-----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, PMHchIsbOtWabkr4Y3j+4sqpzgtgchfcp2nQsjLU0H0bCD5QtS9xaqGwAfmiYlla iUdvEdirTfr7r/+QFZz6Mg== 0000811671-99-000006.txt : 19990326 0000811671-99-000006.hdr.sgml : 19990326 ACCESSION NUMBER: 0000811671-99-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990325 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: 99572163 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, 1998 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. |X| 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 26, 1999 was approximately $175,748,981. The number of shares of Registrant's Common Stock outstanding on February 26, 1999 was 6,447,136. Documents Incorporated by Reference Portions of the Proxy Statement for the Registrant's 1999 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............................................. 1 Item 2. Properties........................................... 3 Item 3. Legal Proceedings.................................... 4 Item 4. Submission of Matters to a Vote of Security Holders.. 4 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.......................... 4 Item 6. Selected Financial Data.............................. 5 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 6 Item 7A. Quantitative and Qualitative Disclosure About Market Risk.................................... 6 Item 8. Financial Statements and Supplementary Data.......... 25 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 50 Part III Item 10. Directors and Executive Officers of the Registrant... 51 Item 11. Executive Compensation............................... 51 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................... 51 Item 13. Certain Relationships and Related Transactions....... 51 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................................... 52 Signatures...................................................... 53 PART I Item 1 - Business Sterling Financial Corporation Sterling Financial Corporation is a Pennsylvania business corporation, based in Lancaster, Pennsylvania. The corporation was organized on February 23, 1987 and became a bank holding company through the acquisition on June 30, 1987 of all the outstanding stock of The First National Bank of Lancaster County, now by change of name, Bank of Lancaster County, N.A. The corporation provides a wide variety of commercial banking and trust services through its wholly owned subsidiary, Bank of Lancaster County, N.A. 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 and is subject to regulation by the Federal Reserve Board and by the Pennsylvania Department of Banking. On July 21, 1998, Sterling Financial Corporation organized T & C Leasing, Inc., a Pennsylvania corporation. T & C Leasing, Inc. is a nationwide vehicle and equipment leasing company operating primarily in Pennsylvania. Its principal office is located at 1097 Commercial Avenue, East Petersburg, Pennsylvania. In addition, the corporation also owns all of the outstanding stock of a non-bank subsidiary, Sterling Mortgage Services, Inc., a mortgage service company formed by the corporation as a wholly owned subsidiary that presently is 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, we changed the name to The First National Bank of Lancaster County. At the time of the holding company reorganization, on June 30, 1987, the name was changed to its present name, Bank of Lancaster County, N.A. At December 31, 1998, the bank had total assets of $918,688,000 and total deposits of $784,422,000. The main office of the bank is located at 1 East Main Street, Strasburg, Pennsylvania. In addition to its main office, the bank had 29 branches in Lancaster County and 1 branch in Chester County, Pennsylvania in operation at December 31, 1998. 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, and a full spectrum of personal and commercial lending activities. The bank maintains correspondent relationships with major banks in New York City and Philadelphia. Through these correspondent relationships, the bank can offer a variety of collection and international services. With the installation of 3 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. In mid-year 1998, the Bank of Lancaster County began offering fixed annuities in addition to mutual funds as an alternative investment vehicle for appropriate customers. The annuities are available from 3 insurance companies, AIG, Jackson National and CIGNA, with BankMark Corporation, Morris Plains, New Jersey, providing marketing support services. As required, the bank obtained an insurance license from the Commonwealth of Pennsylvania. Management believes these services are important additions to our product line and make a statement about our progressive attitude in providing financial services for the future. The Comptroller of the Currency gave the bank permission to open a Trust Department 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 nearly $531 million at December 31, 1998. On January 31, 1983, the bank purchased Town & Country, Inc., which is 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 50 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 455,000 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 economy. One of the best agricultural areas in the nation, Lancaster 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. Lancaster County ended 1998 with the lowest unemployment rate in Pennsylvania. The unemployment rate of the county in December 1998 was 2.7% which was significantly lower than the statewide rate of 3.8% and national rate of 4.0%. Lancaster County's December unemployment rate of 2.7% tied for the lowest in the state with State College. 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 applications 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. Several of the financial institutions exceed $20 billion in assets while one is in excess of $235 billion in assets. The increased competition has resulted from a changing legal and regulatory climate, as well as, from the economic climate. As of December 31, 1998, the bank ranked, as measured by total deposits, as the second largest in market share within Lancaster County of the banks doing business in Lancaster County. The bank is not, however, the second largest bank in Lancaster County. As of December 31, 1998, the bank had total assets of over $918 million. 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 under the Bank Holding Company Act. 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 Bank Holding Company Act 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, 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 Bank Holding Company Act, 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 Bank Holding Company Act 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 Bank Holding Company Act 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 Bank Holding Company Act 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: making, acquiring, or servicing loans or other extensions of credit for its own account or for the account of others; 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; 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; 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; subject to limitations, leasing real or personal property or acting as agent, broker, or adviser in leasing such property in accordance with prescribed conditions; investing in corporations or projects designed primarily to promote community welfare; providing to others data processing services and data transmission services, data bases, and facilities, within certain limitations; 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; 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; providing courier services for certain financial documents; subject to limitations, providing management consulting advice to nonaffiliated bank and nonbank depository institutions; 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; performing appraisals of real estate and personal property; 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; providing certain securities brokerage services; subject to limitations, underwriting and dealing in government obligations and certain other instruments; subject to limitations, providing foreign exchange and transactional services; subject to limitations, acting as a futures commission merchant for nonaffiliated persons; subject to limitations, providing investment advice on financial futures and options to futures; subject to limitations, providing consumer financial counseling; subject to limitations, tax planning and preparation; providing check guaranty services; subject to limitations, operating a collection agency; and 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 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, 1998, qualify as "well capitalized" under these regulatory standards. FDIC Insurance The bank is subject to Federal Deposit Insurance Corporation assessments. The FDIC has adopted a risk-related premium assessment system for both the Bank Insurance Fund for banks and the Savings Association Insurance Fund 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 administered by the Federal Deposit Insurance Corporation 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 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 1 year would exceed the bank's net profits, as defined and interpreted by regulation, for the 2 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 availability of funds for lending and investment. Interstate Banking Legislation In September 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act was enacted. The Interstate Banking Act facilitates the interstate expansion and consolidation of banking organizations: 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; 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; 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; 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 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: eliminates the "reciprocity" requirement previously applicable to interstate commercial bank acquisitions by bank holding companies, authorizes interstate bank mergers and reciprocal interstate branching into Pennsylvania by interstate banks, and 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, 1998, there were 468 persons employed by the bank, of which 352 were full-time and 116 were part-time employees. These figures do not include employees of Town & Country, Inc. which employed 50 persons. Item 2 - Properties The bank, in addition to its main office, had, at December 31, 1998, a branch network of 30 offices and 2 off-site electronic MAC/ATM installations. All branches are located in Lancaster County with the exception of 1 office located in Chester County. Branches at 20 locations are occupied under leases and at 3 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 1 or more renewal options. During 1998, aggregate annual rentals for real estate paid did not exceed 3% 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. At December 31, 1998, approximately 24,000 square feet of this building was leased to outside parties. 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 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 39,281 square feet while nearly 13,719 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, 1998, 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 1998. 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 26, 1999, 6,447,136 shares were outstanding. As of February 26, 1999, the corporation had approximately 3,245 stockholders of record. There is no other class of stock authorized or outstanding. 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. These dividends are restated to give effect to the 5% stock dividend paid in June, 1998. 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 1998 Consolidated Financial Statements. The following table reflects the quarterly high and low prices of the corporation's common stock for the periods 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 June, 1998. Price Range Per Share Per Share 1998 High Low Dividend First Quarter $34.76 $29.76 $.20 Second Quarter 57.00 33.81 .21 Third Quarter 49.88 35.00 .21 Fourth Quarter 44.00 39.63 .21 Price Range Per Share Per Share 1997 High Low Dividend First Quarter $24.76 $24.29 $.18 Second Quarter 24.52 24.29 .18 Third Quarter 24.88 24.29 .23 Fourth Quarter 30.24 24.76 .19 The corporation maintains a Dividend Reinvestment and Stock Purchase Plan for eligible shareholders who elect to participate in the plan. You may obtain a copy of the prospectus for the plan by writing to: Bank of Lancaster County, N.A. Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard, Lancaster, Pennsylvania 17601-4133. As of December 31, 1998, the following firms made a market in the corporation's common stock: Hopper Soliday & Co. F.J. Morrissey & Co., Inc. Prudential Securities, Inc. 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 1998 1997 1996 1995 1994 Interest income............. $60,066 $ 56,499 $ 52,558 $ 48,850 $ 41,931 Interest expense............ 27,925 25,326 22,823 21,153 14,926 ------ ------ ------ ------ ------ Net interest income......... 32,141 31,173 29,735 27,697 27,005 Provision for loan losses... 896 1,129 580 534 1,081 ------ ------ ------ ------ ------ Net interest income after provision for loan losses.. 31,245 30,044 29,155 27,163 25,924 Other income................ 14,187 11,930 9,442 7,397 6,222 Other expenses.............. 30,188 28,082 25,639 22,527 21,232 ------ ------ ------ ------ ------ Income before income taxes.. 15,244 13,892 12,958 12,033 10,914 Applicable income taxes..... 3,643 3,491 3,147 3,039 2,637 ------ ------ ------ ------ ------ NET INCOME..................$ 11,601 $ 10,401 $ 9,811 $ 8,994 $ 8,277 ====== ====== ====== ====== ====== Per Common Share:* Net income - basic..........$ 1.80 $ 1.60 $ 1.50 $ 1.38 $ 1.29 Net Income - diluted........ 1.79 1.60 1.50 1.38 1.29 Cash dividends declared**... .83 .78 .70 .85 .55 Book value.................. 12.63 11.46 10.59 10.28 9.30 Book value (excluding SFAS 115)................. 11.90 11.01 10.34 10.01 9.23 Average shares outstanding - basic.................... 6,456,896 6,511,742 6,545,925 6,513,333 6,433,385 Average shares outstanding - diluted...................6,478,290 6,514,984 6,546,002 6,513,333 6,433,385 Ratios: Return on average assets.. 1.33% 1.32% 1.34% 1.36% 1.38% Return on average equity.. 15.63% 14.89% 15.01% 15.02% 15.47% Financial Condition at Year-End: Assets.................... $ 919,264 $ 845,488 $ 764,072 $ 711,154 $ 633,395 Loans (net of unearned)... 534,209 511,637 473,832 426,312 392,649 Deposits.................. 781,383 718,661 647,036 610,105 537,002 Stockholders' Equity...... 81,313 73,987 69,179 63,909 57,285 Average Assets............ 874,640 789,314 732,226 659,335 600,263
*Figures prior to 1998 were restated for stock dividends of 5% paid in 1998 and 5% paid in 1996, 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. Both have been restated to give effect to the 5% stock dividends paid in 1998 and 1996. 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., T & C Leasing, 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 1998 was $11,601,000, an increase of $1,200,000 or 11.5% over the $10,401,000 earned in 1997. The results of 1997 were $590,000 or 6% higher than the $9,811,000 reported in 1996. Basic earnings per share on net income amounted to $1.80, $1.60 and $1.50 for the years ended 1998, 1997 and 1996. Basic earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding, which were 6,456,896, 6,511,742 and 6,545,925 for 1998, 1997 and 1996. Diluted earnings per share on net income amounted to $1.79, $1.60 and $1.50 for the years ending 1998, 1997 and 1996. The weighted number of common shares and dilutive potential common stock used in calculating the diluted earnings per share were 6,478,290, 6,514,984 and 6,546,002 for 1998, 1997 and 1996. Figures prior to 1998 were restated to reflect a 5% stock dividend paid in June, 1998. Return on average total assets was 1.33% in 1998 compared to 1.32% in 1997 and 1.34% in 1996. Return on average stockholders' equity was 15.63%, in 1998 compared to 14.89% in 1997 and 15.01% in 1996. Growth in earning assets was the primary factor contributing to the increased earnings in 1998 and 1997. As of December 31, 1998, earning assets were approximately $810 million compared to $747 million at December 31, 1997, and $673 million at December 31, 1996. Average earning assets for 1998 increased over $74 million, to approximately $773 million, up 10.6% from the prior year. Similarly, in 1997, average earning assets increased over $51 million, up 7.9% from 1996. The current year increase, as well as the increase in 1997, was primarily due to increases in both loans and investments. Average interest bearing liabilities increased over $68 million or 10.9% in 1998, compared to an increase of nearly $48 million, or 8.3% in 1997. The increase in average earning assets exceeded the increase in average interest-bearing liabilities in both 1998 and 1997. Provision for loan losses decreased to $896,000 in 1998 from $1,129,000 in 1997. The provision in 1996 was $580,000. Non-interest income increased $2,257,000 in 1998, compared to an increase of $2,488,000 in 1997. Non-interest expenses increased $2,106,000 or 7.5% in 1998 compared to an increase of $2,443,000 or 9.5% in 1997 over 1996. 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 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 1998 and 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 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 ready. On December 31, 1998, approximately 71% of the corporation's systems were ready, with all systems expected to be ready by June 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 year to have a material effect on its financial position or results of operations. On February 10, 1999, the corporation entered into an agreement to acquire Northeast Bancorp, Inc., the parent company of First National Bank of North East, based in Maryland. Northeast Bancorp is an $82 million bank holding company for First National Bank of North East, with 4 branches located in Cecil County, Maryland. Under the terms of the agreement, Northeast Bancorp shareholders will receive 2 shares of Sterling Financial Corporation common stock for each share of Northeast Bancorp's common stock in a tax-free exchange. The purchase, which is subject to regulatory approval, will give Sterling Financial its first banking presence outside of Pennsylvania. The transaction is expected to be completed in mid 1999 and the acquisition is expected to be accounted for as a pooling of interests. First National Bank of North East will continue to operate as a separate bank after the acquisition. 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 1998, 1997 and 1996. 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 1998 and 1997 resulted from increased volumes in average earning assets. Average earning assets increased 10.6% in 1998 and 7.9% in 1997. These increases were primarily funded with interest bearing liabilities which increased 10.9% in 1998 and 8.3% in 1997.
Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity Interest Rates and Interest Differential-Tax Equivalent Yields (Unaudited) Years ended December 31, 1998 1997 1996 Average Annual Average Annual Average Annual Balance Interest Rate Balance Interest Rate Balance Interest Rate Assets Interest bearing deposits with banks..............$ 170 $ 10 5.70% $ 214 $ 13 5.90% $ 103 $ 6 5.72% Federal Funds sold......... 18,077 985 5.45% 13,110 730 5.57% 7,376 398 5.39% Investment securities: U.S. Treasury securities. 32,581 1,910 5.86% 28,330 1,679 5.93% 28,789 1,686 5.86% U.S. Government agencies. 37,607 2,318 6.16% 33,508 2,100 6.27% 33,895 2,192 6.47% State and Municipal securities.............. 68,457 5,180 7.57% 60,324 4,702 7.79% 57,966 4,615 7.96% Other securities......... 86,540 5,301 6.13% 66,207 4,131 6.24% 57,189 3,535 6.18% ------ ----- ----- ------- ------ ------ ------- ------ ------ Total investment securities225,185 14,709 6.53% 188,369 12,612 6.70% 177,839 12,028 6.76% Loans: Commercial...............292,666 25,750 8.80% 265,638 24,021 9.04% 245,018 22,276 9.09% Consumer.................131,084 11,615 8.86% 133,125 11,927 8.96% 130,044 11,401 8.77% Mortgages................ 51,278 4,012 7.82% 47,983 3,814 7.95% 41,046 3,330 8.11% Leases................... 55,004 5,463 9.93% 50,811 5,221 10.28% 46,420 4,865 10.48% ------ ------ ----- ------- ------- ------- ------- ------- ------ Total loans................530,032 46,840 8.84% 497,557 44,983 9.04% 462,528 41,872 9.05% ------- ------ ----- ------- ------- ------ ------- ------- ------ Total earning assets.......773,464 62,544 8.09% 699,250 58,338 8.34% 647,846 54,304 8.38% Allowance for loan losses.. (7,894) (7,863) (7,863) Cash and due from banks.... 27,625 32,409 30,238 Other non-earning assets... 81,445 65,518 62,005 ------- ------- ------- Total non-earning assets...101,176 90,064 84,380 ------- ------- ------ ------- ------- ------ ------- ------- ------ Total assets..............$874,640 $62,544 7.15% $789,314 $ 58,338 7.39% $732,226 $54,304 7.42% ======== ======= ====== ======== ======= ====== ======= ====== ===== Liabilities and Stockholders' Equity Deposits: Demand deposits Noninterest-bearing....$ 83,972 $ 0 0.00% $ 74,332 $ 0 0.00% $ 72,052 $ 0 0.00% Demand deposits Interest-bearing........289,062 7,289 2.52% 267,987 6,931 2.59% 257,622 6,726 2.61% Savings deposits......... 57,615 1,131 1.96% 58,149 1,188 2.04% 58,232 1,288 2.21% Time deposits............313,963 17,522 5.58% 262,681 14,805 5.64% 229,835 12,695 5.52% ------- ------ ----- ------- -------- ------ -------- ------- ------ Total deposits.............744,612 25,942 3.48% 663,149 22,924 3.46% 617,741 20,709 3.35% Other borrowed funds....... 31,549 1,983 6.29% 35,316 2,402 6.80% 30,578 2,114 6.91% Other liabilities.......... 20,684 18,894 17,122 Stockholders' equity....... 77,795 71,955 66,785 ------ ------ ----- ------- ------- ------ -------- ------- ------ Total liabilities and Stockholders' equity....$874,640 $ 27,925 3.19% $789,314 $ 25,326 3.21% $732,226 $22,823 3.12% ======== ======= ====== ======== ======== ====== ======== ======= ====== Net interest income/ Average total assets...... $ 34,619 3.96% $ 33,012 4.18% $31,481 4.30% Net interest income/ Average earning assets.... $ 34,619 4.48% $ 33,012 4.72% $31,481 4.86%
Net interest income on a fully taxable equivalent basis increased by $1,607,000 in 1998 compared to an increase of $1,531,000 in 1997. Table 2 indicates that of the increase in 1998, $2,507,000 was the result of increased volumes. This figure was reduced by $900,000 due to changes in interest rates. The increase in 1997 resulted in $1,788,000 from increased volumes and a reduction of $257,000 due to changes in interest rates. For the year 1998 compared to 1997, loan volumes, on average, increased over $32 million and income earned on loans increased $1,857,000, tax adjusted. This compares to a volume increase of over $35 million in 1997 over 1996 with an increase in income earned on loans amounting to $3,111,000. As a result of increased volumes in 1998, nearly $3 million contributed to the increase in income on loans. Rates charged on loans decreased in 1998. The decrease in rates reduced interest $1,079,000 in income earned on loans. Increased volume in loans in 1997 contributed nearly $3.2 million to the increase in income, while a decrease in interest rates reduced income earned on loans by $60,000. Total investment securities, on average, increased over $36.8 million in 1998 over 1997 compared to an increase of over $10.5 million in 1997 over 1996. Increased volume in both periods was responsible for the increase in interest income on securities. Table 2 indicates that, of the increase in interest income in 1998, $2,465,000 was the result of increased volume while a decrease in interest rates caused a $368,000 reduction. Increased volume in securities in 1997 contributed nearly $712,000 to the increase while a decrease in rates caused a $128,000 reduction. Interest income on federal funds sold contributed $255,000 to the increase in net income in 1998 over 1997. Increased volumes generated an increase of $277,000 which was reduced by $22,000 due to a decrease in rates. Interest bearing deposits, on average, grew over $71.8 million in 1998. The major portion of the increase in interest expense on deposits was generated on time deposits, as a result of increased volumes. Although there were increased volumes on the other deposits, with the exception of savings deposits, the decrease in rates paid on these deposits reduced the total interest expense by $406,000. Interest expense on interest bearing deposits increased over $2.2 million in 1997 over 1996. Increased volumes generated an increase of $2,083,000 while an increase in income of $132,000 resulted from increased rates. Interest expense on borrowed funds decreased $419,000 in 1998 over 1997 compared to an increase of $288,000 in 1997 over 1996. A decrease in volume as well as a decrease in interest rates generated the decrease in 1997. The major portion of the increase in 1997 over 1996 was a result of increased volume. Table 2 - Analysis of Changes in Net Interest Income The rate-volume variance analysis set forth in the table below, which is computed on a tax equivalent basis, compares changes in net interest income for the periods indicated by their rate and volume components.
1998 Versus 1997 1997 Versus 1996 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Volume Rate Total Volume Rate Total Interest Income Interest on deposits with banks...........$ (3) 0 $ (3) $ 6 $ 1 $ 7 Interest on federal funds sold........... 277 (22) 255 309 23 332 Interest on investment securities........... 2,465 (368) 2,097 712 (128) 584 Interest and fees on loans................ 2,936 (1,079) 1,857 3,171 (60) 3,111 ------- -------- ------ ------ ------- ------- Total interest income...$ 5,675 $ (1,469) $ 4,206 $ 4,198 $ (164) $ 4,034 ------- -------- ------ ------ ------- ------- Interest Expense Interest on interest-bearing demand deposits......$ 545 (187) 358 $ 271 $ (66) $ 205 Interest on savings deposits...... (11) (46) (57) (2) (97) (99) Interest on time deposits......... 2,890 (173) 2,717 1,814 295 2,109 Interest on borrowed funds........ (256) (163) (419) 327 (39) 288 ------- -------- ------ ------- ------- ------- Total interest expense.. $ 3,168 $ (569) $ 2,599 $ 2,410 $ 93 $ 2,503 ------- -------- ------ ------- ------- ------- Net interest income..... $ 2,507 $ (900) $ 1,607 $ 1,788 $ (257) $ 1,531 ======= ======== ======= ======= ======= =======
Provision for Loan Losses The provision for loan losses charged against earnings was $896,000 in 1998 compared to $1,129,000 in 1997 and $580,000 in 1996. 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 $1,008,000 in 1998, $1,199,000 in 1997 and $560,000 in 1996. Gross charge-offs for 1998 were $1,269,000, a 15% decline from the $1,502,000 reported in 1997. The decline in the provision for loan losses, gross and net charge-offs was a result of improvement in credit quality, particularly in the consumer portfolio. Management instituted certain underwriting criteria during 1997 and 1998 that had a positive effect on the quality of the consumer portfolio. Personal bankruptcies continue to play a significant role in the losses. Management expects further improvement in 1999 in the consumer portfolio. Loan quality remains high in the commercial loan portfolio. The net losses to average loans and leases in 1998 were in line with the bank's peers. The allowance for loan losses as a percent of loans at December 31, 1997 was 1.51%, while at December 31, 1998 it was 1.43%. Non-Interest Income
Table 3 - Non-Interest Income 1998/1997 1997/1996 Increase Increase (Decrease) (Decrease) 1998 Amount % 1997 Amount % 1996 Income from fiduciary activities.$ 1,879 $ 366 24.2% $ 1,513 $ 374 32.8% $1,139 Service charges on deposit accounts....................... 2,908 (1) ---- 2,909 424 17.1% 2,485 Other service charges, commissions and fees....................... 1,729 273 18.8% 1,456 512 54.2% 944 Mortgage banking income........... 1,811 506 38.8% 1,305 113 9.5% 1,192 Income from sale of assets........ 1,338 1,338 ---- none none ---- none Other operating income............ 4,522 (17) (.4%) 4,539 1,015 28.8% 3,524 Investment securities gains or (losses)....................... none (208)(100.0%) 208 50 31.7% 158 ------ ------ ------ ------ ------ ------ ------ Total............................$14,187 $2,257 18.9% $11,930 $ 2,488 26.4% $9,442 ======= ======= ====== ====== ====== ====== ======
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. Reflected in non-interest income is the sale of the bank's credit card portfolio. Income from fiduciary activities in the amount of $1,879,000 in 1998 was $366,000 or 24.2% greater than the $1,513,000 recorded in 1997. Income in 1997 was $374,000 or 32.8% greater than the $1,139,000 recorded in 1996. Fees increased primarily due to increased transaction volumes. Service charges on deposit accounts decreased to $2,908,000, a decrease of $1,000 over the $2,909,000 reported for 1997. Service charges on deposit accounts in 1997 was $424,000 more than the $2,485,000 reported for 1996. General increases in service charges on various accounts, as well as, transaction volume produced the increase in 1997 over 1996. Management continuously monitors the fee structure and makes changes where appropriate. Other service charges, commissions and fees were $1,729,000 in 1998 compared to $1,456,000 in 1997 and $944,000 in 1996. The increase in 1998 over 1997 was $273,000 or 18.8%. The significant increase in 1997 is attributable to the introduction of ATM charges. Other contributors to the increase in 1998 as well as 1997 were the fees received on mutual funds transactions and fees on the bank's debit card. Income from mortgage banking activities increased to $1,811,000 in 1998 from $1,305,000 in 1997. Mortgages sold in the secondary market in 1998 increased to approximately $88.9 million from $40.9 million in 1997. All mortgages sold were originated by the bank's mortgage operation and branch network. No mortgages were acquired from third parties, nor have servicing rights been purchased from third parties. A low interest rate environment in 1998 and 1997, as well as an expansion in mortgage products and services resulted in the increase in volume in 1998 and 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 totaled $221 million as of December 31, 1998 compared to $175 million on December 31, 1997. Another component of the mortgage banking increase in income was a result of the implementation of FASB 122, subsequently replaced by FASB 125, which required that mortgage servicing rights be recognized for their economic value, beginning January 1, 1996. Mortgage servicing has an economic value because of future servicing income to be received over the life of the mortgage. The value of servicing rights is available through third party purchasers in private transactions. The bank has developed a business relationship with an independent consultant to determine the values of mortgage servicing rights. In 1998, the amount recognized to income was $839,880. 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, 1998 and 1997 amounted to $1,382,000 and $892,000. The market value of all mortgage servicing assets is also determined by the independent consultant. The market valuation, or impairment, of all the mortgage assets was $41,000 as of December 31, 1998. This impairment was charged against earnings and is carried as a valuaion allowance for mortgage servicing assets. Other operating income decreased $17,000 to $4,522,000 in 1998 from $4,539,000 in 1997. Other income was $3,524,000 in 1996. Income generated from operating leases was a major contributor to the increase in 1997. 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 in 1997. Income on operating leases increased nearly $415,000 in 1998 over 1997. The major contributor to the increase in total other operating income was a one-time earnings gain of $1,338,507 as a result of the sale of the bank's credit card portfolio in the second quarter of 1998. Investment securities transaction reflect a gain of $208,000 in 1997 compared to $158,000 in 1996 on securities sold from the available-for-sale securities. There were no securities sold in 1998. 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 $2,257,000 in 1998 over 1997 compared to an increase of $2,448,000 in 1997 over 1996. Non-Interest Expense
Table 4 - Non-Interest Expense 1998/1997 1997/1996 Increase Increase (Decrease) (Decrease) 1998 Amount % 1997 Amount % 1996 Salaries and employee benefits...$17,638 $ 1,240 7.6% $16,398 $ 1,371 9.1% $15,027 Net occupancy expense............. 2,088 (202) (8.8%) 2,290 181 8.6% 2,109 Furniture & equipment expense..... 2,755 275 11.1% 2,480 436 21.3% 2,044 FDIC insurance assessment......... 87 6 7.4% 81 79 --- 2 Other operating expense........... 7,620 787 11.5% 6,833 376 5.8% 6,457 ----- ------ ----- ------ ------ ----- ------- Total............................$30,188 $ 2,106 7.5% $28,082 $2,443 9.5% $25,639 ======= ======= ===== ======= ====== ===== =======
