ITEM 1. BUSINESS
Dauphin Deposit Corporation (the "Corporation") is a bank holding company incorporated under the laws of the Commonwealth of Pennsylvania in 1974. The Corporation's principal banking subsidiaries are Dauphin Deposit Bank and Trust Company ("Dauphin Bank") and Farmers Bank and Trust Company of Hanover ("Farmers Bank") (hereinafter sometimes collectively referred to as the "Banks"), through which the Corporation provides banking services. The Banks are engaged in the commercial and retail banking and trust business including the taking of time and regular savings and demand deposits, the making of commercial and consumer loans and mortgage loans, the providing of credit cards, safe deposit services and the performance of personal, corporate and pension trust services. Auxiliary services such as cash management are provided to commercial customers. The Banks are Pennsylvania chartered bank and trust companies and are not members of the Federal Reserve System. The Banks' deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") to the extent provided by law.
Effective February 1, 1994, the Corporation sold 100% of the issued and outstanding stock of Farmers Bank, a Federal Savings Bank ("Farmers Savings") for a cash purchase price of $796,872. Farmers Savings operates one office in Baltimore City and one office in Baltimore County, Maryland. Both Farmers Bank and Farmers Savings became wholly-owned subsidiaries of the Corporation on July 1, 1992 as a result of the merger of FB&T Corporation with and into the Corporation. Farmers Savings had total assets of $12.7 million at December 31, 1993. The sale of Farmers Savings will not have a material impact on the financial condition or results of operations for the Corporation in 1994.
The Corporation is registered with and is subject to regulatory supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended. Following the sale of Farmers Savings, the Corporation is no longer subject to regulatory supervision by the Office of Thrift Supervision (the "OTS"). The Corporation is restricted to activities which are found by the Federal Reserve Board to be bank-related and which are expected to produce benefits for the public that will outweigh any potentially adverse effects. The operations of the Banks, as well as those of other banks, are significantly affected by the monetary and credit policies and regulations of the federal regulatory agencies.
DAUPHIN BANK - ------------
Dauphin Bank, which includes the Bank of Pennsylvania Division, operates primarily in central and eastern Pennsylvania. Dauphin Bank presently operates 83 banking offices with 60 automated teller machines serving Dauphin, Berks, Chester, Cumberland, Lancaster, Lebanon, Lehigh, Montgomery, Northampton and York Counties. In addition to its main office in Harrisburg, Dauphin County, Dauphin Bank owns an office building in Harrisburg which is used as an administrative center and includes one of the banking offices.
At December 31, 1993, Dauphin Bank had total deposits of $2,792,775,000 and total loans of $1,986,790,000.
FARMERS BANK - ------------
Farmers Bank operates primarily in the south central Pennsylvania counties of York, Adams, Franklin and Cumberland. Farmers Bank presently operates 15 banking offices with eight automated teller machines and one loan production office.
At December 31, 1993, Farmers Bank had total deposits of $498,578,000 and total loans of $376,464,000.
DAUPHIN DEPOSIT CORPORATION
NON-BANKING SUBSIDIARIES - ------------------------
Dauphin Life Insurance Company (the "Insurance Company") is an Arizona corporation which was formed in 1979 as a wholly-owned subsidiary of the Corporation. The Insurance Company reinsures credit life, health and accident insurance directly related to extensions of credit by Dauphin Bank and Farmers Bank and is presently limited to those activities by regulations of the Federal Reserve Board. Directors of the Insurance Company are officers or directors of the Corporation. Effective January 1, 1993, Center Square Life Insurance Company, a credit life insurance company acquired through the merger of FB&T Corporation on July 1, 1992, was merged into the Insurance Company.
Dauphin Investment Company (the "Investment Company") is a Delaware corporation which was formed in 1982 as a wholly-owned subsidiary of the Corporation. The Investment Company manages equity investments for the Corporation. Directors of the Investment Company are officers or directors of the Corporation.
Financial Realty, Inc. is a wholly-owned subsidiary of the Corporation. It is incorporated under the laws of the State of Delaware, and commenced operations in 1982. Financial Realty, Inc. holds title to certain bank buildings which are leased to Dauphin Bank.
Hopper Soliday & Co., Inc. ("HSC") is a wholly-owned subsidiary of the Corporation acquired effective July 1, 1991. HSC is a Delaware corporation which engages in municipal finance, institutional sales, financial advisory and other general securities businesses permitted for bank holding companies and their non-bank subsidiaries.
Farmers Mortgage Company ("Farmers Mortgage") is a wholly-owned subsidiary of the Corporation acquired through the merger of FB&T Corporation on July 1, 1992. Farmers Mortgage was organized in 1983 as a Pennsylvania corporation. Farmers Mortgage makes and acquires loans and other extensions of credit secured by real estate mortgages and deeds of trust.
FARMCO Realty, Inc. ("FARMCO") is a Pennsylvania corporation organized in 1967 as a subsidiary of Farmers Bank. Effective September 30, 1985, FARMCO became a wholly-owned subsidiary of FB&T Corporation and, as a consequence of the merger of FB&T Corporation with and into the Corporation on July 1, 1992, is now a wholly-owned subsidiary of the Corporation. FARMCO is a real estate holding company which holds property leased to Farmers Bank for its branch office locations.
Financial Land Corporation is a Pennsylvania corporation wholly-owned by Dauphin bank which was formed to hold assets acquired in loan liquidations.
Financial Mineral Corporation is a Pennsylvania corporation wholly-owned by Dauphin Bank which was formed to hold assets acquired in loan liquidations.
Reliance Consumer Discount Company (the "Discount Company") is a wholly-owned subsidiary of the Corporation acquired through the merger of FB&T Corporation on July 1, 1992. The Discount Company was organized in 1982 as a Pennsylvania corporation. The assets of the Discount Company were sold by the Corporation in October, 1992 and the Discount Company is no longer an operating subsidiary.
COMPETITION - -----------
The banking industry in the Banks' service areas continues to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds and credit unions. The increased competition has resulted from a changing legal and regulatory climate, as well as from the economic climate.
DAUPHIN DEPOSIT CORPORATION
SUPERVISION AND REGULATION - --------------------------
The Corporation is subject to regulation by the Pennsylvania Department of Banking, the Federal Reserve Board and the Securities and Exchange Commission. Prior to the sale of Farmers Savings on February 1, 1994, the Corporation also was subject to regulation by the OTS. The deposits of the Banks are insured by the FDIC and the Banks are members of the Bank Insurance Fund which is administered by the FDIC. The Banks are subject to regulation and supervision by the Pennsylvania Department of Banking and the FDIC.
The Corporation is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The Federal Reserve Board may also make examinations of the Corporation and each of its non-bank subsidiaries. The BHC Act requires each bank holding company to obtain the approval of the Federal Reserve Board before it may acquire substantially all the assets of any bank, or before it may acquire ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting shares of such bank.
Pursuant to provisions of the BHC Act and regulations promulgated by the Federal Reserve Board thereunder, the Corporation may only engage in or own companies that engage in activities deemed by the Federal Reserve Board to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and the Corporation must gain permission from the Federal Reserve Board prior to engaging in most new business activities.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the BHC Act on any extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
Since March 4, 1990, the Pennsylvania Banking Code of 1965, as amended (the "Banking Code"), has authorized reciprocal interstate banking without any geographic limitation. Reciprocity between states exists when a foreign state's law authorizes Pennsylvania bank holding companies to acquire banks or bank holding companies located in that state on terms and conditions substantially no more restrictive than those applicable to such an acquisition by a bank holding company located in that state. Currently, the state banking statutes in Alaska, Delaware, Idaho, Indiana, Kentucky, Louisiana, Maine, Maryland, Michigan, Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Dakota, Texas, Utah, Vermont, Washington, West Virginia and Wyoming authorize interstate ownership of banks and bank holding companies in each of those states and Pennsylvania. Other states also are considering legislation to authorize reciprocal interstate banking. Congress may pass interstate banking legislation that would accelerate the authorization for interstate banking. The Pennsylvania Banking Department is responsible for determining whether the laws of other states satisfy the reciprocity requirements on a case-by-case basis and also shall determine whether the interstate banking statutes in the above states continue to be reciprocal following any amendments to such statutes.
In addition, pursuant to provisions of the Banking Code, since March 4, 1990, the number of Pennsylvania banks owned or controlled by a bank holding company is not limited.
During 1989, Congress passed new legislation (the Financial Institutions Reform, Recovery and Enforcement Act of 1989) to provide a workable solution to the financial problems of the financial services industry. The direct effect of this legislation on the banking industry was to substantially increase the assessments banks pay to the FDIC for the insurance of bank deposits. The effect of this legislation on the Corporation was to increase the FDIC insurance assessment by approximately 84% or $3.1 million for 1991 over 1990. In 1992, the FDIC insurance assessment increase over 1991 was approximately $.8 million. During 1993, a risk-based assessment was
DAUPHIN DEPOSIT CORPORATION
established which requires banks to pay an assessment rate based on the combination of its capital and supervisory condition.
