ITEM 1. BUSINESS
Dauphin Deposit Corporation (Dauphin or Registrant) is a bank holding company, incorporated under the laws of the Commonwealth of Pennsylvania in 1974. Dauphin's wholly-owned bank subsidiary is Dauphin Deposit Bank and Trust Company (Dauphin Bank), which includes the Bank of Pennsylvania, Valleybank and Farmers Bank Divisions, through which Dauphin provides banking services. Dauphin Bank is 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. Dauphin Bank is a Pennsylvania chartered bank and trust company and a member of the Federal Reserve System. Dauphin Bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law.
Commercial lending services provided by Dauphin Bank include short and medium term loans, revolving credit loans, lines of credit, asset-based lending, real estate construction loans, agricultural loans, and equipment leasing financial arrangements. Consumer lending services include various types of secured and unsecured loans, including installment loans, home equity loans and automobile leasing. Dauphin Bank had no foreign loans in its portfolio at December 31, 1995. Residential mortgage loans are offered by Eastern Mortgage Services, Inc. (Eastern Mortgage), a Pennsylvania mortgage banking company acquired as a wholly-owned subsidiary of Dauphin Bank in July, 1994. Eastern Mortgage offers the following types of residential mortgage loans: Conventional first and second mortgage loans; FHA/VA loans; State housing bond loans; residential construction/permanent financing; and special programs for low and moderate income borrowers. All conforming conventional residential mortgage loans originated for sale in the secondary mortgage market under a FNMA or FHLMC product are generally underwritten to the standards as specified in the Fannie Mae Selling Guide. All non-conforming loans are underwritten to private investor standards. FHA and VA loans are processed and underwritten in accordance with the relevant handbooks and supplementary circular letters issued respectively by the Department of Housing and Urban Development and by the Veterans Administration.
Dauphin is registered with and is subject to regulatory supervision by the Board of Governors of the Federal Reserve System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended. Dauphin 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 operation of Dauphin Bank, as well as those of other banks, are significantly affected by the monetary and credit policies and regulations of the federal regulatory agencies.
DAUPHIN DEPOSIT BANK AND TRUST COMPANY
Dauphin Bank maintains 101 offices with 87 automated teller machines located in Adams, Berks, Chester, Cumberland, Dauphin, Franklin, Lancaster, Lebanon, Lehigh, Montgomery, Northampton and York Counties, Pennsylvania. 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. Dauphin Bank maintains multiple offices in nine south central Pennsylvania counties. Single offices are located in each of Chester, Montgomery and Northampton Counties, in near proximity to the boundary lines with Berks and Lehigh Counties. The amounts of deposits attributable to zip code areas within Chester, Montgomery and Northampton Counties are insignificant in terms of the amounts of deposits attributable to zip code areas in the other nine counties. Accordingly, the Adams, Berks, Cumberland, Dauphin, Franklin, Lancaster, Lebanon, Lehigh and York nine county region constitutes the principal geographic area for Dauphin Bank.
At December 31, 1995, Dauphin Bank had total deposits of $3,949,801,000, total loans of $2,981,338,000 and total assets of $5,186,082,000.
DAUPHIN DEPOSIT CORPORATION
NON-BANKING SUBSIDIARIES
Eastern Mortgage Services, Inc. (Eastern Mortgage) is a Pennsylvania mortgage banking corporation which was acquired by Dauphin Bank on July 1, 1994. Eastern Mortgage is a full service mortgage banking company which originates, services and sells first and second residential mortgage loans of varying types primarily to the eastern Pennsylvania and New Jersey mortgage markets.
Dauphin Life Insurance Company (Dauphin Life) is an Arizona corporation which was formed in 1979 as a wholly-owned subsidiary of Dauphin. Dauphin Life reinsures credit life, health and accident insurance directly related to extensions of credit by Dauphin Bank and is presently limited to those activities by regulations of the Federal Reserve Board. Directors of Dauphin Life are officers or directors of Dauphin.
Dauphin Investment Company (Dauphin Investment) is a Delaware corporation which was formed in 1982 as a wholly-owned subsidiary of Dauphin. Dauphin Investment manages equity investments for Dauphin. Directors of Dauphin Investment are officers or directors of Dauphin.
Hopper Soliday & Co., Inc. (Hopper Soliday) is a wholly-owned subsidiary of Dauphin acquired effective July 1, 1991. Hopper Soliday 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.
COMPETITION
The banking industry in Dauphin Bank's service area 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. Mortgage banking firms, real estate investment trusts, insurance companies, leasing companies, financial affiliates of industrial companies, brokerage and factoring companies and government agencies also provide additional competition for loans and for many other financial services. Some of the financial services providers operating in Dauphin's market area operate on a regional and, in some cases, national scale, and possess resources greater than those of Dauphin.
SUPERVISION AND REGULATION
General.
Dauphin is subject to regulation by the Pennsylvania Department of Banking, the Federal Reserve Board and the Securities and Exchange Commission. The deposits of Dauphin Bank are insured by the FDIC and Dauphin Bank is a member of the Bank Insurance Fund which is administered by the FDIC. In addition, Dauphin Bank is a Pennsylvania bank and trust company and member of the Federal Reserve System subject to regulation and supervision by the Pennsylvania Department of Banking and the Federal Reserve Board. The operations of Dauphin Bank are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and limits upon the types of services which may be offered. Various consumer laws and regulations also affect the operations of Dauphin Bank and Eastern Mortgage, its wholly-owned mortgage banking company subsidiary. Regulatory approvals also are required for branching and for bank mergers.
Dauphin 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
DAUPHIN DEPOSIT CORPORATION (BHC Act). The Federal Reserve Board may also make examinations of Dauphin 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, Dauphin 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 Dauphin 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. Such transfers by Dauphin Bank to Dauphin or any nonbanking subsidiary are limited in amount to 10% of Dauphin Bank's capital and surplus and, with respect to Dauphin and all nonbanking subsidiaries, to an aggregate of 20% of Dauphin Bank's capital and surplus. Such loans and extensions of credit also are required to be secured in specified amounts, and all such transactions are required to be on an arm's length basis. 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.
Source of Strength Doctrine.
Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations or both. This doctrine is commonly known as the "source of strength" doctrine.
Dividends.
Dividend payments by Dauphin Bank to Dauphin are subject to the Pennsylvania Banking Code of 1965 (Banking Code) and the Federal Deposit Insurance Act (FDIA). Under the Banking Code, no dividends may be paid except from "accumulated net earnings" (generally, undivided profits). Under the FDIA, no dividends may be paid by an insured bank if the bank is in arrears in the payment of any insurance assessment due to the FDIC. State and federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by banks. Adherence to such standards further limits the ability of banks to pay dividends.
Under these policies and subject to the restrictions applicable to Dauphin Bank, Dauphin Bank could declare without prior regulatory approval, aggregate dividends of $26.0 million, plus net profits for the remainder of 1996.
The payment of dividends by Dauphin Bank may also be affected by other regulatory requirements and policies, such as the maintenance of adequate capital. If, in the opinion of the applicable regulatory authority a bank under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (which,
DAUPHIN DEPOSIT CORPORATION depending on the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.
Capital Adequacy.
The Federal Reserve Board adopted risk-based capital guidelines for bank holding companies, such as Dauphin. The guidelines were phased in over a two year period ended December 31, 1992. Currently, the required minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders' equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. During the two-year phase-in period, a limited portion of Tier 2 capital was permitted to be included as Tier 1 capital.
In addition to the risk-based capital guidelines, the Federal Reserve Board established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 1% to 2% above the 3% stated minimum. Dauphin Bank is subject to the same capital requirements since its primary federal regulator is the Federal Reserve Board. Dauphin and Dauphin Bank exceed all applicable capital requirements.
FDICIA.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required the federal banking agencies to promulgate regulations specifying the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under these regulations, a bank is considered "well capitalized" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. An "adequately capitalized" bank is defined under the regulations as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater, (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with the highest composite regulatory examination rating of 1) and (iv) does not meet the definition of a well capitalized bank. A bank will be considered (A) "undercapitalized" if it has (i) a total risk- based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with the highest regulatory examination rating of 1); (B) "significantly undercapitalized" if the bank has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (C) "critically undercapitalized" if the bank has a ratio of tangible equity to total assets of equal to or less than 2%. Notwithstanding the foregoing, the applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a "well capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings).