Non-interest expense consists of salaries and employee benefits, net occupancy expense, furniture and equipment expense and other operating expenses. Total operating expenses for 1998 were $30,188,000 compared to $28,082,000 in 1997. This represents an increase of $2,106,000 or 7.5%. This compares to an increase of $2,443,000 or 9.5% in 1997. The largest component of the corporation's other operating expense is salaries and employee benefits which increased to $17,638,000 in 1998 or $1,240,000 or 7.6% over the $16,398,000 reported in 1997. In 1997, expenses increased $1,371,000 or 9.1% over the $15,027,000 reported in 1996. The increase in 1997 was primarily due to increases in staff as well as increases in wages and the increased cost of employee benefits. The increase in 1998 was related more to increases in wages and the increased cost of employee benefits. The full-time equivalent employees in 1998 rose to 436 from 431 in 1997. The full-time equivalent in 1996 was 400. Occupancy expenses decreased $202,000 or 8.8% to $2,088,000 in 1998 from $2,290,000 in 1997. By comparison, during 1997, there was an increase of $181,000 or 8.6%. 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, PA 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 along with expenses relating to occupancy such as real estate taxes, insurance, utilities, maintenance and janitor services contributed to the increase in occupancy expense in 1997. One new branch facility was opened in 1997 as well as 1998. At December 31, 1998, approximately 24,000 square feet of the building at 1097 Commercial Avenue was leased to outside parties. Furniture and equipment expenses were $2,755,000 in 1998 and $2,480,000 in 1997. This represents an increase of $275.000 or 11.1%. The increase in 1997 over 1996 was $436,000 or 21.3%. Reflected in this increase is a $159,000 increase in depreciation expense in 1998. Service contracts on equipment also contributed to the increase in 1998. The FDIC insurance assessment reflects an increase of $6,000 in 1998 over 1997. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund administered by the Federal Deposit Insurance Corporation 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 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 of $79,000 in the 1997 FDIC assessment over the 1996 assessment. Other operating expenses increased $787,000 or 11.5% in 1998 compared to an increase of $376,000 in 1997. The 1998 increase is consistent with rising costs associated with acquiring services covered 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 1998 were increases in Pennsylvania Shares Tax, professional services, MAC fees, telephone expense, stationery and supplies, other real estate expenses and losses associated with a limited partnership. Income Taxes Income tax expense was $3,643,000 in 1998 compared to $3,491,000 in 1997 and $3,147,000 in 1996. These increases were a result of higher levels of taxable income and increased earnings each year. The corporation's effective tax rate was 23.9% in 1998 compared with 25.1% in 1997 and 24.3% in 1996. Use of tax credits in 1998 and an increase in tax exempt interest resulted in a lower effective tax rate than 1997 even though income taxes increased. Additional information related to income taxation is presented in the Notes to Consolidated Financial Statements. Financial Condition Investment Portfolio Table 5 - Investment Securities at Cost The following table shows the amortized cost of the held-to-maturity securities owned by the corporation as of the dates indicated. Investment securities are stated at cost adjusted for amortization of premiums and accretion of discounts. December 31, 1998 1997 1996 U.S. Treasury securities................$ 2,508 $ 6,537 $ 12,888 Obligations of other U.S. Government agencies and corporations............. 2,208 9,696 11,607 Obligations of states and political subdivisions.......................... 44,465 45,816 37,584 Mortgage-backed securities.............. 1,219 1,575 2,076 Other bonds, notes and debentures....... 10,808 18,574 27,269 --------- --------- --------- Subtotal................................ 61,208 82,198 91,424 Non-marketable securities............... 3,201 2,957 2,798 --------- --------- --------- Total...................................$ 64,409 $ 85,155 $ 94,222 ========= ========= ========= The following table shows the amortized cost and fair value of the available-for-sale securities owned as of the dates indicated.
December 31, 1998 1997 1996 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- --------- -------- -------- ----------- -------- U.S. Treasury securities............$ 29,265 $ 29,930 $ 24,435 $ 24,625 $ 13,611 $ 13,598 Obligations of other U.S. Government agencies and corporations.......... 37,713 38,285 26,821 27,008 18,800 18,718 Obligations of states and political subdivisions....................... 36,938 37,986 21,840 22,571 20,488 20,819 Mortgage-backed securities........... 461 461 832 829 1,125 1,117 Other bonds, notes and debentures.... 66,215 67,312 42,955 43,178 22,752 22,771 -------- --------- -------- -------- --------- -------- Subtotal............................. 170,592 173,974 116,883 118,211 76,776 77,023 Equity securities.................... 174 3,904 174 3,263 171 2,352 -------- --------- -------- -------- --------- -------- Total................................$170,766 $ 177,878 $117,057 $121,474 $ 76,947 $ 79,375 ======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields) The following table shows the maturities of held-to-maturity debt securities at amortized cost as of December 31, 1998 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....$ 2,005 6.03% $ 503 5.84% $ --- ---% $ --- ---% $ 2,508 5.99% Obligations of other U.S. Government agencies and corporations.. 252 6.69% 1,956 6.08% --- ---% --- ---% 2,208 6.15% Obligations of states and political sub- divisions..... 2,499 5.41% 11,738 5.23% 22,943 5.12% 7,285 4.90% 44,465 5.13% Mortgage-backed securities.... 260 8.54% 646 8.52% 200 8.33% 113 7.41% 1,219 8.39% Other bonds, notes and debentures.... 5,047 6.61% 5,761 5.82% --- ---% --- ---% 10,808 6.19% ------- ----- ------- ------ -------- ----- ------- ----- ------- ----- $10,063 6.25% $20,604 5.59% $ 23,143 5.15% $ 7,398 4.94% $61,208 5.45% ======= ===== ======= ====== ======== ===== ======= ===== ======= =====
The following table shows the maturities of available-for-sale debt securities at amortized cost as of December 31, 1998 and approximate weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru 1 Year and less 5 Years 10 Years Over 10 Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury securities....$ 7,568 4.91% $ 21,697 5.82%$ --- ---% $ --- ---% $ 29,265 5.58% Obligations of other U.S. Government agencies and corporations.. 3,424 6.37% 23,325 6.05% 10,964 6.17% --- ---% 37,713 6.11% Obligations of states and political sub- divisions..... 1,142 5.70% 9,127 5.30% 15,134 5.12% 11,535 4.57% 36,938 5.01% Mortgage-backed securities.... 189 5.65% 272 5.65% --- ---% --- ---% 461 5.65% Other bonds, notes and debentures.... 11,885 6.48% 54,330 6.15% --- ---% --- ---% 66,215 6.21% ------- ------ ------- ------ ------- ----- ------- ----- -------- ------ $24,208 5.93% $108,751 5.99% $26,098 5.56% $11,535 4.57% $170,592 5.82% ======= ====== ======= ====== ======= ===== ======= ===== ======== ======
Loans Table 7 - Loan Portfolio The following table sets forth the composition of the corporation's loan portfolio as of the dates indicated:
December 31, 1998 1997 1996 1995 1994 Commercial, financial and agricultural..............$ 290,619 $ 271,605 $ 239,701 $ 228,058 $ 208,918 Real estate-construction... 6,053 6,045 5,608 6,378 8,542 Real estate-mortgage....... 48,381 49,438 45,373 33,124 30,505 Consumer................... 131,939 132,778 136,989 116,210 106,921 Lease financing (net of unearned income)......... 57,327 52,207 47,346 43,904 38,771 ---------- ---------- ---------- ---------- --------- Total loans.................$ 534,319 $ 512,073 $ 475,017 $ 427,674 $ 393,657 ========== ========== ========== ========== =========
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, 1998:
After one Within but within After one year five years five years Total Commercial, financial and agricultural....................$ 104,041 $ 146,505 $ 40,073 $ 290,619 Real estate-construction........ 5,111 289 653 6,053 --------- --------- -------- --------- $ 109,152 $ 146,794 $ 40,726 $ 296,672 ========= ========= ======== =========
Loans due after one year totaling $107,980,000 have variable interest rates. The remaining $79,540,000 in loans have fixed rates. Table 9 - Nonaccrual, Past Due and Restructured Loans The following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans:
December 31, 1998 1997 1996 1995 1994 Nonaccrual loans...........$ 812 $ 1,314 $ 1,193 $ 1,010 $ 2,127 Accruing loans, past due 90 days or more......... 613 787 737 330 1,127 Restructured loans........ 1,993 2,105 none none none ------- -------- -------- -------- -------- Total non-performing loans. 3,418 4,206 1,930 1,340 3,254 Other real estate owned.... 180 341 81 252 759 ------- -------- -------- -------- -------- Total non-performing assets $ 3,598 $ 4,547 $ 2,011 $ 1,592 $ 4,013 ======= ======== ======= ======== ======== Ratios: Non-performing loans to total loans.......... .64% .82% .41% .31% .83% Non-performing assets to total loans and other real estate owned.... .67% .89% .42% .37% 1.02% Non-performing assets to total assets.......... .39% .54% .26% .22% .63% Allowance for loan losses to non-performing loans.. 222.9% 183.8% 404.1% 580.6% 234.8%
The economic conditions within the corporation's market area remained healthy in 1998. This is reflected in the unemployment rate for Lancaster County, which is the bank's primary market area. The jobless rate during 1998 hovered close to 3%, staying the lowest or second lowest in the state. The county's unemployment rate has not exceeded 3% since November of 1997. 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 average national and state average unemployment figures of 4.4% and 4.6% respectively. The unemployment rate for 1999 is expected to mirror that of 1998 with little movement in either direction. Lancaster's labor market is expected to remain one of the tightest in the state. The strength in the employment sector in Lancaster County was also seen at the national level. The U.S. unemployment rate stood at 4.5% in December 1998 compared to 4.7% in December 1997. Economists aren't looking for much change this year in the health of labor markets. Indications are that the job market remains robust. The bank's loan delinquency as a percent of loans outstanding declined during 1998. At December 31, 1998, this rate stood at .44% compared to .83% and .96% for December 31, 1997 and December 31, 1996. The average delinquency rate for 1998 of .56% declined from .99% in 1997. The decline in the average delinquency rate was primarily attributed to improvement in the consumer portfolio. The bank, however, is not immune to the significant role that bankruptcies have on losses. During 1998, the bank's credit card portfolio was sold, which, is believed, will have a positive effect on delinquencies and losses. While management believes delinquency rates could rise during 1999, expectations are that they will not approach the national delinquency rates. The .44% remains well below the accepted level established by management and that of its peers. During the year, total nonaccrual loans and other real estate owned declined to $992,000 from $1,655,000 at December 31, 1997. Total non-performing assets declined to $3,598,000 compared to $4,547,000 for December 31, 1997 representing a 21% decrease. The restructured loans are a series of loans to one borrower involving $1,993,000. 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 such 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 continues. The bank's reserve coverage increased during the year as reserves as a percent of non-performing loans increased to 223% compared to 184% for December 31, 1997. A portion of the bank's loan portfolio consists of loans to agricultural-related borrowers. These loans consist of loans 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 latter part of 1998, milk prices increased significantly. While the bank continues to pursue quality loans to the dairy industry and the agricultural community in general, it should be noted that these loans are susceptible to a variety of external factors such as adverse climate, economic conditions, etc., in addition to factors common to other industries. The residential real estate market in 1998 for Lancaster County enjoyed a strong year. The county recorded a record year for sales of existing homes. Residential construction contracts, however, increased at a much slower pace, suggesting that the building boom in recent years may be over. Reasonably low interest rates, a continuing strong economy, and minimal inflation accounted for the sales performance. Non-residential contracts broke even with 1997, which had experienced a significant increase over 1996. Most of the bank's business activity is with customers located within the bank's defined market area. Since the majority of the bank's real estate loans are located within this area, a substantial portion of the debtor's ability to honor their obligations and increases and decreases in the market value of the real estate collateralizing such loans may be affected by the level of economic activity in the market area. The bank recognizes that the potential Year 2000 problems, relating to computers, hardware, microchips, software and additional software applications utilized by the bank's borrowers in their businesses, or by their suppliers, vendors and their customers, may result in unexpected and material adverse changes in borrowers' businesses or financial condition. In order to reduce the potential risk to the bank from its borrowers, the bank has substantially completed an assessment of the Year 2000 risk posed by its borrowers. Based on this assessment, management does not believe that the Year 2000 risks from its borrowers pose a material risk or threat to the safety and soundness of the bank. Management believes that the provision for loan losses is adequate to meet the present and forseeable risk characteristics of the loan portfolio including the potential Year 2000 risks posed by its borrowers. 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. Loans on a nonaccrual status amounted to $812,000 at December 31, 1998 compared to $1,314,000 at December 31, 1997. If interest income had been recorded on all such loans for the years indicated, such interest income would been been increased by approximately $85,667 and $152,755 for 1998 and 1997. Interest income recorded on nonaccrual loans amounted to $561 and $20,020 for 1998 and 1997. Potential problem loans are loans which are included as performing loans, but for which possible credit problems of the borrower causes management to have doubts as to the ability of such borrower to comply with present repayment terms and which may eventually result in disclosure as a non-performing loan. At December 31, 1998, there were no such loans that had to be disclosed 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 impairement 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: 1998 1997 Gross impaired loans which have allowances..........$2,805 $3,419 Less: Related allowances for loan losses......... (140) (410) ------ ------ Net impaired loans..................................$2,665 $3,009 ====== ====== The decline in impaired loans is primarily attributed to a reduction in non-accrual loans. A large portion of the impaired loans is attributed to the restructure of a series of loans to one borrower. A loan is categorized as restructured if the original interest rate on such loan, repayment terms, or both are restructured due to a deterioration in the financial condition of the borrower that otherwise would not have been granted. In the case of the above referenced loans, the bank is fully secured with real estate. The loans are current and have performed in accordance with the contractural term, both prior to and after the restructure. Accrual of interest on these loans continues. At December 31, 1998, there were no concentrations exceeding 10% of loans. A concentration is defined as amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by changes in economic or other conditions. There were no foreign loans outstanding at December 31, 1998. Allowance for Loan Losses Table 10 - Summary of Loan Loss Experience Years ended December 31, 1998 1997 1996 1995 1994 Allowance for Loan Losses: Beginning balance.............$ 7,730 $ 7,800 $ 7,780 $ 7,640 $ 7,180 Loans charged off during year: Commercial, financial and agricultural.............. 447 43 37 50 157 Real estate mortgage........ 268 419 184 252 235 Consumer.................... 500 919 458 360 360 Lease financing............. 54 121 24 14 10 ------- ------- ------- ------- ------- Total charge-offs........... 1,269 1,502 703 676 762 ------- ------- ------- ------- ------- Recoveries: Commercial, financial and agricultural.............. 34 4 5 117 61 Real estate mortgage........ 72 112 42 72 2 Consumer.................... 127 122 88 91 77 Lease financing............. 28 65 8 2 1 ------- ------- ------- ------- ------- Total recoveries............ 261 303 143 282 141 ------- ------- ------- ------- ------- Net loans charged off......... 1,008 1,199 560 394 621 Additions charged to operations.................. 896 1,129 580 534 1,081 ------- ------- ------- ------- ------- Balance at end of year........$ 7,618 $ 7,730 $ 7,800 $ 7,780 $ 7,640 ======= ======= ======= ======= ======= Ratio of net loans charged off to average loans outstanding................. .19% .24% .12% .10% .17% Ratio of net loans charged off to loans at end of year. .19% .23% .12% .09% .16% Net loans charged off to allowance for loan losses.. 13.23% 15.51% 7.18% 5.06% 8.13% Net loans charged off to provision for loan losses.. 112.50% 106.20% 96.55% 73.78% 57.45% Allowance for loan losses as a percent of average loans... 