Item 1. Description of Business
On August 19, 1993, Fidelity Bank, PaSB ("Fidelity" or the "Bank") consummated its reorganization into a bank holding company form of organization (the "Reorganization") and thereby became a wholly owned subsidiary of the Company. The Company's other subsidiary, FB Capital Trust (the "Trust"), was created in May 1997 solely to facilitate the issuance of preferred securities and the sale of the Company's junior subordinated debentures. However, since the primary activities of the Company are those of the Bank, much of the discussion herein pertains to the Bank, even though comparisons to total assets, liabilities, etc. are based on the Company's consolidated numbers.
The Bank is a Pennsylvania-chartered stock savings bank which is headquartered in Pittsburgh, Pennsylvania. Deposits in the Bank are insured by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Bank, incorporated in 1927, conducts business from eight full-service offices located in Allegheny and Butler counties, two of five Pennsylvania counties which comprise the metropolitan and suburban areas of greater Pittsburgh.
At September 30, 1998, the Company had total assets of $406.0 million, savings deposits of $261.7 million and stockholders' equity of $29.0 million. The Bank's principal business consists of attracting deposits from the general public through its home office and branch offices and investing such
deposits primarily in single-family (one-to-four family) residential loans, mortgage-backed securities and, to a lesser extent, commercial real estate loans in the Bank's primary market area. In recent years, the Bank has also been an active originator of home equity and consumer loans and has originated loans to small businesses in its immediate market area.
The Bank's earnings have historically depended primarily on its level of net interest income, which is determined by the difference between the yield earned on its loans, investment and mortgage-backed securities and other interest-earning assets and the rate paid on its deposits and borrowings. In recent years, the Bank has sought to improve profitability by (i) emphasizing the origination and purchase of interest-rate sensitive assets and assets with short-term maturities; and (ii) developing a long-range asset and liability management strategy to reduce the imbalance between the Bank's interest-earning assets and its interest-bearing liabilities with short-term maturities. The Bank has emphasized the origination of adjustable-rate mortgage loans and home equity, consumer and commercial business loans, because such loans traditionally have shorter terms to maturity. The Bank's Board of Directors has also adopted written management and investment policies, formulated with the cooperation of its senior officers, to implement portions of the Bank's assets and liability management strategy.
As a result of the Bank's actions, the amount by which the Bank's interest-earning that mature or reprice within one year exceed its interest-bearing liabilities with similar characteristics equaled $4.1 million or 1.0% of total assets at September 30, 1998. Adjustable-rate mortgage loans amounted to 29.3%, 31.3% and 20.7% of the Bank's originations of mortgage loans in fiscal 1998, 1997, and 1996 respectively. The origination of adjustable-rate mortgage loans has been emphasized in recent years. The Bank also is emphasizing the origination of home equity loans (loans secured by the equity in the borrower's residence but not necessarily for the purpose of property improvement). In recent years, the Bank has also been an active originator of consumer loans and has increased its commercial business lending. These home equity, consumer and commercial business loans generally have shorter maturities and higher interest rates than residential mortgage loans. The Bank continues to offer long-term, fixed-rate residential mortgage loans, but generally only under terms, conditions, and documentation which permit the sale of a portion of such loans in the secondary market.
Customer savings deposits with the Bank are insured by the SAIF to the maximum extent provided by law and the Bank is now, following its charter conversion, subject to examination and comprehensive regulation by the FDIC and the Pennsylvania Department of Banking ("Department"). The Bank is also a member of the Federal Home Loan Bank of Pittsburgh ("FHLB of Pittsburgh" or "FHLB"), which is one of the 12 regional banks comprising the FHLB System. The Bank is further subject to regulations of the Board of Governors of the Federal Reserve System ("Federal Reserve Board") governing reserves required to be maintained against deposits and certain other matters.
The Bank conducts its main business through its executive office located at 1009 Perry Highway, Pittsburgh, Pennsylvania 15237, and eight (8) branch offices located in Allegheny and Butler Counties in Pennsylvania. The Bank's primary market area is in these counties in western Pennsylvania, and is one of many financial institutions serving this market area. The competition for deposit products and loan originations comes from other insured financial institutions such as commercial banks, thrift institutions and credit unions in the Bank's market area. Deposit competition also includes a number of insurance products sold by local agents and investment products such as mutual funds and other securities sold by local and regional brokers. The Bank's main office telephone number is (412) 367-3300.
Lending Activities
The following table sets forth information concerning the Bank's loan portfolio by type at the dates indicated.
Contractual Maturities. The following table sets forth contractual maturities of the total loans receivable of the Bank as of September 30, 1998 by categories of loans.
(1) Of the $224.6 million of principal repayments contractually due after September 30, 1999, $178.6 million have fixed rates of interest and $46 million have adjustable or floating rates of interest.
Contractual principal repayments of loans do not necessarily reflect the actual term of the Bank's loan portfolio. The average life of mortgage loans is substantially less than their average contractual maturities because of loan payments and prepayments and because of enforcement of due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan rates are substantially lower than rates on existing mortgage loans.
Origination, Purchase and Sale of Loans. As a Pennsylvania-chartered savings institution, the Bank has general authority to originate and purchase loans secured by real estate located throughout the United States. Notwithstanding this nationwide authority, it has been the Bank's policy to concentrate its lending activities in its immediate market area. As a result, over 95% of the mortgage loans originated by the Bank are secured by real estate located in Allegheny County and adjacent Pennsylvania counties. Generally, the Bank has departed from this policy to purchase loans only when overall demand is low in its immediate market area or when it has needed to supplement its adjustable-rate mortgage ("ARM") loan portfolio. The Bank reviews all such loans to ensure each meets the same underwriting standards that the Bank applies to loans it originates. The Bank did not purchase any loans during fiscal 1998, 1997, or 1996.
Applications for all types of loans are taken at the Bank's home office and branch offices by branch managers and loan originators and forwarded to the administrative office for processing. In most cases, an interview with the applicant is conducted at the branch office by a branch manager. Residential and commercial real estate loan originations are primarily attributable to walk-in and existing customers, real estate brokers and mortgage loan brokers. Installment loans are primarily obtained through existing and walk-in customers. The Board of Directors has delegated authority to the Loan Committee, consisting of the President, Executive Vice President and Chief Financial Officer and Executive Vice President and Chief Lending Officer, to approve first mortgage, home equity, secured consumer, unsecured consumer
and commercial loans up to $500,000, $200,000, $75,000, $50,000, and $400,000, respectively. Any loan in excess of those amounts must be approved by the Board of Directors. The Board of Directors has further delegated authority to the Bank's President to approve first mortgage, home equity, secured consumer, unsecured consumer and commercial loans up to $175,000, $100,000, $75,000, $50,000, and $125,000, respectively. The terms of the delegation also permit the President to delegate authority to any other Bank officer under the same or more limited terms. Pursuant to this authority, the President of the Bank has delegated to the Executive Vice President and Chief Lending Officer, subject to certain conditions, the authority to approve motor vehicle loans, secured personal loans and unsecured personal loans up to $50,000, $50,000, and $15,000, respectively; to approve first mortgage one-to-four family loans up to $175,000, with a loan-to-value of 65% or less; to approve home equity loans up to $100,000 if the amount of the loan is not in excess of 80% of the equity; to approve commercial loans up to $100,000; to approve education loans up to levels approved by the Pennsylvania Higher Education Assistance Agency; and to approve credit cards and checking account overdraft protection loans that conform to the parameters of the program.