On December 19, 1991, the President signed into law the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). The primary purpose of FDICIA was to authorize approximately $70 billion in Federal Government loans to the FDIC's Bank Insurance Fund, which is used to satisfy the deposit insurance claims of customers of failed banks and thrifts. FDICIA also created a strict uniform system of capital-based regulation, which became effective on December 19, 1992. FDICIA established five different levels of capitalization of financial institutions, with "prompt corrective actions" and significant operational restrictions imposed on institutions that are capital deficient under the categories. The five categories are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
To be considered well capitalized, an institution must have a total risk- based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, a leverage capital ratio of 5%, and must not be subject to any order or directive requiring the institution to improve its capital level. An institution falls within the adequately capitalized category if it has a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a leverage capital ratio of at least 4%. Institutions with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual capital levels. In addition, the appropriate federal regulatory agency may downgrade an institution to the next lower capital category upon a determination that the institution is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice. Institutions are required under FDICIA to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category. On December 31, 1993, the Corporation and its banking subsidiaries all exceeded the minimum capital levels of the well capitalized category.
Regulatory oversight of an institution becomes more stringent with each lower capital category, with certain "prompt corrective actions" imposed depending on the level of capital deficiency.
FDICIA also includes a provision (Section 303) that generally restricts federally insured state banks, such as the Banks, to activities permitted to national banks. On December 8, 1993, the FDIC published its final rule implementing Section 303. Under the rule, state chartered banks must obtain the FDIC's prior consent before engaging as a principal in any activity not permissible for a national bank, unless one of the exceptions contained in the rule applies. Among the exceptions are activities that the Federal Reserve Board, by regulation (Regulation Y) or order, has found to be closely related to banking for purposes of the BHC Act. Compliance with the rule is not expected to have a material adverse effect on the Banks' operations.
On December 21, 1993, the Federal Reserve Board, FDIC, OTS and Office of the Comptroller of the Currency published a Joint Notice of Proposed Rule Making relating to proposed Community Reinvestment Act regulations. The proposed regulations would substitute a performance based evaluation system in lieu of the 12 Assessment Factors set forth in the current regulations. If adopted, compliance with the proposed regulations may require changes in certain operating procedures and additional costs, both of which cannot currently be determined.
EMPLOYEES - ---------
At December 31, 1993, the Corporation and its subsidiaries employed approximately 1,950 persons.
MERGERS AND ACQUISITIONS - ------------------------
On January 1, 1994 (the "Effective Date"), Valley Bancorp., Inc., a Pennsylvania corporation and bank holding company ("Valley"), was merged with and into the Corporation (the "Merger"). The Merger was approved by the shareholders of Valley at a special shareholders meeting held on October 21, 1993.
DAUPHIN DEPOSIT CORPORATION
Pursuant to the Agreement and Plan of Merger dated June 16, 1993 (the "Plan of Merger"), by and between Valley and the Corporation, each issued and outstanding share of Valley Common Stock was converted into 2.1401 shares of Dauphin common stock, par value $5.00 per share ("Dauphin Common Stock"), and cash in lieu of fractional shares of Dauphin Common stock.
As of the Effective Date, there were 1,236,480 shares of Valley Common Stock issued and outstanding, including 21,000 shares owned by the Corporation. As a result of the Merger, outstanding Valley shares (other than those owned by the Corporation, which were canceled) were converted into approximately 2,600,643 shares of Dauphin Common Stock, plus cash in the approximate aggregate amount of $15,767 in lieu of fractional share interests. On December 31, 1993, the last trading day before the Merger, the closing sale price of Dauphin Common Stock in the NASDAQ National Market System was $25.25. Thus, the total consideration paid by the Corporation to the holders of Valley Common Stock in dollar equivalent terms was approximately $65.7 million as of the Effective Date.
Simultaneously with the Merger of Valley into the Corporation, Valley Bank and Trust Company ("Valleybank"), a subsidiary of Valley and a Pennsylvania chartered bank, was merged (the "Bank Merger") with and into Dauphin Bank, with Dauphin Bank being the surviving corporation. Valleybank, which operates 13 branch banking offices in south central Pennsylvania (primarily Franklin County, Pennsylvania), will be operated after the Effective Date as the Valleybank Division of Dauphin Deposit Bank.
Valley had total assets of $324 million at December 31, 1993. The Merger was accounted for as a pooling-of-interests.
ITEM 2.

ITEM 2. PROPERTIES
The Corporation's principal office is located in Dauphin Bank's main banking offices at 213 Market Street, Harrisburg, Pennsylvania. The Corporation owns no real estate.
The Banks, Financial Realty, Inc. and FARMCO Realty, Inc. own 67 of the branch offices and lease 35 other offices including two leases which are treated as capitalized leases for financial reporting purposes. Hopper Soliday & Co., Inc. leases three of its sales offices. Leases expire intermittently through 2010 and most contain options to renew.
Aggregate annual rentals for real estate and equipment paid during the Corporation's last fiscal year did not exceed five percent of its operating expenses.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Various legal actions or proceedings are pending involving Dauphin or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions of all of the executive officers of the Corporation as of February 3, 1994 are listed below along with their business experience during the past five years. Executive officers are appointed by the Board of Directors. There are no family relationships among these executive officers, nor any arrangement or understanding between any executive officer and any other person pursuant to which the executive officer was selected.
DAUPHIN DEPOSIT CORPORATION
DAUPHIN DEPOSIT CORPORATION PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF DAUPHIN COMMON STOCK AND DIVIDENDS PAID
The price information provided below reflects actual high, low and closing sales prices as quoted on the NASDAQ National Market System.
DAUPHIN DEPOSIT CORPORATION
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
DAUPHIN DEPOSIT CORPORATION ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section presents management's discussion and analysis of the financial condition and results of operations of Dauphin Deposit Corporation and subsidiaries (Dauphin), including Dauphin Deposit Bank and Trust Company, which includes the Bank of Pennsylvania Division, and Farmers Bank and Trust Company of Hanover (the Banks). This discussion and analysis should be read in conjunction with the financial statements which appear elsewhere in this report.
In 1993 the provisions of Statement of Financial Accounting Standards No. 112 (SFAS 112), "Employers' Accounting for Postemployment Benefits" were adopted. Effective January 1, 1992, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions". Also during 1992, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes".
Effective July 1, 1991, Hopper Soliday & Co., Inc. (Hopper Soliday), a securities broker/dealer, was acquired for $3.3 million in cash pursuant to a stock purchase agreement signed in November 1990. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of Hopper Soliday since the date of acquisition are included with the results of Dauphin.
RESULTS OF OPERATIONS
SUMMARY
Dauphin Deposit Corporation recorded net income of $64.5 million for 1993, compared with $57.2 million recorded in 1992. On a per common share basis, net income rose to $2.15 from $1.93 in 1992 and $1.84 in 1991. The 1993 results of operations represent the 22nd consecutive year that Dauphin has reported increased earnings per share.
Return on average total assets was 1.43% for 1993, compared with 1.31% for 1992 and 1.29% for 1991. Return on average equity for 1993 was 14.33%, compared with 14.07% for 1992 and 14.75% for 1991.
During 1993 average earning assets increased 3.9% to $4.2 billion and the net interest margin increased from 4.11% to 4.16%. This growth in earning assets and the improved net interest margin produced an increase of $8.9 million or 5.3% in fully taxable equivalent net interest income.
Dauphin continues to maintain a high quality loan portfolio. The percentage of non-performing assets, comprised of non-accrual loans, restructured loans and other real estate owned represented 1.10% of year-end loans and other real estate owned, down from 1.26% at December 31, 1992. The allowance for loan losses was maintained at 1.53% of year-end loans. The allowance exceeds non- performing loans by 56% and includes $17.7 million which is not allocated to any specific loan category. Because of this strong asset quality, the provision for loan losses was decreased by $1.6 million in 1993.
Non-interest income, other than securities gains, increased $5.0 million, or 10.0%. Included in other non-interest income is a $3.6 million non-recurring tax refund from a settlement with the Commonwealth of Pennsylvania. Increased income was also the result of growth in fiduciary activities, service charges on deposit accounts, credit card related activities, mortgage sales and servicing and letter of credit fees. Offsetting these increases somewhat was a decline in commission and fee income generated by Hopper Soliday.
Non-interest expense items increased $3.9 million, or 3.2%. Effective January 1, 1993, Dauphin adopted SFAS 112. The incremental effect of SFAS 112 was to increase non-interest expense by $.5 million. Also contributing to this increase were normal salary adjustments and controlled additions to staffing levels, a $1.0 million increase in professional fees and increases in other miscellaneous expenses. 1992 included $2.4 million in merger related expenses in connection with the acquisition of Farmers Bank and Trust Company of Hanover.
