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Item 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Forward-Looking Statements
Except for historical information, this report may be deemed to contain
“forward-looking” statements regarding the Corporation. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income,
earnings or loss per share, asset mix and quality, growth prospects, capital structure and other financial terms, (b) statements of plans and objectives of management or the board of directors, and (c) statements of assumptions, such as
economic conditions in the Corporation’s market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “intends”,
“will”, “should”, “anticipates”, or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by forward-looking statements will be achieved. Such statements are subject to risks, uncertainties, and other
factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could impact the Corporation’s operating results include, but are not limited to,
(i) the effects of changing economic conditions in the Corporation’s market areas and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates,
(iv) changes in federal and state banking laws and regulations which could impact the Corporation’s operations, (v) funding costs, and (vi) other external developments which could materially affect the Corporation’s business
and operations.
Critical Accounting Policies
The
consolidated financial statements include the Corporation and its wholly-owned subsidiary, The First National Bank of Mifflintown (the “Bank”). All significant intercompany accounts and transactions have been eliminated.
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require the
Corporation to make estimates and assumptions (see footnote 1 to the financial statements for the year ended December 31, 2006). The Corporation believes that of its significant accounting policies, the allowance for loan losses involves a
higher degree of judgment and complexity.
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The allowance for loan losses is established through a charge to the provision for loan losses. In determining the
balance in the allowance for loan losses, consideration is given to a variety of factors in establishing this estimate. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan
portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and managerial strengths, the adequacy of the underlying collateral, if collateral dependent, or present value of future cash flows and other
relevant factors. The use of different estimates or assumptions could produce different provisions for loan losses. Additional information is provided in the discussion below about the provision for loan losses under “Results of
Operations”.
Financial Condition
Total assets of
the Corporation increased $18,712,000 or 6.7% during the first nine months of 2007. Net loans increased $11,570,000 or 6.5% and securities increased by $10,493,000 or 15.0% from December 31, 2006 to September 30, 2007. The loan growth was
principally in the Bank’s residential and commercial real estate loan portfolios.
Total deposits increased by $19,298,000 or 8.7% from
December 31, 2006 while long-term borrowings decreased by $4,000,000 or 18.2% during the same time period. The Corporation’s new business development was primarily responsible for the deposit growth during the first nine months of 2007.
The bulk of the deposit growth was in time certificates of deposit.
Results of Operations
Net income for the nine months ending September 30, 2007 was $1,506,000 or $1.08 per share compared to $1,420,000 or $1.01 per share for the same period in 2006.
Annualized return on average equity was 10.02% for the first nine months of 2007 and 10.12% for the same period in 2006. Annualized return on average assets was 0.71% for the first nine months of 2007 and 0.70% for the same period in 2006.
Net income for the quarter ending September 30, 2007 was $603,000 or $0.43 per share compared to $508,000 or $0.36 per share for the same period in
2006. Annualized return on average equity was 11.75% for the third quarter of 2007 and 10.63% for the same period in 2006. Annualized return on average assets for the third quarter was 0.82% compared to 0.74% during the third quarter of 2006.
Net interest income for the first nine months of 2007 increased by $113,000 or 2.1% compared to the same period in 2006. This increase is primarily a
result of increased volume of interest earning assets as well as an increase in the yield on earning assets partially offset by an increase in the volume of interest bearing liabilities and an increase in the cost of those liabilities. For the first
nine months of 2007, the net interest margin on a
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fully tax equivalent (FTE) basis was 2.92% compared to 3.04% for the same period in 2006. The FTE basis is calculated by grossing up the yield on tax-exempt
securities and loans by the federal tax rate of 34%, in order that the yield on tax-exempt assets may be comparable to interest earned on taxable assets. The primary driver of the decrease in the net interest margin was the increase in the cost of
funds of 0.40% from 3.09% during the first nine months of 2006 to 3.49% during the same time period in 2007.
Net interest income for the quarter ended
September 30, 2007 increased by $131,000 compared to the same period in 2006. Net interest margin for the quarter ended September 30, 2007 was 2.94% compared to 2.96% during the same period in 2006. The increase in the yield on earning
assets of 0.24% from 6.18% during the third quarter of 2006 to 6.42% during the same period in 2007 was offset by the increase in the cost of funds of 0.26% from 3.22% during the third quarter of 2006 to 3.48% during the same time period in 2007.
Given the current interest rate scenario, expectations are for the net interest margin to remain relatively stable for the next few quarters.
The
Corporation recorded a $30,000 provision for loan losses for the first nine months of 2007 compared to no provision for the first nine months of 2006. As a percentage of loans, the allowance for loan losses was 0.66% at September 30, 2007,
compared to 0.69% at year-end 2006 and 0.71% at September 30, 2006. The decrease in the allowance for loan loss percentage is due to the increase in loan volume with 57.3 % of that increase in residential real estate secured loans.
Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. Management determines the adequacy of the allowance based on on-going quarterly assessments of the loan portfolio,
including such factors as: changes in the nature and volume of the portfolio, effects of concentrations of credit, current and projected economic and business conditions, regulatory and consultant recommendations, repayment patterns on loans,
borrower’s financial condition, current charge-offs, trends in volume and severity of past due loans and classified loans, potential problem loans and supporting collateral. After reviewing the growth in the loan portfolio as well as the other
factors listed above, management believes the allowance is presently adequate to cover the inherent risks associated with the Corporation’s loan portfolio.
Non-interest income in the first nine months of 2007 increased by $136,000 or 9.6% compared to the same period in 2006. Gains on sales of securities decreased by $22,000, income from fiduciary activities increased by $45,000, increased
activity led to ATM card fees increasing by $31,000, realized gain on sale of foreclosed real estate increased $21,000 and service charges on deposit accounts increased by $35,000 during the first nine months of 2007 compared to the same period in
2006.
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Non-interest income for the quarter ending September 30, 2007 was $540,000 compared to $534,000 in 2006. This
increase is in income from fiduciary activities of $20,000 and an increase of $8,000 in ATM fees was offset by a decrease in gains on sales of securities of $24,000.
Total non-interest expense increased in the first nine months of 2007 by $78,000 or 1.6% compared to the first nine months of 2006. Net occupancy & equipment expense increased $32,000, or 3.8%, and
professional fees increased by $109,000 as a result of increased legal and accounting fees, including costs associated with outsourced Sarbanes Oxley compliance consulting services. These increases were offset by a decrease in ATM expense of
$49,000. The decrease in ATM expense is a result of the buydown of the current contract by our ATM and debit card processor, which resulted in a refund of amounts previously expensed of $83,000. As the Corporation continues to add new services,
additional operating costs will be generated. Over time it is anticipated these costs will be offset by the additional income generated through the expansion of services to our customers and community and new business development.
During the quarter ending September 30, 2007, total non-interest expense decreased $31,000 compared to the third quarter of 2006. Supplies and postage expense
increased $19,000, professional fees increased $17,000 and ATM expenses decreased $71,000. As discussed above, the decrease in ATM expense is the result of the buydown of the current contract by our ATM and debit card processor.
Income tax expense was $386,000 for the nine month time period ending September 30, 2007 compared to $331,000 for the same time period in 2006. Income tax expense
as a percentage of income before income taxes was 20.4% for the period compared to 18.9% for 2006. The decrease in the Corporation’s effective tax rate below the statutory rate of 34.0% is a result of tax-exempt income on loans, securities and
bank-owned life insurance. In 2007, these sources of tax-exempt income represented a smaller portion of the Corporation’s pre-tax income thereby increasing the Corporation’s effective tax rate.
Liquidity
Liquidity represents the Corporation’s ability to
efficiently manage cash flows to support customers’ loan demand, withdrawals by depositors, the payment of operating expenses, as well as the ability to take advantage of business and investment opportunities as they arise. One of the
Corporation’s sources of liquidity is $241,672,000 in deposits at September 30, 2007, which increased $19,298,000 over total deposits of $222,374,000 at December 31, 2006. Other sources of liquidity at September 30, 2007 are
available from the following: (1) investments in interest-bearing deposits with banks and federal funds sold, which totaled $2,826,000, (2) securities and time certificates of deposit maturing in one year or less, which totaled $4,411,000,
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and (3) investments in mortgage-backed securities, which supply income and principal cash flow streams on an ongoing basis. In addition, the Corporation
has established federal funds lines of credit with Atlantic Central Bankers Bank and with the Federal Home Loan Bank of Pittsburgh, which can be drawn upon if needed as a source of liquidity. Management is of the opinion that the Corporation’s
liquidity is sufficient to meet its anticipated needs.
Capital Resources
Total shareholders’ equity was $20,897,000 as of September 30, 2007, representing a $1,223,000 increase from December 31, 2006. The growth in capital was a result of net earnings retention of $1,016,000
and an increase in the accumulated other comprehensive income of $207,000. The other comprehensive income during the period is due to the change in value of the Corporation’s available for sale securities.
At September 30, 2007, the Bank had a leverage ratio of 8.70%, a Tier I capital to risk-based assets ratio of 15.18% and a total capital to risk-based assets ratio
of 15.93%. These ratios indicate the Bank exceeds the federal regulatory minimum requirements for a “well capitalized bank”. The Corporation’s ratios are not materially different than those of the Bank.