Generally, the Bank originated mortgage loans for inclusion in its loan portfolio and not for sale in the secondary market. Although the Bank may sell fixed-rate mortgage loans to FNMA, they prefer instead to retain the loans in its portfolio as part of its effort to increase the overall size of the loan portfolio.
Real Estate Lending. The Bank concentrates its lending activities on the origination of loans and purchase of loan participations secured primarily by first mortgage liens on existing single-family residences. At September 30, 1998, $127.5 million or 54.2% of the Bank's total loan portfolio consisted of such loans (including $11.9 million of residential construction loans).
In response to a concern for more effective asset and liability management, in recent years the Bank has been emphasizing single-family residential loans which provide for annual interest rate adjustments. The adjustable-rate residential mortgage loans offered by the Bank in recent years have 10, 15 or 30-year terms and interest rates which adjust every year generally in accordance with the index of average yield on U.S. Treasury Securities adjusted to a constant maturity of one year. There is generally a 2% cap or limit on any increase or decrease in the interest rate per year with a 5% or 6% limit on the amount by which the interest can increase over the life of the loan. The Bank has not engaged in the practice of using a cap on the payments that could allow the loan balance to increase rather than decrease, resulting in negative amortization.
Adjustable-rate mortgage loans comprised approximately 29.3%, 31.3% and 20.7% of the total originations of mortgage loans by the Bank in fiscal 1998, 1997, and 1996, respectively, and amounted to approximately $42.8 million or 26.2% of the Bank's portfolio of mortgage loans at September 30, 1998.
The Bank continues to originate fixed-rate loans with terms of 10, 15, 20 or 30 years in order to provide a full range of products to its customers, but generally only under terms, conditions and documentation which permit the sale of a portion of these loans in the secondary market. The Bank also offers a 10-year balloon loan with payments based on 30-year amortization. At September 30, 1998, approximately $120.2 million or 73.8% of the mortgage loans in the Bank's loan portfolio consisted of loans which provide for fixed rates of interest. Although these loans provide for repayments of principal over a fixed period of up to 30 years, it is the Bank's experience that such loans have remained outstanding for a substantially shorter period of time. The Bank's policy is to enforce the "due-on-sale"
clauses contained in most of its fixed-rate, conventional mortgage loans, which generally permit the Bank to require payment of the outstanding loan balance if the mortgaged property is sold or transferred and, thus, contributes to shortening the average life of such loans.
The Bank will lend generally up to 80% of the appraised value of the property securing the loan (referred to as the loan-to-value ratio) up to a maximum amount of $227,150 but will lend up to 95% of the appraised value up to the same amount if the borrower obtains private mortgage insurance on the portion of the principal amount of the loan that exceeds 80% of the value of the property securing the loan. The Bank also originates residential mortgage loans in amounts over $227,150. The Bank will generally lend up to 80% of the appraised value of the property securing such loans. These loans may have terms of up to 30 years, but frequently have terms of 10 or 15 years or are 10-year balloon loans with payments based on 15-year to 30-year amortization. Generally, such loans will not exceed a maximum loan amount of $1.0 million, although the Bank may consider loans above that limit on a case-by-case basis.
The Bank also, in recent years, has developed single-family residential mortgage loan programs targeted to the economically disadvantaged and minorities in the Bank's primary lending area. Under the programs, the Bank will lend up to 97% of the appraised value of the property securing the loan as well as reducing the closing costs the borrower is normally required to pay. The Bank does not believe that these loans pose a significantly greater risk of non-performance than similar single-family residential mortgage loans underwritten using the Bank's normal criteria.
The Bank requires the properties securing mortgage loans it originates and purchases to be appraised by independent appraisers who are approved by or who meet certain prescribed standards established by the Board of Directors. The Bank also requires title, hazard and (where applicable) flood insurance in order to protect the properties securing its residential and other mortgage loans. Borrowers are subject to employment verification and credit evaluation reports, and must meet established underwriting criteria with respect to their ability to make monthly mortgage payments.
In addition to loans secured by single-family residential real estate, the Bank also originates, to a lesser extent, loans secured by commercial real estate and multi-family residential real estate. Over 95% of this type of lending is done within the Bank's primary market area. At September 30, 1998, $35.5 million or 15.1% of the Bank's total loan portfolio consisted of commercial real estate and multi-family residential real estate loans (including $9.3 million of commercial construction loans).
Although terms vary, commercial and multi-family residential real estate loans are generally made for terms of up to 10 years with a longer period for amortization and in amounts of up to 80% of the lesser of appraised value or sales price. These loans are usually made with adjustable rates of interest, but the Bank occasionally will make fixed-rate commercial or multi-family real estate loans on a 10 or 7 year payment basis, with the period of amortization negotiated on a case-by-case basis.
The Bank, to a limited extent, also engages in loans to finance the construction of one-to-four family dwellings. This activity is generally limited to individual units and may, to a limited degree, include speculative construction by developers. The inspections, for approval of payment vouchers, are performed by Bank personnel and are based on stages of completion. Applications for construction loans primarily are received from former borrowers and builders who have worked with the Bank in the past. At September 30, 1998, the Bank had 52 construction projects of this type in process. In addition, the
Bank also engages in loans to finance the construction of commercial properties. At September 30, 1998, the Bank had seven construction projects of this type in process.
Loans to finance commercial and multi-family residential real estate and for the financing of construction generally provide a greater rate of return but are considered to have a greater risk of loss than loans to finance the purchase of single-family, owner-occupied dwellings. However, the Bank has adopted underwriting guidelines to ensure that the loans involve only a minimal amount of additional risk.
Installment Lending. The Bank offers a wide variety of installment loans, including home equity loans and consumer loans.
Home equity loans amounted to $42.3 million or 86.1% of the Bank's total installment loan portfolio at September 30, 1998. These loans are made on the security of the unencumbered equity in the borrower's residence. Home equity loans are made at fixed rates for terms of up to 15 years, and home equity lines of credit are made at variable rates. Home equity loans generally may not exceed 80% of the value of the security property when aggregated with all other liens, although a limited number of loans up to 100% value may be made at increased rates.
Consumer loans consist of motor vehicle loans, other types of secured consumer loans and unsecured personal loans. At September 30, 1998, these loans amounted to $2.4 million, which represented 4.8% of the Bank's total installment loan portfolio. At September 30, 1998, motor vehicle loans amounted to $1.4 million and unsecured loans and loans secured by property other than real estate amounted to $1.0 million.
