, with the exception of certificates of deposit, have not been rate sensitive. All interest rates do not move in full and equal amounts for loans and deposits. Deposit rates historically lag loans in rate movement, and rate movement occurs to a smaller degree for deposits than loans. Modeling is used to forecast projected impact to the net interest margin as a result of rate movements, either increasing or decreasing. Historic pricing correlations are calculated for all interest-bearing deposit products for rate change repricing impact as - immediate, monthly, and annually over a five year time period. As illustrated in Table 15, management's view of interest rate sensitivity reflects a calculated interpretation of net interest margin exposure to rate changes. Pricing correlations are constantly refined by management. There is no guarantee that past history will accurately reflect future changes. Table 15 - Interest Rate Sensitivity Gaps
0-30 31-90 91-180 181-365 Over 1 Over 2 Over 3 Over 4 Over Days Days Days Days to 2 Yrs to 3 Yrs to 4 Yrs to 5 Yrs 5 Yrs Assets Fed Funds sold......$ 28,150 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 Investment securities- Maturities.......... 5,252 8,325 11,735 19,150 34,185 27,889 21,376 18,017 61,507 Loans-Variable Rate.. 101,135 Loans-Fixed Rate..... 2,241 13,973 19,927 35,098 59,621 54,961 46,254 38,029 88,191 Leases-Finance....... 2,287 4,568 4,868 8,942 15,905 9,273 5,888 473 3 Allowance for loan losses.............. 0 0 0 0 0 0 0 0 (7,730) Non-earning assets... 0 0 0 0 0 0 0 0 105,995 -------- -------- -------- -------- -------- -------- -------- -------- ------- Total...............$ 139,065 $ 26,866 $ 36,530 $ 63,190 $ 109,711 $ 92,123 $ 73,518 $ 56,519 $247,966 Cumulative..........$ 139,065 165,931 202,461 265,651 375,362 467,485 541,003 597,522 845,488 Liabilities & Capital Interest Deposits-NOW, Super NOW, Savings & Money Market.......$ 63,752 $ 14,420 $ 5,620 $ 11,240 $ 19,089 $ 19,089 $ 19,089 $ 19,089 $170,662 C/D - Maturities.... 12,608 34,328 41,464 69,022 99,392 29,818 5,916 1,498 0 Borrowings- Banking activity... 3,001 2 3 6 12 962 681 12 320 Borrowings- Leasing activity... 1,255 2,510 5,020 7,157 7,080 7,291 0 0 0 Non Interest Bearing Deposits........... 0 0 0 0 0 0 0 0 82,565 Non Interest Bearing Liabilities........ 0 0 0 0 0 0 0 0 17,528 Stockholders'Equity. 0 0 0 0 0 0 0 0 73,987 -------- -------- -------- -------- -------- -------- -------- -------- ------- Total...............$ 80,616 $ 51,260 $ 52,107 $ 87,425 $ 125,573 $ 57,160 $ 25,686 $ 20,599 $345,062 Cumulative..........$ 80,616 $ 131,876 $ 183,983 $ 271,408 $ 396,981 454,141 479,827 500,426 845,488 Period GAP (Dollars)$ 58,449 $ (24,394)$ (15,577)$ (24,235)$ (15,862)$ 34,963 $ 47,832 $ 35,920 $(97,096) as % of Total Assets 7% -3% -2% -3% -2% 4% 6% 4% -11% Cumulative GAP (Dollars)..........$ 58,449 $ 34,055 $ 18,478$ (5,757)$ (21,619)$ 13,344 $ 61,176 $ 97,096 $ 0 as % of Total Assets 7% 4% 2% -1% -3% 1% 7% 11% 0%
During 1997, the net interest income tax-equivalent yield margin on average earning assets dropped to 4.72% from 4.86% in 1996. Prime rate in 1997 started at 8.25%, increased in March to 8.50% and stayed at that level for the remainder of the year. The average tax-equivalent yield on earning assets decreased in 1997 to 8.34%, down from 8.38% in 1996. Average earning assets increased by $51,400,000 in 1997. Average deposit funding increased $45,400,000 in 1997. Total deposit funding cost increased to 3.46% from 3.35% in 1996. Compression of the net interest margin was primarily a result of growth in certificates of deposit funding as a percentage of total funding mix, local competitive cost for these certificates of deposits, and a very competitive local market for loans. Future change in net income as a result of interest rate change is presented in the graph (Table 15a). This analysis, completed by Sheshunoff, depicts the projected change to income resulting from interest rate movements. The Bank's risk to interest rate movement illustrates that the future income of the Bank will increase with increasing market rates. Future income would increase by 6.01% and 11.84% with market rate increases of 1.00% and 2.00% respectively. Future income would decrease by 2.21% and 6.13% with market rate decreases of 1.00% and 2.00% respectively. These projections assume that management does not actively manage the balance sheet during changing market environments. Present value of equity as a result of interest rate change is presented in the graph (Table 15b). This analysis, completed by Sheshunoff, depicts the projected change in the market value of equity as result of interest rate movements. Future market value of equity would decrease by 2.55% and 5.15% with market rate increases of 1.00% and 2.00% respectively. Future market value of equity would increase by 2.49% and 4.09% with market rate decreases of 1.00% and 2.00% respectively.
Table 15a Table 15b 1998 Net Income Projections Present Value Equity Changes in Changes in Basis Points Net Income % Change Basis Points Market Value % Change -200 $ 8,542 -6.13% -200 $117,135 4.09% -150 8,721 -4.16% -150 116,229 3.29% -100 8,898 -2.21% -100 115,334 2.49% -50 9,078 -0.24% -50 114,459 1.72% 0 9,099 0.00% 0 112,528 0.00% 50 9,378 3.06% 50 111,137 -1.24% 100 9,646 6.01% 100 109,660 -2.55% 150 9,910 8.91% 150 108,179 -3.87% 200 10,177 11.84% 200 106,738 -5.15%
Item 8 - Financial Statements and Supplementary Data (a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages: Page Report of Independent Auditors 31 Consolidated Balance Sheets 32 Consolidated Statements of Income 33 Consolidated Statements of Changes in Stockholders' Equity 34 Consolidated Statements of Cash Flows 35 Notes to Consolidated Financial Statements 36 (b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages: Summary of Quarterly Financial Data (Unaudited) 54 Trout, Ebersole & Groff, LLP Certified Public Accountants 1705 Oregon Pike Lancaster, Pennsylvania 17601 (717)569-2900 FAX (717) 569-0141 Independent Auditors' Report Board of Directors and Shareholders Sterling Financial Corporation and Subsidiaries Lancaster, Pennsylvania We have audited the accompanying consolidated balance sheets of Sterling Financial Corporation and Subsidiaries as of December 31, 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 management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sterling Financial Corporation and Subsidiaries at December 31, 1997 and 1996 and the consolidated 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. As discussed in Note 2, the Corporation changed its method of accounting for mortgage servicing rights to adopt the provisions of the Financial Accounting Standards Board's SFAS No. 122, "Accounting for Mortgage Servicing Rights," at January 1, 1996. Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants January 22, 1998 Lancaster, Pennsylvania
Consolidated Balance Sheets Sterling Financial Corporation and Subsidiaries As of December 31, (Dollars in thousands) 1997 1996 Assets Cash and due from banks...........................................$ 34,292 $ 31,339 Interest-bearing deposits in other banks.......................... 15 644 Federal funds sold................................................ 28,150 24,150 Mortgage loans held for sale...................................... 792 1,016 Investment Securities: (Note 4) Securities held-to-maturity (market value - $86,465 - 1997 and $94,778 - 1996)............. 85,155 94,222 Securities available-for-sale.................................... 121,474 79,375 Loans (Note 5).................................................... 512,073 475,017 Less: Unearned income........................................... (436) (1,185) Allowance for loan losses (Note 6)......................... (7,730) (7,800) -------- ------- Loans, net........................................................ 503,907 466,032 -------- ------- Premises and equipment (Note 7)................................... 21,938 22,658 Other real estate owned........................................... 341 81 Accrued interest receivable and prepaid expenses.................. 12,243 11,262 Other assets (Note 8)............................................. 37,181 33,293 -------- ------- Total Assets..................................................... $845,488 $764,072 ======== ======== Liabilities Deposits: Noninterest bearing.............................................$ 82,565 $ 82,175 Interest bearing (Note 9)....................................... 636,096 564,861 -------- -------- Total Deposits.................................................... 718,661 647,036 -------- -------- Interest-bearing demand notes issued to U.S. Treasury (Note 10)... 3,000 2,741 Other liabilities for borrowed money (Note 10).................... 32,312 30,434 Accrued interest payable and accrued expenses..................... 10,165 8,705 Other liabilities................................................. 7,363 5,977 -------- -------- Total Liabilities................................................. 771,501 694,893 Stockholders' Equity -------- -------- Common Stock -(par value:$5.00) No. shares authorized: 1997 and 1996 - 35,000,000 No. shares issued: 1997 - 6,237,009; 1996 - 6,237,009 No. shares outstanding: 1997 - 6,149,795; 1996 - 6,220,078...... 31,185 31,185 Capital surplus................................................... 16,321 16,325 Retained earnings................................................. 25,828 20,502 Net unrealized gain on securities available-for-sale, net of taxes 2,916 1,603 Less: Treasury Stock (87,214 shares in 1997 and 16,931 shares in 1996) - at cost........................... (2,263) (436) -------- -------- Total Stockholders' Equity........................................ 73,987 69,179 -------- -------- Total Liabilities and Stockholders' Equity........................$845,488 $764,072 ======== ======== See accompanying notes to financial statements