DAUPHIN DEPOSIT CORPORATION
TABLE 1--AVERAGE BALANCES, RATES AND INTEREST INCOME AND EXPENSE SUMMARY (TAXABLE EQUIVALENT BASIS)
- -------- (1) Includes fees on loans. Average loan balances include non-accruing loans. (2) Includes home equity loans. (3) Loans outstanding net of unearned income.
DAUPHIN DEPOSIT CORPORATION
NET INTEREST INCOME
Net interest income is the product of the volume of average earning assets and the average rates earned on them, less the volume of average interest bearing liabilities and the average rates paid thereon. The amount of net interest income is affected by changes in interest rates, account balances, or volume, and the mix of earning assets and interest bearing liabilities.
For analytical purposes, net interest income is adjusted to a taxable equivalent basis. This adjustment facilitates performance comparisons among taxable and tax exempt assets by increasing tax exempt income by an amount equivalent to the federal income taxes which would have been paid if this income were taxable at the federal statutory rate of 35% for 1993 and 34% for prior years.
Table 2 presents the net interest income on a fully taxable equivalent basis for each of the years in the three year period ended December 31, 1993.
TABLE 2--NET INTEREST INCOME
TABLE 3--RATE-VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
Note: The changes not due solely to change in volume or solely to change in rate are allocated proportionally to both change in volume and rate.
Net interest income on a fully taxable equivalent basis totaled $176.5 million in 1993, an increase of $8.9 million or 5.3% from $167.6 million in 1992. Net interest income in 1992 was up 7.8% from $155.5 million in 1991.
DAUPHIN DEPOSIT CORPORATION
Table 1 presents average balances, taxable equivalent interest income and expense and average rates earned and paid for Dauphin's assets and liabilities. Table 3 analyzes the changes attributable to the volume and rate components of net interest income.
During 1993 there was an increase in net interest income of $12.9 million due to changes in volume and a decrease of $4.0 million due to changes in rate. In 1992 there was an increase of $13.1 million due to changes in volume and a decrease of $1.0 million due to changes in rate.
The change in the net interest margin attributable to interest rates can be understood by analyzing the interest rate spread and the net interest margin on earning assets. While the interest rate spread considers only the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities, the net interest margin takes into account the contribution of assets funded by interest free sources.
As reflected in Table 4, average earning assets increased to $4.2 billion in 1993 from $4.1 billion in 1992 and $3.8 billion in 1991. The interest rate spread for 1993 was 3.63% compared with 3.50% for 1992 and 3.30% for 1991. The net interest margin for 1993 was 4.16% compared with 4.11% for 1992 and 4.05% for 1991.
TABLE 4--INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
Interest rates continued to fall during 1993. The average prime rate in 1993 was 6.00% compared with 6.25% in 1992. The average federal funds rate decreased to 3.02% for 1993 compared with 3.53% for 1992. During 1993, compared with 1992, the average yield on earning assets decreased 77 basis points while the average cost of funds decreased 90 basis points resulting in an increase in the interest rate spread of 13 basis points. The yield on the investment portfolio decreased 73 basis points due to the reinvestment of maturities at significantly lower rates. Average loans, which represent the highest yielding earning assets, increased $56.5 million or 2.6% and produced a yield of 7.86% in 1993 compared with 8.63% in 1992. This 77 basis point decrease in yield was caused by the decrease in the prime interest rate affecting variable rate loans, the amount of refinancings of fixed rate loans and the interest rates on consumer loans compared with 1992. Average loans represented 52.9% of the average earning assets for 1993. The cost of interest bearing deposits decreased to 3.89% in 1993 compared with 4.84% in 1992. The overall interest rates offered on these deposits continued to decline during 1993. Additionally, the mix of these deposits continued to change significantly as depositors allowed longer term certificates of deposit to mature and decided to reinvest these proceeds into shorter term instruments. The decrease in the cost of short-term borrowings (52 basis points) was caused primarily by the decline in the federal funds rate. As in recent prior years, the increase in the net interest margin, compared with the increase in the interest rate spread, was negatively affected by the decreased value of non-interest bearing funds in a lower interest rate environment.
DAUPHIN DEPOSIT CORPORATION
During 1992, compared with 1991, the average yield on earning assets decreased 130 basis points while the average cost of interest bearing liabilities decreased 150 basis points resulting in an increase in the interest rate spread of 20 basis points. The increase in the interest rate spread was the result of several factors. The yield on the investment portfolio decreased only moderately (100 basis points) due to the longer maturity structure of the portfolio, the amount of state and municipal securities in the portfolio at higher rates and the increased yield generated from mortgage-backed securities. Average loans increased $49.6 million or 2.3% and represented 53.6% of the average earning assets for 1992 compared with 55.7% for 1991. The average prime interest rate for 1992 was 6.25% compared with 8.48% for 1991, a decrease of 223 basis points. This decrease in the average prime interest rate was the primary reason for the 151 basis point decrease in the overall average loan yield for 1992 compared with 1991. The cost of interest bearing deposits decreased to 4.84% in 1992 compared with 6.26% in 1991. This decline was caused by lower rates offered and the change in the mix of deposits from longer term instruments to shorter term instruments. Finally, the average cost of short- term borrowings decreased 209 basis points during 1992 as a result of the lower federal funds rate during 1992 compared with 1991. While the interest rate spread increased 20 basis points, the net interest margin increased six basis points. As previously mentioned, the net interest margin was negatively affected by the decreased value of non-interest bearing funds in a lower interest rate environment.
PROVISION FOR LOAN LOSSES
The provision for loan losses charged against earnings was $9.4 million in 1993 compared with $10.9 million in 1992, a decrease of 14.4%. This decrease was mainly due to the good asset quality of the loan portfolio. The provision is based on management's estimate of the amount needed to maintain an adequate allowance for loan losses. This estimate is based on the review of the loan portfolio, the level of net credit losses, past loan loss experience, the general economic outlook and other factors that management feels are appropriate.
Management takes an aggressive approach to charging off loans partly due to its analysis of the general economic outlook. This does not necessarily indicate a material decline in the asset quality of the loan portfolio.
Several improvements were seen in certain measures of loan portfolio performance. The ratio of net charge-offs to average loans decreased to .31% in 1993 from .33% in 1992 and the level of non-accruing loans and restructured loans decreased to $23.1 million (.98% of year-end loans) from $24.2 million (1.10% of year-end loans) at December 31, 1992.
NON-INTEREST INCOME
Total non-interest income increased $4.3 million or 7.9% in 1993 compared with an increase of $10.0 million or 22.7% in 1992. Excluding gains on investment securities, the 1993 increase was $ 5.0 million or 10.0% compared with $8.8 million or 21.4% for 1992.
Income from fiduciary activities increased $.2 million or 1.1% in 1993. Revenue in 1993 was negatively impacted by a decline in trust income fees as interest rates fell during 1993. Also, estate fees declined in 1993 when compared to 1992. The increase of $.5 million or 3.9% in 1992 was primarily the result of revenue improvements in the areas of corporate services and employee benefits.
Service charges on deposit accounts increased $1.1 million or 9.6% during 1993. In 1992, this increase was $.8 million or 8.1%. Management continuously monitors the fee structure and makes changes where appropriate. These increases reflect both the growth in fee-based accounts and changes in the fee structure. Included in 1993 is $.5 million from new fees on certain individual retirement accounts.
Other service charges and fees increased $1.0 million or 10.8% in 1993 compared with a decrease of $.6 million or 6.6% in 1992. The increase in 1993 was due to increases in credit card related activities, mortgage sales and servicing and letter of credit fees. The decrease for 1992 was primarily the result of the negative impact on the valuation of the excess servicing rights due to the large amount of home mortgage refinancings in 1992.
DAUPHIN DEPOSIT CORPORATION
Broker/dealer commissions and fees represent the income generated by Hopper Soliday. This income is generated from underwriting securities which are predominantly general obligations of Central Pennsylvania municipalities, providing financial advisory services, selling securities to individual and institutional investors and other related activities.
Securities gains totaled $3.2 million in 1993 as compared with $4.0 million in 1992 and $2.8 million in 1991. The sale of debt securities generated $1.5 million in net gains for 1993. The sale of equity securities generated $1.7 million in net gains. During 1992 the sale of debt securities generated $2.9 million in net gains compared with $1.1 million in net gains from equity securities transactions.
Other non-interest income increased $3.5 million for 1993 compared with 1992. In 1992, compared with 1991, other non-interest income increased $.4 million. In December 1993 a settlement with the Commonwealth of Pennsylvania was entered into which resulted in a refund of $3.6 million in previously paid Bank Shares Tax plus interest. This non-recurring refund is the result of litigation contesting the Commonwealth's ability to tax United States Obligations. Gains from loan sales, primarily fixed rate residential mortgages, included in other non-interest income amounted to $1.6 million for 1993 and 1992 compared with $1.3 million for 1991.