The Bank also makes other types of installment loans such as savings account loans, education loans, credit card loans and overdraft loans. At September 30, 1998, these loans amounted to $4.5 million or 9.1% of the total installment loan portfolio. That total consisted of $1.2 million of education loans, $630,000 of savings account loans, $2.3 million of credit card loans and $360,000 of overdraft loans.
Consumer, credit card and overdraft loans and, to a lesser extent, home equity loans may involve a greater risk of nonpayment than traditional first mortgage loans on single-family residential dwellings. However, such loans generally provide a greater rate of return, and the Bank underwrites the loans in conformity to standards adopted by its Board of Directors.
Commercial Business Loans and Leases: Commercial business loans of both a secured and unsecured nature are made by the Bank for business purposes to incorporated and unincorporated businesses. Typically, these are loans made for the purchase of equipment, to finance accounts receivable and to finance inventory, as well as other business purposes. At September 30, 1998, these loans amounted to $19.5 million or 8.3% of the total loan portfolio. In addition, the Bank makes commercial leases to businesses, typically for the purchase of equipment. All leases are funded as capital leases and the Bank does not assume any residual risk at the end of the lease term. At September 30, 1998, commercial leases amounted to $3.7 million or 1.6% of the total loan portfolio.
Loans-to-One Borrower Limitations
The Federal law generally does not permit loans-to-one borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount equal to an additional 10% of unimpaired capital and surplus also may be made to a borrower if the loans are fully secured by readily marketable securities. At September
30, 1998, the Bank's limit on loans-to-one borrower was $4.0 million, and the Bank's largest loan or group of loans-to-one borrower, including related entities, aggregated $2.2 million. This represents three commercial mortgage loans, secured by four apartment buildings located in Allegheny county, and a residential mortgage loan secured by a single family residence in Allegheny county. The combined appraised value of the properties is $3.2 million. The loans are current and performing at September 30, 1998.
Loan Fee and Servicing Income. In addition to interest earned on loans, the Bank receives income through the servicing of loans and loan fees charged in connection with loan originations and modifications, late payments, changes of property ownership and for miscellaneous services related to its loans. Income from these activities varies from period to period with the volume and type of loans made.
The Bank charges loan origination fees which are calculated as a percentage of the amount loaned. The fees received in connection with the origination of conventional, single-family, residential real estate loans have generally amounted to two to three points (one point being equivalent to 1% of the principal amount of the loan). In addition, the Bank typically receives fees of one or two points in connection with the origination of conventional, multi-family residential loans and commercial real estate loans. Loan fees and certain direct costs are deferred, and the net fee or cost is amortized into income using the interest method over the expected life of the loan.
The Bank also receives income from servicing loans which are owned by others. The amount of loans serviced by the Bank for others has decreased from $6.5 million at September 30, 1996 to $6.1 million at September 30, 1998.
Non-performing Loans and Real Estate Owned. When a borrower fails to make a required payment on a loan, the Bank attempts to cause the default to be cured by contacting the borrower. In general, contacts are made after a payment is more than 15 days past due, and a late charge is assessed at that time. In most cases, defaults are cured promptly. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Bank's normal collection procedures or an acceptable arrangement is not worked out with the borrower, the Bank will normally institute measures to remedy the default, including commencing a foreclosure action or, in special circumstances, accepting from the mortgagor a voluntary deed of the secured property in lieu of foreclosure.
The remedies available to a lender in the event of a default or delinquency with respect to residential mortgage loans, and the procedures by which such remedies may be exercised, are subject to Pennsylvania laws and regulations. Under Pennsylvania law, a lender is prohibited from accelerating the maturity of a residential mortgage loan, commencing any legal action (including foreclosure proceedings) to collect on such loan, or taking possession of any loan collateral until the lender has first provided the delinquent borrower with at least 30 days' prior written notice specifying the nature of the delinquency and the borrower's right to correct such delinquency. In addition, the Homeowner's Emergency Assistance Act of 1983 further restricts the ability of a lender to exercise any remedies it may have with respect to loans for one- and two-family principal residences located in Pennsylvania (including the lender's right to foreclose on such property) until the lender has provided the delinquent borrower with written notice detailing the borrower's rights under such Act to seek consumer credit counseling and state financial assistance and until the borrower has exhausted or failed to pursue such rights.
If foreclosure is effected, the property is sold at a public auction in which the Bank may participate as a bidder. If the Bank is the successful bidder, the acquired real estate is then included in the Bank "real estate owned" account until it is sold. Although the Bank is permitted to finance sales of real estate owned by "loans to facilitate," which may involve more favorable interest rates and terms than generally would be granted under the Bank's underwriting guidelines, it is the policy of the Bank to provide such loans only in rare circumstances.
Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual, generally when a loan is ninety days or more delinquent. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income.
Real estate owned consists of properties acquired through foreclosure and are recorded at the lower of cost (principal balance of the former mortgage loan plus costs of obtaining title and possession) or fair value less estimated cost to sell. Costs relating to development and improvement of the property are capitalized, whereas costs of holding such real estate are expensed as incurred. Additional write downs are charged to income, and the carrying value of the property reduced, when the carrying value exceeds fair value less estimated cost to sell.
The following tables sets forth information regarding nonaccrual loans and real estate owned by the Bank at the dates indicated. The Bank did not have any accruing loans which were 90 days or more overdue or any loans which were classified as troubled debt restructurings at the dates presented.
At September 30, 1998, non-accrual loans consisted of six 1-4 family residential real estate loans totaling $224,000, one commercial real estate loan totaling $199,000, seven installment loans totaling $28,000, and four commercial business loan totaling $101,000.
The Bank currently has one property in real estate owned which is a single-family residence valued at $21,000.
The following table sets forth an analysis of the Bank's allowance for loan losses.
The following table shows the amount of the Bank's allowance for loan losses attributable to each category of loan indicated and the percent of loans in each category to total loans, at each of the dates indicated.
Management establishes both allowances for estimated losses on delinquent loans when it determines that losses are anticipated to be incurred and general loan loss allowances for losses management believes are inherent in the portfolio. In determining the appropriate level of allowances for possible losses, consideration is given to general economic conditions, diversification of loan portfolios, historical loss experience, identified credit problems, delinquency levels and adequacy of collateral. For the year ended September 30, 1998, the Bank recorded provisions for loan losses of $405,000. At September 30, 1998, the Bank had an allowance for possible loan losses of $2.2 million or 1.02% of net loans receivable. The allowance for possible loan losses was 406.3% of total non-performing loans at that date.
Management also establishes specific allowances for estimated losses on real estate owned when it determines that losses are anticipated to be incurred on the underlying properties. At September 30, 1998, the Bank had no allowances for estimated losses on real estate owned recorded.
The Bank's management believes that its present allowances are adequate and that the carrying value of its real estate owned approximates the net realizable value of the properties. However, while management uses the best information available to make such determinations, future adjustments to reserves may become necessary, based on changes in economic conditions, or as a result of examinations by various regulatory agencies, who review the allowance as a part of their examination procedures.