Consolidated Statements of Income Sterling Financial Corporation and Subsidiaries For the years ended December 31, (Dollars in thousands, except per share data) 1997 1996 1995 Interest Income Interest and fees on loans...........................$ 44,744 $ 41,611 $ 37,975 Interest on deposits in other banks.................. 13 6 2 Interest on federal funds sold....................... 730 398 449 Interest and dividends on investment securities: Taxable............................................ 7,681 7,442 7,526 Tax-exempt......................................... 3,103 2,882 2,695 Dividends on stock................................. 228 219 203 --------- --------- --------- Total Interest Income................................ 56,499 52,558 48,850 --------- --------- --------- Interest Expense Interest on time certificates of deposit of $100,000 or more................................... 1,710 934 893 Interest on all other deposits....................... 21,214 19,775 18,200 Interest on demand notes issued to the U.S. Treasury. 113 95 114 Interest on federal funds purchased.................. 1 89 66 Interest on other borrowed money..................... 2,288 1,930 1,880 --------- --------- --------- Total Interest Expense............................... 25,326 22,823 21,153 --------- --------- --------- Net Interest Income.................................. 31,173 29,735 27,697 Provision for loan losses (Note 6)................... 1,129 580 534 --------- --------- --------- Net Interest Income after Provision for Loan Losses.. 30,044 29,155 27,163 --------- --------- --------- Other Operating Income Income from fiduciary activities..................... 1,513 1,139 856 Service charges on deposit accounts.................. 2,909 2,485 2,010 Other service charges, commissions and fees.......... 1,456 944 820 Mortgage banking..................................... 1,305 1,192 525 Other operating income (Note 8)...................... 4,539 3,524 3,186 Investment securities gains or (losses).............. 208 158 none --------- --------- --------- Total Other Operating Income......................... 11,930 9,442 7,397 --------- --------- --------- Other Operating Expenses Salaries and employee benefits (Note 11)............. 16,398 15,027 13,040 Net occupancy expense................................ 2,290 2,109 1,721 Furniture and equipment expense (including depreciation of $1,500 in 1997, $1,256 in 1996 and $917 in 1995). 2,480 2,044 1,605 FDIC insurance assessment............................ 81 2 622 Other operating expenses............................. 6,833 6,457 5,539 --------- --------- --------- Total Other Operating Expenses....................... 28,082 25,639 22,527 --------- --------- --------- Income Before Income Taxes........................... 13,892 12,958 12,033 Applicable income taxes (Note 15).................... 3,491 3,147 3,039 --------- --------- --------- Net Income...........................................$ 10,401 $ 9,811 $ 8,994 ========= ========= ========= Earnings per common share: Net Income (Basic earnings per share)..............$ 1.68 $ 1.57 $ 1.45 Net Income (Diluted earnings per share)............$ 1.68 $ 1.57 $ 1.45 Cash dividends declared per common share.............$ .82 $ .74 $ .89 See accompanying notes to financial statements
Consolidated Statements of Changes in Stockholders' Equity Sterling Financial Corporation and Subsidiaries Net Unrealized Gain on Available- Shares for-Sale Common Common Capital Retained Securities, Treasury Stock Stock Surplus Earnings Net of Taxes Stock Total (Dollars in thousands) Balance, January 1, 1995.......5,874,417 $ 29,372 $ 8,544 $ 19,114 $ 420 $ (165)$ 57,285 Net income.................... 8,994 8,994 Common stock issued Dividend Reinvestment Plan... 45,121 225 1,115 1,340 Employee Stock Plan.......... 13,148 66 325 391 Cash dividends declared - Common stock................. (5,260) (5,260) Purchase of Treasury Stock (41,880 shares).............. (1,252) (1,252) Issuance of Treasury Stock Dividend Reinvestment Plan (40,528 shares).............. 3 1,204 1,207 Change in net unrealized gain on available-for-sale securities, net of taxes................. 1,204 1,204 --------- -------- -------- -------- ---------- ------- -------- Balance, December 31, 1995....5,932,686 29,663 9,987 22,848 1,624 (213) 63,909 Net income.................... 9,811 9,811 Common stock issued Dividend Reinvestment Plan... 2,517 13 58 71 Employee Stock Plan.......... 5,690 28 140 168 Stock dividend issued - Common stock - 5%, including cash paid in lieu of fractional shares........... 296,116 1,481 6,144 (7,649) (24) Cash dividends declared - Common stock................. (4,508) (4,508) Purchase of Treasury Stock (21,026 shares).............. (547) (547) Issuance of Treasury Stock Dividend Reinvestment Plan (8,435 shares)............... (3) 247 244 Employee Stock Plan (2,819 shares)............... (1) 77 76 Change in net unrealized gain on available-for-sale securities, net of taxes...... (21) (21) --------- -------- -------- -------- ---------- ------- ------- Balance, December 31, 1996....6,237,009 31,185 16,325 20,502 1,603 (436) 69,179 Net Income.................... 10,401 10,401 Cash dividends declared - Common stock................. (5,075) (5,075) Purchase of Treasury Stock (127,751 shares)............. (3,302) (3,302) Issuance of Treasury Stock Dividend Reinvestment Plan (55,868 shares).............. (4) 1,434 1,430 Director's Compensation Plan (1,600 shares)............... 41 41 Change in net unrealized gain on available-for-sale securities, net of taxes...... 1,313 1,313 --------- -------- -------- -------- ---------- ------- ------- Balance, December 31, 1997... 6,237,009 $ 31,185 $ 16,321 $ 25,828 $ 2,916 $(2,263) $73,987 ========= ======== ======== ======== ========== ======= ======= See accompanying notes to financial statements
Consolidated Statements of Cash Flows Sterling Financial Corporation and Subsidiaries For the years ended December 31, (Dollars in thousands) 1997 1996 1995 Cash Flows from Operating Activities Net Income...........................................$ 10,401 $ 9,811 $ 8,994 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Depreciation...................................... 1,948 1,625 1,198 Accretion & amortization of investment securities. 266 356 367 Provision for possible loan losses................ 1,129 580 534 Provision for deferred income taxes............... 638 824 579 (Gain) on sale of property and equipment.......... (456) (2) (1) (Gain) on sales of investment securities.......... (208) (158) none (Gain) on sale of mortgage loans.................. (319) (262) (163) Proceeds from sales of mortgage loans............. 41,188 33,480 16,283 Originations of mortgage loans held for sale...... (40,645) (33,272) (16,558) Change in operating assets and liabilities: (Increase) decrease in accrued interest receivable and prepaid expenses............................ (981) 517 (2,825) (Increase) in other assets....................... (4,148) (6,583) (2,469) Increase (decrease) in accrued interest payable and accrued expenses........................... 822 (350) 1,915 Increase (decrease) in other liabilities........ 711 836 (753) --------- --------- --------- Net cash provided by/(used in) operating activities.. 10,346 7,402 7,101 Cash Flows from Investing Activities Proceeds from interest bearing deposits in other banks..................................... 968 1,023 1,052 Purchase of interest bearing deposits in other banks. (339) (1,643) (1,052) Proceeds from sales of investment securities available-for-sale.................................. 214 670 none Proceeds from maturities or calls of investment securities held-to-maturity.... .................... 30,541 37,508 30,095 Proceeds from maturities or calls of investment securities available-for-sale....................... 10,007 8,948 2,921 Purchases of investment securities held-to-maturity.. (22,185) (9,791) (46,273) Purchases of investment securities available-for-sale (49,678) (19,310) (6,926) Federal funds sold, net.............................. (4,000) (14,800) (9,350) Net loans and leases made to customers............... (39,004) (48,080) (34,057) Purchases of premises and equipment.................. (2,562) (7,880) (5,681) Proceeds from sale of premises and equipment......... 1,790 49 11 --------- --------- --------- Net cash provided by/(used in) investing activities.. (74,248) (53,306) (69,260) Cash Flows from Financing Activities Net increase in demand deposits, NOW and savings accounts................................... 18,429 12,013 32,041 Net increase in time deposits........................ 53,195 24,918 41,062 Net increrase (decrease) in interest bearing demand notes issued to the U.S. Treasury................... 259 507 (680) Proceeds from borrowings............................. 25,652 58,474 39,180 Repayments of borrowings............................. (23,774) (49,563) (36,830) Federal funds purchased, net......................... none none (6,000) Proceeds from issuance of common stock............... none 239 1,731 Cash dividends paid.................................. (5,075) (4,508) (5,260) Cash paid in lieu of fractional shares............... none (24) none Acquisition of treasury stock........................ (3,302) (547) (1,252) Proceeds from issuance of treasury stock............. 1,471 320 1,207 --------- --------- --------- Net cash provided by/(used in) financing activities.. 66,855 41,829 65,199 --------- --------- --------- Increase (decrease) in cash and due from banks....... 2,953 (4,075) 3,040 Cash and due from banks: Beginning............................................ 31,339 35,414 32,374 --------- --------- --------- Ending...............................................$ 34,292 $ 31,339 $ 35,414 ========= ========= ========= Supplemental Disclosure of Cash Flow Information: Cash payments for: Interest paid to depositors and on borrowed money..$ 24,702 $ 22,637 $ 19,937 Income taxes....................................... 2,600 2,230 2,526 Supplemental Schedule of Noncash Investing and Financing Activities: Other real estate acquired in settlement of loans....