TABLE 5--NON-INTEREST INCOME
NON-INTEREST EXPENSE
Non-interest expense increased $3.9 million or 3.2% in 1993 compared with an increase of $14.4 million or 13.4% in 1992. Without including the expenses of Hopper Soliday, the increase for 1993 would have been $4.2 million or 3.8% and $7.8 million or 7.5% for 1992.
Salaries and employee benefits increased .9% in 1993 and 17.7% in 1992. The increase for 1993 was, for the most part, due to normal salary adjustments and increased benefits costs, which were partially offset by a $.3 million decrease in Hopper Soliday's salaries and employee benefits due to the decreased commission and fee income produced. Without Hopper Soliday, salaries and employee benefits increased $1.1 million or 2.0% for 1993 compared with 1992. For 1992, compared with 1991, this increase was $4.5 million or 8.8%. 1993 includes the impact of adopting SFAS 112 which amounted to an incremental cost of $.5 million. As explained in more detail in Note 13 of the Notes to Consolidated Financial Statements, SFAS 112 changed the practice of accounting for postemployment benefits from a pay-as-you-go basis to an accrual basis. Full-time equivalent employees increased 1.7% to 1,950 at December 31, 1993 compared with 1,917 at year-end 1992. The ratio of average assets (millions) per full-time equivalent employee was 2.31 at December 31, 1993 compared with 2.27 at December 31, 1992.
DAUPHIN DEPOSIT CORPORATION
All other non-interest expense items increased $3.3 million or 5.6% in 1993 and $5.0 million or 9.1% in 1992. Without the effect of Hopper Soliday, the increase would have been $3.1 million or 5.4% for 1993 and $3.3 million or 6.2% for 1992. The increase for 1993 was primarily the result of increases in insurance, occupancy expenses, professional fees, computer processing, purchased software costs, merchant processing interchange expense, advertising costs and $.5 million in merger expenses in connection with the acquisition of Valley Bancorp., Inc. (see Note 2 of the Notes to Consolidated Financial Statements). The increase in 1992 included $2.4 million in merger expenses in connection with the acquisition of Farmers Bank and Trust Company of Hanover along with increases in occupancy expenses, professional fees, deposit insurance, computer processing and purchased software costs. Increases in computer processing and purchased software costs are, in most cases, brought about by increases in volume of transactions and the acquisition of new software and hardware for future growth and expansion.
During 1989 Congress passed legislation (The Financial Institutions Reform, Recovery and Enforcement Act of 1989) to provide a workable solution to the financial problems of the financial services industry. The direct effect of this legislation on the banking industry was to substantially increase both the expense and burden of regulation and the assessment banks pay to the FDIC, the entity which insures a bank's depositors of their funds deposited with a bank. The effect of this increase on Dauphin was to increase this expense by 11.3% or $.8 million for 1992. During 1993 a risk-based assessment was established which required banks to pay an assessment rate based on the combination of its capital and supervisory condition.
TABLE 6--NON-INTEREST EXPENSE
PROVISION FOR INCOME TAXES
Income tax expense amounted to $20.5 million in 1993 as compared with $17.2 million in 1992 and $13.3 million in 1991. Dauphin's effective tax rate for 1993 was 24.1% compared with 23.1% in 1992 and 20.1% in 1991. In 1992 Dauphin adopted the provisions of SFAS 109 (see Note 1 of the Notes to Consolidated Financial Statements) and elected to restate prior years financial statements. In connection with this adoption, net income for the years 1992 and 1991 was increased by $.5 million and $1.2 million, respectively. Additionally, during 1993 new tax legislation was enacted retroactive to January 1, 1993. The immediate impact, among other things, was to increase the corporate tax rate from 34% to 35%. This increased rate resulted in additional income tax expense of $.3 million for 1993. For a more comprehensive analysis of income tax expense, refer to Note 12 of the Notes to Consolidated Financial Statements.
DAUPHIN DEPOSIT CORPORATION
FINANCIAL CONDITION
SOURCES AND USES OF FUNDS
Dauphin's financial condition can be evaluated in terms of trends in its sources and uses of funds. The comparison of average balances in Table 7 indicates how Dauphin has managed these elements. Average funding uses increased $157.7 million or 3.9% in 1993 as compared with an increase of $247.8 million or 6.5% in 1992.
TABLE 7--SOURCES AND USES OF FUNDS
- -------- (1) Non-interest bearing liabilities and stockholders' equity less non-interest bearing assets.
INVESTMENT SECURITIES AND OTHER SHORT-TERM INVESTMENTS
Average short-term investments and investment securities, in the aggregate, increased $77.3 million or 4.1% during 1993 compared with an increase of $192.1 million or 11.4% during 1992. During both 1993 and 1992 funds provided from increases in deposits and short-term borrowings exceeded the increase in the loan portfolio.
The balances maintained for short-term investments and investment securities are, for the most part, supported by short-term deposits such as money market and NOW accounts, short-term borrowings and time deposits. As reflected in Table 8, the average maturity of the investment portfolio was 6.8 years at year-end 1993. Included in the portfolio are state and municipal securities and mortgage-backed securities that have a longer term maturity but are sometimes either called before maturity or have repricing characteristics that occur before final maturity. The average life to call or repricing of the portfolio was 1.8 years at December 31, 1993.
DAUPHIN DEPOSIT CORPORATION
Dauphin had no investments in any foreign country that aggregated more than 1% of assets at December 31, 1993, 1992 or 1991.
At December 31, 1993, net unrealized appreciation in the portfolio was $63.2 million consisting of gross unrealized gains of $64.9 million and gross unrealized losses of $1.7 million. Dauphin will adopt Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities" as of January 1, 1994. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments are to be classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity.
Management has determined that the entire investment securities portfolio will be classified as available-for-sale. The impact of this change will result in an increase in investment securities of $63.2 million and an increase in stockholders' equity of $41.1 million, representing the after tax impact.
TABLE 8--ANALYSIS OF INVESTMENT SECURITIES
LOANS
Average loans increased $56.5 million or 2.6% during 1993 compared with an increase of $49.6 million or 2.3% in 1992. Loan demand improved slightly as 1993 progressed.
The economy in our market area is diversified and has been relatively stable. This affords Dauphin the opportunity to select quality commercial credits and stabilizes our consumer business.
DAUPHIN DEPOSIT CORPORATION
Loan balances during 1993 were influenced by the improving economy and, as a result, balances in both the commercial and consumer areas increased. Additionally, as interest rates continued to fall, many residential mortgages were refinanced into lower fixed rate mortgages. These fixed rate mortgages were sold in the secondary mortgage market. It has been Dauphin's policy to sell and continue to service these mortgages in order to avoid taking interest rate risk.
Dauphin's policy is to make the vast majority of its loans and commitments in the market area it serves. This tends to reduce risk and gives Dauphin the opportunity to deliver its many products to the same customer base. Dauphin had no foreign loans in its portfolio at December 31, 1993.
TABLE 9--LOANS OUTSTANDING, NET OF UNEARNED INCOME
- -------- (1) Includes home equity loans
TABLE 10--LOAN MATURITIES AND INTEREST SENSITIVITY (1)
- -------- (1) Excludes residential mortgages, consumer loans and lease financing
DEPOSITS
Average deposits, including non-interest bearing demand deposits, decreased $57.7 million or 1.7% during 1993 compared with an increase of $59.0 million or 1.8% in 1992. Dauphin's subsidiary banks, like many other commercial banks, have experienced slow deposit growth as the competition for depositors' funds has become more intense. Competition for deposits has come from other commercial banks, thrift institutions, credit unions, brokerage houses and mutual funds. Deposit growth is also affected by the movement of interest rates. During
DAUPHIN DEPOSIT CORPORATION 1993 and 1992 interest rates offered on time deposits have fallen substantially, whereby rates offered on longer term instruments are not materially higher than short-term instruments. This resulted in a greater increase in interest bearing demand deposits and savings deposits compared with certificates of deposit. Included in interest bearing deposits are certain individual retirement accounts (IRA) totaling $157.8 million which are invested in 18 month variable interest rate products with a minimum interest rate of 10%. During 1993, Dauphin charged a service fee on these products, and initiated the process to discontinue them in accordance with the terms of the IRA contract. Litigation was filed against Dauphin challenging the right to charge fees on these particular products. The right to terminate this product is also in dispute. Management intends, however, to vigorously defend its entitlement to charge fees and its right to terminate these products in accordance with their terms. Also during 1993 and 1992 average time deposits of $100,000 or more decreased $37.4 million and $19.7 million, respectively. This funding source was replaced by lower costing overnight federal funds. Additionally, the growth of non-interest bearing deposits has been relatively slow in recent years. The percentage of average non-interest bearing demand deposits to average total deposits amounted to 11.1% in 1993, 10.1% for 1992 and 9.9% for 1991. Dauphin's banking subsidiaries have remained interest rate competitive and have introduced new deposit products to maintain and attract deposits.