The Chief Lending Officer, Chief Financial Officer and the Collection Manager meet monthly to review non-performing assets and any other assets that may require classification or special consideration. Adjustments to the carrying values of such assets are made as needed and a detailed report is submitted to the Board of Directors on a monthly basis.
Investment Activities
Mortgage-Backed Securities. Mortgage-backed securities (which also are known as mortgage participation certificates or pass-through certificates) typically represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises such as the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and Government National Mortgage Association ("GNMA")) that pool and repackage the participation interests in the form of securities, to investors such as the Bank.
Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages, i.e., fixed rate or adjustable rate, as well as the prepayment risk, are passed on to the certificate holders. Accordingly, the life of a mortgage-backed pass-through security approximates the life of the underlying mortgages.
The actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and adversely affect its yield to maturity. The yield is based upon the interest income and the amortization of any premium or discount related to the mortgage-backed security. In accordance with generally accepted accounting principals, premiums and discounts are amortized over the estimated lives of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect actual
prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, the Bank may be subject to reinvestment risk because to the extent that the Bank's mortgage-backed securities amortize or prepay faster than anticipated, the Bank may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. Mortgage-backed securities held-to-maturity decreased $14.2 million or 41.5% to $19.9 million at September 30, 1998 from $34.1 million at September 30, 1997. The Bank did not sell or purchase any mortgage-backed securities held-to-maturity in fiscal 1998.
On November 15, 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities" ("Guide"). The Guide permitted a one-time reclassification of securities without calling into question the propriety of a company's stated intent in prior or subsequent periods. The reclassification had to occur between November 15, 1995 and December 31, 1995. The Bank utilized this opportunity to reclassify approximately $55.0 million of mortgage-backed securities as available-for-sale.
Mortgage-backed securities available-for-sale were $83.0 and $93.9 million at September 30, 1998 and 1997, respectively. These securities may be held for indefinite periods of time and are generally used as part of the Bank's asset/liability management strategy. These securities may be sold in response to changes in interest rates, prepayment rates or to meet liquidity needs. During fiscal 1998, the Bank purchased $52.6 million of these securities and sold $43.8 million. Sales of these securities in fiscal 1998 resulted in a pretax loss of $125,000.
The following table sets forth the composition and amortized cost of the Bank's mortgage-backed securities at the dates indicated.
Information regarding the contractual maturities and weighted average yield of the Bank's mortgage-backed securities portfolio at September 30, 1998 is presented below.
As of September 30, 1998, non-U.S. Government and U.S. Government agency mortgage-backed securities that exceeded ten percent of stockholders' equity are as follows:
Issuer Book Value Market Value ------ ---------- ------------ (Dollars in thousands) Paine Webber Mortgage Acceptance Corporation $3,112 $3,122
The above securities are fixed rate collateralized mortgage obligations that are rated AAA by Moody's.
Investments
At September 30, 1998, the Bank's investments amounted to $69.3 million, which includes $57.6 million available-for-sale, which represented 17.1% of total assets. Pursuant to the Bank's investment policy, the Bank's investments include obligations issued or fully guaranteed by the United States government, certain federal agency obligations, FHLB stock and other specified investments.
It is the Bank's policy that investments are to be made with a primary consideration for safety and liquidity. Pursuant to this policy, the Bank invests only in government and government-guaranteed securities, federal funds, banker acceptances, A-rated commercial paper and corporate obligations, money market accounts, mutual funds, repurchase agreements, certain collateralized investments and FHLMC preferred stock. The Company, in addition to being able to invest in the same investments as the Bank, can also invest in equity securities.
The method of calculating the carrying value of the Bank's investments differs by type of security. Investment account securities held to maturity are carried at cost, adjusted for amortization of premium and accretion of discounts, if any, over the term of the security. Management has the intent and ability to hold these securities to maturity. Gains or losses on the sale of investment securities are recognized upon realization using the specific identification method.
The Bank has identified those securities which may be sold prior to maturity. These assets are classified as available-for-sale and are recorded at fair value. Unrealized gains or losses are reported as a separate component of equity. Gains or losses on the sale of available-for-sale securities are recognized using the specific identification method.
The following tables set forth the Bank's investment portfolio at carrying value at the dates indicated.
- ------------- (1) Consists of investment in the Federated Investors ARM Fund and Legg Mason Value Trust Fund.
At September 30, 1998, the Bank holds no securities of any issuer, the aggregate value of which exceeds ten percent of stockholders equity, other than U.S. Government and U.S. Government agency securities.
The following tables set forth the amount of each category of investment securities of the Bank at September 30, 1998 which mature during each of the periods indicated and the weighted average yield for each range at maturities. The yields on the tax-exempt investments have been adjusted to their pre-tax equivalents. At September 30, 1998, the Bank held no securities of any issuer, the aggregate value of which exceeds ten percent of stockholders equity, other than U.S. Government and U.S. Government agency securities.
(1) Consists of investment in the Federated Investors ARM Fund and Legg Mason Value Trust Fund.
Sources of Funds
General. Savings deposits obtained through the home office and branch offices have traditionally been the principal source of the Bank's funds for use in lending and for other general business purposes. The Bank also derives funds from scheduled amortizations and prepayments of outstanding loans and mortgage-backed securities and sales of investments available-for-sale. The Bank also may borrow funds from the FHLB of Pittsburgh and other sources. Borrowings generally may be used on a short-term basis to compensate for seasonal or other reductions in savings deposits or other inflows at less than projected levels, as well as on a longer-term basis to support expanded lending activities.
Savings Deposits. The Bank's current savings deposit products include passbook savings accounts, demand deposit accounts, NOW accounts, money market deposit accounts and certificates of deposit ranging in terms from three months to ten years. Included among these savings deposit products are Individual Retirement Account ("IRA") certificates and Keogh Plan retirement certificates (collectively "retirement accounts"). The Bank offers preferred rates for certificates of deposit in denominations of $99,000 or more at terms ranging from one month to five years and, at September 30, 1998, such certificates accounted for 1.6% of total savings deposits.
The Bank's savings deposits are obtained primarily from residents of Allegheny and Butler Counties. The principal methods used by the Bank to attract savings deposit accounts include the offering of a wide variety of services and accounts, competitive interest rates and convenient office locations and service hours. The Bank does not currently pay, nor has it in the past paid, fees to brokers to obtain its savings deposits.
The following table shows the distribution of, and certain other information relating to the Bank's savings deposits by type as of the dates indicated.
In recent years, the Bank has been required by market conditions to rely increasingly on newly-authorized types of short-term certificate accounts and other savings deposit alternatives that are more responsive to market interest rates than passbook accounts and regulated fixed-rate, fixed-term certificates that were historically the Bank's primary source of savings deposits. As a result of deregulation and consumer preference for shorter term, market-rate sensitive accounts, the Bank has, like most financial institutions, experienced a significant shift in savings deposits towards relatively short-term, market-rate accounts. In recent years, the Bank has been successful in attracting retirement accounts
which have provided the Bank with a relatively stable source of funds. As of September 30, 1998, the Bank's total retirement funds were $35.3 million or 13.5% of its total savings deposits.