Undercapitalized institutions, including significantly and critically undercapitalized institutions, are required to submit capital restoration plans to the appropriate federal banking regulator and are subject to restrictions on
DAUPHIN DEPOSIT CORPORATION operations, including prohibitions on branching, engaging in new activities, paying management fees, making capital distributions such as dividends, and growing without regulatory approval. On December 31, 1995, Dauphin and Dauphin Bank exceeded the minimum capital levels of the "well capitalized" category.
Other Provisions of FDICIA.
Each depository institution must submit audited financial statements to its primary regulator and the FDIC, which reports are made publicly available. In addition, the audit committee of each depository institution must consist of outside directors and the audit committee at "large institutions" (as defined by FDIC regulation) must include members with banking or financial management expertise. The audit committee at "large institutions" must also have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution's primary regulator of any change in the institution's independent auditor, and annual management letters must be provided to the FDIC and the depository institution's primary regulator. The regulations define a "large institution" as one with over $500 million in assets, which would include Dauphin Bank. Also, under the rule, an institution's independent auditor must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance with laws and regulations concerning safety and soundness.
Under FDICIA, each federal banking agency must prescribe certain safety and soundness standards for depository institutions and their holding companies. Three types of standards must be prescribed: Asset quality and earnings, operational and managerial, and compensation. Such standards would include a ratio of classified assets to capital, minimum earnings, and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of such institutions and holding companies. Operational and managerial standards must relate to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) interest rate exposure, (v) asset growth, and (vi) compensation, fees and benefits. In November, 1993, the federal banking agencies released proposed rules setting forth some of the required safety and soundness standards. Under such proposed rules, if the primary federal regulator determines that any standard has not been met, the regulator can require the institution to submit a compliance plan that describes the steps the institution will take to eradicate the deficiency. Failure to adopt or implement a compliance plan could lead to further sanctions by the responsible regulator. Pursuant to the Riegle Community Development and Regulatory Improvement Act of 1994, federal banking agencies have been given the discretion to adopt safety and soundness guidelines rather than regulations.
Provisions of FDICIA relax certain requirements for mergers and acquisitions among financial institutions, including authorization of mergers of insured institutions that are not members of the same insurance fund, and provide specific authorization for a federally chartered savings association or national bank to be acquired by an insured depository institution.
FDICIA also includes a provision that generally restricts federally insured state banks, such as Dauphin Bank, to activities permitted to national banks. Under final FDIC rules implementing Section 303, 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 Dauphin Bank's operations.
Under FDICIA, all depository institutions must provide 90 days notice to their primary federal regulator of branch closings, and penalties are imposed for false reports by financial institutions. Depository institutions with assets in excess of $250 million must be examined on-site annually by their primary federal, state regulator or the FDIC.
DAUPHIN DEPOSIT CORPORATION
FDICIA also sets forth Truth in Savings disclosure and advertising requirements applicable to all depository institutions.
FDIC Insurance Assessments.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) created two deposit insurance funds to be administered by the FDIC: the Savings Association Insurance Fund (SAIF) and the Bank Insurance Fund (BIF). Dauphin Bank's deposits are insured under BIF. The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures.
Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each institution to one of three capital groups (well capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater and a Tier 1 leverage ratio of 5% or greater, are assigned to the well capitalized group. As of December 31, 1994, Dauphin Bank was subject to FDIC deposit insurance assessments at the rate of $.23 for every $100 of deposits.
In the second quarter of 1995, the BIF reached its statutory reserve ratio requirement. Consequently, the FDIC has significantly reduced the assessment rates applicable to BIF members and refunded to BIF members that portion of the assessment for the second and third quarters of 1995 which represented an overpayment once the BIF had achieved full funding in accordance with the statutory reserve ratio requirement. Dauphin Bank received a refund from the FDIC in September 1995 in the amount of $2,215,000, which amount also includes interest on the refund from June 1 to September 14, 1995. According to the new rate schedule, BIF institutions deemed to have the highest risk will pay up to $.31 for every $100 of deposits annually while those deemed to have the least risk will pay $.04 for every $100 of deposits annually. In the case of Dauphin Bank, for the second half of 1995, it was assessed at the rate of $.04 for every $100 of deposits. At the same time, the FDIC has indicated that it anticipates that the SAIF assessment rate in even the lowest risk-based category will not fall below the current rate of $.23 for every $100 of deposits before 2002.
Interstate Banking.
Prior to the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal Act) in September 1994, interstate banking was restricted under the terms of the Douglas Amendment to the BHC Act which prohibited the Federal Reserve Board from approving an application by a bank holding company located in one state to acquire a bank or all of its assets located in another state unless the acquisition was specifically authorized by a reciprocal interstate banking statute, such as the statute adopted in Pennsylvania in 1990, specifically permitting interstate acquisitions. Similarly, interstate branching was prohibited for national banks and state- chartered member banks by the McFadden Act, although some states, not including Pennsylvania, had passed laws permitting limited interstate branching by non- Federal Reserve member state banks. The Riegle-Neal Act permits an adequately capitalized, adequately managed bank holding company to acquire a bank in another state as of September 29, 1994, whether or not the state permits the acquisition, subject to certain deposit concentration caps and the Federal Reserve Board's approval. A state may not impose discriminatory requirements on acquisitions by out-of-state holding companies. In addition, beginning on June 1, 1997, under the Riegle-Neal Act, a bank can expand interstate by merging with a bank in another state and also may consolidate the acquired bank into new branch offices of the acquiring bank, unless the other state affirmatively opts out of the legislation before that date. A state may also opt into the legislation
DAUPHIN DEPOSIT CORPORATION earlier than June 1, 1997 if it wishes to do so. The Riegle-Neal Act also permits de novo interstate branching as of June 1, 1997 but only if a state affirmatively opts in by appropriate legislation. Once a state opts in to interstate branching, it may not opt out at a later date. The Riegle-Neal Act also allows foreign banks to branch by merger or de novo branch to the same extent as banks from the foreign bank's home state. The Riegle-Neal Act also subjects foreign banks to some additional requirements, including extending obligations under the Community Reinvestment Act to certain foreign bank acquisitions and regulating the types of activities off-shore branches of foreign banks may conduct. The Pennsylvania Legislature amended the Pennsylvania Banking Code of 1965 in July, 1995, to opt in to all of the provisions of the Riegle-Neal Act, including interstate bank mergers and de novo interstate branching. The management of Dauphin cannot predict with any reasonable degree of certainty the effects, if any, which the Riegle-Neal Act may have on Dauphin.
Proposed Legislation.
Legislation has been introduced in Congress to recapitalize the SAIF via a one-time special assessment on SAIF deposits and thereafter to merge the SAIF with the BIF. Legislation also is pending in Congress which would repeal certain aspects of the Glass-Steagall Act, which prohibits commercial banks from engaging in securities underwriting activities. It is not anticipated that the enactment of such legislation, in its current form, would have a material effect on the financial condition or results of operations of Dauphin.
Employees
At December 31, 1995, Dauphin and its subsidiaries employed approximately 2,681 persons.
ITEM 2.

ITEM 2. PROPERTIES
Dauphin's principal office is located in Dauphin Bank's main banking offices at 213 Market Street, Harrisburg, Pennsylvania. Dauphin owns 18 of the branch banking offices which are leased to Dauphin Bank.