SHORT-TERM BORROWINGS
Average short-term borrowings increased $163.0 million or 33.9% during 1993 compared with an increase of $108.3 million or 29.0% in 1992. Short-term borrowings are primarily represented by federal funds purchased and securities sold under agreements to repurchase. The level of short-term borrowings is dependent upon many items such as loan growth, deposit growth and the interest rates paid for these funds. As previously mentioned, a portion of the growth in 1993 and 1992 was the result of a need to replace the decrease in time deposits of $100,000 or more. The average cost of short-term borrowings decreased from 5.62% in 1991 to 3.53% in 1992 and to 3.01% in 1993.
NON-PERFORMING ASSETS
Table 11 reflects Dauphin's non-performing assets for the five years ended December 31, 1993. Dauphin's policy is to discontinue the accrual of interest on commercial loans on which principal or interest is past due 90 days or more and on commercial mortgages on which principal or interest is past due 120 days or more. Consumer loans, excluding residential mortgages, which are 150 days past due are charged off. Residential mortgages are placed on non-accrual status after becoming 180 days past due. When a loan is placed on non-accrual status, any unpaid interest is generally charged against income. Management believes that strict adherence to this policy with regard to non-accruals and charge-offs will insure that the historically high quality of the loan portfolio will be maintained. Other real estate owned represents property acquired through foreclosure or considered to be in an in-substance foreclosure status.
Loan quality is maintained through diversification of risk, strict enforcement of credit control practices and continued monitoring of the loan portfolio.
At December 31, 1993, Dauphin had no loan concentrations exceeding 10% of total loans. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by economic or other industry specific conditions.
Loans which are not included in non-performing and are current as to payments of principal and interest but have a somewhat higher than normal risk of becoming non-accrual or reduced rate in the future are estimated to total approximately $7.0 million at December 31, 1993 compared with $7.4 million at December 31, 1992.
DAUPHIN DEPOSIT CORPORATION
Federal regulatory authorities have defined "highly leveraged transactions" (HLT's) as a credit of $20 million or more which is extended in connection with an acquisition by, or a restructuring of, an organization, and the extension of credit results in "high leverage" or is made to an already highly leveraged organization. It is the policy of Dauphin to consider financing HLT's for its customers or for potential customers in its market area which usually involves the change of ownership from one generation of a family to the next, or from present owners to the existing management team. The amount of HLT's, as defined by the Federal regulatory authorities, was $10.2 million at December 31, 1993 and $7.2 million at December 31, 1992 and represents Dauphin's portion of a shared national credit within its market area.
TABLE 11--NON-PERFORMING ASSETS
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is based on management's continuing evaluation of the loan portfolio, assessment of economic conditions, the diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience and the amount and quality of non-performing loans. Table 12 presents the allocation of the allowance for loan losses by major loan category for the past five years. The specific allocations in any particular category may prove excessive or inadequate and consequently may be re-allocated in the future to reflect then current conditions. Accordingly, the entire allowance is considered available to absorb losses in any category.
TABLE 12--ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
DAUPHIN DEPOSIT CORPORATION
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowance for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Table 13 reflects an analysis of the allowance for loan losses for the past five years.
The provision for loan losses of $9.4 million exceeded the net charge-offs of $6.9 million, thereby increasing the allowance for loan losses from $33.6 million in 1992 to $36.1 million in 1993. The allowance for loan losses as a percentage of year-end loans was 1.53% at December 31, 1993 and 1992.
TABLE 13--ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
In May 1993, Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan" was issued. SFAS 114 addresses the accounting by creditors for impairment of certain
DAUPHIN DEPOSIT CORPORATION loans. SFAS 114 requires that impaired loans that are within the scope of the Statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, at the loan's market price of the fair value of the collateral if the loan is collateral dependent. Management presently does not know and cannot reasonably estimate the impact of SFAS 114 on its financial statements. SFAS 114 is effective for fiscal years beginning after December 15, 1994 and earlier adoption is permitted. Dauphin expects to adopt SFAS 114 in January 1995.
LIQUIDITY
Liquidity management involves meeting the funds flow requirements of customers who may be either depositors wanting to withdraw funds, or borrowers needing assurance that sufficient funds will be available to meet their credit needs.
Liquidity from asset categories is provided primarily through investment securities with maturities of less than one year and short-term investments, such as deposits with other banks, federal funds sold and other short-term investments. Dauphin's asset liquidity position is strong because of the investment portfolio's maturity structure (Table 8), the amount of short-term investments, the funds provided by loan maturities (Table 10) and the funds available to Dauphin by established federal funds lines of credit. Additionally, in 1991 Dauphin Deposit Bank and Trust Company became a member of the Federal Home Loan Bank of Pittsburgh. These established credit arrangements provide the Banks with increased liquidity.
The generation of deposit balances is the primary source of liquidity from liability categories. Total deposits decreased by $100.3 million or 2.9% from year-end 1992 to year-end 1993. As previously mentioned, this funding source was replaced by lower costing overnight federal funds. Table 14 reflects the growth in the major classifications of deposits by comparing the year-end balances for the past three years and Table 15 reflects the maturity of large dollar deposits for the same periods. Federal funds purchased and other forms of short-term borrowings are also significant sources of liquidity. Dauphin continues to maintain diverse liability funding sources.
TABLE 14--DEPOSITS BY MAJOR CLASSIFICATION
TABLE 15--MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
DAUPHIN DEPOSIT CORPORATION
CAPITAL RESOURCES
Total stockholders' equity increased $42.1 million or 9.8% in 1993 compared with an increase of $50.0 million or 13.1% in 1992. The increase for 1993 was, for the most part, retained earnings or internal capital generation. The increase for 1992 was primarily the result of retained earnings and the $12.6 million net proceeds received from the reissuance of 700,000 shares of previously acquired treasury stock in a public offering. The purpose of the offering was to enable the acquisition of Farmers Bank and Trust Company of Hanover to be accounted for as a pooling-of-interests. The proceeds have been used for general corporate purposes. The ratio of average equity to average assets amounted to 9.98% for 1993, compared with 9.34% for 1992 and 8.77% for 1991. Internal capital generation is measured as the percent of return on average equity multiplied by the percent of earnings retained. The resulting internal capital generation percentage amounted to 8.8% for 1993 compared with 8.4% for 1992 and 9.1% for 1991.
Common measures of adequate capitalization for banking institutions are ratios of capital to assets. These ratios indicate the proportion of permanently committed funds to the total asset base. Guidelines issued by federal regulatory authorities require both banks and bank holding companies to meet minimum risk-based capital ratios in an effort to make regulatory capital more responsive to the risk exposure related to a bank's on- and off-balance sheet items. Risk-based capital guidelines redefine the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of capital requirements. The components of risk- based capital are segregated as Tier 1 and Tier 2 capital. Tier 1 capital is composed of total stockholders' equity reduced by goodwill and other intangible assets. Tier 2 capital is the allowance for loan losses (with certain limitations) and qualifying debt obligations. Regulators have also adopted minimum Tier 1 leverage ratio standards. Tier 1 capital for the leverage ratio is the same as the Tier 1 capital definition in the risk-based capital guidelines. Table 16 presents the capital ratios for Dauphin for the past three years calculated at year-end in accordance with these guidelines. At December 31, 1993, Dauphin and its banking subsidiaries exceeded all capital requirements.
TABLE 16--CAPITAL RATIOS
In January 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 1,000,000 shares of its outstanding common stock. Dauphin expects to use available cash to fund the share repurchases which will be made from time to time on the open market or in privately negotiated transactions. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan,Stock Option Plan and other appropriate uses.
INTEREST RATE SENSITIVITY
Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.
Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between prime rates and rates paid on purchased funds are not constant over time. The rate of growth in interest free sources of funds will influence
DAUPHIN DEPOSIT CORPORATION the level of interest sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest sensitivity gap is only one factor to be considered in estimating the net interest margin.
Table 17 presents an interest sensitivity analysis of Dauphin's assets and liabilities at December 31,1993 for several time intervals. This table reflects the interest sensitivity gap in two formats. The detailed presentation represents management's position on certain interest bearing deposits, such as passbook savings and NOW accounts, as not being subject to immediate repricing. Management is of the opinion that historical interest rate movements indicate that these products do not reprice in direct relation to the change in the interest rate environment. Additionally, these products have provided Dauphin with a stable core deposit base. Therefore, the detailed presentation within Table 17 attempts to reflect these products in the appropriate interest sensitivity time interval based on their interest sensitivity to the movement of other interest rates. Also included in Table 17 is a summary of the gap, as viewed by certain regulatory authorities, which presents these interest bearing deposits as being subject to immediate repricing.