The Bank attempts to control the flow of savings deposits by pricing its accounts to remain generally competitive with other financial institutions in its market area, but does not necessarily seek to match the highest rates paid by competing institutions. In this regard, the senior officers of the Bank meet weekly to determine the interest rates which the Bank will offer to the general public.
Rates established by the Bank are also affected by the amount of funds needed by the Bank on both a short-term and long-term basis, alternative sources of funds and the projected level of interest rates in the future. The ability of the Bank to attract and maintain savings deposits and the Bank's cost of funds have been, and will continue to be, significantly affected by economic and competitive conditions.
The following table presents by various interest rate categories the amounts of certificate accounts at the date indicated and the amounts of certificate accounts at such date which mature during the periods indicated.
Maturities of certificates of deposit of $100,000 or more that were outstanding as of September 30, 1998 are summarized as follows:
(In thousands)
3 months or less ........................................... $1,367 Over 3 months through 6 months ............................. 1,892 Over 6 months through 12 months ............................ 440 Over 12 months ............................................. 384 ------ Total ............................................. $4,083 ======
Borrowings. The Bank is eligible to obtain advances from the FHLB of Pittsburgh upon the security of the common stock it owns in that bank, securities owned by the Bank and held in safekeeping by the FHLB and certain of its residential mortgages, provided certain standards related to credit worthiness have been met. See "Regulation of the Bank - Federal Home Loan Bank System." Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. FHLB advances are generally available to meet seasonal and other withdrawals of deposit accounts and to expand lending, as well as to aid the effort of members to establish better asset
and liability management through the extension of maturities of liabilities. At September 30, 1998, the Bank had $100.2 million of advances outstanding.
The Bank also, from time to time, enters into sales of securities under agreements to repurchase ("reverse repurchase agreements"). Such reverse repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as liabilities in the statement of financial condition. At September 30, 1998, the Bank had $1.9 million reverse repurchase agreements outstanding.
On May 13, 1997, the Trust, a statutory business trust created under Delaware law that is a subsidiary of the Company, issued $10.25 million, 9.75% Preferred Securities ("Preferred Securities") with a stated value and liquidation preference of $10 per share. The Trust's obligations under the Preferred Securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the Preferred Securities of the Trust, as well as proceeds from the issuance of common securities to the Company, were utilized by the Trust to invest in $10.57 million of 9.75% Junior Subordinated Debentures (the "Debentures") of the Company. The Debentures are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Interest on the Preferred Securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the Debentures prior to the maturity date of July 15, 2027, on or after July 15, 2002, at 100% of the stated liquidation amount, plus accrued and unpaid distributions, if any, to the redemption date. Under the occurrence of certain events, specifically, a Tax Event, Investment Company Event or Capital Treatment Event as more fully defined in the FB Capital Trust Prospectus dated May 8, 1997, the Company may redeem in whole, but not in part, the Debentures prior to July 15, 2002. Proceeds from any redemption of the Debentures would cause a mandatory redemption of the Preferred Securities and the common securities having an aggregate liquidation amount equal to the principal amount of the Debentures redeemed.
The following table sets forth certain information regarding the short-term borrowings (due within one year or less) of the Bank at the dates or for the periods indicated.
Subsidiaries
Pennsylvania law permits a Pennsylvania-chartered savings institution to invest up to 3% of its assets in the capital stock, securities or other obligations of subsidiary corporations or service corporations. The Department is empowered to authorize Pennsylvania-chartered savings institutions,
upon specific application, to invest a greater percentage of assets in subsidiaries. As a result of FIRREA, the types of activities and the magnitude of the Bank's activities in its investments in service corporations are restricted (with certain exceptions) to the levels and magnitude of investments permitted state-chartered savings institutions. The Company's only subsidiaries at September 30, 1998 were the Bank and FB Capital Trust. The Bank had no subsidiaries at September 30, 1998.
Employees
At September 30, 1998, the Bank had 105 full-time and 28 part-time employees. None of these employees are represented by a collective bargaining agent, and the Bank believes that it enjoys good relations with its personnel.
Competition
Federal legislation in recent years has given savings institutions the opportunity to compete on a more equal footing in many of the areas previously reserved for other types of financial intermediaries, mainly commercial banks. As a result, the competitive pressures among savings institutions, commercial banks and other financial institutions have increased significantly and are expected to continue to do so.
The Bank faces significant competition in attracting savings deposits. Its most direct competition for savings deposits has historically come from commercial banks, savings banks and other financial institutions located in its market area, however, in recent years significant competition has also come from mutual funds. Particularly in times of high interest rates, the Bank faces additional significant competition for investors' funds from short-term money market mutual funds and issuers of corporate and government securities. The Bank competes for savings deposits principally by offering depositors a variety of deposit programs, convenient branch locations and hours, and other services. The Bank does not rely upon any individual group or entity for a material portion of its savings deposits.
The Bank's competition for real estate loans comes principally from mortgage banking companies, commercial banks, savings banks and other financial institutions. The Bank competes for loan originations primarily through the interest rates and loan fees it charges, and the efficiency and quality of services it provides borrowers and real estate brokers. Factors which affect competition include the general and local economic conditions, current interest rate levels and volatility in the mortgage markets.
Market Area
The Bank now conducts business from eight full-service offices located in its primary market area, Allegheny and Butler counties, which are two of the five Pennsylvania counties which comprise the metropolitan and suburban areas of greater Pittsburgh. Approximately 1.5 million people live in the market area served by the Bank. Substantially all of the Bank's deposits and loans are received from residents and businesses located in its primary market area. In addition, the Bank participates in the MACTM and PLUSTM automatic teller machine networks which provide locations throughout the Bank's primary market area, as well as the rest of Pennsylvania and most other states.
The area's economy is reasonably diversified, including manufacturing, transportation, utilities, banks, hospitals and educational services segments. The population in Allegheny County, the Bank's largest market area, is aging and population growth is minimal. Areas to the north and south of Allegheny County are, however, experiencing growth both in population and in the real estate market. The area,
like the nation as a whole, continues to experience low unemployment and the labor market remains tight. The region's unemployment rate has dropped to approximately 4.3%, down from approximately 4.9% one year ago. Construction activity remains strong, with residential construction up approximately 6.5% over the year ago period. The Bank believes the diversity of the area's industry will continue to help provide for a stable economy for the foreseeable future; however, a general national economic slowdown may curtail the slow but steady growth the area has experienced in recent years.
Average Balance Sheet and Analysis of Net Interest Earnings
The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The average balance of loans receivable includes non-accrual loans. Interest income on tax free investments has been adjusted for federal income tax purposes using a rate of 34%.
(1) Net interest margin is net interest income divided by average interest-earning assets.
Rate/Volume Analysis
The following table presents certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in volume (change in volume multiplied by old rate), (2) changes in rate (change in rate multiplied by old volume), and (3) changes in rate/volume (change in rate multiplied by change in volume).
Certain Ratios
The following table presents certain information regarding the return on average assets and average equity, and the ratio of average equity to assets of the Bank and the dividend payout ratio for the periods indicated.