$ 630 $ 119 $ 293 See accompanying notes to financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sterling Financial Corporation and Subsidiaries (All dollar amounts presented in the tables are in thousands, except per share data) Note 1 - Formation of Sterling Financial Corporation As a result of a plan of reorganization, The First National Bank of Lancaster County, now by name change, Bank of Lancaster County, N.A. (Bank), became the wholly owned subsidiary of Sterling Financial Corporation (Parent Company), a new bank holding company, at the close of business June 30, 1987. Each outstanding share of the Bank's common stock (par value $10.00) was converted into two shares of common stock (par value $5.00) of the Parent Company. The authorized capital of the Parent Company is 35,000,000 shares of common stock. Note 2 - Summary of Significant Accounting Policies Business - Sterling Financial Corporation, through its subsidiary bank, Bank of Lancaster County, N.A., and its subsidiary, Town & Country, Inc., provides a full range of banking services to individual and corporate customers. The principal market area is Lancaster County, Pennsylvania. Sterling Financial Corporation and the Bank of Lancaster County, N.A. are subject to competition from other financial institutions. Both are subject to regulations of certain federal agencies and, accordingly, they are periodically examined by those regulatory authorities. Basis of Financial Statement Presentation - The accounting and reporting policies of Sterling Financial Corporation and its subsidiaries (the Corporation) conform to generally accepted accounting principles and to general practices within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from these estimates. Principles of Consolidation - The accompanying consolidated financial statements include the accounts of Sterling Financial Corporation and its wholly owned subsidiaries, Bank of Lancaster County, N.A. and its subsidiary Town & Country, Inc., and Sterling Mortgage Services, Inc. (presently inactive). All significant intercompany transactions have been eliminated in the consolidation. Investment Securities - Investment securities include both debt securities and equity securities. Sterling adopted Statement of Financial Accounting Standards Board Statement No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities" as of January 1, 1994. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments are to be classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value with unrealized gains and losses included in earnings; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Sterling has segregated its investment securities into two categories: those held-to-maturity and those available-for-sale. Investment securities in the held-to-maturity category are carried at cost adjusted for amortization of premiums and accretion of discounts, both computed on the constant yield method. It is management's intent to hold investment account securities until maturity. However, the investment portfolio does serve as an ultimate source of liquidity. In order to acknowledge this function, Sterling has designated certain specific debt securities as being available- for-sale. Premiums and discounts are recognized in interest income computed on the constant yield method. All marketable equity securities are classified as available-for-sale. Realized gains and losses on securities are computed using the specific identification method and are included in Other Operating Income in the Consolidated Statements of Income. Future purchases of securities will be evaluated on an individual basis for classification among the three permissible categories based on management's intent and the ability to hold each security to maturity, on the relative sizes of the security categories in relation to future liquidity needs, on current asset/liability management strategies and other criteria as appropriate. Premises and Equipment - Premises, furniture and equipment, leasehold improvements, and capitalized leases are stated at cost, less accumulated depreciation and amortization. For book purposes, depreciation is computed primarily by using the straight-line method over the estimated useful life of the asset. Charges for maintenance and repairs are expensed as incurred. Gains and losses on dispositions are reflected in current operations. Other Real Estate Owned - Other real estate owned is carried at the lower of cost or an amount not in excess of estimated fair value. Allowance for Loan Losses - The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. Interest Income - Interest on installment loans is recognized primarily on the simple interest, actuarial and the rule of seventy-eights methods. Interest on other loans is recognized based upon the principal amount outstanding. The general policy has been to cease accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest income on these loans is only recognized to the extent payments are received. Loan Origination Fees and Costs - Loan fees, net of loan origination costs, are deferred and amortized to interest income over the life of the loan. The amortization of net deferred fees is discontinued on non-accrual loans. Federal Income Taxes - Applicable income taxes are based on income as reported in the consolidated financial statements. Deferred income taxes are provided for those elements of income and expense which are recognized in different periods for financial reporting and income tax purposes. Trust Department Assets and Income - Trust assets held by the Bank in a fiduciary or agency capacity for customers of the Trust Department are not included in the financial statements since such items are not assets of the Bank. Trust income has been recognized on the cash basis which is not significantly different from amounts that would have been recognized on the accrual basis. Presentation of Cash Flows - For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Reclassifications - Certain income items for prior years have been reclassified in order to conform with the current year presentation with no effect to net income. Accounting for Mortgage Servicing Rights - FASB Statement No. 122, "Accounting for Mortgage Servicing Rights - an amendment of FASB Statement No. 65," effective for fiscal years beginning after December 15, 1995, establishes accounting standards for recognizing servicing rights on mortgage loans. The Corporation has historically originated mortgage loans as a normal business activity, selling the mortgages on the secondary market to Federal Home Loan Mortgage Corporation and Federal National Mortgage Association and retaining all mortgage servicing. Mortgage sale income has been recorded on a "net" gain/loss basis. FASB No. 122 requires recognition of servicing "value" as an asset and immediate income as though mortgage servicing has been sold rather than retained. The servicing asset valuation must be amortized over the expected servicing life of the mortgage portfolio. In addition, the mortgage servicing asset must be valued periodically for impairment, based upon review of expected servicing life in relation to current market rates. The implementation of FASB No. 122 results in a greater recognition of income from mortgage origination and sales activity and a corresponding decrease of servicing income over the serviced mortgage portfolio life. In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 - "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This Statement amends and extends to all servicing assets and liabilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities," and supercedes FASB Statement No. 122, "Accounting for Mortgage Servicing Rights." This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The application of this Standard did not have a material effect on earnings. The FASB also subsequently issued FASB No. 127 that delayed until January 1, 1998, the effective date of certain provisions of FASB 125. Transactions subject to the later effective date include securities lending, repurchase agreements, dollar-rolls and similar secured financing arrangements. Application of the new rules is not expected to have a material impact on Sterling's consolidated financial statements. Mortgage Loans Held for Sale - Mortgage loans held for sale are recorded at the lesser of current secondary market value or the actual book value of loans. Note 3 - Restrictions on Cash and Due From Banks The Bank is required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against their deposit liabilities. The average amount of these reserve balances for the year ended December 31, 1997 was approximately $3,389,000. Balances maintained at the Federal Reserve Bank are included in cash and due from banks. Note 4 - Investment Securities Securities pledged to secure government and other public deposits, trust deposits, short-term borrowings, and other balances as required or permitted by law were carried at $49,320,182 in 1997 and $47,763,546 in 1996. The amortized cost and fair values of investment securities held-to- maturity are as follows:
December 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 6,537 $ 16 $ 3 $ 6,550 Obligations of other U.S. Government agencies and corporations......... 9,696 26 10 9,712 Obligations of states and political subdivisions...................... 45,816 1,129 14 46,931 Mortgage-backed securities.......... 1,575 84 1 1,658 Other bonds, notes and debentures... 18,574 95 12 18,657 ---------- --------- --------- -------- Subtotal............................ 82,198 1,350 40 83,508 Nonmarketable equity securities..... 2,957 none none 2,957 ---------- --------- --------- -------- Total...............................$ 85,155 $ 1,350 $ 40 $ 86,465 ========== ========= ========= ========
December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 12,888 $ 42 $ 32 $ 12,898 Obligations of other U.S. Government agencies and corporations......... 11,607 35 77 11,565 Obligations of states and political subdivisions...................... 37,584 560 169 37,975 Mortgage-backed securities.......... 2,076 108 1 2,183 Other bonds, notes and debentures... 27,269 154 64 27,359 ---------- --------- -------- -------- Subtotal............................ 91,424 899 343 91,980 Nonmarketable equity securities..... 2,798 none none 2,798 ---------- ---------- --------- -------- Total...............................$ 94,222 $ 899 $ 343 $ 94,778 =========== ========== ========= ========
Included in nonmarketable equity securities is Federal Reserve stock, Federal Home Loan Bank of Pittsburgh stock and Atlantic Central Bankers Bank stock. The amortized cost and fair values of held-to-maturity debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 1997 Amortized Fair Cost Value Due in one year or less................$ 22,893 $ 22,929 Due after one year through five years.. 26,321 26,553 Due after five years through ten years. 22,286 23,018 Due after ten years.................... 9,123 9,350 ----------- ----------- 80,623 81,850 Mortgage-backed securities............. 1,575 1,658 ----------- ----------- $ 82,198 $ 83,508 =========== =========== The amortized cost and fair values of investment securities available-for-sale are as follows:
December 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities..............$ 24,435 $ 211 $ 21 $ 24,625 Obligations of other U.S. Government agencies and Corporations............ 26,821 208 21 27,008 Obligations of states and political subdivisions......................... 21,840 750 19 22,571 Mortgage-backed securities............ 832 none 3 829 Other bonds, notes and debentures..... 42,955 281 58 43,178 -------- ------- ------ -------- Subtotal.............................. 116,883 1,450 122 118,211 Equity securities and corporate stock............................... 174 3,089 none 3,263 -------- ------- ------ -------- Total.................................$117,057 $ 4,539 $ 122 $121,474 ======== ======= ====== ========
December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 13,611 $ 60 $ 73 $ 13,598 Obligations of other U.S. Government agencies and corporations......... 18,800 63 145 18,718 Obligations of states and political subdivisions...................... 20,488 400 69 20,819 Mortgage-backed securities.......... 1,125 1 9 1,117 Other bonds, notes and debentures... 22,752 129 110 22,771 ---------- --------- -------- -------- Subtotal............................ 76,776 653 406 77,023 Equity securities and corporate stock............................. 171 2,181 none 2,352 ---------- ---------- --------- -------- Total...............................$ 76,947 $ 2,834 $ 406 $ 79,375 =========== ========== ========= ========
The amortized cost and fair values of available-for-sale debt securities at December 31, 1997 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 1997 Amortized Fair Cost Value Due in one year or less...................$ 11,354 $ 11,356 Due after one year through five years..... 81,619 82,224 Due after five years through ten years.... 21,268 21,941 Due after ten years....................... 1,810 1,861 -------- -------- 116,051 117,382 Mortgage-backed securities................ 832 829 -------- -------- $116,883 $118,211 ======== ======== Proceeds from sales of investment securities available-for-sale during 1997 and 1996 were $214,000 and $670,095 respectively. Gains of $208,457 in 1997 and $158,373 in 1996 were realized on these sales. There were no sales of investment securities in 1995. Note 5 - Loans
Loans outstanding at December 31, are as follows: 1997 1996 Commercial, financial and agricultural.....................$ 271,605 $ 239,701 Real estate - construction................................. 6,045 5,608 Real estate - mortgage..................................... 49,438 45,373 Consumer................................................... 132,778 136,989 Lease financing receivables (net of unearned income)....... 52,207 47,346 ------------ ------------ Total loans, gross.........................................$ 512,073 $ 475,017 ============ ============
Loans on a nonaccrual status amounted to $1,314,000 at December 31, 1997, compared to $1,193,000 at December 31, 1996. If interest income had been recorded on all such loans for the years indicated, such interest income would have increased by approximately $152,755 and $116,567 for 1997 and 1996 respectively. Restructured loans at December 31, 1997 amounted to $2,105,000. There were no restructured loans at December 31, 1996. SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures," an amendment of SFAS No. 114, was implemented at the beginning of 1995. The Bank has defined impaired loans as all loans on nonaccrual status and troubled debt restructured loans, except those specifically excluded from the scope of SFAS No. 114, regardless of the credit grade assigned by loan review. All impaired loans were measured by utilizing the fair value of the collateral for each loan. When the measure of an impaired loan is less than the recorded investment in the loan, the Bank will compare the impairment to the existing allowance assigned to the loan. If the impairment is greater than the allowance, the Bank will adjust the existing allowance to reflect the greater amount or take a corresponding charge to the provision for loan losses. If the impairment is less than the existing allowance for a particular loan, no adjustments to the allowance or the provision for loan and lease losses will be made. There was no adjustment necessary for the impaired loans for the periods indicated. The average amount of impaired loans for the fourth quarter of 1997 was $3,586,053 compared to $1,171,599 for the fourth quarter 1996, while the average for the year 1997 was $2,203,003 compared to $1,119,305 for 1996. The following table presents information concerning impaired loans at December 31: 1997 1996 Gross impaired loans which have allowances..........$ 3,419 $1,193 Less: Related allowances for loan losses......... (410) (179) ------- ------ Net impaired loans..................................$ 3,009 $1,014 ======= ====== Note 6 - Allowance for Loan Losses Changes in the Allowance for Loan Losses were as follows:
1997 1996 1995 Balance at January 1..................................$ 7,800 $ 7,780 $ 7,640 Recoveries credited to allowance...................... 303 143 282 Provisions for loan losses charged to income.......... 1,129 580 534 -------- -------- -------- Total................................................. 9,232 8,503 8,456 Losses charged to allowance........................... 1,502 703 676 -------- -------- -------- Balance at December 31................................$ 7,730 $ 7,800 $ 7,780 ========= ======== ======== Ratio of Allowance to loans, net of unearned income at end of year..................................... 1.51% 1.65% 1.82%
Note 7 - Premises and Equipment Premises and equipment at December 31, 1997 and 1996 is summarized as follows:
1997 1996 Land.............................................$ 3,539 $ 3,756 Buildings........................................ 15,977 16,603 Buildings under capitalized lease................ 104 104 Leasehold improvements........................... 796 813 Equipment, furniture and fixtures................ 12,604 11,553 Construction in progress......................... none 430 ---------- ---------- 33,020 33,259 Less: Accumulated depreciation................... (11,082) (10,601) ---------- ---------- $ 21,938 $ 22,658 ========== ==========
Depreciation expense amounted to $1,947,904 in 1997, $1,625,184 in 1996 and $1,197,980 in 1995. Note 8 - Other Assets Included in other assets for 1997 and 1996 is $30,650,237 and $26,533,442 respectively which represents operating leases generated by Town & Country, Inc. The income generated from the leases for 1997 and 1996 amounted to $3,050,664 and $2,647,810 respectively and is reflected in other operating income. The following schedule provides an analysis of Town & Country's investment in property on operating leases and property held for lease by major classes as of December 31, 1997 and 1996: 1997 1996 Construction equipment...........$ 932 $ 400 Transportation equipment......... 17,108 14,604 Automobiles...................... 18,855 17,218 Manufacturing equipment.......... 1,044 961 Trucks........................... 17,889 14,956 Other............................ 5,107 4,028 ---------- ----------- Total............................ 60,935 52,167 Less: Accumulated depreciation... (30,285) (25,634) ---------- ----------- $ 30,650 $ 26,533 ========== =========== The following is a schedule by years of minimum future rentals on noncancelable operating leases as of December 31, 1997: Year ending December 31: 1998...............................$ 14,740 1999................................ 2,441 2000................................ 611 2001................................ 320 2002................................ 122 ------- Total minimum future rentals.......$ 18,234 ======= Also included in other assets is mortgage servicing rights activity. The activity for the years ended December 31, 1997 and 1996 is as follows: 1997 1996 Balance beginning of year.............$ 442 $ none Capitalized mortgage servicing rights. 563 471 Amortization.......................... (113) (29) ------- ------ Balance at end of year................$ 892 $ 442 ======= ====== The Corporation adopted, effective January 1, 1996, Statement of Financial Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights," an ammendment of FASB Statement No. 65. In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Statement amends and extends to all servicing assets and liabilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities," and supercedes SFAS No. 122. This Statement requires that servicing assets and liabilities be subsequently measured by (a) amortization in proporation to and over the period of estimated net servicing income or loss and (b) assessment for asset impairment or increased obligation based on their fair values. A valuation allowance will be recorded if the unamortized mortgage servicing rights exceed their fair value. There was no valuation allowance for servicing rights for the year ended December 31, 1997. Mortgage servicing rights are a result of originated mortgages. There have been no mortgage servicing rights purchased. Note 9 - Time Certificates of Deposit At December 31, 1997 and 1996, time certificates of deposit of $100,000 or more aggregated $36,164,467 and $26,196,721 respectively. Note 10 - Short-Term Borrowings and Other Liabilities for Borrowed Money The Bank maintains lines of credit with various correspondent banks to use as sources of short-term funds. Federal funds purchased, borrowings from the Federal Reserve Bank and interest bearing demand notes issued to the U.S. Treasury would be considered short-term borrowings. There were no federal funds purchased or borrowings from the Federal Reserve Bank at December 31, 1997 or 1996. Interest-bearing demand notes issued to U.S. Treasury were $3,000,000 and $2,741,000 for 1997 and 1996 respectively. In addition, the Bank maintains a line of credit with the Federal Home Loan Bank of Pittsburgh. Based on the amount of the Federal Home Loan Bank stock owned by the Bank, the maximum borrowing capacity at December 31, 1997 was $16,800,000. There were no advances from the Federal Home Loan Bank considered as short-term borrowings at December 31, 1997 or 1996. The average balance outstanding for any category of short-term borrowings during the periods reported was less than 30 per cent of stockholders' equity at the end of each period reported. The following represents other liabilities for borrowed money at December 31:
1997 1996 Notes payable-Town & Country, Inc.(Subsidiary of Bank) borrowings from various lenders for leasing operations......$30,313 $28,423 Federal Home Loan Bank advances............................... 1,999 2,011 ------ ------ Total.........................................................$32,312 $30,434 ====== ======
Liabilities in connection with Town & Country, Inc. leasing operations are payable to various lenders at various terms. The estimated current portion of this debt is $15,941,971 at December 31, 1997. The borrowings from the Federal Home Loan Bank of Pittsburgh, which total $1,999,395, consist of three advances. An advance in 1993 in the amount of $950,000 carries an interest rate of 5.39% per year and matures September 13, 2000. In 1995 an advance was obtained in the amount of $668,700, at a rate of 6.41% per year and matures September 28, 2001. In 1996, $400,000 was advanced at the rate of 3% per year and matures March 7, 2011. The balance on this obligation at December 31, 1997 was $380,695. Note 11 - Pension and Employee Stock Bonus Plan The Bank of Lancaster County, N.A. and its subsidiary, Town & Country, Inc. maintains a qualified non-contributory pension plan for their employees. The Plan specifies fixed benefits to provide a monthly pension benefit at age 65 for life equal to one and one-half percent of each participant's final average salary (highest five consecutive years' base compensation preceding retirement) for each year of credited service. Salary in excess of $160,000 (effective in the year 1997) is disregarded in determining a participant's retirement benefit pursuant to IRS regulations. All employees with one year of service who work at least 1,000 hours per year and who are at least age 21 are eligible to participate. A participant becomes 100% vested upon completion of five years with a vesting credit. Net periodic pension cost for 1997, 1996 and 1995 included the following: 1997 1996 1995 Service cost.......................$ 583 $ 614 $ 579 Interest cost...................... 608 567 504 Return on Plan assets..............(2,208) (1,049) (950) Net amortization and deferral...... 1,351 368 417 ------ ------ ------ Net periodic pension cost..........$ 334 $ 500 $ 550 ====== ====== ====== The following table sets forth the Plan's funded status at December 31, 1997, 1996 and 1995:
Actuarial present value of benefit obligations: 1997 1996 1995 Accumulated benefit obligation, including vested benefits of $6,389,173 for 1997, $5,499,101 for 1996 and $5,238,774 for 1995..................................$ 6,580 $ 5,551 $ 5,275 ======= ======= ======= Projected benefit obligation for service rendered to date......................................................$(9,670) $(8,451) $(8,143) Plan assets at fair value.. ............................... 10,554 8,265 6,728 ------- ------- ------- Projected plan assets in excess of or (less than) benefit obligation........................................$ 884 $ (186) $(1,415) Unrecognized net (gain) or loss from past experience different from that assumed and effects of changes in assumptions............................................ (694) 449 1,495 Unrecognized net (asset) or obligation..................... (138) (207) (276) Unrecognized prior service cost............................ (111) (120) (128) ------- ------- ------- Prepaid (accrued) pension cost included in other assets (liabilities).............................$ (59) $ (64) $ (324) ======= ======= =======
The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7% and 4.50%, respectively, at December 31, 1997. The expected long-term rate of return on plan assets in 1997 was 9%. The Bank of Lancaster County maintained during 1997, an Employee Stock Plan (the "Plan") which was approved by the shareholders in 1982. All employees of the Bank who have attained the age of 18, have completed one year of service and worked at least 1,000 hours per year are eligible to participate in the Plan. Outside directors are not eligible to participate in the Plan. Employees of Town & Country, Inc., a wholly-owned subsidiary of the Bank participate only in the salary deferral feature of the Plan. The Plan has two components, a salary deferral feature and a performance incentive feature. Under the salary deferral feature of the Plan, a participant may make voluntary contributions to the Plan each year of between 2% and 10% of compensation. The Bank will make a matching contribution equal to 25% of each participant's voluntary contributions, up to the first 6%. Under the performance incentive feature of the Plan, the Bank contributes to the Plan each year an amount determined by the Board of Directors on the basis of the achievement by the Bank of certain performance objectives. Contributions made by the Bank to the Plan pursuant to the performance incentive feature are allocated to participants in the same proportion that each participant's compensation bears to the aggregate compensation of all participants. During 1997, the Plan was amended to allow participants to defer their contributions to five different investment alternatives. Previously, all contributions to the Plan were invested in Sterling Financial Corporation stock. The matching contributions and the performance incentive feature continue to be invested in Sterling Financial Corporation stock. The number of shares owned by the Employees Stock Plan at December 31, 1997 was 527,566 with an approximate market value of $16,486,000. Bank contributions to the Plan vest in each participant's account at the rate of 20% for each year of service. Normally, benefits may be paid from the Plan on retirement, termination, disability or death. Participants in the Plan may withdraw their own contribution earlier under several restricted conditions of hardship with approval of the Plan Committee. The Plan provides that each participant may vote the shares in his or her account through the Plan Trustee at any shareholder meeting. The Bank of Lancaster County Trust Department serves as Trustee for the Plan. All dividends received on Sterling Financial Corporation stock are reinvested in additional shares of Sterling Financial Corporation stock. The amount of dividends received during 1997 amounted to $423,093. The contribution to the performance incentive portion of the Plan was $245,000, $235,000 and $216,000 for 1997, 1996 and 1995 respectively. The contribution to the salary deferral portion of the Plan was $100,682 in 1997, $75,619 in 1996 and $65,946 in 1995. Effective January 1, 1993, Sterling adopted Statement of Financial Accounting Standards No. 106 - "Employers' Accounting for Postretirement Benefits Other Than Pensions." Under SFAS No. 106, the cost of postretirement benefits other than pensions must be recognized on an accrual basis as employees perform services to earn the benefits. This is a significant change from the previous generally accepted practice of accounting for these benefits which was on a cash basis. The accumulated postretirement benefit obligation at the date of adoption (the "transition obligation") could have been recognized in operations as the cumulative effect of an accounting change in the period of adoption, which would have resulted in an actuarially determined pre-tax charge to earnings of $1,026,457, or its recognition could be delayed by amortizing the obligation over future periods as a component of the postretirement benefit cost. Sterling adopted SFAS No. 106 by recognizing the transition on a delayed basis. The transition obligation in the amount of $1,026,457 is being amortized on a straight-line basis over a 20 year period which is the average remaining service period of active plan participants. The cost for postretirement benefits other than pensions consisted of the following components at December 31, 1997, 1996 and 1995: 1997 1996 1995 Service cost......................$ 77 $ 96 $ 93 Interest cost..................... 86 100 99 Amortization of unrecognized transition obligation........... 51 51 51 Amortization of unrecognized prior service cost.............. (19) none none Amortization of unrecognized net (gain) or loss.............. (4) none none ----- ----- ----- Net periodic postretirement benefit cost.................... $191 $247 $243 ==== ==== ==== Sterling's postretirement benefits other than pensions are currently not funded. The status of the plans at December 31, 1997, 1996 and 1995 is as follows: Actuarial valuation of accumulated postretirement benefit obligation: 1997 1996 1995 Retirees..................................$ 295 $ 319 $ 324 Fully eligible active plan participants... 314 290 323 Other active plan participants............ 610 601 787 ----- ----- ----- $1,219 $1,210 $1,434 Unrecognized transition obligation........ (770) (821) (872) Unrecognized prior service cost........... 232 251 none Unrecognized net gain (loss).............. 315 195 56 ----- ----- ----- Accrued postretirement benefit cost....... $ 996 $ 835 $ 618 ===== ===== ===== The assumed postretirement health care cost trend rate used in measuring the accumulated postretirement benefit was 7% in 1997, decreasing by .5% per year to an ultimate rate of 5% in 2001 and remains at that level thereafter. The discount rate used to measure the accumulated postretirement benefit obligation was 7% in 1997. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $241,275 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1997 by $40,761. The Board of Directors of the Bank adopted a Retirement Restoration Plan during 1996 for any officer whose compensation exceeded $160,000. The Plan was designed to "restore" the level of benefits which is lost to these employees under the organization's qualified retirement plans because of Internal Revenue Code restrictions. The Plan is designed to mirror the provisions set forth in the qualified retirement plans available to all Bank of Lancaster County employees -- the defined benefit pension plan, and the employee stock or 401(k) plan. The Plan allows for the calculation of benefits on the officer's salary in excess of $160,000. The effective date of the Plan was May 1, 1996. The net periodic pension cost for the Retirement Restoration Plan for 1997 and 1996 included the following: 1997 1996 ---- ---- Service cost.....................................