TABLE 17--INTEREST SENSITIVITY ANALYSIS
An interest sensitivity analysis is measured as of a specified date and, therefore, is subject to almost immediate change as the maturities of assets are reinvested and liabilities, such as deposits and short-term borrowings, are received or mature. The mismatch of assets and liabilities in a specific time frame is referred to as a sensitivity gap. An asset sensitive gap will benefit Dauphin during periods of rising interest rates, while a liability sensitive gap will benefit Dauphin during declining rates. The gap reflects Dauphin's sensitivity to rate changes over a period of time. Dauphin continuously monitors and adjusts the gap position, taking into consideration current interest rate projections, and maintaining flexibility if rates move contrary to expectations.
DAUPHIN DEPOSIT CORPORATION
ACQUISITION AND DIVESTITURE
On January 1, 1994, Dauphin acquired all the outstanding stock of Valley Bancorp., Inc. (Valley) in exchange for 2,600,643 shares of Dauphin's common stock, along with cash of $16,000 in lieu of fractional shares, consummating the merger announced in June 1993. Valley's principal subsidiary was Valley Bank and Trust Company. Valley has total assets of $324 million at December 31, 1993. The acquisition was accounted for as a pooling-of-interests.
In addition, on August 23, 1993 Dauphin entered into an agreement to sell 100% of the stock of Farmers Savings Bank, a Federal Savings Bank (FSB), for $.8 million. The sale was consummated on February 1, 1994. FSB had total assets of $12.7 million at December 31, 1993. The sale of FSB will not have a material impact on the financial condition or results of operations for Dauphin in 1994.
EFFECTS OF INFLATION
The impact of inflation upon banks differs from the impact upon non-financial institutions. Banks, as financial intermediaries, have assets which are primarily monetary in nature and change corresponding to movements in the inflation rate. The precise impact of inflation upon Dauphin is difficult to measure. Inflation may cause non-interest expense items to increase at a more rapid rate than earning sources. Inflation may also affect the borrowing needs of consumers, thereby affecting the growth rate of Dauphin's assets. Inflation may also affect the general level of interest rates, which can have an effect on the profitability of Dauphin.
DAUPHIN DEPOSIT CORPORATION ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited consolidated financial statements and documents are set forth in this Annual Report on Form 10-K on the following pages:
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1993, 1992 and 1991
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1993, 1992 and 1991
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1993, 1992 and 1991
Total interest paid amounted to $97,691, $129,598 and $164,214, respectively. Total income taxes paid amounted to $22,458, $19,693 and $12,256, respectively. Total loan sales amounted to $104,541, $89,318 and $67,114, respectively.
See accompanying notes to consolidated financial statements.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1993, 1992 AND 1991
1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting policies of Dauphin Deposit Corporation and subsidiaries.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. The material estimate that is particularly susceptible to significant change in the near-term relates to the determination of the allowance for loan losses.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Dauphin Deposit Corporation and subsidiaries (Dauphin), including its principal subsidiaries, Dauphin Deposit Bank and Trust Company, which includes the Bank of Pennsylvania Division, and Farmers Bank and Trust Company of Hanover (the Banks). All material intercompany balances and transactions have been eliminated in consolidation.
INVESTMENT SECURITIES
Investment debt securities are carried at cost adjusted for amortization of premium and accretion of discount. Debt securities are carried at cost since Dauphin currently has the ability and intent to hold to maturity. Marketable equity securities are carried at the lower of cost or market value. Unrealized losses on equity securities are reported as a reduction of investment securities and net of taxes as a reduction of stockholders' equity. Realized gains or losses on the sale of investment securities (determined by the specific identification method) are shown separately in the statements of income.
Dauphin will adopt Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities" as of January 1, 1994. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments are to be classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity.
Management has determined that the entire investment securities portfolio will be classified as available-for-sale. This change will result in an increase in investment securities of $63,243,000 and an increase in stockholders' equity of $41,108,000, representing the after tax impact.
LOANS
Loans are carried at the principal amount outstanding, net of unearned income. Interest income is accounted for on an accrual basis. Interest income is not accrued when, in the opinion of management, its collectibility is doubtful. When a loan is designated as non-accrual, any accrued interest receivable is generally
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 charged against current earnings. Lease income is recorded using the finance method which provides for a level rate of return on the investment outstanding.
Mortgages held for sale are carried at the lower of aggregate cost or market value with resulting gains and losses included in other income. Excess servicing fees are computed as the present value of the difference between the estimated future net servicing revenues and normal servicing revenues as established by the federally sponsored secondary market makers. Upon the sale of mortgage loans, excess servicing fees are deferred and amortized over the estimated life of the related mortgages.
Loan fees and costs of loan origination are deferred and recognized over the life of the loan as a component of interest income.
ASSETS HELD FOR SALE
Assets held for sale are comprised of mortgages held for sale and the securities inventory of Hopper Soliday & Co., Inc., Dauphin's broker/dealer subsidiary.
Mortgage loans held for sale are recorded at the lesser of current secondary market value or the actual book value of loans. The securities inventory is recorded at current quoted market value.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a valuation reserve to absorb losses on loans which may become uncollectible. The provision for loan losses is management's estimate of the amount required to establish a reserve adequate to reflect risks in the loan portfolio of the Banks. Loan losses are charged directly against the allowance for loan losses, and recoveries on previously charged off loans are added to the allowance.
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowance for loan losses. Such agencies may require the Banks to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
In May 1993, Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan" was issued. SFAS 114 addresses the accounting by creditors for impairment of certain loans. SFAS 114 requires that impaired loans that are within the scope of the Statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, at the loan's market price or the fair value of the collateral if the loan is collateral dependent. Management presently does not know and cannot reasonably estimate the impact of SFAS 114 on its financial statements. SFAS 114 is effective for fiscal years beginning after December 15, 1994 and earlier adoption is permitted. Dauphin expects to adopt SFAS 114 in January 1995.
BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost, including capitalized interest during construction, less accumulated depreciation and amortization. Bank premises and equipment under capitalized leases are recorded at the lower of the present value of minimum lease payments or the fair value of the leased assets determined at the inception of the lease term. Depreciation charged to operating expense, including amounts
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 applicable to capitalized leases, is computed on the straight-line method for financial reporting and the straight-line and accelerated methods for income tax purposes. Leasehold improvements are capitalized and amortized over the lives of the respective leases or the estimated useful life of the leasehold improvement, whichever is shorter. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period. Maintenance, repairs and minor improvements are charged to expense as incurred; significant renewals and betterments are capitalized.
TRUST ASSETS
Assets held by the Banks in a fiduciary or agency capacity are not included in the consolidated financial statements since such assets are not assets of the Banks. Income from fiduciary activities is recorded on an accrual basis.
BENEFIT PLANS
Pension plan costs for Dauphin's defined benefit plans are accounted for in accordance with the requirements of Statement of Financial Accounting Standards No. 87 "Employers' Accounting for Pensions". The projected unit credit method is utilized for measuring net periodic pension cost over the employees' service lives.
Dauphin adopted Statement of Financial Acccounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", as of January 1, 1992, which established a new accounting principle for the cost of retiree health care and other postretirement benefits. Prior to 1992, Dauphin recognized these benefits on a cash basis.
Dauphin adopted Statement of Financial Acccounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" effective January 1, 1993. This standard established accounting requirements for employers who provide benefits to former or inactive employees after employment but before retirement. Prior to 1993, these costs were recognized on a cash basis.
INCOME TAXES
In 1992, Dauphin adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes". SFAS 109 requires the asset and liability method in computing income tax expense for financial reporting purposes. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
NET INCOME PER SHARE
Net income per share is computed based upon the weighted average number of common shares outstanding and dilutive common equivalent shares from stock options using the treasury stock method. The difference between primary and fully diluted earnings per share is not significant in any year.
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, Dauphin considers cash and due from banks and overnight federal funds sold to be cash and cash equivalents.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
2--ACQUISITION AND DIVESTITURE
On January 1, 1994, Dauphin acquired all the outstanding stock of Valley Bancorp., Inc. (Valley) in exchange for 2,600,643 shares of Dauphin's common stock, along with cash of $16,000 in lieu of fractional shares, consummating the merger announced in June 1993. At December 31, 1993 Valley had total assets, deposits and equity of $324,164,000, $285,310,000 and $33,948,000, respectively. Valley's principal subsidiary was Valley Bank and Trust Company. The acquisition was accounted for as a pooling-of-interests.