Year Ended September 30, ------------------------------------ 1998 1997 1996 ----- ---- ---- Return on average assets.............. .74% .80% .44% Return on average equity.............. 10.64 11.42 5.96 Average equity to assets ratio........ 6.94 7.01 7.37 Dividend payout ratio ................ 21.77 19.01 31.06
Asset and Liability Management
The Bank in fiscal 1998 continued to utilize strategies designed to decrease the Bank's vulnerability to significant and prolonged increases in interest rates. This process involves monitoring the imbalance between the generally long-term, fixed rate nature of the Bank's interest-earning assets and its generally short or medium-term, interest-bearing liabilities on a regular basis and implementing actions designed to reduce this imbalance. Although management of the Bank believes that the steps it has taken, as discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in the Company's 1998 Annual Report to Stockholders, have reduced the Bank's overall vulnerability to increases in interest rates, the Bank continues to remain vulnerable to significant and prolonged increases in interest rates because its interest rate sensitive liabilities exceed its interest rate sensitive assets with short-term maturities.
The following table summaries the anticipated repayments of the Bank's interest-earning assets and interest-bearing liabilities as of September 30, 1998. Adjustable and floating-rate assets are included in the period in which interest rates are next scheduled to adjust and fixed-rate loans, mortgage-backed securities held-for-investment and investment securities are included in the periods in which they are anticipated to be repaid based on scheduled maturities and certain assumptions that estimate the projected repayments of loans, mortgage-backed securities and investments with specified characteristics. The Bank has assumed that passbook, money market and NOW accounts, which generally are subject to immediate withdrawal, are withdrawn at various rates applied to the cumulative declining balances based on certain assumptions for passbook, money market and NOW accounts.
Regulation of the Company
Bank Holding Company Act ("BHCA") - General. The Company, as a bank holding company, is subject to regulation and supervision by the Federal Reserve Board. Under the BHCA, a bank holding company is required to file annually with the Federal Reserve Board a report of its operations and, with its subsidiaries, is subject to examination by the Federal Reserve Board.
BHCA - Activities and Other Limitations. The BHCA prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, without prior approval of the Federal Reserve Board. The BHCA also generally prohibits a bank holding company from acquiring any bank located outside of the state in which the existing bank subsidiaries of the bank holding company are located unless specifically authorized by applicable state law. Pennsylvania banking law permits the interstate acquisition of banking institutions by bank holding companies on a regional and reciprocal basis. No approval under the BHCA is required, however, for a bank holding company already owning or controlling 50% of the voting shares of a bank to acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to approve the ownership of shares by a bank holding company in any company, the activities
of which the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. In making such determinations, the Federal Reserve Board is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.
The Federal Reserve Board has by regulation determined that certain activities are closely related to banking within the meaning of the BHCA. These activities include providing services for internal operations for itself and its subsidiaries and operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation services; operating a collection agency; providing certain courier services; providing management consulting services to depository institutions; issuing and selling money orders, travelers checks and savings bonds; performing real estate and personal property appraisals; arranging commercial real estate equity financing; underwriting and dealing in government obligations and money market instruments; providing foreign exchange advisory and transactional services; acting as a futures commission merchant; providing check guaranty services; and operating a credit bureau. The Federal Rreserve Board also has determined that certain other activities, including real estate brokerage and syndication, land development, property management and underwriting of life insurance not related to credit transactions, are not closely related to banking and a proper incident thereto.
Capital Requirements (Consolidated). The Federal Reserve Board measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. The guidelines include the concept of Tier 1 capital and total capital. Tier 1 capital is essentially common equity,
excluding net unrealized gain (loss) on equity securities available-for-sale and goodwill, plus certain types of preferred stock, including the Preferred Securities issued by the Trust in 1997. The Preferred Securities may comprise up to 25% of the Company's Tier 1 capital. Total capital includes Tier 1 capital and other forms of capital such as the allowance for loan losses, subject to limitations, and subordinated debt. The guidelines establish a minimum standard risk-based target ratio of 8%, of which at least 4% must be in the form of Tier 1 capital. At September 30, 1998, the company had Tier 1 capital as a percentage of risk-weighted assets of 16.17% and total risk-based capital as a percentage of risk-weighted assets of 17.52%.
In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines currently provide for a minimum ratio of Tier 1 capital as a
percentage of average assets (the "Leverage Ratio") of 3% for bank holding companies that meet certain criteria, including that they maintain a Leverage Ratio of at least 100 to 200 basis points above the minimum. At September 30, 1998, the Company has a Leverage Ratio of 9.35%.
Limitations on Acquisitions of Voting Stock. The Federal Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company unless the Federal Reserve Board has been given 60 days' prior written notice of such proposed acquisition and within that time period the Federal Reserve Board has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to expiration of the disapproval period if the Federal Reserve Board issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of more than 10% of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act would, under the circumstances set forth in the presumption, constitute the acquisition of control.
In addition, any "company" would be required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquiror that is a bank holding company) or more of the outstanding Common Stock of, or such lesser number of shares as constitute control over, the Company.
Regulation of the Bank
The Bank is subject to extensive regulation by the FDIC and the Department. There are periodic examinations by the Department and the FDIC to test the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors.
FDIC Insurance Premiums. The deposits of the Bank are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examination of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions.
On September 30, 1996, President Clinton signed into law legislation to eliminate the premium differential between SAIF-insured institutions and BIF-insured institutions by recapitalizing the SAIF's reserves to the required ratio of 1.25% of insured deposits. The legislation provided that the holders of SAIF-assessable deposits pay a one-time special assessment to recapitalize the SAIF. The legislation also provided for the merger of the BIF and the SAIF, with such merger being conditioned upon the prior elimination of the thrift charter. Effective October 8, 1996, FDIC regulations imposed a one-time special assessment equal to 65.7 basis points for all SAIF-assessable deposits as of March 31, 1995, which was collected on November 27, 1996.
Following the imposition of the one-time special assessment, the FDIC lowered assessment rates for SAIF members to reduce the disparity in the assessment rates paid by BIF and SAIF members. Beginning October 1, 1996, effective BIF and SAIF rates both range from zero basis points to 27 basis points. From 1997 through 1999, FDIC-insured institutions will pay approximately 1.3 basis points of
their BIF-assessable deposits and 6.4 basis points of their SAIF-assessable deposits to fund the Financing Corporation.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. Management is aware of no existing circumstances which would result in termination of the Bank's deposit insurance.
Capital Requirements. The FDIC has promulgated regulations and adopted a statement of policy regarding the capital adequacy of state-chartered banks which, like the Bank, will not be members of the Federal Reserve System. These requirements are substantially similar to those adopted by the Federal Reserve Board regarding bank holding companies, as described above.
The FDIC's capital regulations establish a minimum 3.0% Tier I leverage capital requirement for the most highly-rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively will increase the minimum Tier I leverage ratio for such other banks to 4.0% to 5.0% or more. Under the FDIC's regulation, highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization and are rated composite 1 under the Uniform Financial Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain qualifying supervisory goodwill, and certain purchased mortgage servicing rights and purchased credit and relationships.