1.44% 1.55% 1.69% 1.91% 2.04% Allowance for loan losses as a percent of loans at end of year................ 1.43% 1.51% 1.65% 1.82% 1.95% Allowance for loan losses as a percent of non-performing loans....... 222.9% 183.8% 404.1% 580.6% 234.8% The corporation experienced a 15% decline in gross charge-offs, while net charge-offs declined 16%. The decline in charge offs was a result of improvement in the consumer loan portfolios. During 1998, the bank sold its credit card portfolio, which had a positive effect on losses. Personal bankruptcies continue to play a significant role in the losses. Management instituted certain underwriting criteria in 1997 and 1998 which is believed to also have had a positive effect on losses. For the year, the corporation recorded net charge-offs of $1,008,000 or .19% of average loans outstanding compared to $1,199,000 or .24% of average loans in 1997 and $560,000 or .12% of average loans in 1996. The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present risk and inherent risk in the loan portfolio, including the potential Year 2000 risks posed by its borrowers. Management performs a quarterly assessment of the loan portfolio to determine the appropriate level of the allowance. The factors considered in this evaluation include, but are not limited to, estimated loan losses identified through a loan review process, general economic conditions, deterioration in pledged collateral, past loan experiences and trends in delinquencies and non-accruals. Managment uses available information to determine the appropriate level of the allowance for possible loan losses. However, the allowance may be affected in the future based upon changes in the economic conditions and other factors. While there can be no assurance that material amounts of additional loan loss provisions will not be required in the future, management believes that, based upon information presently available, the amount of the allowance for possible loan losses is adequate. Management has not targeted any specific coverage ratio of nonperforming loans by the allowance for loan losses and the coverage ratio may fluctuate based on loans placed into or removed from nonperforming status. Table 11 - Allocation of Allowance for Loan Losses December 31, 1998 1997 Commercial, financial and agricultural..........$ 4,705 $ 3,529 Real estate - mortgage.......................... 107 25 Consumer........................................ 660 910 Leases.......................................... 527 599 Unallocated..................................... 1,619 2,667 ------- ------- Total...........................................$ 7,618 $ 7,730 ======= ======= Deposits Table 12 - Average Deposit Balances and Rates Paid
The average amounts of deposits and rates paid for the years indicated are summarized below: 1998 1997 1996 Amount Rate Amount Rate Amount Rate Demand deposits.....................$ 83,972 --- $ 74,332 --- $ 72,052 --- Interest bearing demand deposits.... 289,062 2.52% 267,987 2.59% 257,622 2.61% Savings deposits.................... 57,615 1.96% 58,149 2.04% 58,232 2.21% Time deposits....................... 313,963 5.58% 262,681 5.64% 229,835 5.52% -------- ----- -------- ----- -------- ----- $744,612 3.48% $663,149 3.46% $617,741 3.35% ======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity The maturities of time deposits of $100,000 or more are summarized below: December 31, 1998 1997 Three months or less..........................$ 7,352 $ 11,058 Over three thru six months.................... 7,262 6,541 Over six thru twelve months................... 9,676 9,209 Over twelve months............................ 8,469 10,357 ------- ------- Total.........................................$ 32,759 $ 37,165 ======= ======= Capital Total stockholders' equity increased over $7.3 million or 9.9% in 1998 to $81,313,000. Total stockholders' equity at December 31, 1997 in the amount of $73,987,000 represented an increase of over $4.8 million or 7% over the $69,179,000 reported at December 31, 1996. A major portion of the increase for 1998 was the difference between net income of $11.6 million less dividends declared of approximately $5.4 million. Adding to the increase in stockholders' equity was an increase in net unrealized gains on available-for-sale securities, accumulated other comprehensive income, in the amount of $1.8 million. Treasury stock purchased during the period was $2.5 million. The corporation issued $1.8 million in treasury shares. The major portion of the increase in 1997 was due to net income of $10.4 million less dividends declared of approximately $5.1 million. Adding to the increase in 1997 was an increase in accumulated other comprehensive income in the amount of $1.3 million. These increases were offset by the repurchase of outstanding stock throughout the year. 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. During 1998, the Board of Directors authorized the repurchase of up to 250,000 shares of the outstanding common stock. During 1998, the Corporation repurchased 70,266 shares for $2.5 million. The Corporation used, during 1998, 79,332 shares for a portion of the common stock issued for a 5% stock dividend, 36,448 shares for the Dividend Reinvestment Plan, 7,414 shares for the Employee Stock Plan, 2,000 shares for the Directors' Compensation Plan and 1,400 shares for stock options exercised. Effective December 1998, the Board of Directors of the corporation terminated the common stock repurchase program that was approved in 1998. Federal regulatory authorities promulgate risk-based capital guidelines 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 holding gains and losses 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, 1998, 1997 and 1996 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, 1998 was 9.73% and the total risk-based capital ratio was 10.94%, which exceeds the minimum capital guidelines. Tier 1 capital ratio was 10.23% and the total risk-based capital ratio was 11.38% at December 31, 1997 while Tier 1 capital ratio was 10.68% and the total risk-based capital ratio was 11.93% at December 31, 1996. At December 31, 1998, 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: 1998 1997 1996 Return on average assets...................... 1.33% 1.32% 1.34% Return on average equity...................... 15.63% 14.89% 15.01% Dividend payout ratio......................... 46.17% 48.79% 45.95% Average total equity to average assets........ 8.54% 8.89% 8.95% Total equity to assets at year end............ 8.40% 8.45% 8.87% Primary capital ratio......................... 9.16% 9.28% 9.80% Tier 1 risk-based capital ratio............... 9.73% 10.23% 10.68% Total risk-based capital ratio................ 10.94% 11.38% 11.93%
Liquidity and Interest Rate Sensitivity 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 amounted to $34,221,000 at December 31, 1998 compared to $34,585,000 at December 31, 1997. Interest bearing deposits with banks were $557,000 at December 31, 1998 compared to $15,000 at December 31, 1997. Federal funds sold totaled $26,850,000 at December 31, 1998 compared to $28,150,000 at December 31, 1997. Securities available-for-sale as of December 31, 1998 were $177,878,000 compared to $121,474,000 as of December 31, 1997. 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 $88.9 million in 1998 and $40.9 million in 1997, 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 of $87 million during the next 12 months. 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, 1998 was $17,300,000 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 changes in levels of deposits and in the demand for loans. Management believes that these mentioned sources of funds provide sufficient liquidity. YEAR 2000 The following section contains forward-looking statements which involve risks and uncertainties. The actual impact on the corporation of the Year 2000 issue could materially differ from that which is anticipated in the forward-looking statements as a result of certain factors identified below. The Year 2000 issue ("Y2K") is the result of computer programs being written using two digits rather than four to define the applicable year. It is anticipated that most systems may recognize a date using "00" as the year "1900" rather than "2000". This could result in system failures, miscalculations, and disruptions of normal business operations including, among other things, a temporary inability to process transactions, send statements, or engage in similar day to day business activities. At Sterling Financial Corporation, we recognize the Year 2000 problem is more than just a systems issue. It is a business issue, and we are dealing with it in that manner. Corporation's State of Readiness Sterling Financial Corporation is committed to ensuring that the corporation's daily operations suffer little or no impact from the century date change. The corporation has applied due diligence throughout the Y2K process, following the guidelines contained in the series of Federal Financial Institutions Examination Council's Interagency Guidelines. These guidelines include the following five phases: awareness, assessment, renovation or remediation, testing or validation and implementation. Management has initiated an enterprise-wide program to prepare the corporation's computer systems and applications for the Year 2000. The corporation has developed a comprehensive inventory of all mainframe and PC based applications, third-party relationships, environmental (bank vaults, VCRs, security systems, etc.) and proprietary programs. This assessment identified 224 systems or processes and 448 proprietary programs, which could be impacted by the century date change. The 448 proprietary programs consist of management reporting, interface programs, and bridge programs. As of December 31, 1998, the corporation has remediated 324 or 72% of these programs. In January of 1997, the corporation began converting its computer systems to be Year 2000 ready. As of December 31, 1998, approximately 71% of the corporation's systems were ready, with all systems expected to be ready by June 1999. Vendor Type Total# # Y2K Ready % Y2K Ready PC Based Applications 125 81 65% Mainframe Applications 49 36 73% Third-Party Relationships 25 12 48% Environmental 25 24 96% Proprietary Programs 448 324 72% Total 672 477 71% The corporation has acquired its core mission-critical systems from a highly regarded third-party vendor. Thus, even though the corporation does not have direct control over the renovation process, it is monitoring the progress of its third-party vendors to assess the status of their Y2K readiness efforts. However, because most computer systems are, by their very nature, independent, it is possible that noncompliant third-party computers could impact the corporation's computer systems. The corporation could be adversely affected by the Y2K problem if it or unrelated parties fail to successfully address the problem. Steps have been taken to communicate with the unrelated parties with whom it deals to coordinate Year 2000 readiness. Additionally, we are dependent on external suppliers, such as, wire transfer systems, telephone systems, electric companies, and other utility companies for continuation of service. The corporation is also assessing the impact, if any, the century date change may have on its credit risk. The corporation is contacting its large commercial loan customers concerning their level of readiness for Year 2000. Formal communications have been initiated with all of its vendors and large commercial customers to determine the extent to which the corporation is vulnerable to those third-parties' failure to remedy their own Year 2000 issues. The Y2K Project Manager has available each vendors' Y2K readiness efforts which includes their remediation plan, renovation approach, testing methodologies and target dates. A comprehensive testing plan has been developed. The corporation has prioritized all mainframe and PC based applications, third-party relationships, environmental and proprietary programs to be tested. Separate environments for testing have been defined and established. Beginning in the fourth quarter of 1998, the corporation performed a variety of testing to include limited unit testing (aging dates forward on files), system testing (advancing the computer system date forward) and combined system integration (running applications dependent on each other together with the data files aged and computer system date advanced forward) and acceptance testing (user review and validation). Test scripts have been written which define the type of testing to be performed, the resources necessary to perform the test, the transactions or files to be processed, and expected results for each type of testing performed. Additionally, a testing validation, certification and reporting process has been established. Costs of Year 2000 As of December 31, 1998, $245,532 has been expended as Year 2000 costs. Management expects to spend a total of $329,927 for the entire project. The estimated Year 2000 project costs include the costs and time associated with the impact of third-parties' Year 2000 issues, and are based on presently available information. The total cost of the project is being funded through operating cash flows. 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. Accordingly, the corporation does not expect the amounts required to be expensed over the next 12 months to have a material effect on the financial position or results of operations. However, if readiness is not achieved in a timely manner by the corporation or any of its significant related third-parties, be it a supplier of services or customer, the Y2K issue could possibly have a material effect on the corporation's operations and financial position. The cost of the projects and the date on which the corporation plans to complete both Year 2000 modifications and systems conversions are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. Risks of Year 2000 At present, management believes its progress in remediating the proprietary programs and installing Y2K upgrades to the third-party vendor mainframe and PC based computer applications is on target. The Year 2000 computer problem creates risk for the corporation from unforseen problems in its own computer systems and from third-party vendors who provide the majority of the corporation's mainframe and PC based computer applications. Failures of third-party systems relative to the Y2K issue could have a material impact on the corporation's ability to conduct business. Continency Plans A contingency plan has been developed for mission-critical and required mainframe and PC based applications, third-party relationships, environmental and proprietary programs. The corporation's contingency plans involve the use of manual labor and replacement or update of computer systems to compensate for the loss or inconveniences caused by the disruption of certain automated computer systems. The contingency plans define scheduled completion dates, test dates and trigger dates. The trigger date being the date the corporation would implement the continency plan. A detailed business resumption contingency plan is currently under development with a target completion date of March 31, 1999. This detailed business resumption contingency plan will calculate a risk factor for each core business line and/or product. Based on the calculated risk factor, a specific business resumption contingency plan will be written and tested. New Financial Accounting Standards 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 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 was effective for such transfers of financial assets after December 31, 1997. Adoption of SFAS No. 127 did not 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 was not permitted. The Statement requires restatement of all prior period earnings per share data when adopted. Adoption of SFAS No. 128 did not have a 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. There was no material financial statement impact as a result of adopting SFAS No. 129. 