The effect of the merger on Dauphin's reported net interest income, net income and net income per share for the periods presented is as follows:
On August 23, 1993 Dauphin entered into an agreement to sell 100% of the stock of Farmers Savings Bank, a Federal Savings Bank (FSB) for $797,000. The sale is subject to regulatory approval and is expected to be consummated during the first quarter of 1994. FSB had total assets of $12,678,000 at December 31, 1993. The sale of FSB will not have a material impact on the financial condition or results of operations for Dauphin in 1994.
3--RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS AND INVESTMENT SECURITIES
The Banks are required to maintain average reserve balances with the Federal Reserve Bank. The average amount of those required reserve balances at December 31, 1993 and 1992 was approximately $38,336,000 and $31,678,000, respectively.
Dauphin Deposit Bank and Trust Company is required to maintain an investment in Federal Home Loan Bank of Pittsburgh stock of $10,651,000 which is included in equity securities.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
4--INVESTMENT SECURITIES
The amortized cost and estimated market value of investment securities are as follows:
The amortized cost and estimated market value of debt securities at December 31, 1993, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
Gains and losses from sales of investment securities are as follows:
Securities with a carrying value of $827,404,000 at December 31, 1993 and $790,706,000 at December 31, 1992 are pledged to secure public deposits and for other purposes as provided by law.
5--LOANS
The loan portfolio, net of unearned income, at December 31, 1993 and 1992 is as follows:
The Banks have granted loans to officers, directors and their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans, which excludes aggregate loans totaling less than $60,000 to any one related party, is as follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 Included within the loan portfolio are loans on which the Banks have ceased the accrual of interest and restructured loans. Such loans amounted to $23,129,000 and $24,154,000 at December 31, 1993 and 1992, respectively. If interest income had been recorded on all such loans outstanding during the years 1993, 1992 and 1991, interest income would have been increased as shown in the following table:
6--ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses is as follows:
7--BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 1993 and 1992 is as follows:
Depreciation and amortization amounted to $5,957,000 for 1993, $5,673,000 for 1992 and $5,435,000 for 1991.
8--TIME CERTIFICATES OF DEPOSIT
Time certificates of deposit of $100,000 or more at December 31, 1993 and 1992 amounted to $287,673,000 and $304,528,000, respectively.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
9--SHORT-TERM BORROWINGS
Federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings generally mature within one to ninety days from the transaction date.
A summary of aggregate short-term borrowings is as follows for the years ended December 31, 1993, 1992 and 1991:
The Banks have approved federal funds lines of credit that amounted to approximately $1,600,000,000 at December 31, 1993.
10--LONG-TERM DEBT
The following is a summary of long-term debt at December 31, 1993 and 1992:
In November 1986, Dauphin issued $35,000,000, 8.70% Senior Notes due 1996 at par. These Senior Notes are not subordinated in right of payment to any other unsecured indebtedness of Dauphin.
Advances from The Federal Home Loan Bank of Pittsburgh consists of two advances with interest rates ranging from 5.89% to 6.17% and mature in 1995. These advances are subject to restrictions and penalties if repaid prior to maturity and are collateralized by qualifying investments.
Aggregate long-term debt maturities, for each of the next five years are as follows:
1994--$78,000; 1995--$51,087,000; 1996--$35,097,000; 1997--$108,000; 1998-- $86,000
At December 31, 1993, Dauphin and its subsidiaries had unused lines of credit totaling approximately $3,000,000 with a non-affiliated bank.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
11--RESTRICTION ON PAYMENT OF DIVIDENDS
Certain restrictions exist regarding the ability of the subsidiaries to transfer funds to Dauphin in the form of cash dividends. Additionally, regulatory agencies restrict the availability of surplus for the payment of dividends. As of December 31, 1993, $307,691,000 of undistributed earnings of the Banks were available for distribution to Dauphin as dividends without restriction.
12--INCOME TAXES
The provision for income taxes, consisting primarily of Federal income taxes, for the years 1993, 1992 and 1991, consists of the following:
Deferred income taxes result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. The sources of those temporary differences and the related tax effect are as follows:
A reconciliation between the effective income tax rate and the statutory rate follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993, 1992 and 1991 are as follows:
Management is of the opinion that the deferred tax asset is realizable since Dauphin has had a long history of strong earnings and has carryback potential greater than the deferred tax asset. Management is not aware of any evidence that would preclude Dauphin from ultimately realizing this asset.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
13--BENEFIT PLANS
The Banks have noncontributory defined benefit pension plans covering substantially all employees. The Plans' benefit formulas generally base payments to retired employees upon their length of service and a percentage of qualifying compensation during the final years of employment. Dauphin's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Pension expense (credit) associated with these plans amounted to $(269,000), $(262,000) and $(178,000) for 1993, 1992 and 1991, respectively.
The following table sets forth the pension plans' funded status and amounts recognized in Dauphin's consolidated financial statements at December 31, 1993 and 1992:
The assumptions used in determining the actuarial present value of the projected benefit obligation and the expected rate of return on plan assets are as follows:
Net pension expense (credit) for 1993, 1992 and 1991 was comprised of the following:
Plan assets are primarily invested in listed stocks (including 86,000 shares of Dauphin at December 31, 1993 and 1992) and U.S. Treasury and federal agency securities.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
Effective January 1, 1992, Dauphin adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other than Pensions". This pronouncement focuses principally on postretirement health care and life insurance benefits and significantly changed Dauphin's prior practice of accounting for these benefits on a pay-as- you-go basis to an accrual basis during the years that the employee renders the necessary service to eventually receive these benefits.
Dauphin's postretirement benefits other than pensions are currently not funded. The status of the plan at December 31, 1993 and 1992 is as follows:
The assumptions used in determining the actuarial present value of the accumulated postretirement benefit obligation are as follows:
The cost for postretirement benefits other than pensions for 1993 and 1992 consisted of the following components:
Prior to January 1, 1992, Dauphin recognized the cost of retiree health care and life insurance benefits as an expense as premiums were incurred. These costs approximated $444,000 for 1991.
The assumed postretirement health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 16 1/2% in 1992, the year of adoption, decreasing by 1% per year to an ultimate rate of 6% in 2012 and thereafter over the projected payout period of benefits.
The health care cost trend rate assumption has a significant effect on the amounts reported. For example, one-percentage-point increase in the assumed health care cost trend would increase the accumulated postretirement benefit obligation by $2,000,000 and $1,500,000 at December 31, 1993 and 1992, respectively and
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 increase the aggregate of the service and interest cost components by $200,000 and $150,000 for the years ended December 31, 1993 and 1992, respectively.
Dauphin offers a savings plan for all eligible employees. Under the plan, Dauphin contributes 25% of the participants' contribution which cannot exceed 10% of their salaries. Participants' contributions are at all times fully vested, and Dauphin's contributions become fully vested with two years of service. Contributions to the plan amounted to $468,000, $405,000 and $312,000 during 1993, 1992 and 1991, respectively.
Farmers Bank and Trust Company of Hanover (FB&T) maintained two defined contribution plans. A savings plan permitted eligible employees to make Section 401(k) salary withholding contributions. This savings plan also permitted FB&T to make contributions to the plan on behalf of eligible employees by way of matching Employer Contributions and Regular Employer Contributions. An Employee Stock Ownership Plan (ESOP), designed to invest primarily in common stock of FB&T, was initially funded in 1988 by reversionary assets from FB&T's terminated employee pension plan. FB&T stock held by the ESOP was periodically released from the ESOP's suspense account as yearly allocations were made to eligible employees. Both plans were discontinued during 1992. The expense for these two plans amounted to $505,000 and $398,000 during 1992 and 1991, respectively.
In 1993, Dauphin adopted Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits". The adoption resulted in an incremental cost of $500,000 to salaries and benefits expense. This accrual was established to record the liability for benefits to former or inactive employees after employment but before retirement.
14--EMPLOYEE STOCK PURCHASE PLAN, STOCK OPTION PLAN AND STOCKHOLDERS' EQUITY
Under the employee stock purchase plan, all eligible employees may purchase shares of Dauphin's common stock through payroll deductions (limited to an amount aggregating 10% of annual base pay). The purchase price, established 30 days prior to the offering date, is not less than 85% or more than 100% of the average market price on the offering date or exercise date, whichever is lower. 840,000 shares of common stock have been authorized to be offered under the plan, of which 588,205 shares have been issued. Because of a difference between the plan offering date, and Dauphin's year-end, no shares were under option at December 31, 1993.