Dauphin Bank owns 67 of its branch banking offices and leases 26 other facilities including two leases which are treated as capitalized leases for financial reporting purposes. Hopper Soliday & Co., Inc. leases four of its sales offices. Eastern Mortgage leases 12 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 Dauphin's last fiscal year did not exceed five percent of its operating expenses.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Various legal actions and proceedings are pending involving Dauphin or its subsidiaries. Management believes that the aggregate liability or loss, if any, will not be material to Dauphin's financial condition or results of operations. Included among outstanding litigation is a class action law suit instituted by Dauphin seeking a declaratory judgment from the Court specifically permitting Dauphin to discontinue offering an 18 month variable rate investment product carrying a minimum interest rate of 10% for the 18 month term held in certain individual retirement accounts (IRA) and/or to charge an annual maintenance fee and fee on rollovers or transfers into the investment product. Dauphin's right to terminate the variable rate investment product and to charge a service fee is in dispute and is being challenged by the holders of the IRA accounts in question. Management intends to vigorously assert its right to terminate the 18 month variable rate investment product in accordance with its terms. Pending the outcome of the litigation, Dauphin has continued to date to pay a 10% interest rate with regard to the product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.
DAUPHIN DEPOSIT CORPORATION
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 Dauphin as of February 1, 1996 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
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF DAUPHIN DEPOSIT CORPORATION STOCK AND DIVIDENDS PAID
The price information provided below reflects actual sales prices of high, low and closing trades as quoted on The Nasdaq Stock Market.
The approximate number of holders of common stock is 11,585 as of December 31, 1995.
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 (Bank), which includes the Bank of Pennsylvania, Farmers Bank and Valleybank Divisions. The other primary subsidiaries include Hopper Soliday & Co., Inc. (Hopper Soliday), a broker/dealer, and Eastern Mortgage Services, Inc. (Eastern Mortgage), a mortgage banking company. This discussion and analysis should be read in conjunction with the financial statements which appear elsewhere in this report.
On July 1, 1994, Dauphin acquired Eastern Mortgage Services, Inc., a mortgage banking company headquartered in Trevose, Pennsylvania, for approximately $21.0 million in cash pursuant to a definitive agreement signed in May 1994. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of Eastern Mortgage from the date of acquisition are included with the results of Dauphin.
RESULTS OF OPERATIONS
SUMMARY
Dauphin Deposit Corporation recorded net income of $65.6 million for 1995, compared with $70.0 million recorded in 1994. On a per common share basis, net income was $2.12 in 1995 compared with $2.18 in 1994 and $2.08 in 1993.
Return on average total assets was 1.31% for 1995, compared with 1.42% for 1994 and 1.40% for 1993. Return on average equity, excluding the SFAS 115 (as defined in "Investment Securities and Other Short-Term Investments") adjustment, was 12.64% for 1995 compared with 13.72% for 1994 and 14.06% for 1993. Return on average stockholders' equity, including the SFAS 115 adjustment, was 12.81% for 1995 compared with 13.81% for 1994.
During 1995 average earning assets increased 1.4% to $4.7 billion and the interest rate spread decreased to 3.29% from 3.61%. The decrease in the interest rate spread was primarily the result of a shifting of deposits from transaction oriented deposits to time deposits. The result was a decrease of $5.6 million or 2.9% 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, loans past due 90 or more days as to principal or interest payments, restructured loans and other real estate owned, represented .69% of year- end loans and other real estate owned, down from .82% at December 31, 1994. The allowance for loan losses was 1.40% of year-end loans at December 31, 1995 compared with 1.41% at December 31, 1994. Non-performing loans were covered 2.3 times by the allowance for loan losses. The allowance includes $ 6.7 million which is not allocated to any specific loan category. Because of this strong asset quality, the provision for loan losses was decreased by $1.9 million in 1995.
Non-interest income, other than securities gains, increased $11.9 million, or 20.6%. Increased non-interest income was the result of growth in fiduciary activities, increase in volume of merchant credit card processing and mortgage banking activities. Offsetting these increases was a decline in commission and fee income generated by Hopper Soliday.
Non-interest expense items increased $14.0 million, or 10.1%. Contributing to this increase were strategic initiatives implemented, normal salary adjustments and additions to staffing levels and the inclusion of a full year of results for Eastern Mortgage. Additionally, other non-interest expenses decreased due to the industry-wide reduction in FDIC insurance premiums.
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.
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 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%.
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, 1995.
Net interest income on a fully taxable equivalent basis totaled $188.0 million in 1995, a decrease of $5.6 million or 2.9% from $193.6 million in 1994. Net interest income in 1994 was up 1.1% from $191.4 million in 1993.
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.
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.
DAUPHIN DEPOSIT CORPORATION
During 1995 there was a decrease in net interest income of $3.1 million due to changes in volume and a decrease of $2.5 million due to changes in rate. In 1994 there was an increase of $9.4 million due to changes in volume and a decrease of $7.2 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 were $4.7 billion in 1995 and $4.6 billion in 1994 and 1993. The interest rate spread for 1995 was 3.29% compared with 3.61% for 1994 and 3.67% for 1993. The net interest margin for 1995 was 4.00% compared with 4.17% for 1994 and 4.21% for 1993.
TABLE 4--INTEREST RATE SPREAD AND NET INTEREST MARGIN ON EARNING ASSETS
Short-term interest rates (prime, federal funds, etc.) continued to rise during the first half of 1995 followed by a decline in the second half of 1995. Long-term interest rates, in general, declined steadily for the entire year. The net result of these interest rate movements was a flattening of the overall yield curve. The average prime rate in 1995 was 8.83% compared with 7.17% in 1994. The average federal funds rate increased to 5.84% for 1995 compared with 4.23% for 1994. During 1995, compared with 1994, the average yield on earning assets increased 53 basis points while the average cost of funds increased 85 basis points resulting in a decrease in the interest rate spread of 32 basis points. The yield on the investment portfolio increased 23 basis points due to the reinvestment of maturities at higher rates, when compared with the yield of the security maturing. Average loans, which represent the highest yielding earning assets, increased $244.8 million or 9.2% and produced a yield of 8.56% in 1995 compared with 7.92% in 1994. Average loans represented 61.6% of the average earning assets for 1995. The cost of interest bearing deposits increased to 4.47% in 1995 compared with 3.68% in 1994. Rates paid on interest bearing transaction accounts decreased throughout 1995. Interest rates offered on time deposits have been rising. Consequently, depositors have been shifting from transaction accounts to higher yielding time deposits. The increase in the cost of short- term borrowings (143 basis points) was caused primarily by the rise in the federal funds rate. The interest rate spread decreased 32 basis points which was partially offset by an increase in the value of non-interest bearing funds resulting in a net 17 basis point decline in the net interest margin.
Average interest rates rose during 1994 compared to 1993. The average prime rate in 1994 was 7.17% compared with 6.00% in 1993. The average federal funds rate increased to 4.23% for 1994 compared with 3.02% for 1993. During 1994, compared with 1993, the average yield on earning assets decreased 1 basis point while the average cost of funds increased 5 basis points resulting in a decrease in the interest rate spread of 6 basis points. The yield on the investment portfolio decreased 17 basis points due to the reinvestment of maturities at
DAUPHIN DEPOSIT CORPORATION significantly lower rates when compared with the yield of the security maturing. Average loans, which represent the highest yielding earning assets, increased $191.0 million or 7.8% and produced a yield of 7.92% in 1994 compared with 7.91% in 1993. This slight increase was the result of a higher interest rate environment during 1994, somewhat offset by fee income which is included in interest income. The reduction of fees, due to lower refinancings in residential mortgages, reduced the yield by 2 basis points. Average loans represented 57.1% of the average earning assets for 1994. The cost of interest bearing deposits decreased to 3.68% in 1994 compared with 3.86% in 1993. Rates paid on interest bearing transaction accounts decreased in early 1994 and remained relatively flat throughout the year. Interest rates on time deposits have recently been rising. Consequently, depositors are shifting from transaction accounts to higher yielding time deposits, reversing the trend of the prior three years. The increase in the cost of short-term borrowings (111 basis points) was caused primarily by the rise in the federal funds rate. The interest rate spread decreased 6 basis points which was partially offset by an increase in the value of non-interest bearing funds resulting in a 4 basis point decline in the net interest margin.
Dauphin's cost of interest bearing funds is generally higher, and its net interest margin is generally lower, when compared with banking companies of Dauphin's asset size. An important factor in these comparative differences is certain individual retirement accounts which are invested in 18 month variable interest rate products with a minimum interest rate of 10% for the 18 month term as discussed herein under "Deposits". If these interest rate products had paid interest at Dauphin's weighted average cost of funds for all other retail certificates of deposit, Dauphin's cost of interest bearing liabilities would have been decreased by 21 basis points, 24 basis points and 21 basis points for 1995, 1994 and 1993, respectively.