$ 13 $ 8 Interest cost.................................... 15 9 Amortization of unrecognized prior service cost.. 20 13 ------- ------ Net periodic pension cost........................$ 48 $ 30 ======= ====== Actuarial valuation of benefit obligation: 1997 1996 ---- ---- Projected benefit obligation...................$ (216)$ (205) Fair value of plan assets...................... 0 0 -------- ------- Funded status..................................$ (216)$ (205) Unrecognized prior service cost................ 146 167 Unrecognized net (gain) or loss................ (8) 8 -------- ------- Accrued retirement restoration plan liability..$ (78)$ (30) ======== ======= Note 12 - Advertising The Corporation expenses advertising costs as incurred. The expenses for 1997, 1996 and 1995 were $569,484, $552,451 and $474,030 respectively. Note 13 - Stock Options On November 19, 1996, the Board of Directors of the Corporation adopted the Sterling Financial Corporation 1996 Stock Incentive Plan (the "Stock Incentive Plan") which was approved by the shareholders of this Corporation at the 1997 Annual Meeting of Shareholders. The stated purpose of the Stock Incentive Plan is to advance the development, growth and financial condition of the Corporation. The Stock Incentive Plan provides for the issuance of shares of the Corporation's Common Stock to the Corporation's employees. The shares of Common Stock that may be issued under the Stock Incentive Plan shall not exceed in the aggregate 500,000 shares of Common Stock. The Stock Incentive Plan is administered by a disinterested committee of the Corporation's Board of Directors. Incentive awards can be made in the form of incentive stock options, nonqualified stock options, stock appreciation rights or restricted stock as the disinterested committee deems appropriate. Sterling has elected to follow Accounting Principles Board Opinion No. 25, "Acccounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Accordingly, no compensation cost has been recognized. Had compensation cost been determined on the basis for fair value pursuant to FASB Statement No. 123, net income and earnings per share would have been reduced as follows: 1997 1996 1995 Net Income: ---- ---- ---- As reported..................... $10,401 $ 9,811 $ 8,994 Proforma - Granted.............. 10,090 9,594 8,994 Proforma - Exercisable.......... 10,332 9,811 8,994 Earnings Per Share: As reported - basic and diluted. $ 1.68 $ 1.57 1.45 Proforma - Granted.............. 1.62 1.54 1.45 Proforma - Exercisable.......... 1.67 1.57 1.45 Proforma disclosure of net income recognized compensation expense are not likely to be representative of the effects on net income for future years. The following is a summary of the status of the Plan: 1997 1996 1995 Weighted Weighted Weighted Average Average Average Exercised Exercised Exercised Shares Price Shares Price Shares Price ------ ------- ------ ------- ------ ------- Outstanding at January 1....32,850 $ 24.30 0 $ -- 0 $ -- Granted...................36,750 29.06 32,850 24.30 0 -- Exercised................. 0 -- 0 -- 0 -- Forfeited.................(1,500) 24.30 0 -- 0 -- Outstanding at December 31..68,100 26.87 32,850 24.30 0 -- Options Exercisable at December 31................10,450 24.30 0 -- 0 -- Weighted Average Fair Value of Options granted during the year................... $8.45 $6.62 0 The fair value of each option granted is estimated on the grant date using the Black-Scholes model. The following assumptions were made in estimating the fair value. Assumption 1997 1996 Dividend Yield.......... 2.53% 2.91% Risk-Free Interest Rate. 5.78% 6.39% Expected Life........... 10 years 10 years Expected Volatility..... 12.103% 10.617% Note 14 - Operating Leases The Bank leases certain banking facilities under operating leases which expire on various dates to 2022. Renewal options are available on these leases. Minimum future rental payments as of December 31, 1997 are as follows: Operating Leases 1998.........................$ 574 1999......................... 509 2000......................... 333 2001......................... 275 2002......................... 189 Later years.................. 1,784 ------- Total minimum future rental payments...................$ 3,664 ======= Total rent expense charged to operations amounted to $587,126 in 1997, $562,547 in 1996 and $479,809 in 1995. Note 15 - Applicable Income Taxes The effective income tax rates for financial reporting purposes are less than the Federal statutory rate of 34% for 1997, 1996 and 1995 for reasons shown as follows:
For the years ended December 31, Statutory Statutory Statutory 1997 Rate 1996 Rate 1995 Rate Federal income tax expense at statutory rate............$ 4,723 34.0% $ 4,406 34.0% $ 4,091 34.0% Reduction resulting from: Nontaxable interest income... (1,213) (8.7%) (1,153) (8.9%) (1,046) (8.7%) Other, net.................... (112) (.9%) (186) (1.4%) (71) (.6%) ------- ------ ------ ------ ------- ------ Applicable Federal income taxes.$ 3,398 24.4% $ 3,067 23.7% $ 2,974 24.7% State income taxes.............. 93 .7% 80 .6% 65 .6% -------- ------- ------- ------ ------- ------ Applicable income taxes.........$ 3,491 25.1% $ 3,147 24.3% $ 3,039 25.3% ======= ====== ======= ====== ======= ====== Taxes currently payable.........$ $ 2,323 $ 2,460 Deferred income taxes........... 824 579 ------- ------- ------- Applicable income taxes.........$ 3,491 $ 3,147 $ 3,039 ======= ======= =======
The Corporation had net deferred tax credits of $5,639,000, $4,326,000 and $3,512,000 at December 31, 1997, 1996 and 1995 respectively. The tax effect of temporary differences that gave use to significant portions of the deferred tax liabilities at December 31, 1997 and 1996, are as follows: December 31, 1997 1996 ---- ---- Deferred tax assets: Allowance for loan losses.....................$ 2,628 $ 2,763 Deferred loan fees and costs.................. 29 43 Postretirement benefits other than pensions... 339 292 Foreclosed assets............................. 7 7 Pension....................................... 49 47 Other......................................... 79 38 ------- ------- Total deferred tax assets...................$ 3,131 $ 3,190 ======= ======= Deferred tax liabilities: Leasing....................................... (6,930) (6,375) Depreciation.................................. (271) (294) Unrealized gains on investments............... (1,501) (826) Other......................................... (68) (21) ------- ------- Total deferred tax liabilities..............$(8,770) $(7,516) ======= ======= Net deferred tax liability..................$(5,639) $(4,326) ======= ======= Amounts for the current year are based upon estimates and assumptions as of the date of this report and could vary from amounts shown on the tax return when filed. Accordingly, amounts previously reported for 1996 may change as a result of adjustments to conform to tax returns filed. The Financial Accounting Standards Board has issued Statement No. 109, "Accounting for Income Taxes," which significantly changes the recognition and measurement of deferred income tax assets and liabilities. Statement 109 requires that deferred income taxes be recorded on an asset/liability method and adjusted when new tax rates are enacted. The corporation adopted Statement No. 109 beginning with its year ending December 31, 1993. The Statement provides that the effect of its adoption may be recorded entirely in the year of adoption or retroactively by restating one or more prior years. The statement was retroactively applied to 1990. Note 16 - Disclosures about Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. Cash and Short-Term Investments - For those short-term instruments, the carrying amount is a reasonable estimate of fair value. Investment Securities - For investment securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans - For certain homogenous categories of loans, such as some residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Lease contracts as defined in FASB Statement No. 13, "Accounting for Leases," are not included in this disclosure statement. Deposit Liabilities - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Federal Funds Purchased - The carrying amount of federal funds purchased approximates its fair value due to the overnight maturities of these financial instruments. U.S. Treasury Demand Notes - For U.S. Treasury demand notes, the carrying amount is a reasonable estimate of fair value. Other Borrowings - Rates currently available to the Corporation for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The estimated fair values of the Corporation's financial instruments are as follows:
1997 1996 --------------------- -------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------- --------- --------- --------- Financial Assets: Cash and short-term investments.....$ 34,307 $ 34,307 $ 31,983 $ 31,983 Investment securities held-to-maturity................. 85,155 86,465 94,222 94,778 Investment securities available-for-sale............... 121,474 121,474 79,375 79,375 Loans............................... 460,658 428,687 Less: Allowance for loan losses.... (7,131) (7,180) --------- --------- --------- --------- Net loans...........................$ 453,527 $ 454,042 $ 421,507 $ 421,936 Financial Liabilities: Deposits..........................$ 718,661 $ 680,629 $ 647,036 $ 649,315 U.S. Treasury demand notes........ 3,000 3,000 2,741 2,741 Other borrowings.................. 32,312 32,183 30,434 30,189 Unrecognized financial instruments:* Interest rate swaps: In a net receivable position.....$ none $ none $ none $ none In a net payable position........ (none) (none) (none) (none) Commitments to extend credit...... (50) (50) (82) (82) Standby letters of credit......... (50) (50) (48) (48) Financial guarantees written...... (none) (none) (none) (none) * The amounts shown under "Carrying Amount" represent accruals or deferred income (fees) arising from those unrecognized financial instruments.