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 was effective for fiscal years beginning after December 15, 1997. Sterling adopted SFAS No. 130, effective March 31, 1998. The adoption of this Statement requires the corporation to provide additonal 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. The adoption of this Statement requires the corporation to set forth additional disclosures in the corporation's financial statements. In February 1998, the FASB issued SFAS 132 - "Employers' Disclosures about Pensions and Other Postretirement Benefits - an ammendment of FASB Statements 87, 88 and 106." This Statement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligation and fair values of plan assets that will facilitate analysis and eliminates certain disclosures that are no longer useful as they were when FASB Statements No. 87, No. 88 and No. 106 were issued. The Statement suggests combined formats for presentation of pension and other postretirement benefit disclosures. This Statement is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available, in which case the notes to the financial statements should include all available information and a description of the information not available. The adoption of this Statement required the corporation to set forth additional disclosures in the corporation's financial statements. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as: a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, a hedge of the exposure to variable cash flows of a forecasted transaction, or a hedge of the foreign currency exposure of a net investment in a foreign operation and unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecaster transaction. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Sterling has not completed the analysis required to estimate the impact of this Statement. In October 1998, the FASB issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". This statement shall be effective for the first fiscal quarter beginning after December 15, 1998. Sterling has not yet completed the analysis of the effects of this Statement. 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, which are 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. The bank also utilizes 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 1 year, as this time frame directly impacts net interest income and is most difficult to make reactive adjustment to current market rate movements. The bank has various investments structured to change investment yield with current market conditions. Assets subject to repricing include: federal funds sold which reprice daily, loans floating to "treasury bill" indexes which reprice 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 to the point of affecting balances. 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 repricing projections as expected over future time periods based on past history. As illustrated in Table 15, management's view of interest rate sensitivity reflects a calculated interpretation of net interest margin exposure to rate changes. Rate correlations are constantly refined by management. There is no guarantee that past history will accurately reflect future changes. Table 15 - Interest Rate Sensitivity Gaps
0-90 91-365 Over 1 Year Over 3 Years Over Days Days to 3 Years to 5 Years 5 Years Assets Fed funds sold...........$ 26,850 $ 0 $ 0 $ 0 $ 0 Interest bearing balances. 57 0 500 0 0 Investment securities..... 19,218 29,410 77,202 56,676 59,781 Loans and leases.......... 103,132 76,534 151,317 115,693 93,538 Allowance for loan losses. 0 0 0 0 (7,618) Non earning assets........ 0 0 0 0 116,974 -------- -------- -------- -------- -------- Total.....................$ 149,257 $ 105,944 $ 229,019 $ 172,369 $ 262,675 Cumulative................$ 149,257 255,201 484,220 656,589 919,264 Liabilities and Capital Interest Deposits - NOW, SuperNOW, Savings and Money Market.............$ 24,036 $ 72,693 $ 39,564 $ 46,586 $ 190,112 Certificates of Deposit... 54,765 178,535 76,266 8,113 0 Borrowings-US Treasury.... 1,558 0 0 0 0 Other libilities for borrowed money........... 2,010 6,031 17,700 8,053 309 Noninterest bearing deposits................. 0 0 0 0 90,713 Noninterest bearing liabilities.............. 0 0 0 0 20,907 Stockholders' Equity...... 0 0 0 0 81,313 -------- -------- -------- ------- -------- Total.....................$ 82,369 $ 257,259 $ 133,530 $ 62,752 $ 383,354 Cumulative................$ 82,369 $ 339,628 $ 473,158 $535,910 $ 919,264 Period GAP (Dollars)......$ 66,888 $(151,315) $ 95,489 $109,617 $(120,679) as % of total assets...... 7% (16)% 10% 12% (13)% Cumulative GAP (Dollars)..$ 66,888 $ (84,427) $ 11,062 $120,679 $ 0 Cumulative as % of total assets...... 7% (9)% 1% 13% 0%
During 1998, the net interest income tax-equivalent yield margin on average earning assets dropped to 4.48% from 4.72% in 1997. Prime rate in 1998 started at 8.50%, decreased by .25% on 3 occasions during October and November, ending the year at 7.75%. The average tax-equivalent yield on earning assets decreased in 1998 to 8.09%, down from 8.34% in 1997. Average earning assets increased by $74,200,000 in 1998. Average deposit funding increased $81,400,000 in 1998. Total deposit funding cost increased to 3.48% from 3.46% in 1997. Compression of the net interest margin was the result of several factors: earning assets grew by 10.6% during 1998, loan growth could not be acheived at the same level and grew at 6.5% in 1998 and as a result, there was a 20% growth in investment securities. This change in earning asset mix from loans to investment securities, compounded by lower rates resulted in a decrease in the yield on earning assets. Funding by deposits increased 12.2% in 1998. Time deposits increased 19.5% and other deposits increased 7.5%. The change in mix in deposits resulted in higher total cost which offset lower rates paid on deposits. Future change in net income as a result of interest rate movement is presented in the graph in Table 15a. This analysis, completed by Sheshunoff Information Services, 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 decrease with increasing market rates, and future income will increase with decreasing market rates during the next fiscal year. Negative income exposure, resulting from increasing market rates, as an impact to the interest margin is (1.4)%, (3.1)% and (4.9)% with market rate increases of 100, 200 and 300 basis points. The risk position of the bank is within the guidelines set by the bank's asset/liability policies. Present value of equity as a result of interest rate change is presented in the graph in Table 15b. This analysis, completed by Sheshunoff, depicts the projected change in the value of equity as a result of interest rate movements. Future value of equity would decrease with increasing market rates, and increase with decreasing market rates. The risk position of the bank is within the guidlines set by the bank's asset/liability policies. Table 15a Table 15b 1999 Net Income Projections Present Value Equity Changes in Changes in Basis Points % Change Basis Points % Change -300 17.10% -300 12.44% -200 15.81% -200 10.07% -100 9.07% -100 5.45% -50 4.46% -50 2.74% 0 0.00% 0 0.00% 50 -0.64% 50 -1.17% 100 -1.42% 100 -2.38% 200 -3.14% 200 -4.70% 300 -4.94% 300 -6.85% 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 26 Consolidated Balance Sheets 27 Consolidated Statements of Income 28 Consolidated Statements of Changes in Stockholders' Equity 29 Consolidated Statements of Cash Flows 30 Notes to Consolidated Financial Statements 31 (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) 49 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, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. 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, 1998 and 1997 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants Lancaster, Pennsylvania January 21, 1999 except for Note 22 as to which the date is February 10, 1999
Consolidated Balance Sheets Sterling Financial Corporation and Subsidiaries As of December 31, (Dollars in thousands) 1998 1997 Assets Cash and due from banks...........................................$ 34,089 $ 34,292 Interest bearing deposits in other banks.......................... 557 15 Federal funds sold................................................ 26,850 28,150 Mortgage loans held for sale...................................... 6,005 792 Investment Securities: Securities held-to-maturity (market value - $66,290 - 1998 and $86,465 - 1997)............. 64,409 85,155 Securities available-for-sale.................................... 177,878 121,474 Loans............................................................. 534,319 512,073 Less: Unearned income........................................... (110) (436) Allowance for loan losses................................. (7,618) (7,730) -------- ------- Loans, net........................................................ 526,591 503,907 -------- ------- Premises and equipment............................................ 22,195 21,938 Other real estate owned........................................... 180 341 Accrued interest receivable and prepaid expenses.................. 12,829 12,243 Other assets...................................................... 47,681 37,181 -------- ------- Total Assets..................................................... $919,264 $845,488 ======== ======== Liabilities Deposits: Noninterest bearing.............................................$ 90,713 $ 82,565 Interest bearing................................................ 690,670 636,096 -------- -------- Total Deposits.................................................... 781,383 718,661 -------- -------- Interest bearing demand notes issued to U.S. Treasury ............ 1,558 3,000 Other liabilities for borrowed money.............................. 34,103 32,312 Accrued interest payable and accrued expenses..................... 11,233 10,165 Other liabilities................................................. 9,674 7,363 -------- -------- Total Liabilities................................................. 837,951 771,501 Stockholders' Equity -------- -------- Common Stock -(par value:$5.00) No. shares authorized: 1998 and 1997 - 35,000,000 No. shares issued: 1998 - 6,471,057; 1997 - 6,237,009 No. shares outstanding: 1998 - 6,440,171; 1997 - 6,149,795...... 32,355 31,185 Capital surplus................................................... 24,783 16,321 Retained earnings................................................. 20,666 25,828 Accumulated other comprehensive income............................ 4,694 2,916 Less: Treasury Stock (30,886 shares in 1998 and 87,214 shares in 1997) - at cost........................... (1,185) (2,263) -------- -------- Total Stockholders' Equity........................................ 81,313 73,987 -------- -------- Total Liabilities and Stockholders' Equity........................$919,264 $845,488 ======== ======== See accompanying notes to financial statements
Consolidated Statements of Income Sterling Financial Corporation and Subsidiaries For the years ended December 31, (Dollars in thousands, except per share data) 1998 1997 1996 Interest Income Interest and fees on loans...........................$ 46,124 $ 44,744 $ 41,611 Interest on deposits in other banks.................. 10 13 6 Interest on federal funds sold....................... 985 730 398 Interest and dividends on investment securities: Taxable............................................ 9,278 7,681 7,442 Tax-exempt......................................... 3,418 3,103 2,882 Dividends on stock................................. 251 228 219 --------- --------- --------- Total Interest Income................................ 60,066 56,499 52,558 --------- --------- --------- Interest Expense Interest on time certificates of deposit of $100,000 or more................................... 1,999 1,710 934 Interest on all other deposits....................... 23,943 21,214 19,775 Interest on demand notes issued to the U.S. Treasury. 142 113 95 Interest on federal funds purchased.................. none 1 89 Interest on other borrowed money..................... 1,841 2,288 1,930 --------- --------- --------- Total Interest Expense............................... 27,925 25,326 22,823 --------- --------- --------- Net Interest Income.................................. 32,141 31,173 29,735 Provision for loan losses............................ 896 1,129 580 --------- --------- --------- Net Interest Income after Provision for Loan Losses.. 31,245 30,044 29,155 --------- --------- --------- Other Operating Income Income from fiduciary activities..................... 1,879 1,513 1,139 Service charges on deposit accounts.................. 2,908 2,909 2,485 Other service charges, commissions and fees.......... 1,729 1,456 944 Mortgage banking income.............................. 1,811 1,305 1,192 Income from sale of assets........................... 1,338 none none Other operating income............................... 4,522 4,539 3,524 Investment securities gains or (losses).............. none 208 158 --------- --------- --------- Total Other Operating Income......................... 14,187 11,930 9,442 --------- --------- --------- Other Operating Expenses Salaries and employee benefits....................... 17,638 16,398 15,027 Net occupancy expense................................ 2,088 2,290 2,109 Furniture and equipment expense (including depreciation of $1,659 in 1998, $1,500 in 1997 and $1,256 in 1996) 2,755 2,480 2,044 FDIC insurance assessment............................ 87 81 2 Other operating expenses............................. 7,620 6,833 6,457 --------- --------- --------- Total Other Operating Expenses....................... 30,188 28,082 25,639 --------- --------- --------- Income Before Income Taxes........................... 15,244 13,892 12,958 Applicable income taxes.............................. 3,643 3,491 3,147 --------- --------- --------- Net Income...........................................$ 11,601 $ 10,401 $ 9,811 ========= ========= ========= Earnings per common share: Net Income - Basic earnings per share...............$ 1.80 $ 1.60 $ 1.50 Net Income - Diluted earnings per share.............$ 1.79 $ 1.60 $ 1.50 Cash dividends declared per common share.............$ .83 $ .78 $ .70 See accompanying notes to financial statements
Consolidated Statements of Changes in Stockholders' Equity Sterling Financial Corporation and Subsidiaries Accumulated Shares Other Common Common Capital Retained Comprehensive Treasury Stock Stock Surplus Earnings Income Stock Total (Dollars in thousands) Balance, January 1, 1996..............5,932,686 $29,663 $ 9,987 $ 22,848 $ 1,624 $ (213) $ 63,909 Comprehensive Income: Net income........................... 9,811 9,811 Change in net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment and tax effects......................... (21) (21) Total comprehensive income......... 9,790 Common stock issued Dividend Reinvestment Plan........... 2,517 13 58 71 Employee Stock Plan.................. 5,690 28 140 168 Stock dividends 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 Balance, December 31, 1996............6,237,009 31,185 16,325 20,502 1,603 (436) 69,179 Comprehensive Income: Net income........................... 10,401 10,401 Change in net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment and tax effects......................... 1,313 1,313 Total comprehensive income......... 11,714 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 Balance, December 31, 1997............6,237,009 31,185 16,321 25,828 2,916 (2,263) 73,987 Comprehensive Income: Net income........................... 11,601 11,601 Change in net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment and tax effects......................... 1,778 1,778 Total comprehensive income......... 13,379 Common stock issued - Stock Options... 2,624 13 48 61 Stock dividends issued - Common stock - 5%, including cash paid in lieu of fractional shares (231,424 shares including 79,332 shares of Treasury Stock)............ 231,424 1,157 8,042 (11,407) 2,168 (40) Cash dividends declared-Common Stock. (5,356) (5,356) Purchase of Treasury Stock (70,266 shares)..................... (2,492) (2,492) Issuance of Treasury Stock Dividend Reinvestment Plan (36,448 shares)..................... 301 1,080 1,381 Employee Stock Plan (7,414 shares).. 73 190 263 Director's Compensation Plan (2,000 shares)...................... 18 79 97 Stock Options (1,400 shares)......... (20) 53 33 Balance, December 31, 1998...........6,471,057 $32,355 $24,783 $20,666 $4,694 $(1,185) $81,313 ========= ======= ======== ======== ====== ======= ======= See accompanying notes to financial statements