PROVISION FOR LOAN LOSSES
The provision for loan losses charged against earnings was $5.6 million in 1995 compared with $7.5 million in 1994, a decrease of 25.2%. This decrease was mainly due to the improved 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. This does not necessarily indicate a 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 .14% in 1995 from .24% in 1994 and the level of non-accruing loans and restructured loans decreased to $17.9 million (.60% of year-end loans) at December 31, 1995 from $20.3 million (.71% of year-end loans) at December 31, 1994.
NON-INTEREST INCOME
Table 5 reflects Dauphin's total non-interest income which increased $10.8 million or 17.8% in 1995 compared with an increase of $.9 million or 1.5% in 1994. Excluding gains on investment securities, the 1995 increase was $11.9 million or 20.6% compared with an increase of $.8 million or 1.4% for 1994.
DAUPHIN DEPOSIT CORPORATION
TABLE 5--NON-INTEREST INCOME
In the banking segment of Dauphin, income from fiduciary activities increased $.4 million or 2.7% in 1995. Revenue in 1995 increased in the areas of employee benefits and personal trust. The increase of $1.1 million or 7.4% in 1994 was due to similar increases in the employee benefits and personal trust departments.
Service charges on deposit accounts decreased $.6 million or 5.0% during 1995. In 1994, a decrease of $1.0 million or 8.1% was realized. Management continuously monitors the fee structure and makes changes where appropriate. The 1995 and 1994 decrease was primarily due to a lower number of fees assessed for services.
Other service charges and fees increased $1.3 million or 11.4% in 1995 compared with an increase of $2.1 million or 23.4% in 1994. The increase for 1995 and 1994 was due to the volume of merchant credit card processing and other fees relating to increased volume in consumer lending.
Securities gains totaled $2.3 million in 1995 as compared with $3.3 million in 1994 and $3.2 million in 1993. All gains in 1995 were from the sale of debt securities. During 1994 the sale of debt securities generated $2.4 million in net gains compared with $.9 million in net gains from equity securities transactions.
Other non-interest income increased $1.2 million for 1995 compared with 1994. In 1994, compared with 1993, other non-interest income decreased $3.7 million. The increase for 1995 was primarily the result of gains realized on the disposition of certain branches (including deposits) and the realignment of the proceeds to new branch locations. 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 was the result of litigation contesting the Commonwealth's ability to tax United States Obligations.
The broker/dealer segment of Dauphin represents broker/dealer commissions and fees 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. The broker/dealer income decreased $1.4 million or 17.9% in 1995 and decreased $3.2 million or 29.3% in 1994. These decreases are due to reduced volume of business in 1995 and 1994, due primarily to a less favorable interest rate environment.
The mortgage banking segment of Dauphin reflects the mortgage banking subsidiary, Eastern Mortgage. The mortgage banking income increased $11.5 million or 113.6% in 1995 compared with 1994. Because Eastern
DAUPHIN DEPOSIT CORPORATION Mortgage was acquired July 1, 1994, the income in 1994 represents a full service mortgage banking operation for only six months.
In addition, effective January 1, 1995, Dauphin adopted Statement of Financial Accounting Standards No. 122 (SFAS 122), "Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65". SFAS 122 amended Statement 65 to require an institution to recognize as separate assets the rights to service mortgage loans for others when a mortgage loan is sold or securitized and servicing rights retained. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. For the year ended December 31, 1995 the impact of applying the provisions of SFAS 122 resulted in a net increase in mortgage banking income of $5.8 million when compared with 1994.
NON-INTEREST EXPENSE
Table 6 reflects Dauphin's non-interest expense which increased $14.0 million or 10.1% in 1995 compared with an increase of $2.8 million or 2.1% in 1994.
TABLE 6--NON-INTEREST EXPENSE
Dauphin's banking segment non-interest expense increased $4.2 million or 3.4% in 1995 compared with a decrease of $4.6 million or 3.7% for 1994.
In Dauphin's banking segment, salaries and employee benefits increased .5% in 1995 and decreased .9% in 1994. Full-time equivalent employees increased 5.2% to 2,024 at December 31, 1995 compared with 1,924 at year-end 1994. Salaries expense increased 4.1% in 1995, while benefits expense decreased 15.1%, primarily due to a decrease in health insurance costs. Dauphin goes through a continual review to control benefit costs.
In the second quarter of 1995, the Bank Insurance Fund (BIF) reached its statutory reserve ratio requirement of 1.25%. Consequently, the FDIC significantly reduced the assessment rates applicable to BIF members and refunded to BIF members that portion of the assessment for the second and third quarters of 1995 which represented an overpayment once BIF had achieved full funding in accordance with the statutory reserve ratio requirement. Dauphin received a refund from the FDIC in September 1995 in the amount of $2.2 million which included interest from June 1, the date the BIF was fully funded. In addition, Dauphin's assessment rate was dropped from 23 basis points to 4 basis points effective from the date of BIF reaching its statutory reserve ratio requirement. This reduced Dauphin's deposit insurance expense by $3.8 million when compared to 1994. In 1996, Dauphin will record $1,000 for deposit insurance for the period from January through June. Deposit insurance assessments for the second half of 1996 have not yet been determined.
DAUPHIN DEPOSIT CORPORATION
All other non-interest expense items increased $7.7 million or 14.5% in 1995 compared with 1994. The increase for 1995 was primarily the result of increased expenses to reflect numerous strategic initiatives implemented in 1995. The other non-interest expense items that increased include depreciation on technological investments, upgrades to branch facilities, legal, and consulting fees.
The broker/dealer segment had increased non-interest expense of $.2 million or 3.0% in 1995 and a decrease of $2.1 million or 21.7% in 1994.
The mortgage banking segment had increased non-interest expense of $12.0 million or 119.8% in 1995 compared with 1994. This significant increase reflects twelve months of results in 1995 and six months of results in 1994. In addition, the mortgage banking segment experienced significant volume increases in 1996, including large refinancing activities in the last quarter of 1995, which resulted in significantly higher salary expense.
PROVISION FOR INCOME TAXES
Income tax expense amounted to $23.2 million in 1995 as compared with $22.8 million in 1994 and $22.0 million in 1993. Dauphin's effective tax rate for 1995 was 26.1% compared with 24.5% in 1994 and in 1993. The primary increase in the effective tax rate was due to the decreased level of tax exempt income in 1995 compared with 1994 and 1993. For a more comprehensive analysis of income tax expense, refer to Note 13 of the Notes to Consolidated Financial Statements.
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 $63.6 million or 1.4% in 1995 as compared with an increase of $88.0 million or 1.9% in 1994.
TABLE 7--SOURCES AND USES OF FUNDS
- -------- (1) Non-interest bearing liabilities and stockholders' equity less non-interest bearing assets.
DAUPHIN DEPOSIT CORPORATION
INVESTMENT SECURITIES AND OTHER SHORT-TERM INVESTMENTS
Average short-term investments and investment securities, in the aggregate, decreased $230.9 million or 11.8% during 1995 compared with a decrease of $96.5 million or 4.7% during 1994. During 1995 and 1994 investment securities maturing were used to fund loan growth since loan growth exceeded the growth of traditional funding sources of deposits and short-term borrowings.
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 interest bearing demand accounts, short-term borrowings and time deposits. As reflected in Table 8, the average maturity of the investment portfolio was 6.0 years at year-end 1995. 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 2.0 years at December 31, 1995.
TABLE 8--ANALYSIS OF INVESTMENT SECURITIES
Dauphin had no investments in any foreign country that aggregated more than 1% of assets at December 31, 1995, 1994 or 1993.
At December 31, 1995, net unrealized gains in the portfolio were $21.0 million consisting of gross unrealized gains of $29.7 million and gross unrealized losses of $8.7 million. Dauphin accounts for investment securities in accordance with the provisions of Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities". 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
DAUPHIN DEPOSIT CORPORATION 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 should be classified as available- for-sale.