Note 17 - Commitments and Contingent Liabilities In the normal course of business, there are various commitments and contingent liabilities which are not reflected in the financial statements. These include lawsuits and commitments to extend credit, guarantees and letters of credit. In the opinion of management, there are no material commitments which represent unusual risks. A summary of the more significant commitments as of December 31, 1997 and 1996 are as follows: Financial instruments whose contract amounts represent credit risk: 1997 1996 Standby letters of credit ....................$ 3,932 $ 7,594 Commitments to extend credit..................$103,357 $ 80,259 Standby letters of credit are obligations to make payments under certain conditions to meet contingencies related to customers' contractual agreements and are subject to the same risk, credit review and approval process as loans. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. Excluded from these amounts are commitments to extend credit in the form of retail credit cards, check credit or related plans. Sterling's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Sterling uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Most of Sterling's business activity is with customers located within Sterling's defined market area. Sterling grants commercial, residential and consumer loans throughout the market area. The loan portfolio is well diversified and Sterling does not have any significant concentrations of credit risk. In 1994, SFAS No. 119 - "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments" was issued effective for financial statements issued after December 15, 1994. The Corporation has not entered into any derivatives defined as a future, forward, swap, option, caps, floors, etc. However, the financial instruments listed above as standby letters of credit and commitments to extend credit have characteristics similar to derivatives. The following is a schedule that represents the estimated risk of current interest rates versus committed rates. Due to the uncertainty of when and how much a commitment to extend credit will be exercised, estimates were used. Fixed Rate Commitments 1997 1996 Carrying value at December 31,..............$ 0 $ 0 Commitment available not yet exercised......$ 24,992 $ 17,932 Commitment revalued at existing rates with estimated activity........................$ 24,992 $ 17,932 Management has initiated an enterprise-wide program to prepare the Corporation's computer systems and applications for the year 2000. In January 1997, the Corporation began converting its computer systems to be year 2000 compliant. On December 31, 1997, approximately 59 percent of the Corporation's systems were compliant, with all systems expected to be compliant by May of 1999. The Corporation continues to evaluate appropriate courses of corrective action, including replacement of certain systems whose associated costs would be recorded as assets and amortized. The total cost of the project is being funded through operating cash flows. Accordingly, the Corporation does not expect the amounts required to be expensed over the next two years to have a material effect on its financial position or results of operations. Note 18 - Related Party Transactions Certain directors and officers of Sterling Financial Corporation and its subsidiaries, their immediate families and companies in which they are principal owners (more than 10%), were indebted to the Bank during 1997 and 1996. All loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in the opinion of the management of the Bank, do not involve more than a normal risk of collectibility or present other unfavorable features. Total loans to these persons at December 31, 1997 and 1996 amounted to $3,039,888 and $5,435,443 respectively. During 1997, $1,947,765 of new loans were made and repayments totaled $4,343,320. Note 19 - Dividend and Loan Restrictions Dividends are paid by Sterling Financial Corporation from its assets which are provided in part by dividends from Bank of Lancaster County, N.A. However, certain restrictions exist regarding the ability of the Bank to transfer funds to Sterling Financial Corporation in the form of dividends. The approval of the Comptroller of the Currency shall be required if the total of all dividends declared by the Bank in any calendar year shall exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. Under these restrictions, the Bank can declare dividends in 1998 without approval of the Comptroller of the Currency of approximately $7,722,000 plus an additional amount equal to the Bank's net profits for 1998 up to the date of any such dividend declaration. Under current Federal Reserve regulations, the Bank is limited in the amount it may loan to Sterling Financial Corporation. Loans to Sterling Financial Corporation may not exceed 10% of the Bank's capital stock and surplus. Note 20 - Earnings per Share Computations In 1997, the Financial Accounting Standards Board issued Statement No. 128 - "Earnings per Share." The Statement is effective for periods ending after December 15, 1997. The Statement is designed to simplify the computation of earnings per share and requires disclosure of "basic earnings per share" and if applicable, "diluted earnings per share." Basic earnings per share is simply the per share allocation of income available to common stockholders based only on the weighted average number of common shares actually outstanding during the period. Diluted earnings per share represents the per share allocation of income attributable to common stockholders based on the weighted average number of common shares actually outstanding plus all dilutive potential common shares outstanding during the period. The Statement requires restatement of all prior period earnings per share date when adopted. Basic earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding which were 6,202,696, 6,235,257 and 6,204,212 for 1997, 1996 and 1995 respectively, after giving retroactive effect to a 5% stock dividend paid in July 1996. Diluted earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding plus all dilutive potential common shares outstanding during the period which were 6,205,784, 6,235,330 and 6,204,212 at 1997, 1996 and 1995, respectively, after giving retroactive effect to a 5% stock dividend paid in July 1996. The following data show the amounts used in computing earnings per share and the effect of income and the weighted average number of shares of dilutive potential common stock.
1997 1996 1995 Net Income...................................... $ 10,401 $ 9,811 $ 8,994 -------- ------- ------- Income available to common stockholders used in basic and diluted earnings per share... $ 10,401 $ 9,811 $ 8,994 ======== ======= ======= Weighted average number of common shares used in basic earnings per share................... 6,202,696 6,235,257 6,204,212 Effect of dilutive securities Stock Options................................. 3,088 73 0 --------- --------- --------- Weighted number of common shares and dilutive potential common stock used in diluted earnings per share............................ 6,205,784 6,235,330 6,204,212 ========= ========= =========
Note 21 - Sterling Financial Corporation (Parent Company Only) Financial Information
Condensed Balance Sheets As of December 31, 1997 1996 Assets Cash.......................................................$ 1,760 $ 1,109 Securities available-for-sale.............................. 216 185 Investment in subsidiaries at equity....................... 72,980 69,026 Other assets............................................... 68 51 -------- ------- Total Assets.................................................$ 75,024 $ 70,371 ======== ======== Liabilities Other liabilities..........................................$ 1,037 $ 1,192 Stockholders' Equity Common Stock...............................................$ 31,185 $ 31,185 Capital Surplus............................................ 16,321 16,325 Retained Earnings.......................................... 25,828 20,502 Net Unrealized Gain on securities available-for-sale, net of taxes........................................... 2,916 1,603 Less: Treasury Stock at cost............................... (2,263) (436) -------- -------- Total Stockholders' Equity...................................$ 73,987 $ 69,179 -------- -------- Total Liabilities and Stockholders' Equity...................$ 75,024 $ 70,371 ======== ========
Condensed Statements of Income
Years Ended December 31, 1997 1996 1995 Income Dividends from subsidiaries...............$ 7,876 $ 4,847 $ 3,837 Dividends on investment securities........ 4 3 2 Other income.............................. 1 1 1 Investment securities gains............... 4 none none -------- -------- -------- Total Income............................ 7,885 4,851 3,840 -------- -------- -------- Expenses Other expense............................. 210 155 141 -------- -------- -------- Total Expenses.......................... 210 155 141 -------- -------- -------- Income before income taxes and equity in undistributed net income of subsidiaries........................... 7,675 4,696 3,699 Income taxes (credits)...................... (68) (51) (47) -------- -------- -------- 7,743 4,747 3,746 Equity in undistributed income of subsidiaries.............................. 2,658 5,064 5,248 -------- -------- -------- Net Income..................................$ 10,401 $ 9,811 $ 8,994 ======== ======== ========
Statements of Cash Flows
Years Ended December 31, 1997 1996 1995 Cash flows from operating activities Net income........................................$ 10,401 $ 9,811 $ 8,994 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Undistributed (earnings) loss of subsidiaries..... (2,658) (5,064) (5,248) (Gain) on sales of investment securities.......... (4) none none Changes in operating assets and liabilities: (Increase) decrease in other assets............. (17) 796 (519) (Decrease) increase in other liabilities........ (165) 164 142 -------- -------- -------- Net cash provided by/(used in) operating activities............................ 7,557 5,707 3,369 -------- -------- -------- Cash flows from investing activities Proceeds from sales of investment securities avaiable-for sale............................... 9 none none Purchase of investment securities available-for-sale.............................. (9) (83) (81) -------- -------- -------- Net cash provided by/(used in) investing activities...................................... none (83) (81) -------- -------- -------- Cash flows from financing activities Proceeds from issuance of common stock........... none 239 1,731 Cash dividends paid.............................. (5,075) (4,508) (5,260) Cash dividends paid in lieu of fractional shares............................... none (24) none Acquisition of treasury stock.................... (3,302) (547) (1,252) Proceeds from issuance of treasury stock......... 1,471 320 1,207 -------- -------- -------- Net cash provided by/(used in) financing activities...................................... (6,906) (4,520) (3,574) -------- -------- -------- Increase (decrease) in cash....................... 651 1,104 (286) Cash Beginning....................................... 1,109 5 291 -------- -------- ------- Ending.........................................$ 1,760 $ 1,109 $ 5 ========= ======== =======