Consolidated Statements of Cash Flows Sterling Financial Corporation and Subsidiaries For the years ended December 31, (Dollars in thousands) 1998 1997 1996 Cash Flows from Operating Activities Net Income...........................................$ 11,601 $ 10,401 $ 9,811 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Depreciation...................................... 2,113 1,948 1,625 Accretion & amortization of investment securities. 395 266 356 Provision for possible loan losses................ 896 1,129 580 Provision for deferred income taxes............... 579 638 824 (Gain) on sale of property and equipment.......... (2) (456) (2) (Gain) on sales of investment securities.......... none (208) (158) (Gain) on sale of mortgage loans.................. (642) (319) (262) Proceeds from sales of mortgage loans............. 89,517 41,188 33,480 Originations of mortgage loans held for sale...... (94,088) (40,645) (33,272) Change in operating assets and liabilities: (Increase) decrease in accrued interest receivable and prepaid expenses............................ (586) (981) 517 (Increase) in other assets....................... (10,339) (4,148) (6,583) Increase in accrued interest payable and accrued expenses........................... 489 822 (350) Increase (decrease) in other liabilities........ 1,394 711 836 --------- --------- --------- Net cash provided by/(used in) operating activities.. 1,327 10,346 7,402 Cash Flows from Investing Activities Proceeds from interest bearing deposits in other banks..................................... 361 968 1,023 Purchase of interest bearing deposits in other banks. (903) (339) (1,643) Proceeds from sales of investment securities available-for-sale.................................. none 214 670 Proceeds from maturities or calls of investment securities held-to-maturity.... .................... 29,354 30,541 37,508 Proceeds from maturities or calls of investment securities available-for-sale....................... 19,637 10,007 8,948 Purchases of investment securities held-to-maturity.. (8,614) (22,185) (9,791) Purchases of investment securities available-for-sale (73,735) (49,678) (19,310) Federal funds sold, net.............................. 1,300 (4,000) (14,800) Net loans and leases made to customers............... (23,580) (39,004) (48,080) Purchases of premises and equipment.................. (2,382) (2,562) (7,880) Proceeds from sale of premises and equipment......... 14 1,790 49 --------- --------- --------- Net cash provided by/(used in) investing activities.. (58,548) (74,248) (53,306) Cash Flows from Financing Activities Net increase in demand deposits, NOW and savings accounts................................... 42,003 18,429 12,013 Net increase in time deposits........................ 20,719 53,195 24,918 Net increrase (decrease) in interest bearing demand notes issued to the U.S. Treasury................... (1,442) 259 507 Proceeds from borrowings............................. 19,080 25,652 58,474 Repayments of borrowings............................. (17,289) (23,774) (49,563) Proceeds from issuance of common stock............... 61 none 239 Cash dividends paid.................................. (5,356) (5,075) (4,508) Cash paid in lieu of fractional shares............... (40) none (24) Acquisition of treasury stock........................ (2,492) (3,302) (547) Proceeds from issuance of treasury stock............. 1,774 1,471 320 --------- --------- --------- Net cash provided by/(used in) financing activities.. 57,018 66,855 41,829 --------- --------- --------- Increase (decrease) in cash and due from banks....... (203) 2,953 (4,075) Cash and due from banks: Beginning............................................ 34,292 31,339 35,414 --------- --------- --------- Ending...............................................$ 34,089 $ 34,292 $ 31,339 ========= ========= ========= Supplemental Disclosure of Cash Flow Information: Cash payments for: Interest paid to depositors and on borrowed money..$ 27,626 $ 24,702 $ 22,637 Income taxes....................................... 3,151 2,600 2,230 Supplemental Schedule of Noncash Investing and Financing Activities: Other real estate acquired in settlement of loans....$ 353 $ 630 $ 119 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., became the wholly owned subsidiary of Sterling Financial Corporation, 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 2 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 subsidiaries, Bank of Lancaster County, N.A., and its subsidiary, Town & Country, Inc., and T & C Leasing, Inc., provides a full range of banking services to individual and corporate customers. The principal market area is Lancaster County, Pennsylvania. Sterling Financial Corpoation 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 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., T & C Leasing, Inc. and Sterling Mortgage Services, Inc., which is 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, "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: 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; 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 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. Costs to maintain the assets and subsequent gains and losses on sales are included in other income or other expense. 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 retaining all mortgage servicing. Mortgage sale income had 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 will 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 did not 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. Comprehensive Income - In June, 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 - "Reporting Comprehensive Income". SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items. Statement No. 130 was effective for fiscal years beginning after December 15, 1997. This statement requires the corporation to set forth additional disclosures in the financial statements. The adoption of this statement had no effect on the corporation's consolidated financial position or results of operations. 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 years ended December 31, 1998 and 1997 were approximately $4,052,000 and $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 $56,894,078 in 1998 and $49,320,182 in 1997. The amortized cost and fair values of investment securities held-to- maturity are as follows:
December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 2,508 $ 20 $ none $ 2,528 Obligations of other U.S. Government agencies and Corporations......... 2,208 30 none 2,238 Obligations of states and political subdivisions...................... 44,465 1,642 4 46,103 Mortgage-backed securities.......... 1,219 64 none 1,283 Other bonds, notes and debentures... 10,808 129 none 10,937 ---------- --------- -------- -------- Subtotal............................ 61,208 1,885 4 63,089 Nonmarketable equity securities..... 3,201 none none 3,201 ---------- --------- -------- -------- Total...............................$ 64,409 $ 1,885 $ 4 $ 66,290 ========== ========= ======== ========
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 =========== ========= ========== =========
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, 1998, 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, 1998 Amortized Fair Cost Value Due in one year or less................$ 9,803 $ 9,885 Due after one year through five years.. 19,958 20,425 Due after five years through ten years. 22,943 23,989 Due after ten years.................... 7,285 7,507 ----------- ----------- 59,989 61,806 Mortgage-backed securities............. 1,219 1,283 ----------- ----------- $ 61,208 $ 63,089 =========== =========== The amortized cost and fair values of investment securities available-for-sale are as follows:
December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities..............$ 29,265 $ 666 $ 1 $ 29,930 Obligations of other U.S. Government agencies and Corporations............ 37,713 613 41 38,285 Obligations of states and political subdivisions......................... 36,938 1,074 26 37,986 Mortgage-backed securities............ 461 none none 461 Other bonds, notes and debentures..... 66,215 1,119 22 67,312 -------- ------- ------ -------- Subtotal.............................. 170,592 3,472 90 173,974 Equity securities and corporate stock............................... 174 3,730 none 3,904 -------- ------- ------ -------- Total.................................$170,766 $ 7,202 $ 90 $177,878 ======== ======= ====== ========
December 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 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 =========== ========= ======== ========
The amortized cost and fair values of available-for-sale debt securities at December 31, 1998 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, 1998 Amortized Fair Cost Value Due in one year or less...................$ 24,019 $ 24,199 Due after one year through five years..... 108,479 110,855 Due after five years through ten years.... 26,098 26,799 Due after ten years....................... 11,535 11,660 -------- -------- 170,131 173,513 Mortgage-backed securities................ 461 461 -------- -------- $170,592 $173,974 ======== ======== Proceeds from sales of investment securities available-for-sale during 1997 were $214,000. Gains of $208,457 in 1997 were realized on these sales. There were no sales of investments securities in 1998. Note 5 - Loans
Loans outstanding at December 31, are as follows: 1998 1997 Commercial, financial and agricultural..................$ 290,619 $ 271,605 Real estate - construction.............................. 6,053 6,045 Real estate - mortgage.................................. 48,381 49,438 Consumer................................................ 131,939 132,778 Lease financing receivables (net of unearned income).... 57,327 52,207 ----------- ----------- Total loans, gross......................................$ 534,319 $ 512,073 =========== ===========
Loans on a non-accrual status amounted to $812,000 at December 31, 1998, compared to $1,314,000 at December 31, 1997. If interest income had been recorded on all such loans for the years indicated, such interest income would have increased by approximately $85,667 and $152,755 for 1998 and 1997. 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 average amount of impaired loans for the fourth quarter of 1998 was $2,961,327 compared to $3,586,053 for the fourth quarter 1997, while the average for the year 1998 was $3,125,142 compared to $2,203,003 for 1997. The following table presents information concerning impaired loans at December 31, 1998 and 1997: 1998 1997 Gross impaired loans which have allowances..........$ 2,805 $3,419 Less: Related allowances for loan losses......... (140) (410) ------- ------ Net impaired loans..................................$ 2,665 $3,009 ======= ====== Note 6 - Allowance for Loan Losses
Changes in the Allowance for Loan Losses were as follows: 1998 1997 1996 Balance at January 1..................................$ 7,730 $ 7,800 $ 7,780 Recoveries credited to allowance...................... 261 303 143 Provisions for loan losses charged to income.......... 896 1,129 580 --------- -------- -------- Total................................................. 8,887 9,232 8,503 Losses charged to allowance........................... 1,269 1,502 703 --------- -------- -------- Balance at December 31................................$ 7,618 $ 7,730 $ 7,800 ========= ======== ======== Ratio of Allowance to loans, net of unearned income at end of year..................................... 1.43% 1.51% 1.65%
Note 7 - Premises and Equipment Premises and equipment at December 31, 1998 and 1997 is summarized as follows: 1998 1997 Land...........................................$ 3,539 $ 3,539 Buildings...................................... 16,586 15,977 Buildings under capitalized lease.............. 104 104 Leasehold improvements......................... 830 796 Equipment, furniture and fixtures.............. 13,953 12,604 ---------- ---------- 35,012 33,020 Less: Accumulated depreciation................ (12,817) (11,082) ---------- ---------- $ 22,195 $ 21,938 ========== ========== Depreciation expense amounted to $2,113,379 in 1998, $1,947,904 in 1997 and $1,625,184 in 1996. Note 8 - Other Assets Included in other assets for 1998 and 1997 is $37,171,117 and $30,650,237 respectively which represents operating leases generated by Town & Country, Inc. and T & C Leasing, Inc. The income generated from the leases for 1998 and 1997 amounted to $3,473,966 and $3,050,664 and is reflected in other operating income. The following schedule provides an analysis of Town & Country's and T & C Leasing's investment in property on operating leases and property held for lease by major classes as of December 31, 1998 and 1997: 1998 1997 Construction equipment...........$ 1,985 $ 932 Transportation equipment......... 20,032 17,108 Automobiles...................... 21,051 18,855 Manufacturing equipment.......... 1,063 1,044 Trucks........................... 21,007 17,889 Other............................ 8,166 5,107 ---------- ----------- Total............................ 73,304 60,935 Less: Accumulated depreciation... (36,133) (30,285) ---------- ----------- $ 37,171 $ 30,650 ========== =========== The following is a schedule by years of minimum future rentals on noncancelable operating leases as of December 31, 1998: Year ending December 31: 1999...............................$ 16,688 2000............................... 3,280 2001................................ 1,460 2002................................ 739 2003................................ 611 Later years ........................ 661 ------- Total minimum future rentals.......$ 23,439 ======= Also included in other assets is mortgage servicing rights activity. The activity for the year ended December 31, 1998 and 1997 is as follows: 1998 1997 Balance beginning of year.............$ 892 $ 442 Capitalized mortgage servicing rights. 840 563 Amortization.......................... (350) (113) ------- ------- Balance at end of year................$ 1,382 892 Valuation allowance .................. (41) none ------- ------- $ 1,341 $ 892 ======= ======= The corporation adopted, effective January 1, 1996, Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights", an ammendment of FASB Statement No. 65. In June 1996, the Financial Accounting Standards Board 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. Mortgage servicing rights are a result of originated mortgages. There have been no mortgage servicing rights purchased. The bank's mortgage servicing portfolio totaled $221 million as of December 31, 1998 compared to $175 million at December 31, 1997. Note 9 - Time Certificates of Deposit At December 31, 1998, scheduled maturities of certificates of deposit are as follows: Years ended December 31, 1999 2000 2001 2002 2003 Thereafter Total Amount $233,300 $ 59,518 $ 16,748 $ 7,802 $ 311 $ none $ 317,679 ======= ======= ======= ======= ======= ========= ======== At December 31, 1998 and 1997, time certificates of deposit of $100,000 or more aggregated $31,758,924 and $36,164,467. 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, 1998 or 1997. Interest-bearing demand notes issued to U.S. Treasury were $1,558,000 and $3,000,000 for 1998 and 1997. 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, 1998 was $17,300,000. There were no advances from the Federal Home Loan Bank considered as short-term borrowings at December 31, 1998 or 1997. The average balance outstanding for any category of short-term borrowings during the periods reported was less than 30% of stockholders' equity at the end of each period reported.