LOANS
Average loans increased $244.8 million or 9.2% during 1995 compared with an increase of $191.0 million or 7.8% in 1994. Loan growth continued to increase in 1995, primarily in the area of consumer loans, as more emphasis was placed on this line of business.
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.
Loan balances during 1995 were influenced by the improving economy and, as a result, balances in both the commercial and consumer areas increased. Dauphin continues to sell residential mortgages in the secondary market 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, 1995.
TABLE 9--LOANS OUTSTANDING, NET OF UNEARNED INCOME
TABLE 10--LOAN MATURITIES AND INTEREST SENSITIVITY (1)
- -------- (1) Excludes residential mortgages, home equity, consumer loans and lease financing
DAUPHIN DEPOSIT CORPORATION
DEPOSITS
Average deposits, including non-interest bearing demand deposits, increased $223.6 million or 6.4% during 1995 compared with a decrease of $62.3 million or 1.7% in 1994. Dauphin, like many other commercial banks, has experienced deposit growth even 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 was primarily due to the increase in average interest rates during 1995. While rates paid on interest bearing transaction accounts decreased throughout 1995, rates paid on time deposits have been increasing due to rising interest rates. Depositors appear to be shifting from transaction accounts to time deposits. Included in interest bearing deposits are certain individual retirement accounts (IRA) totaling $184.8 million which are invested in 18 month variable interest rate products with a minimum interest rate of 10% for the 18 month term. During 1993, Dauphin charged a service fee on these products, and initiated the process to discontinue the products in accordance with the terms of the IRA contract. In furtherance of its right to terminate this investment product, Dauphin commenced a legal action for a declaratory judgment in 1994 seeking a judicial determination from the Court permitting Dauphin to discontinue the 18 month variable rate investment product at issue and/or to charge an annual maintenance fee and an additional fee on rollovers or transfers into the IRA account. Dauphin's right to terminate the variable rate investment product and to charge a service fee is in dispute and is being challenged by the holders of the IRA accounts in question. It is management's opinion that continuation of the 18 month variable rate investment product is not in the best interest of Dauphin. Management intends to vigorously assert its legal right to discontinue the 18 month variable rate investment product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.
During 1995 average time deposits increased $400.7 million compared with a decrease of $41.5 million during 1994. This funding source was used to replace volatile liabilities such as 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 11.6% in 1995 and 1994 and 11.0% for 1993. Dauphin's banking subsidiary has remained interest rate competitive and has introduced new deposit products to maintain and attract deposits.
SHORT-TERM BORROWINGS
Average short-term borrowings decreased $132.4 million or 17.0% during 1995 compared with an increase of $132.7 million or 20.5% in 1994. 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. The average cost of short-term borrowings increased from 3.01% in 1993 to 4.12% in 1994 and to 5.55% in 1995.
NON-PERFORMING ASSETS
Table 11 reflects Dauphin's non-performing assets for the five years ended December 31, 1995. 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.
DAUPHIN DEPOSIT CORPORATION
TABLE 11--NON-PERFORMING ASSETS
Loan quality is maintained through diversification of risk, strict enforcement of credit control practices and continued monitoring of the loan portfolio.
At December 31, 1995, 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.
The balance of non-accrual and restructured loans is $12.1 million at December 31, 1995. Interest income on these loans of $.4 million was recorded on a cash basis. If such loans were on the accrual basis, an additional $.3 million of interest income would have been recognized.
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, impaired or reduced rate in the future are estimated to total approximately $8.1 million at December 31, 1995.
On January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan", as amended by Statement of Financial Accounting Standards No. 118 (SFAS 118), "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures". 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 of the fair value of the collateral if the loan is collateral dependent.
On December 31, 1995 the balance of impaired loans was $11.7 million. Impaired loans of $8.2 million have a related allowance for loan losses of $3.8 million and the remaining impaired loans of $3.5 million have no related allowance for loan losses. The impaired loans consist of loans where it is probable that Dauphin will be unable to collect all amounts due according to the contractual term of the loan agreement. Interest income for impaired loans that are on non-accrual status is recognized using the cash basis, while interest on impaired loans that are still accruing is recognized using the accrual method. The average balance of impaired loans for 1995 was $8.4 million and the interest recognized for the year was $.7 million. The interest income includes $.2 million that was recorded on the cash basis.
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 $7.3 million at December 31, 1995 and $8.2 at December 31, 1994 and represents Dauphin's portion of a shared national credit within its market area.
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. In 1995, the unallocated category increased primarily as a result of Dauphin's continued improvement in loan quality which is reflected in Table 11.
TABLE 12--ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
- -------- Gross loans represent loans before unamortized net loan fees. (1) Includes home equity loans
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 Bank's allowance for loan losses. Such agencies may require the Bank 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.
DAUPHIN DEPOSIT CORPORATION
The provision for loan losses of $5.6 million exceeded the net charge-offs of $4.1 million, thereby increasing the allowance for loan losses from $40.2 million in 1994 to $41.7 million in 1995. The allowance for loan losses as a percentage of year-end loans was 1.40% at December 31, 1995 and 1.41% at December 31, 1994.
TABLE 13--ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(1) Includes home equity loans
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
DAUPHIN DEPOSIT CORPORATION the funds available to Dauphin by established federal funds lines of credit. Additionally, the Bank is a member of the Federal Home Loan Bank of Pittsburgh. This established credit arrangement provides the Bank with increased liquidity.
The generation of deposit balances is the primary source of liquidity from liability categories. Total deposits increased by $434.7 million or 12.4% from year-end 1994 to year-end 1995. As previously mentioned, this funding source replaced overnight federal funds borrowings. Table 14 reflects the change 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. As shown in Table 16, 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
TABLE 16--SHORT-TERM BORROWINGS
DAUPHIN DEPOSIT CORPORATION
CAPITAL RESOURCES
During 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 2,000,000 shares of the outstanding common stock. In February 1995, an additional 1,500,000 shares were authorized for repurchase. Available investments are being used to fund the share repurchases. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan, Stock Option Plan, the Dividend Reinvestment and Stock Purchase Plan, and other appropriate uses. During 1995 and 1994, Dauphin repurchased 630,000 shares for $16.1 million and 1,744,500 shares for $42.4 million, respectively.
Total stockholders' equity increased $80.0 million or 17.1% in 1995 compared with an increase of $39.4 million or 7.8% in 1994. The increase for 1995 was due to net income of $65.6 million less dividends declared of $31.2 million and was positively impacted by the change in net unrealized gains on investments available-for-sale of $54.7 million, somewhat offset by the repurchase of outstanding common stock throughout the year of $16.1 million. The decrease for 1994 was adversely impacted by the change in net unrealized losses on investments available-for-sale of $83.1 million. The ratio of average equity to average assets amounted to 10.23% for 1995, compared with 10.27% for 1994 and 9.99% for 1993. 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 6.7% for 1995 compared with 7.9% for 1994 and 8.6% for 1993.
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 17 presents the capital ratios for Dauphin for the past three years calculated at year-end in accordance with these guidelines. At December 31, 1995, Dauphin and its banking subsidiary exceeded all capital requirements and is considered to be "well capitalized".
TABLE 17--CAPITAL RATIOS
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 rate of growth in interest free sources of funds will influence the level of interest sensitive funding sources. In addition, the 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 changes in net interest margin.
DAUPHIN DEPOSIT CORPORATION
Table 18 presents an interest sensitivity analysis of Dauphin's assets and liabilities at December 31, 1995 for several time intervals. This table reflects the interest sensitivity gap in two formats. The detailed presentation represents management's assumption on certain interest bearing deposits, such as passbook savings 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 18 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 18 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 18--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. The gap at December 31, 1995 reflects Dauphin's sensitivity at a point in time to rate changes over future periods of time. Generally, an asset sensitive gap will increase an institution's net interest income during periods of rising interest rates and the liability sensitive gap will increase an institution's net interest income during declining rates. The lower the amount of this gap, the less sensitive an institution's earnings are to interest rate changes. However, Dauphin's assets and liabilities with similar maturities or repricing will, at times, react differently in varying interest rate environments. Therefore, the interest sensitivity
DAUPHIN DEPOSIT CORPORATION gap does not accurately predict the actual impact of market rate changes. The volume and mix of future assets and liabilities changes will also impact Dauphin's net interest income as indicated on Table 3. 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 uses on-balance sheet financial instruments, such as investments classified as available-for-sale, to provide flexibility in managing the interest sensitivity gap.