During 1987, the shareholders approved the adoption of the Stock Option Plan of 1986 (the Plan). Under the Plan, Dauphin may grant either qualified or non- qualified stock options to key employees for the purchase of up to 1,193,000 shares of common stock. The exercise price of options granted may not be less than 85% of the fair market value of Dauphin's common stock at the date of grant. Options become exercisable over periods of one to five years and expire ten years from the date of grant.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
Stock option transactions during 1993, 1992 and 1991 are summarized below:
In connection with the adoption of a shareholder rights plan on January 22, 1990, Dauphin declared a dividend distribution of one Common Stock Purchase Right (a "Right") for each outstanding share of common stock of Dauphin. The Rights are exercisable only if a person or group of affiliated persons acquires or announces an intention to acquire 18% of the common stock of Dauphin and Dauphin's Board of Directors does not redeem the Rights during the specified redemption period. Initially, each Right, upon becoming exercisable, would entitle the holder to purchase from Dauphin one share of common stock at the specified exercise price which is subject to adjustment (currently $50 per share). Once the Rights become exercisable, if any person or group acquires 18% of the common stock of Dauphin, the holder of a Right, other than the acquiring person or group, will be entitled, among other things, to purchase shares of common stock having a value equal to two times the exercise price of the Right. The Board of Directors is entitled to redeem the Rights for $.001 per Right at any time before expiration of the redemption period. The Board of Directors may, at any time after the Rights become exercisable and prior to the time any person becomes a 50% beneficial owner of Dauphin's shares of common stock, exchange each of the outstanding Rights (except Rights of the acquiring person or group which are voided) for one share of common stock, subject to adjustment. The Rights will expire on January 22, 2000, unless earlier redeemed by Dauphin.
In January 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 1,000,000 shares of the outstanding common stock. Dauphin expects to use available cash to fund the share repurchases which will be made from time to time on the open market or in privately negotiated transactions. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan, Stock Option Plan and other appropriate uses.
15--FINANCIAL INSTRUMENTS OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
Dauphin is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuation in interest rates. These financial instruments include commitments to extend credit, financial guarantees and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
Dauphin's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Dauphin uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
At December 31, 1993 and 1992, Dauphin had the following off-balance sheet financial instruments whose contract amounts represent credit risk:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Dauphin evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by Dauphin upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income- producing commercial properties.
Standby letters of credit are conditional commitments issued by Dauphin to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The term of the letters of credit varies from one month to 24 months and may have renewal features. The credit risk involved in using letters of credit is essentially the same as that involved in extending loans to customers. Dauphin holds collateral supporting those commitments for which collateral is deemed necessary.
Most of Dauphin's business activity is with customers located within Dauphin's defined market area, principally Central Pennsylvania. Dauphin grants commercial, residential and consumer loans throughout the state. The loan portfolio is well diversified and Dauphin does not have any significant concentrations of credit risk.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair Value of Financial Instruments" (SFAS 107) requires disclosure of the fair value of financial instruments. The majority of Dauphin's assets and liabilities are considered financial instruments. Significant assumptions and estimates were used in calculation of fair market values.
The following methods and assumptions were used to estimate the fair value of each class of Dauphin's financial instruments for which it is practicable to estimate that value:
CASH AND SHORT-TERM INVESTMENTS
The fair value for cash and short-term instruments is estimated to be book value, due to the short maturity of, and negligible credit concerns within, those instruments.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
INVESTMENT SECURITIES
The fair value for debt and marketable equity securities is based on quoted market prices, if available. If quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
ASSETS HELD FOR SALE
The fair value for mortgage loans held for sale is estimated using the current secondary market rates. For the securities held for sale, the securities are recorded at the current quoted market value.
LOANS
The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The residential mortgages and certain consumer loans include prepayment assumptions.
OTHER FINANCIAL ASSETS
The fair value for accrued interest receivable is estimated to be the current book value. The fair value for excess servicing fees is calculated based on the present value of the difference between the estimated future net revenues and normal servicing.
DEPOSITS
The fair value of deposits with no stated maturity, such as demand deposits, savings accounts, NOW and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is based on the discounted value of contractual cash flows, using the rates currently offered for deposits of similar remaining maturities.
SHORT-TERM BORROWINGS
The fair value of short-term borrowings is estimated using the current rates for similar terms and maturities.
LONG-TERM DEBT
The fair value of long-term debt is estimated using debt with similar terms and remaining maturities.
ACCRUED INTEREST PAYABLE
The fair value of accrued interest payable is estimated to be the current book value.
COMMITMENTS
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms and present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements.
LIMITATIONS
The fair values estimated are dependent upon subjective assumptions and involve significant uncertainties resulting in estimates that vary with changes in assumptions. Any sales of financial instruments may incur potential tax and other expenses that would not be reflected in the fair values. Any changes in assumptions or estimation methodologies may have a material effect on the estimated fair values disclosed. The reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991
At December 31, 1993 and 1992, Dauphin's estimated fair values of financial instruments based on disclosed assumptions are as follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 16--CONDENSED FINANCIAL INFORMATION--PARENT COMPANY ONLY
Dauphin Deposit Corporation (Parent Company Only) Condensed Balance Sheets
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 Dauphin Deposit Corporation (Parent Company Only) Condensed Statements of Income
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1992 AND 1991 Dauphin Deposit Corporation (Parent Company Only) Condensed Statements of Cash Flows
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
DECEMBER 31, 1993, 1992 AND 1991 17--CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)
18--CONTINGENT LIABILITIES
Various legal actions or proceedings are pending involving Dauphin or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material.
[LOGO OF KPMG PEAT MARWICK APPEARS HERE]
CERTIFIED PUBLIC ACCOUNTANTS
225 Market Street Suite 300 P.O. Box 1190 Harrisburg, PA 17108-1190
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Dauphin Deposit Corporation
We have audited the accompanying consolidated balance sheets of Dauphin Deposit Corporation and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of Dauphin's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dauphin Deposit Corporation and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick
January 28, 1994
[LOGO OF MEMBER FIRM OF KLYNVEID PEAT MARWICK GOERDELER APPEARS HERE]
DAUPHIN DEPOSIT CORPORATION ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
DAUPHIN DEPOSIT CORPORATION
PART III --------
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relative to directors of the Registrant is incorporated herein by reference to Election of Directors and Section 16(a) of the Exchange Act in the Corporation's 1994 Proxy Statement. Information relative to executive officers of the Registrant is set forth herein in Part I under the caption "EXECUTIVE OFFICERS OF THE REGISTRANT."
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
This item is incorporated by reference to Executive Compensation in the 1994 Proxy Statement.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is incorporated by reference to Outstanding Stock and Principal Holders Thereof in the 1994 Proxy Statement.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is incorporated by reference to Transactions with Management in the 1994 Proxy Statement.
DAUPHIN DEPOSIT CORPORATION PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
DAUPHIN DEPOSIT CORPORATION
DAUPHIN DEPOSIT CORPORATION
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED.
Dauphin Deposit Corporation
February 22, 1994 /s/ William J. King By: --------------------------------- WILLIAM J. KING CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND DIRECTOR
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT IS SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURES TITLE DATE ---------- ----- ----
/s/ William J. King Chairman of the February 22, 1994 - ------------------------------------- Board, Chief WILLIAM J. KING Executive Officer and Director
/s/ Christopher R. Jennings President, Chief February 10, 1994 - ------------------------------------- Operating Officer CHRISTOPHER R. JENNINGS and Director
/s/ Lawrence J. LaMaina, Jr. Vice Chairman and February 14, 1994 - ------------------------------------- Director LAWRENCE J. LAMAINA, JR.
/s/ Dennis L. Dinger Executive Vice February 10, 1994 - ------------------------------------- President and Chief DENNIS L. DINGER Financial Officer
/s/ William H. Alexander Director February 14, 1994 - ------------------------------------- WILLIAM H. ALEXANDER
/s/ John A. Arnold Director February 10, 1994 - ------------------------------------- JOHN A. ARNOLD
/s/ Jeffrey J. Burdge Director February 10, 1994 - ------------------------------------- JEFFREY J. BURDGE
DAUPHIN DEPOSIT CORPORATION SIGNATURES TITLE DATE
/s/ James O. Green Director February 22, 1994 - ------------------------------------- JAMES O. GREEN
/s/ Alfred G. Hemmerich Director February 22, 1994 - ------------------------------------- ALFRED G. HEMMERICH
Director - ------------------------------------- LEE H. JAVITCH
/s/ William T. Kirchhoff Director February 10, 1994 - ------------------------------------- WILLIAM T. KIRCHHOFF
/s/ James E. Marley Director February 14, 1994 - ------------------------------------- JAMES E. MARLEY
/s/ Robert F. Nation Director February 10, 1994 - ------------------------------------- ROBERT F. NATION
/s/ Elmer E. Naugle Director February 22, 1994 - ------------------------------------- ELMER E. NAUGLE
Director - ------------------------------------- WALTER F. RAAB
/s/ Paul C. Raub Director February 10, 1994 - ------------------------------------- PAUL C. RAUB
/s/ Henry W. Rhoads Director February 10, 1994 - ------------------------------------- HENRY W. RHOADS
Director - ------------------------------------- R. CHAMPLIN SHERIDAN, JR.
DAUPHIN DEPOSIT CORPORATION EXHIBIT INDEX
DAUPHIN DEPOSIT CORPORATION