The following represents other liabilities for borrowed money at December 31: 1998 1997 Notes payable-Town & Country, Inc.(subsidiary of bank) borrowings from various lenders for leasing operations.....$32,115 $30,313 Federal Home Loan Bank advances.............................. 1,988 1,999 ------- ------- Total........................................................$34,103 $32,312 ======= =======
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 $17,044,517 at December 31, 1998. The borrowings from the Federal Home Loan Bank of Pittsburgh, which total $1,987,894, 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, 1998 was $369,194. 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 $160,000, effective in the year 1997, is disregarded in determining a participant's retirement benefit pursuant to IRS regulations. All employees with 1 year of service who work at least 1,000 hours per year and who are at least age 21 are eligible to participate. A participant becomes 100% vested upon completion of 5 years with a vesting credit. The following represents the components of net periodic benefit cost for 1998, 1997 and 1996: 1998 1997 1996 Service cost....................................$ 639 $ 583 $ 614 Interest cost................................... 672 608 567 Actual return on assets......................... (918) (2,208) (1,049) Amortization of unrecognized net transition (asset) or obligation............. (69) (69) (69) Amortization of unrecognized prior service cost. (9) (9) (9) Amortization of unrecognized net (gain) or loss. none none 40 Asset gain or (loss) deferred .................. (44) 1,429 406 ------ ------ ------ Net periodic benefit cost.......................$ 271 $ 334 $ 500 ====== ====== ====== The following table sets forth the plan's change in benefit obligation, change in plan assets and funded status at December 31, 1998, 1997 and 1996:
Pension Benefits Change in Benefit Obligation: 1998 1997 1996 Benefit obligation at beginning of year..................$ 9,670 $ 8,451 $ 8,143 Service cost............................................. 639 583 614 Interest cost ........................................... 672 608 567 Actuarial (gain) or loss................................. 205 286 (601) Benefits paid............................................ (322) (258) (272) ------- ------- ------- Benefit obligation at end of year........................ 10,864 9,670 8,451 ------- ------- ------- Change in Plan Assets: Fair value of plan assets at beginning of year........... 10,554 8,265 6,728 Actual return on plan assets............................. 918 2,208 1,049 Employer contribution ................................... none 339 760 Benefits paid ........................................... (322) (258) (272) ------- ------- ------- Fair value of plan assets at end of year ................ 11,150 10,554 8,265 ------- ------- ------- Funded status ........................................... 286 884 (186) Unrecognized net (gain) or loss ......................... (445) (694) 449 Unrecognized net transition (asset) or obligation ....... (69) (138) (207) Unrecognized prior service cost ......................... (102) (111) (120) ------- ------- ------- Prepaid (accrued) benefit cost .......................... $ (330) $ (59) $ (64) ======= ======= =======
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 for 1998, 1997 and 1996 are as follows: Weighted-Average Assumptions as of December 31: 1998 1997 1996 Discount rate........................................ 6.5% 7.0% 7.25% Expected return on plan assets....................... 9.0% 9.0% 9.00% Rate of compensation increase........................ 4.0% 4.5% 5.25% The Bank of Lancaster County maintained during 1998, an Employee Stock Plan which was approved by the shareholders in 1982. All employees of the bank who have attained the age of 18, have completed 1 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 2 components, a salary deferral feature and a performance 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 5 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, 1998 and December 31, 1997 was 559,688 and 553,944 with an approximate market value of $23,227,000 and $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 contributions 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 Corporationstock are reinvested in additional share of Sterling Financial Corporation stock. The amount of dividends received during 1998 and 1997 amounted to $454,268 and $423,093. The contribution to the performance incentive portion of the plan was $273,000, $245,000 and $235,000 for 1998, 1997 and 1996. The contribution to the salary deferral portion of the plan was $120,318 in 1998, $100,682 in 1997 and $75,619 in 1996. 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, 1998, 1997 and 1996: 1998 1997 1996 Service cost...................................... $ 70 $ 77 $ 96 Interest cost..................................... 84 86 100 Amortization of unrecognized net transition (asset) or obligation............... 51 51 51 Amortization of unrecognized prior service cost... (19) (19) none Amortization of unrecognized net (gain) or loss... (16) (4) none ---- ---- ---- Net periodic benefit cost......................... $170 $191 $247 ==== ==== ==== Sterling's postretirement benefits other than pensions are currently not funded. The status of the plans at December 31, 1998, 1997 and 1996 is as follows: Postretirement Benefits Change in Benefit Obligation: 1998 1997 1996 Benefit obligation at beginning of year... $1,219 $1,210 $1,182 Service cost ............................. 70 77 96 Interest cost ............................ 84 86 100 Actuarial (gain) or loss ................. (158) (124) (138) Benefits paid ............................ (35) (30) (30) ----- ----- ----- Benefit obligation at end of year ........ $1,180 $1,219 $1,210 ----- ----- ----- Change in Plan Assets: Fair value of plan assets at beginning of year ................................... 0 0 0 Actual return on plan assets ............. 0 0 0 Employer contribution .................... 35 30 30 Benefits paid ............................ (35) (30) (30) ----- ----- ----- Fair value of plan assets at end of year.. 0 0 0 ----- ----- ----- Funded Status ............................ (1,180) (1,219) (1,210) Unrecognized net(gain) or loss ........... (457) (315) (195) Unrecognized net transition (asset) or obligation ............................. 719 770 821 Unrecognized prior service cost........... (213) (232) (251) ----- ----- ----- Prepaid (accrued) benefit cost............$(1,131) $ (996) $ (835) ===== ===== ===== Weighted-Average Assumptions as of December 31: Discount rate 6.50% 7.00% 7.25% The health care cost trend rate assumption has a significant effect on the amounts reported. The following table reflects the effect of a 1-percentage- point increase and a 1-percentage-point decrease in the healthcare cost trend rates:
1-Percentage- 1-Percentage- Point Increase Point Decrease Effect on total of service and interest cost components.... $ 36 $ 29 Effect on postretirement benefit obligation ............... 215 170
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, which are 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 1998, 1997 and 1996 included the following: 1998 1997 1996 Service cost................................. $ 13 $ 13 $ 8 Interest cost................................ 15 15 8 Amortization of unrecognized prior service cost ...................................... 20 20 14 ----- ----- ----- Net periodic benefit cost.................... $ 48 $ 48 $ 30 ===== ===== ===== The following table sets forth the change in benefit obligation, change in plan assets and funded status for the Retirement Restoration Plan at December 31, 1998, 1997 and 1996. Retirement Restoration Plan 1998 1997 1996 Change in Benefit Obligation: Benefit obligation at beginning of year.... $ 216 $ 205 $ 180 Service cost .............................. 13 13 8 Interest cost ............................. 15 15 8 Actuarial (gain) or loss .................. 0 (17) 9 Benefits paid ............................. 0 0 0 ---- ---- ---- Benefit obligation at end of year ......... $ 244 $ 216 $ 205 ---- ---- ---- Change in Plan Assets: Fair value of plan assets at beginning of year .................................... $ 0 $ 0 $ 0 Actual return on plan assets .............. 0 0 0 Benefits paid ............................. 0 0 0 ---- ---- ---- Fair value of plan assets at end of year .. $ 0 $ 0 $ 0 ---- ---- ---- Fund Status ............................... (244) (216) (205) Unrecognized net (gain) or loss ........... (8) (8) 9 Unrecognized prior service cost ........... 126 146 166 ---- ---- ---- Prepaid (accrued) benefit cost ............ $(126) $ (78) $ (30) ==== ==== ==== Weighted-Average Assumptions as of December 31: Discount rate ............................. 6.50% 7.00% 7.25% Expected return on plan assets ............ 9.00% 9.00% 9.00% Rate of compensation increase ............. 4.00% 4.50% 5.25% Note 12 - Advertising The corporation expenses advertising costs as incurred. The expenses for 1998, 1997 and 1996 were $518,789, $569,484 and $552,451. Note 13 - Stock Options On November 19, 1996, the Board of Directors of the corporation adopted the Sterling Financial Corporation 1996 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 an opportunity for employees to purchase shares of the corporation's common stock at a grant price established by market conditions on the date of the grant. The shares of common stock that may be issued under the Stock Incentive Plan shall not exceed in the aggregate 525,000 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" 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: 1998 1997 1996 ---- ---- ---- Net Income: As reported ................................ $11,601 $10,401 $9,811 Proforma ................................... 10,858 10,090 9,594 Earnings Per Share - Basic As reported ................................ $ 1.80 $ 1.60 $ 1.50 Proforma ................................... 1.68 1.54 1.47 Earnings Per Share - Diluted As reported ................................ $ 1.79 $ 1.60 $ 1.50 Proforma ................................... 1.68 1.54 1.47 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 1998 1997 1996 Weighted Weighted Weighted Average Average Average Exercised Exercised Exercised Shares Price Shares Price Shares Price Outstanding at January 1.... 71,505 25.59 34,492 $23.14 0 $ ---- Granted ...... 53,675 42.25 38,588 27.68 34,492 23.14 Exercised .... (4,024) 23.22 0 --- 0 ---- Forfeited .... (14,090) 26.10 (1,575) 23.14 0 ---- Outstanding at December 31 . 107,066 33.96 71,505 25.59 34,492 23.14 Options Exercisable at December 31............. 25,269 24.89 10,973 23.14 0 ---- Weighted Average Fair Value of Options granted during the year................... $13.85 $8.05 $6.30
The fair value of each option granted is estimated on the grant date using the Black-Scholes model. The following assumptions were made in estimating the fair value. Assumption 1998 1997 1996 ---------- ---- ---- ---- Dividend Yield .......................... 2.01% 2.53% 2.91% Risk-Free Interest Rate ................. 4.58% 5.78% 6.39% Expected Life ........................... 10 years 10 years 10 years Expected Volatility ..................... 26.645% 12.103% 10.617% Note 14 - Operating Leases The bank leases certain banking facilities under operating leases which expire on various dates to 2022. Renewal options are available on these leases. Minimum future rental payments as of December 31, 1998 are as follows: Operating Leases 1999.........................$ 576 2000......................... 473 2001......................... 420 2002......................... 335 2003......................... 280 Later years.................. 1,663 ------- Total minimum future rental payments...................$ 3,747 ======= Total rent expense charged to operations amounted to $600,098 in 1998, $587,126 in 1997 and $562,547 in 1996. Note 15- Applicable Income Taxes The effective income tax rates for financial reporting purposes are less than the Federal statutory rate of 34% for 1998, 1997 and 1996 for reasons shown as follows:
For the years ended December 31, Statutory Statutory Statutory 1998 Rate 1997 Rate 1996 Rate Federal income tax expense at statutory rate.............$ 5,183 34.0% $ 4,723 34.0% $ 4,406 34.0% Reduction resulting from: Non-taxable interest income..... (1,643) (10.8%) (1,213) (8.7%) (1,153) (8.9%) Other, net...................... 35 .2% (112) (.9%) (186) (1.4%) ------- ------ ------- ------ ------- ------ Applicable Federal income taxes.$ 3,575 23.4% $ 3,398 24.4% $ 3,067 23.7% State income taxes.............. 68 .5% 93 .7% 80 .6% ------- ------ ------- ------ ------- ------ Applicable income taxes.........$ 3,643 23.9% $ 3,491 25.1% $ 3,147 24.3% ======= ====== ======= ====== ======= ====== Taxes currently payable.........$ 3,064 $ 2,853 $ 2,323 Deferred income taxes........... 579 638 824 ------- ------- ------- Applicable income taxes.........$ 3,643 $3,491 $ 3,147 ======= ======= =======
The Corporation had net deferred tax credits of $7,135,000, $5,639,000 and $4,326,000 at December 31, 1998, 1997 and 1996. The tax effect of temporary differences that gave rise to significant portions of the deferred tax liabilities at December 31, 1998 and 1997, are as follows:
December 31, 1998 1997 ---- ---- Deferred tax assets: Allowance for loan losses.....................$ 2,590 $ 2,628 Deferred loan fees and costs.................. 43 29 Postretirement benefits other than pensions... 385 339 Foreclosed assets............................. 7 7 Pension....................................... 194 49 Other......................................... 107 79 ------- ------- Total deferred tax assets...................$ 3,326 $ 3,131 ======= ======= Deferred tax liabilities: Leasing....................................... (7,413) (6,930) Depreciation.................................. (257) (271) Unrealized gains on investments............... (2,418) (1,501) Other......................................... (373) (68) ------- ------- Total deferred tax liabilities.............$(10,461) $(8,770) ======= ======= Net deferred tax liability.................$ (7,135) $(5,639) ======= =======
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 1997 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 present value of such deposits at short term inteest rates. 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:
1998 1997 --------------------- ------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------- --------- --------- -------- Financial Assets: Cash and short-term investments...$ 34,646 $ 34,646 $ 34,307 $ 34,307 Investment securities held-to-maturity............... 64,409 66,290 85,155 86,465 Investment securities available-for-sale............. 177,878 177,878 121,474 121,474 Loans............................. 482,997 460,658 Less: Allowance for loan losses.. (6,984) (7,131) -------- --------- -------- -------- Net loans..........................$476,013 $ 481,177 $453,527 $ 454,042 Financial Liabilities: Deposits.........................$781,383 $ 714,879 $718,661 $ 680,629 U.S. Treasury demand notes....... 1,558 1,558 3,000 3,000 Other borrowings................. 34,103 34,243 32,312 32,183 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..... (69) (69) (50) (50) Standby letters of credit........ (72) (72) (50) (50) 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, 1998 and 1997 are as follows: Financial instruments whose contract amounts represent credit risk: 1998 1997 Standby letters of credit ....................$ 6,688 $ 3,932 Commitments to extend credit..................$131,451 $ 103,357 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 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 1998 1997 Carrying value at December 31,..............$ 0 $ 0 Commitment available not yet exercised......$ 41,978 24,992 Commitment revalued at existing rates with estimated activity........................$ 41,953 24,992 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 1998 and 1997. 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, 1998 and 1997 amounted to $8,498,187 and $3,039,888. During 1998, $6,622,194 of new loans were made and repayments totaled $1,163,895. 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 1999 without approval of the Comptroller of the Currency of approximately $6,446,000 plus an additional amount equal to the bank's net profits for 1999 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 data 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 6,456,896, 6,511,742, 6,545,925 for 1998, 1997 and 1996, after giving retroactive effect to a 5% stock dividend paid in June 1998. 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 6,478,290, 6,514,984 and 6,546,002 at 1998, 1997 and 1996, after giving retroactive effect to a 5% stock dividend paid in June 1998. 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. 1998 1997 1996 Net Income................................... $ 11,601 $10,401 $ 9,811 -------- ------- ------- Income available to common stockholders used in basic and diluted earnings per share.$ 11,601 $10,401 $ 9,811 ======== ======= ======= Weighted average number of common shares used in basic earnings per share.................6,456,896 6,511,742 6,545,925 Effect of dilutive securities Stock Options................................. 21,394 3,242 77 --------- --------- --------- Weighted number of common shares and dilutive potential common stock used in diluted earnings per share......................... 6,478,290 6,514,984 6,546,002 ========= ========= ========= Note 21 - Segment Information In 1998, the corporation adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 requires disclosure of segment information on the basis used internally by management to evaluate segment performance. The corporation's segments are commercial and retail banking, leasing, mortgage banking, and trust and investment services. The accounting policies of each segment are the same as described in Note 2. Intersegment income (expense) is based upon commercial and retail bank funding of the leasing and mortgage banking segments and of trust funding of the commercial and retail bank segment. The commercial and retail bank segment consist of all the general banking of the corporation. Leasing includes the vehicle and equipment leasing of Town and Country, Inc. and T & C Leasing, Inc. Mortgage banking includes the origination sales and servicing of mortgages. The trust and investment services segment is the trust department of the Bank of Lancaster County, N.A. Commercial Trust and and Retail Mortgage Investment Consolidated Banking Leasing Banking Services Total Interest Income......$ 50,591 $ 5,463 $ 4,012 $ --- $ 60,066 Interest Expense..... 25,071 1,736 25 1,093 27,925 Intersegment Income (Expense)........... 5,465 (3,795) (2,875) 1,205 --- Other Income......... 6,504 3,888 1,829 1,966 14,187 Operating Expenses... 26,266 2,769 602 1,447 31,084 Profit before tax.... 11,223 1,051 2,339 631 15,244 Assets............... 766,216 100,114 52,934 530,931 919,264 Expenditures for long- lived assets........ 2,021 320 8 43 2,392 Depreciation and amortization........ 1,870 181 22 40 2,113 Income taxes......... 2,213 420 795 215 3,643 Not included in the above information under the leasing segment are expenditures for long-lived assets consisting of operating leases of $21,629,000 and depreciation of $12,452,000. The following is a reconcilement of total assets as reported on the accompanying financial statements. Assets Reportable segments......................$1,450,195 Less: Trust assets not included on consolidated financial statements... 530,931 ---------- Total assets.............................$ 919,264 ========== Note 22 - Merger and Acquisition Activity On February 10, 1999, the corporation entered into an agreement to acquire Northeast Bancorp, Inc., the parent company of First National Bank of North East, based in Maryland. Northeast Bancorp is an $82 million bank holding company for First National Bank of North East, with 4 branches located in Cecil County, Maryland. Under the terms of the agreement, Northeast Bancorp shareholders will receive 2 shares of Sterling Financial Corporation common stock for each share of Northeast Bancorp's common stock in a tax-free exchange. The purchase, which is subject to regulatory approval, will give Sterling Financial its first banking presence outside of Pennsylvania. The transaction is expected to be completed in mid 1999 and the acquisition is expected to be accounted for as a pooling of interests. First National Bank of North East will continue to operate as a separate bank after the acquisition. Note 23 - Sterling Financial Corporation (Parent Company Only) Financial Information
Condensed Balance Sheets As of December 31, 1998 1997 Assets Cash.......................................................$ 1,901 $ 1,760 Securities available-for-sale.............................. 237 216 Investment in subsidiaries at equity....................... 80,033 72,980 Other assets............................................... 70 68 -------- ------- Total Assets.................................................$ 82,241 $ 75,024 ======== ======== Liabilities Other liabilities..........................................$ 928 $ 1,037 Stockholders' Equity Common Stock...............................................$ 32,355 $ 31,185 Capital Surplus............................................ 24,783 16,321 Retained Earnings.......................................... 20,666 25,828 Accumulated other comprehensive income..................... 4,694 2,916 Less: Treasury Stock at cost............................... (1,185) (2,263) -------- -------- Total Stockholders' Equity...................................$ 81,313 $ 73,987 -------- -------- Total Liabilities and Stockholders' Equity...................$ 82,241 $ 75,024 ======== ========
Condensed Statements of Income
Years Ended December 31, 1998 1997 1996 Income Dividends from subsidiaries...............$ 7,948 $ 7,876 $ 4,847 Dividends on investment securities........ 6 4 3 Other income.............................. 4 1 1 Investment securities gains............... none 4 none -------- ------- ------- Total Income............................ 7,958 7,885 4,851 -------- ------- ------- Expenses Other expense............................. 215 210 155 -------- ------- ------- Total Expenses.......................... 215 210 155 -------- ------- ------- Income before income taxes and equity in undistributed net income of subsidiaries........................... 7,743 7,675 4,696 Income taxes (credits)...................... (70) (68) (51) -------- ------- ------- 7,813 7,743 4,747 Equity in undistributed income of subsidiaries.............................. 3,788 2,658 5,064 -------- ------- ------- Net Income..................................$ 11,601 $10,401 $ 9,811 ======== ======= =======
Statements of Cash Flows Years Ended December 31, 1998 1997 1996 Cash flows from operating activities Net income........................................$ 11,601 $ 10,401 $ 9,811 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Undistributed (earnings) loss of subsidiaries..... (3,788) (2,658) (5,064) (Gain) on sales of investment securities.......... none (4) none Changes in operating assets and liabilities: (Increase) decrease in other assets............. (2) (17) 796 (Decrease) increase in other liabilities........ (117) (165) 164 -------- -------- -------- Net cash provided by/(used in) operating activities............................ 7,694 7,557 5,707 -------- -------- -------- Cash flows from investing activities Proceeds from sales of investment securities avaiable-for sale............................... none 9 none Purchase of investment securities available-for-sale.............................. none (9) (83) Payments for investment in subsidiary ........... (1,500) none none -------- -------- -------- Net cash provided by/(used in) investing activities...................................... (1,500) none (83) -------- -------- -------- Cash flows from financing activities Proceeds from issuance of common stock........... 61 none 239 Cash dividends paid.............................. (5,356) (5,075) (4,508) Cash dividends paid in lieu of fractional shares............................... (40) none (24) Acquisition of treasury stock.................... (2,492) (3,302) (547) Proceeds from issuance of treasury stock......... 1,774 1,471 320 -------- -------- -------- Net cash provided by/(used in) financing activities...................................... (6,053) (6,906) (4,520) -------- -------- -------- Increase (decrease) in cash....................... 141 651 1,104 Cash Beginning....................................... 1,760 1,109 5 -------- -------- -------- Ending.........................................$ 1,901 $ 1,760 $ 1,109 ========= ======== ========
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, 1998 and 1997. Net income per share of common stock has been restated to retroactively reflect a 5% stock dividend paid in June 1998. 1998 Quarter Ended March June September December 31 30 30 31 Interest income................. $ 14,722 $15,116 $15,201 $15,027 Interest expense................ 6,824 7,023 7,197 6,881 -------- ------- ------- ------- Net interest income............. 7,898 8,093 8,004 8,146 Provision for loan losses....... 360 346 175 15 -------- ------- ------- ------- Net interest income after provision for loan losses..... 7,538 7,747 7,829 8,131 Other income.................... 3,303 4,414 3,424 3,046 Other expenses.................. 7,110 7,831 7,548 7,699 -------- ------- ------- ------- Income before income taxes...... 3,731 4,330 3,705 3,478 Applicable income taxes......... 906 1,106 867 764 -------- ------- ------- ------- Net income.......................$ 2,825 $ 3,224 $ 2,838 $ 2,714 ======== ======= ======= ======= Net income per share (basic).....$ .44 $ .50 $ .44 $ .42 Net income per share (diluted)...$ .43 $ .50 $ .44 $ .42 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 (basic and diluted)............ $ .40 $ .39 $ .41 $ .40 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 "Executive Officers" in the 1999 Annual Meeting Proxy Statement. Item 11 - Executive Compensation Incorporated by reference is the information under the headings "Compensation of Directors" and "Executive Compensation" in the 1999 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" in the 1999 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" in the 1999 Annual Meeting Proxy Statement and under "Notes to Consolidated Financial Statements - Note 18 - Related Party Transactions" on page 56 in 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 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 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 the corporation's Registration Statement No. 33-55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994, and ammended by the registrant's Rule 424 (b) prospectus filed with the Commission on December 23, 1998.) 10e Letter Agreement between Sterling Financial Corporation and Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by reference to Exhibit 10b on Form 10-Q, 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. 33-28101 on Form S-8, filed with the Securities and Exchange Commission on May 10, 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, 1998. 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 23, 1999 (John E. Stefan) Executive Officer; Director /s/ J. Roger Moyer, Jr. Executive Vice President, February 23, 1999 (J. Roger Moyer, Jr.) Assistant Secretary, Director /s/ Jere L. Obetz Executive Vice President/Treasurer, (Jere L. Obetz) Chief Financial Officer February 23, 1999 /s/ Ronald L. Bowman Vice President/Secretary, February 23, 1999 (Ronald L. Bowman) Principal Accounting Officer /s/ Richard H. Albright, Jr. Director February 23, 1999 (Richard H. Albright, Jr.) Director February 23, 1999 (Robert H. Caldwell) /s/ Howard E. Groff, Jr. Director February 23, 1999 (Howard E. Groff, Jr.) /s/ Joan R. Henderson Director February 23, 1999 (Joan R. Henderson) /s/ J. Robert Hess Director February 23, 1999 (J. Robert Hess) /s/ Calvin G. High Director February 23, 1999 (Calvin G. High) /s/ David E. Hosler Director February 23, 1999 (David E. Hosler) /s/ E. Glenn Nauman Director February 23, 1999 (E. Glenn Nauman) /s/ W/ Garth Sprecher Director February 23, 1999 (W. Garth Sprecher) /s/ Glenn R. Walz Vice Chairman of the Board, February 23, 1999 (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 T & C Leasing, Inc. Pennsylvania 1097 Commercial Avenue East Petersburg, PA 17520 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 21, 1999, except for Note 22 as to which the date is February 10, 1999, on the consolidated financial statements of Sterling Financial Corporation for the year ended December 31, 1998 as set forth in this form 10-K. /s/ Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants Lancaster, Pennsylvania March 11, 1999 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 19, 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 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 the corporation's Statement No. 33-55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994 and ammended by the registrant's Rule 424 (b) prospectus filed with the Commission on December 23, 1998.) 10e Letter Agreement between Sterling Financial Corporation and Howard E. Groff, Sr., dated June 30, 1994. (Incorporated by reference to Exhibit 10b on Form 10-Q, 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. 33-28101 on Form S-8, filed with the Securities and Exchange Commission on May 10, 1997.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 2.) 21 List of Subsidiaries 54 23 Consent of Auditors 55 27 Financial Data Schedule EX-27 2
9 1,000 12-MOS DEC-31-1998 DEC-31-1998 34,089 557 26,850 0 177,878 64,409 66,290 540,214 7,618 919,264 781,383 1,558 20,907 34,103 0 0 32,355 48,958 919,264 46,124 13,942 0 60,066 25,942 27,925 32,141 896 0 30,188 15,244 15,244 0 0 11,601 1.80 1.79 7.316 812 613 0 0 7,730 1,269 261 7,618 7,618 0 1,619
-----END PRIVACY-ENHANCED MESSAGE-----