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.
RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of". SFAS 121 provides guidance for recognition and measurement of impairment of long-lived assets, certain identifiable intangibles and goodwill related both to assets to be held and used and assets to be disposed of. SFAS 121 becomes effective January 1, 1996 and will not have a material effect on Dauphin's financial position or results of operations.
In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation". SFAS 123 becomes effective January 1, 1996, and will not have a material effect on Dauphin's financial position or results of operations. Management anticipates that upon adoption of SFAS 123 it will continue to measure compensation expense for its stock-based employee compensation plans, using the methods as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" and will provide pro forma disclosures of net income and earnings per share as if the fair value- based method prescribed by SFAS 123 had been applied in measuring compensation expense.
REGULATORY DEVELOPMENTS
During 1994, Congress passed legislation to remove geographic restrictions on bank expansion. The Riegle-Neal Interstate Banking and Branch Efficiency Act of 1994 will allow banks to expand across state lines to merge existing multi- state branching operations into a single institution or to acquire new branches in other states. Interstate banking and branching authority will be subject to certain conditions and restrictions, such as capital adequacy, management, Community Reinvestment Act compliance and limits on deposit concentrations. The legislation permits a bank holding company to acquire a bank in another state as of September 29, 1994, whether or not the state permits the acquisition. Interstate bank mergers and de novo interstate branching are permitted as of June 1, 1997, although states may choose to opt in to these provisions prior to June 1, 1997, or to opt out of these provisions completely by enacting appropriate legislation. The Pennsylvania legislature amended the Pennsylvania Banking Code of 1965 in July, 1995, to opt in to the interstate bank merger and de novo branching provisions of the Riegle-Neal Act. The management of Dauphin cannot predict with any reasonable degree of certainty the effects, if any, which the Riegle-Neal Act may have on Dauphin.
Legislation has been introduced in Congress to recapitalize the Savings Association Insurance Fund (SAIF) via a one-time special assessment on SAIF deposits and thereafter to merge the SAIF with the Bank Insurance Fund (BIF). Legislation is also pending in Congress which would repeal certain aspects of the Glass-Steagall Act, which prohibits commercial banks from engaging in securities underwriting activities. It is not anticipated that the enactment of such legislation, in its current form, would have a material effect on the financial condition or results of operations 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, 1995 and 1994
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1995, 1994 and 1993
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1995, 1994 and 1993
See accompanying notes to consolidated financial statements.
Dauphin Deposit Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993
See accompanying notes to consolidated financial statements.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1994 AND 1993
1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting policies of Dauphin Deposit Corporation and subsidiaries.
BUSINESS
Dauphin Deposit Corporation (Dauphin) is a bank holding company, incorporated under the laws of the Commonwealth of Pennsylvania in 1974. Dauphin's wholly- owned bank subsidiary is Dauphin Deposit Bank and Trust Company (the Bank), through which Dauphin provides banking services. The Bank is engaged in the commercial and retail banking and trust business. The Bank's mortgage banking subsidiary, Eastern Mortgage Services, Inc. (Eastern Mortgage) is a full service mortgage banking company which originates, services and sells first and second residential mortgage loans of varying types primarily to the eastern Pennsylvania and New Jersey mortgage markets. Dauphin's wholly-owned subsidiary Hopper Soliday & Co., Inc. (Hopper Soliday) 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.
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 and subsidiaries, including its principal subsidiary, the Bank, which includes the Bank of Pennsylvania, Farmers Bank and Valleybank Divisions. All material intercompany balances and transactions have been eliminated in consolidation.
INVESTMENT SECURITIES
Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities" on January 1, 1994. Under SFAS 115 investments are 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.
Premiums and discounts are amortized and accreted over the term of the related securities using a method that approximates the interest method. Realized gains or losses on the sale of investment securities (determined by the specific identification method) are shown separately in the statements of income. A decline in the fair
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993 value of any investment below cost that is deemed other than temporary results in a reduction of the carrying amount to fair value through a charge to income. Dividend and interest income are recognized when earned.
ASSETS HELD FOR SALE
Assets held for sale consist of the securities inventory of Hopper Soliday and mortages held for sale, primarily the inventory of Eastern Mortgage. The securities inventory is recorded at current quoted market value. The mortgages held for sale are carried at the lower of aggregate cost or estimated market value with unrealized losses recognized through a provision included in other income. Gains and losses on the sale of mortgages held for sale are determined using the specific identification method.
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 charged against current earnings. Non-accruing loans are returned to accruing status after at least six consecutive months of current performance. Lease income is recorded using the finance method which provides for a level rate of return on the investment outstanding.
Loan fees and costs of loan origination are deferred and recognized over the life of the loan as a component of interest income. The amortization of deferred fees and costs is discontinued on non-accrual loans.
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 Bank. 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 Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Dauphin adopted the provisions of Statement of Financial Accounting Standard No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118 (SFAS 118), "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure" on January 1, 1995. Generally, all non-accrual loans are deemed to be impaired. In addition, management, considering current information and events regarding the borrowers ability to repay their obligations, considers a loan to be impaired when it is probable that Dauphin will be unable to collect all amounts due according to the contractual terms of the loan agreement. In evaluating whether a loan is impaired, management considers not only the amount that Dauphin expects to collect but also the timing of collection. Generally, if a delay in payment is insignificant (e.g. less than 90 days), a loan is not deemed to be impaired.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
When a loan is considered to be impaired, the amount of impairment is 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 fair value of the collateral if the loan is collateral dependent. The majority of loans deemed to be impaired by management are collateral dependent. Loans are evaluated individually for impairment. Dauphin excludes smaller balance, homogeneous loans (e.g. primarily consumer and residential mortgages) from the evaluation for impairment. Impairment losses are included in the allowance loan losses. Impaired loans are charged-off when management believes that the ultimate collectibility of a loan is not likely.
Income for impaired loans that are on non-accrual status is recognized using the cash basis, while interest on impaired loans that are still accruing is recognized using the accrual method.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, including capitalized interest during construction, less accumulated depreciation and amortization. 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 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.
OTHER ASSETS
Goodwill is the excess of the purchase price over the fair value of net assets of entities acquired through business combinations that are recorded using the purchase method of accounting. Included in other assets is $15.5 million of goodwill at December 31, 1995 and 1994. Goodwill is being amortized using the straight-line method over periods not exceeding 15 years.
Excess servicing fees are computed as the present value of the difference between the estimated future net 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.
Effective January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 122 (SFAS 122), "Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65". SFAS 122 amended Statement 65 to require an institution to recognize as separate assets the rights to service mortgage loans for others when a mortgage loan is sold or securitized and servicing rights retained. When capitalizing mortgage servicing rights, Dauphin allocates the total cost of the mortgage loans (the recorded investment in the mortgage loans including net deferred fees or costs and any purchase premium or discount) to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. Such fair value is primarily based on observable market prices. Mortgage servicing rights (including purchased mortgage servicing) are amortized in proportion to, and over the period of, estimated net servicing revenue based on management's best estimate of remaining loan lives.
Dauphin measures the impairment of servicing rights based on the difference between the carrying amount of the servicing rights and their current fair value. Impairment of servicing rights is recognized through a
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
valuation allowance. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights exceed their fair value. For the purpose of evaluating and measuring impairment of capitalized mortgage servicing rights, Dauphin stratifies those rights based on the predominant risk characteristics of the underlying loans. Dauphin primarily stratifies mortgage servicing rights by loan type (e.g. conventional or government guaranteed and adjustable-rate or fixed-rate mortgage loans). Valuation techniques for measuring fair value incorporate assumptions that market participants use in estimating future servicing income and expense, including assumptions about prepayment, default and interest rates.