Summary of Quarterly Financial Data (Unaudited) Sterling Financial Corporation and Subsidiaries The following is a summary of the quarterly results of operations for the years ended December 31, 1997 and 1996. Net income per share of common stock has been restated to retroactively reflect a 5% stock dividend paid in July 1996. 1997 Quarter Ended March June September December 31 30 30 31 Interest income..................$ 13,396 $ 13,950 $ 14,434 $ 14,719 Interest expense................. 5,735 6,173 6,574 6,844 --------- ------- -------- -------- Net interest income.............. 7,661 7,777 7,860 7,875 Provision for loan losses........ 198 453 335 143 --------- ------- -------- -------- Net interest income after provision for loan losses...... 7,463 7,324 7,525 7,732 Other income..................... 2,739 3,284 2,949 2,958 Other expenses................... 6,763 7,121 6,932 7,266 --------- -------- -------- -------- Income before income taxes....... 3,439 3,487 3,542 3,424 Applicable income taxes.......... 851 910 893 837 --------- -------- -------- -------- Net income.......................$ 2,588 $ 2,577 $ 2,649 $ 2,587 ========= ======== ======== ======== Net income per share of common stock (basic and diluted)......$ .42 $ .41 $ .43 $ .42 1996 Quarter Ended March June September December 31 30 30 31 Interest income..................$ 12,798 $ 13,013 $ 13,227 $ 13,520 Interest expense................. 5,465 5,635 5,832 5,891 --------- ------- -------- -------- Net interest income.............. 7,333 7,378 7,395 7,629 Provision for loan losses........ 159 102 50 269 --------- ------- -------- -------- Net interest income after provision for loan losses...... 7,174 7,276 7,345 7,360 Other income..................... 2,286 2,275 2,269 2,612 Other expenses................... 6,256 6,247 6,349 6,787 --------- -------- -------- -------- Income before income taxes....... 3,204 3,304 3,265 3,185 Applicable income taxes.......... 768 818 802 759 --------- -------- -------- -------- Net income.......................$ 2,436 $ 2,486 $ 2,463 $ 2,426 ========= ======== ======== ======== Net income per share of common stock (basic and diluted)......$ .39 $ .40 $ .39 $ .39 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None PART III Item 10 - Directors and Executive Officers of the Registrant Incorporated by reference is the information appearing under the headings "Information about Nominees and Continuing Directors" and "Officers and Executive Officers" of the 1998 Annual Meeting Proxy Statement. Item 11 - Executive Compensation Incorporated by reference is the information under the headings "Compensation of Directors" and "Executive Compensation" of the 1998 Annual Meeting Proxy Statement. Item 12 - Security Ownership of Certain Beneficial Owners and Management Incorporated by reference is the information appearing under the headings "Principal Holders" and "Beneficial Ownership of Executive Officers, Directors and Nominees" of the 1998 Annual Meeting Proxy Statement. Item 13 - Certain Relationships and Related Transactions Incorporated by reference is the information appearing under the heading "Transactions with Directors and Executive Officers" of the 1998 Annual Meeting Proxy Statement and under "Notes to Consolidated Financial Statements - Note 18 - -Related Party Transactions" on page 51 of this Form 10-K. PART IV Item 14 - Exhibits, Financial Statement Schedules and Reports of Form 8-K (a) The following documents are filed as part of this report: 1. The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report. 2. Financial Statement Schedules All schedules are omitted because they are not either applicable, the data are not significant or the required information is shown in the financial statements or the notes thereto or elsewhere herein. 3. Exhibits The following is a list of the Exhibits required by Item 601 of Regulation S-K and are incorporated by reference herein or annexed to this Annual Report. 3(i) Amended Articles of Incorporation of Sterling Financial Corporation. (Incorporated by reference to Exhibit 3(i) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on June 14, 1996.) 3(ii) Amended Bylaws of Sterling Financial Corporation. (Incorporated by reference to Exhibit 3(ii) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 7, 1996.) 10a Employment Agreement, dated as of April 30, 1983, between The First National Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10a of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997.) 10b Assumption and Modification Agreeement, dated July 14, 1987, by and among John E. Stefan, Bank of Lancaster County, N.A. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 10b of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997.) 10c Sterling Financial Corporation 1996 Stock Incentive Plan. (Incorporated by refernce to Exhibit 99 of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on February 5, 1997.) 10d The Sterling Financial Corporation Dividend Reinvestment and Stock Purchase Plan. (Incorporated by reference to Exhibit A to the Prospectus included in the Registration Statement No. 33- 55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994.) 10e Letter Agreement between Sterling Financial Corporation and Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by reference to Exhibit 10b on Form 10Q, filed with the Securities and Exchange Commission, on November 14, 1994.) 10f The Corporation's 1997 Directors Stock Compensation Plan and Policy. (Incorporated by reference to Exhibit 4.3 to the Corporation's Registration Statement No. 333-28101 on Form S-8, filed with the Securities and Exchange Commission on May 30, 1997.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 20.) 21 Subsidiaries of the Registrant 23 Consent of Auditors 27 Financial Data Schedule (b) Reports on Form 8-K There were no reports on Form 8-K filed during the three months ended December 31, 1997. Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STERLING FINANCIAL CORPORATION By: /s/ John E. Stefan John E. Stefan Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated. Signature Title Date Chairman of the Board, /s/ John E. Stefan President and Chief February 24, 1998 (John E. Stefan) Executive Officer; Director /s/ J. Roger Moyer, Jr. Executive Vice President, February 24, 1998 (J. Roger Moyer, Jr.) Director /s/ Jere L. Obetz Senior Vice President/Treasurer, February 24, 1998 (Jere L. Obetz) Chief Financial Officer /s/ Ronald L. Bowman Vice President/Secretary, February 24, 1998 (Ronald L. Bowman) Principal Accounting Officer Director February 24, 1998 (Richard H. Albright, Jr.) Director February 24, 1998 (Robert H. Caldwell) /s/ Howard E. Groff, Jr. Director February 24, 1998 (Howard E. Groff, Jr.) /s/ Joan R. Henderson Director February 24, 1998 (Joan R. Henderson) /s/ J. Robert Hess Director February 24, 1998 (J. Robert Hess) /s/ Calvin G. High Director February 24, 1998 (Calvin G. High) /s/ E. Glenn Nauman Director February 24, 1998 (E. Glenn Nauman) /s/ Glenn R. Walz Vice Chairman of the Board, February 24, 1998 (Glenn R. Walz) Director EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The following are the subsidiaries of Sterling Financial Corporation: Subsidiary State of Incorporation or Organization Bank of Lancaster County, N.A. Pennsylvania 1 East Main Street (National Banking Association) P.O. Box 0300 Strasburg, PA 17579 Town & Country, Inc. (Wholly owned Pennsylvania Subsidiary of Bank of Lancaster County, N.A.) 1097 Commercial Avenue East Petersburg, PA 17520 Sterling Mortgage Services, Inc. Pennsylvania (Presently inactive) 101 North Pointe Boulevard Lancaster, PA 17601-4133 Trout, Ebersole & Groff, LLP Certified Public Accountants 1705 Oregon Pike Lancaster, Pennsylvania 17061 Exhibit 23 Consent of Independent Certified Public Accountants We hereby consent to the incorporation by reference in Registration Statement No. 33-55131 on Form S-3 filed August 19, 1994 of our opinion dated January 24, 1998, on the consolidated financial statements of Sterling Financial Corporation for the year ended December 31, 1997 as set forth in this form 10-K. /s/ Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants Lancaster, Pennsylvania March 6, 1998 Exhibit Index Page Exhibits Required Pursuant to (in accordance with Item 601 of Regulation S-K sequential numbering system) 3(i). Articles of Incorporation of Sterling Financial Corporation incorporated by reference to Exhibit 3 of Registration Statement on Form S-4 (No. 33-12635) filed with the Securities and Exchange Commission on March 13, 1987. 3(ii). Amended Bylaws of Sterling Financial Corporation incorporated by reference to Exhibit 3(ii) on Form 8-K filed with the Securities and Exchange Commission on March 7, 1996. 10a Employment Agreement, dated as of April 30, 1983, between The First National Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10a of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 18, 1997.) 10b Assumption an Modification Agreeement, dated July 14, 1987, by and among John E. Stefan, Bank of Lancaster County, N.A. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 10b of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 18, 1997.) 10c Sterling Financial Corporation 1996 Stock Incentive Plan. (Incorporated by refernce to Exhibit 99 of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on February 5, 1997.) 10d The Sterling Financial Corporation Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Exhibit A to the Prospectus included in the Registration Statement No. 33- 55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994.) 10e Letter Agreement between Sterling Financial Corporation and Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by reference to Exhibit 10b on Form 10Q, filed with the Securities and Exchange Commission, on November 14, 1994.) 10f The Corporation's 1997 Directors Stock Compensation Plan and Policy. (Incorporated by reference to Exhibit 4.3 to the Corporation's Registration Statement No. 333-28101 on Form S-8, filed with the Securities and Exchange Commission on May 30, 1997.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 20.) 21 List of Subsidiaries 54 23 Consent of Auditors 55 27 Financial Data Schedule EX-27 2
9 1,000 12-MOS DEC-31-1997 DEC-31-1997 34,292 15 28,150 0 121,474 85,155 86,465 512,429 7,730 845,488 718,661 3,000 17,528 32,312 0 0 31,185 42,802 845,488 44,744 11,755 0 56,499 22,924 25,326 31,173 1,129 208 28,082 13,892 13,892 0 0 10,401 1.68 1.68 7.827 1,314 787 0 0 7,800 1,502 303 7,730 7,730 0 2,667
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