The FDIC also requires that savings banks meet a risk-based capital standard. The risk-based capital standard for savings banks requires the maintenance of total capital (which is defined as Tier I capital and supplementary (Tier 2 capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item.
The components of Tier I capital are equivalent to those discussed above under the 3% leverage standard. The components of supplementary (Tier 2) capital include certain perpetual preferred stock, certain mandatory convertible securities, certain subordinated debt and intermediate preferred stock and general allowances for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital. At September 30, 1998, the Bank met each of its capital requirements.
The following table sets forth certain information concerning the Bank's regulatory capital at September 30, 1998.
(1) Represents equity capital of the Bank as reported to the FDIC and the Pennsylvania Department of Banking on Form 032 for the quarter ended September 30, 1998.
(2) Limited to 1.25% of risk adjusted assets.
(3) Tier 1 capital is calculated as a percentage of adjusted total average assets of $390.4 million. Tier I and Tier II risk-based capital are calculated as a percentage of adjusted risk-weighted assets of $225.8 million.
The Bank is also subject to more stringent Department capital guidelines. Although not adopted in regulation form, the Department utilizes capital standards requiring a minimum of 6% leverage capital and 10% risk-based capital. The components of leverage and risk-based capital are substantially the same as those defined by the FDIC.
Safety and Soundness. FDICIA requires each federal banking regulatory agency to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to (i) internal controls, information systems and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) compensation, fees and benefits; and (vii) such other operational and managerial standards as the agency determines to be appropriate. If an insured depository institution or its holding company fails to meet any of the standards promulgated by regulation, then such institution or company will be required to submit a plan within 30 days to the FDIC specifying the steps it will take to correct the deficiency. In the event that an institution or company
fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the agency, Section 39 of the FDIA provides that the FDIC must order the institution or company to correct the deficiency and may (1) restrict asset growth; (2) require the institution or company to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the institution or company may pay; or (4) take any other action that would better carry out the purpose of prompt corrective action. The Bank believes that it is in compliance with each of the standards adopted.
Regulatory Enforcement Authority. FIRREA included substantial enhancement to the enforcement powers available to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement actions, including misleading or untimely reports filed with regulatory authorities. FIRREA significantly increased the amount of and grounds for civil money penalties and requires, except under certain circumstances, public disclosure of final enforcement actions by the federal banking agencies. In addition, under FIRREA and regulations adopted by the FDIC thereunder, the FDIC must be given 30 days' notice of any changes in directors or senior executive officers of the Bank, and the FDIC may object to such changes.
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA, as amended by the FDICIA, generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (I) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
The FDIC adopted final regulation governing the activities and investments of insured state banks which further implemented Section 24 of the FDIA, as amended by FDICIA. Under the regulations, an insured state-chartered bank may not, directly, or indirectly through a subsidiary, engage as "principal" in any activity that is not permissible for a national bank unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements. Any insured state-chartered bank directly or indirectly engaged in any activity that is not permitted for a national bank must cease the impermissible activity.
Federal Home Loan Bank System. The Bank is a member of the FHLB System, which consists of 12 regional FHLBs, with each subject to supervision and regulation by the Federal Housing Finance Board. The FHLBs provide a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Pittsburgh, is required to acquire and hold shares of capital stock in that FHLB in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 5% of its advances (borrowings) from the FHLB of Pittsburgh, whichever is greater. The Bank had a $5.1 million investment in stock of the FHLB of Pittsburgh at September 30, 1998, which complied with this requirement.
Advances from the FHLB of Pittsburgh are secured by a member's shares of stock in the FHLB of Pittsburgh, certain types of mortgages and other assets. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Pittsburgh and the purpose of the borrowing.
At September 30, 1998, the Bank had $100.2 million of advances from the FHLB of Pittsburgh outstanding.
Classification of Assets. Under current federal regulations, an institution's problem assets are subject to classification according to one of three categories: "substandard," "doubtful" and "loss." For assets classified "substandard" and "doubtful," the institution is required to establish prudent general loan loss reserves in accordance with generally accepted accounting principles. Assets classified "loss" must be either completely written off or supported by a 100% specific reserve. A classification category designated "special mention" also must be established and maintained for assets not currently requiring classification but having potential weaknesses or risk characteristics that could result in future problems. An institution is required to develop an in-house program to classify its assets, including investments in subsidiaries, on a regular basis and set aside appropriate loss reserves on the basis of such classification. At September 30, 1998, the Bank had $552,000 of assets classified as substandard.
Interstate Acquisitions. The Commonwealth of Pennsylvania has enacted legislation regarding the acquisition of commercial banks, bank holding companies, savings banks and savings and loan associations located in Pennsylvania by institutions located outside of Pennsylvania. The statute dealing with savings institutions authorizes (i) a savings bank, savings and loan association or holding company thereof located in Delaware, the District of Columbia, Indiana, Kentucky, Maryland, New Jersey, Ohio, Virginia and West Virginia (collectively, "regional institutions") to acquire the voting stock of, merge or consolidate with, or purchase assets and assume liabilities of, a Pennsylvania-chartered savings bank, (collectively, "Pennsylvania institutions") and (ii) the establishment of branches in Pennsylvania by regional institutions, in each case subject to certain conditions including reciprocal legislation in the state in which the regional institution seeking entry into Pennsylvania is located permitting comparable entry by Pennsylvania institutions and approval by the Pennsylvania Department of Banking. The statute also provides for nationwide branching by Pennsylvania-chartered savings banks and savings and loan associations, subject to Pennsylvania Department of Banking approval and certain other conditions. Of the states within the region, Delaware, Maryland, New Jersey, Ohio and West Virginia currently have laws that permit Pennsylvania institutions to branch into such states and/or acquire savings institutions located is such states.
Miscellaneous. The Bank is subject to certain restrictions on loans to the Company, on investments in the stock or securities thereof, on the taking of such stock or securities as collateral for loans to any borrower, and on the issuance of a guarantee or letter of credit on behalf of the Company. The Bank is also subject to certain restrictions on most types of transactions with the Company, requiring that the terms of such transactions be substantially equivalent to terms of similar transactions with non-affiliated firms. In addition, there will be various limitations on the distribution of dividends to the Company by the Bank.
In addition to requiring a new system of risk-based insurance assessments and a system of prompt corrective action with respect to undercapitalized banks, as discussed above, the FDICIA also contains provisions which are intended to enhance independent auditing requirements, amend various consumer banking laws, limit the ability of "undercapitalized banks" to borrow from the Federal Reserve Board's discount window, and require regulators to perform annual on-site bank examinations and set standards for real estate lending.
Pennsylvania Bank Law
The Bank is incorporated under the Pennsylvania Banking Code of 1965, which contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, employees and members, as well as corporate powers, savings and investment operations and other aspects of the Savings Bank and its affairs. The Banking Code delegates extensive rulemaking power and administrative discretion to the Department so that the supervision and regulation of state-chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.