DERIVATIVES
Dauphin's mortgage subsidiary, Eastern Mortgage, has limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are primarily used to manage well-defined interest rate risks, as described in Note 16.
TRUST ASSETS
Assets held by the Bank in a fiduciary or agency capacity are not included in the consolidated financial statements since such assets are not assets of the Bank. 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 provisions 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's cost of retiree health care and other postretirement benefits are accounted for in accordance with the provisions of Statement of Financial Acccounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions".
Dauphin provides benefits to former or inactive employees after employment but before retirement. These costs are accounted for in accordance with the provisions of Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits".
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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 and performance shares using the
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
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.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform with current year classifications.
2--ACQUISITIONS
On July 1, 1994, Dauphin acquired Eastern Mortgage, a mortgage banking company headquartered in Trevose, Pennsylvania, for approximately $21.0 million in cash pursuant to a definitive agreement signed in May 1994. The acquisition was accounted for using the purchase method of accounting. Therefore, the results of operations of Eastern Mortgage from the date of acquisition are included with the results of Dauphin. The excess of the purchase price over the fair value of the net identifiable assets acquired of $12.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 15 years.
3--RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS AND INVESTMENT SECURITIES
The Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of these required reserve balances at December 31, 1995 and 1994 was approximately $80,353,000 and $78,522,000, respectively.
The Bank is required to maintain an investment in Federal Home Loan Bank of Pittsburgh stock of $14,987,200 which is included with equity securities.
4--INVESTMENT SECURITIES
The amortized cost and fair value of investment securities are as follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
The amortized cost and fair value of debt securities at December 31, 1995, 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.
Gains and losses from sales of investment securities are as follows:
Proceeds from sales of investment securities are as follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
Securities with a carrying value of $1,053,541,000 at December 31, 1995 and $816,290,000 at December 31, 1994 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, 1995 and 1994 is as follows:
The Bank has 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:
Included within the loan portfolio are loans on which the Bank has ceased the accrual of interest and restructured loans. Such loans amounted to $12,103,000 and $15,168,000 at December 31, 1995 and 1994, respectively. If interest income had been recorded on all such loans outstanding during the years 1995, 1994 and 1993, interest income would have been increased as shown in the following table:
The Bank does not have any significant commitments to lend additional funds on non-accrual or restructured loans at December 31, 1995.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
As previously discussed in Note 1, on January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan" as amended by Statement of Financial Accounting Standards No. 118 (SFAS 118), "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures".
On December 31, 1995 the balance of impaired loans was $11.7 million. Impaired loans of $8.2 million have a related allowance for loan losses of $3.8 million and the remaining impaired loans of $3.5 million have no related allowance for loan losses. The average balance of impaired loans for 1995 was $8.4 million and the interest recognized for the year was $.7 million. The interest income includes $.2 million that was recorded on the cash basis.
6--ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses is as follows:
7--PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1995 and 1994 is as follows:
Depreciation and amortization amounted to $7,665,000 for 1995, $6,834,000 for 1994 and $6,495,000 for 1993.
8--MORTGAGE SERVICING RIGHTS
Mortgage loans serviced for others are not included in the consolidated balance sheet. The outstanding balance of these loans at year-end and gains on the sale of servicing during the year are presented below:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
As previously discussed in Note 1, effective January 1, 1995, Dauphin adopted the provisions of Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65". An analysis of the activity of excess, purchased, and originated mortgage servicing rights for the years ended December 31, 1995 and 1994 is as follows:
The fair value of purchased and originated servicing rights was $13.7 million at December 31, 1995. As of and for the year ended December 31, 1995, there was no valuation allowance for purchased and originated servicing rights.
The balances and activities of excess and purchased mortgage servicing rights were not significant to the consolidated balance sheets or results of operations of Dauphin during 1993.
9--TIME CERTIFICATES OF DEPOSIT
Time certificates of deposit of $100,000 or more at December 31, 1995 and 1994 amounted to $459,074,000 and $270,777,000, respectively.
10--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, 1995, 1994 and 1993:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
The securities that serve as collateral for the securities sold under agreements to repurchase are under Dauphin's control.
The Bank has approved federal funds lines of credit that amounted to approximately $2,338,000,000 at December 31, 1995.
11--LONG-TERM DEBT
The following is a summary of long-term debt at December 31, 1995 and 1994:
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.
Aggregate long-term debt maturities, for each of the next five years are as follows:
1996--$35,095,000; 1997--$107,000; 1998--$86,000; 1999--$5,038,000; 2000-- $92,000
At December 31, 1995, Dauphin and its subsidiaries had unused lines of credit totaling approximately $3,000,000 with a non-affiliated bank.
12--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. Dauphin and the Bank are required to maintain minimum amounts of capital to total risk weighted assets as defined by the banking regulators. The requirement is to have a minimum Tier 1 and total capital ratios of 4.00% and 8.00%, respectively. The Bank may not pay dividends to Dauphin, which would allow these risk-based capital ratios to fall below the minimum capital requirements. Under these policies and subject to the restrictions applicable to the Bank, the Bank could declare, without prior regulatory approval, aggregate dividends of $26.0 million, plus net profits for 1996.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
13--INCOME TAXES
The provision for income taxes, consisting primarily of Federal income taxes, for the years 1995, 1994 and 1993, consists of the following:
A reconciliation between the effective income tax rate and the statutory rate follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995, 1994 and 1993 are as follows:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
Included in the table above is the recognition of certain temporary differences for which no deferred tax expense or benefit was recognized in the consolidated statements of income. Such items include unrealized gains and losses on certain investments in debt and equity securities accounted for under SFAS 115 and book and tax basis differences relating to business combinations accounted for under the purchase method of accounting.
Management is of the opinion that it is more likely than not that the deferred tax asset of $21,825,000 will be realized since Dauphin has had a long history of 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.
14--BENEFIT PLANS
The Bank has a noncontributory defined benefit pension plan covering substantially all employees. The Plan's 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.
The following table sets forth the pension plan's funded status and amounts recognized in Dauphin's consolidated financial statements at December 31, 1995 and 1994:
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:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
Net pension expense (credit) for 1995, 1994 and 1993 was comprised of the following:
Plan assets are primarily invested in listed stocks (including 107,000 and 100,000 shares of Dauphin at December 31, 1995 and 1994) and U.S. Treasury and federal agency securities.
Dauphin's postretirement benefits other than pensions are currently not funded. The status of the plan at December 31, 1995 and 1994 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 1995, 1994 and 1993 consisted of the following components:
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
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 per year to an ultimate rate of 5 1/2% in 2005 (10% at December 31, 1995) 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, a one-percentage-point increase in the assumed health care cost trend would increase the accumulated postretirement benefit obligation by $1,760,000 at December 31, 1995 and increase the aggregate of the service and interest cost components by $190,000 for the year ended December 31, 1995.
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 $581,000, $563,000 and $468,000 during 1995, 1994 and 1993, 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 $26,500, $30,000 and $500,000 to salaries and benefits expense in 1995, 1994 and 1993, respectively. This accrual was established to record the liability for benefits to former or inactive employees after employment but before retirement. The balance at December 31, 1995 is $556,500.
15--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 726,974 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, 1995.
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, 1995, 1994 AND 1993
Stock option transactions during 1995, 1994 and 1993 are summarized below:
During 1995, the shareholders approved the adoption of the 1995 Stock Incentive Plan (1995 Plan). Under the 1995 Plan, Dauphin may grant incentive stock options, non-qualified stock options, restricted stock awards, performance share awards and other awards that provide a participant with the right to purchase or otherwise acquire Dauphin common stock or that are valued by reference to the market value of Dauphin common stock. In 1995, Dauphin entered into Performance Share Agreements with certain key employees as permitted under the 1995 Plan. The Performance Share Agreements entitle these employees to a grant of Dauphin common stock after a three year period if specific corporate goals are realized. During 1995, Dauphin recognized $.4 million of expense related to Performance Share Agreements.
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.