One of the purposes of the Banking Code is to provide savings banks with the opportunity to be competitive with each other and with other financial institutions existing under other Pennsylvania laws and other state, federal and foreign laws. A Pennsylvania savings bank may locate or change the location of its principal place of business and establish an office anywhere in the Commonwealth, with the prior approval of the Department.
The Department generally examines each savings bank not less frequently than once every two years. Although the Department may accept the examinations and reports of the FDIC in lieu of the Department's examination, the present practice is for the Department to conduct a joint examination with the FDIC. The Department may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any director, officer, attorney or employee of a savings bank engaged in an objectionable activity, after the Department has ordered the activity to be terminated, to show cause at a hearing before the Department why such person should not be removed.
The foregoing references to laws and regulations which are applicable to the Bank are brief summaries thereof which do no purport to be complete and which are qualified in their entirety by reference to such laws and regulations.
Federal and State Taxation
General. The Company and Bank are subject to federal income taxation in the same general manner as other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the Bank.
Method of Accounting. For federal income tax purposes, the Company and Bank currently report income and expenses on the accrual method of accounting and use a tax year ending September 30 for filing its consolidated federal income tax returns.
Bad Debt Reserves. Savings institutions such as the Bank, which meet certain definitional tests primarily relating to their assets and the nature of their businesses, are permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions may, within specified formula limits, be deducted in arriving at the Bank's taxable income.
Pennsylvania Taxation. The Company is subject to the Pennsylvania Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net Income Tax rate is currently 12.25% and is imposed on the Company's unconsolidated taxable income for federal purposes with certain adjustments.
In general, the Capital Stock Tax is a property tax imposed at a rate of 1.3% of a corporation's capital stock value, which is determined in accordance with a fixed formula based on average net income and net worth.
The Bank is subject to tax under the Pennsylvania Mutual Thrift Institutions Tax Act ("MITA"), currently at the rate of 11.5% on the Bank's net earnings, determined in accordance with GAAP, as shown on its books. For fiscal years beginning in 1983, and thereafter, net operating losses may be carried forward and allowed as a deduction for three succeeding years. MITA exempts the Bank from all other corporate taxes imposed by Pennsylvania for state tax purposes, and from all local taxes imposed by political subdivisions thereof, except taxes on real estate and real estate transfers.
Item 2.
Item 2. Properties
At September 30, 1998, the Bank conducted its business from its main office in Pittsburgh, Pennsylvania and seven full-service branch offices located in Allegheny and Butler counties.
The following table sets forth certain information with respect to the offices of the Bank as of September 30, 1998.
Management of the Bank believes that the above properties are adequately covered by insurance and are in good condition. The Bank generally does not invest in real estate directly. The real estate activities of the Bank generally consist of providing loans to the purchasers of the properties. The properties which serve as collateral for the loans may consist of any type of real estate located anywhere in the United States. For a description of the real estate lending activities of the Bank, see "Item 1. Description of Business - Lending Activities."
Item 3.
Item 3. Legal Proceedings
The Company is not involved in any legal proceedings other than legal proceedings occurring in the ordinary course of business, of which none are expected to have a material adverse effect on the Company. In the opinion of management, the aggregate amount involved in such proceedings is not material to the financial condition or results of operations of the Bank.
Items 4. Submission of Matters to a Vote of Securities Holders
Not applicable.
PART II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Matters
The information required herein is incorporated by reference from page 49 of the Company's Annual Report to Stockholders for fiscal 1998 ("Annual Report"). The Company's ability to pay cash dividends in the future is dependent upon, among other things, the receipt of dividends from the Bank.
Item 6.
Item 6. Selected Financial Data
The information contained in the section captioned "Selected Financial Data" of the Annual Report is incorporated herein by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The information required herein is incorporated by reference from pages 36 to 47 of the Company's Annual Report.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required herein is incorporated by reference from pages 36 to 38 of the Company's annual report.
Item 8.
Item 8. Financial Statements
The information required herein is incorporated by reference from pages 6 to 46 of the Company's Annual Report.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act
The information required herein is incorporated by reference from pages 2 to 3 of the Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed within 120 days of September 30, 1999 ("Proxy Statement").
Item 11.
Item 11. Executive Compensation and Transactions
The information required herein is incorporated by reference from pages 3 to 11 of the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management Contents
The information required herein is incorporated by reference from pages 2 to 3 of the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from page 11 of the Proxy Statement.
Item 14.
Item 14. Exhibits, List and Reports on Form 8-K
(a.) Exhibits
The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
2 Agreement and Plan of Reorganization(1) 3.1 Articles of Incorporation(1) 3.2 Bylaws(1) 4 Common Stock Certificate(2) 10.1 Employee Stock Ownership Plan, as amended(2) 10.2 1988 Employee Stock Compensation Program(2) 10.3 1993 Employee Stock Compensation Program(3) 10.4 1997 Employee Stock Compensation Program(4) 10.5 1993 Directors' Stock Option Plan(3) 10.6 Employment Agreement between the Company, the Bank and William L. Windisch(2) 10.7 1998 Group Term Replacement Plan 10.8 1998 Salary Continuation Plan Agreement by and between W.L. Windisch, the Company and the Bank 10.9 1998 Salary Continuation Plan Agreement by and between R.G. Spencer, the Company and the Bank 10.10 1998 Salary Continuation Plan Agreement by and between M.A. Mooney, the Company and the Bank 13 1998 Annual Report to Stockholders 21 Subsidiaries (see Item 1. Description of Business) 23 Consent of Accountants 27 Financial Data Schedule (in electronic filing only)
(1) Incorporated by reference from the exhibits attached to the Prospectus and Proxy Statement of the Company included in its Registration Statement on Form S-4 (registration No. 33-55384) filed with the SEC on December 3, 1992 (the "Registration Statement"). (2) Incorporated by reference from the Registration Statement. (3) Incorporated by reference from an exhibit in Form S-8 filed with the SEC on May 2, 1997. (4) Incorporated by reference from an Exhibit in Form S-8 with the SEC on March 12, 1998.
(b.) Reports on form 8-K
The Company did not file any reports on Form 8-K during the quarter ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto only authorized.
FIDELITY BANCORP, INC.
December 23, 1998 /s/William L. Windisch ---------------------- William L. Windisch Chief Executive Officer and President
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 Company and in the capacities and on December 23, 1998.
/s/ William L. Windisch /s/ Richard G. Spencer - ----------------------- ---------------------- William L. Windisch Richard G. Spencer Director, President and Vice President and Treasurer Chief Executive Officer (also Principal Accounting Officer)
/s/ John R. Gales /s/ Robert F. Kastelic - ----------------- ---------------------- John R. Gales Robert F. Kastelic Director Director
/s/ Oliver D. Keefer /s/ Charles E. Nettrour - -------------------- ----------------------- Oliver D. Keefer Charles E. Nettrour Director Director
/s/ Joanne Ross Wilder - ---------------------- Joanne Ross Wilder Director