During 1994, Dauphin announced that the Board of Directors authorized the repurchase of up to 2,000,000 shares of the outstanding stock. In February 1995, an additional 1,500,000 shares were authorized for
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
repurchase. Available investments are being used to fund the share repurchases. Dauphin will use the shares for general corporate purposes, including the Employee Stock Purchase Plan, Stock Option Plans, the Dividend Reinvestment and Stock Purchase Plan, and other appropriate uses. During 1995 and 1994, Dauphin repurchased 630,000 shares for $16.1 million and 1,744,500 shares for $42.4 million, respectively.
16--FINANCIAL INSTRUMENTS
Off-Balance-Sheet Risk and Concentrations of Credit Risk
In the normal course of business, Dauphin is a party to financial instruments with off-balance-sheet risk which/or meet the financing needs of its customers and which reduces Dauphin's exposure to fluctuations 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.
For commitments to extend credit and standby letters of credit, Dauphin's exposure to credit loss in the event of non-performance by the other party is represented by the contractual amount of those instruments. Dauphin uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Dauphin had the following off-balance-sheet financial instruments at December 31:
Commitments to extend credit, which includes loans and lines of 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 terms of the letters of
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
credit vary from one month to 24 months and may have renewal features. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Dauphin holds collateral supporting those commitments, as deemed necessary.
Most of the Bank's business activity is with customers located within the Bank's defined market area, principally Central Pennsylvania. The Eastern Pennsylvania and New Jersey mortgage markets are served by Eastern Mortgage, the Bank's mortgage subsidiary. However, the Bank will grant commercial, residential and consumer loans throughout Pennsylvania. The loan portfolio is well diversified and the Bank does not have any significant concentrations of credit risk. However, since a significant share of the Bank's loans are within the geographic area previously defined, a substantial portion of the Bank's debtors' ability to honor their contracts may be significantly affected by the level of economic activity in this area.
Derivative Financial Instruments
Dauphin's mortgage subsidiary, Eastern Mortgage, has limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are primarily used to manage well-defined interest rate risks.
Eastern Mortgage is exposed to interest rate risk when it extends a commitment to a borrower for future settlement. As interest rates increase, the valuation of the commitment to Eastern Mortgage declines. As interest rates decrease, a borrower is more likely to abandon the commitment, which could cause a financial loss to Eastern Mortgage if they have committed to sell that loan for future delivery in the secondary market.
The secondary marketing department at Eastern Mortgage is primarily responsible for mitigating the exposure to interest rate risk through the use of certain hedging techniques. This is accomplished by using a combination of charging non-refundable commitment fees when the borrower elects to lock in their interest rate; selling loans in the secondary market for future delivery on a mandatory basis (via forward and future delivery commitments with third- party investors); and purchasing options.
Forward commitments are contracts wherein Eastern Mortgage agrees to make delivery of a specified type of loan at a specified future date and price. As loans close and are pooled for delivery, forward commitments are filled and executed, and the primary objective of hedging is achieved. However, in the normal course of business, to the extent that management believes that market conditions may change favorably, or fewer loans are closed than previously anticipated, certain forward commitments may be paired-off. In instances where management paired-off forward commitments on the basis of certain expectations of market conditions, any gains or losses arising from paired-off transactions are deferred on the date of the pair-off, and are recognized as an adjustment to gains (losses) on sale of mortgage loans when the underlying pool of mortgage loans is sold. When forward commitments are paired-off due to a lack of loans to fulfill the commitment, the gain or loss is recognized on the date of the pair-off as an adjustment to gains (losses) on sale of mortgage loans.
Certain future delivery contracts to third parties stipulate the duration of the commitment and the amount of loans deliverable under the commitment and may require the payment of a fee. Commitment fees are capitalized when paid and expensed as a component of gains (losses) on sale of mortgage loans when the commitment expires or is delivered into.
Purchased call or put options are contracts that allow the holder of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from the seller, or "writer," of the option. Eastern Mortgage purchases call options on treasury securities and put options on mortgage backed securities as part of its interest rate risk management strategy. The risk of loss is limited to the price paid for the
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
option. The cost of all such options is expensed as an adjustment to gains (losses) on sale of mortgage loans when the options expire. Any gain realized at the time an option is exercised is deferred, and subsequently recognized when the underlying pool of loans is sold.
In the ordinary course of business, Eastern Mortgage deliberately exposes a portion of its mortgage loan portfolio (warehouse and pipeline, net of estimated fall-out) to interest rate risk, as volume and market conditions warrant. This exposure represents those loans which have closed or are expected to close which are not hedged at a given point in time. At December 31, 1995, the maximum exposure position authorized by management is $20 million. The secondary marketing department produces a daily exposure report summarizing the exposure position. This report is reviewed and adjustments to the exposure position, to the extent considered necessary by management, are made daily.
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.
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 inventory 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 originated mortgage servicing rights is based on observable market prices and the fair value of excess servicing fees is the estimated present value of the difference between the anticipated future servicing fees and normal servicing fees using discount rates that approximate market rates and management's estimate of future prepayment rates.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
Deposits
The fair value of deposits with no stated maturity, such as demand deposits, savings accounts, interest bearing demand and money market deposits, is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit, including certain 18 month variable rate certificates of deposit carrying a minimum interest rate of 10% for the 18 month term which are held in certain individual retirement accounts (as discussed herein under Note 19--Litigation), 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 current rates for 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.
Off-balance-sheet financial instruments
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. The fair value of options is estimated based on quoted market prices.
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. Also, the estimates do not reflect any additional premium or discount that could result from the sale of Dauphin's entire holdings of a particular instrument.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
At December 31, 1995 and 1994, Dauphin's estimated fair values of financial instruments based on disclosed assumptions are as follows:
- -------- (1) The amounts shown under "carrying amount" represent accruals or deferred income arising from those unrecognized financial instruments.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
17--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, 1995, 1994 AND 1993
Dauphin Deposit Corporation (Parent Company Only) Condensed Statements of Income
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995, 1994 AND 1993
Dauphin Deposit Corporation (Parent Company Only) Condensed Statements of Cash Flows
Dauphin Deposit Corporation merged three subsidiaries (FARMCO Realty, Inc., Financial Realty, Inc. and Farmers Mortgage Corporation) with and into itself in 1995. The 1995 balance sheet reflects the assets held by the subsidiaries, primarily premises that are leased to the Bank. Previous periods presented have not been restated.
DAUPHIN DEPOSIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
DECEMBER 31, 1995, 1994 AND 1993
18--CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)
19--LITIGATION
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 to Dauphin's financial condition or results of operation. Included among outstanding litigation is a class action law suit instituted by Dauphin seeking a declaratory judgement from the Court specifically permitting Dauphin to discontinue offering an 18 month variable rate investment product carrying a minimum interest rate of 10% for the 18 month term held in certain individual retirement accounts (IRA) and/or to charge an annual maintenance fee and fee on rollovers or transfers into the investment product. Dauphin's rights to terminate the variable rate interest product and to charge a service fee are in dispute and are being challenged by the holders of the IRA accounts in question. Management intends to vigorously assert its right to terminate the 18 month variable rate investment product in accordance with its terms. Pending the outcome of the litigation, Dauphin has continued to date to pay a 10% interest rate with regard to the product. Counsel expects the case to go to trial in the second quarter of 1996 and for a decision to be rendered by the Court promptly thereafter.
[LETTERHEAD]
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, 1995 and 1994, 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, 1995. These consolidated financial statements are the responsibility of the Company'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, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.
As discussed in notes 1 and 8 to the consolidated financial statements, the Company changed its method of accounting for mortgage servicing rights to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights an amendment of FASB Statement No. 65" on January 1, 1995.
(ART)
January 26, 1996
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 Dauphin is incorporated herein by reference to Election of Directors in Dauphin's 1996 Proxy Statement. Information relative to executive officers of Dauphin 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 1996 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 and Security Ownership of Management in the 1996 Proxy Statement.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is incorporated by reference to Transactions with Management in the 1996 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 20, 1996 /s/ Christopher R. Jennings By: _________________________________ CHRISTOPHER R. JENNINGS 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.
DATE
/s/ Christopher R. Jennings Chairman of the February 20, - ------------------------------------- Board, Chief 1996 CHRISTOPHER R. JENNINGS Executive Officer and Director
/s/ Robert L. Fryer, Jr. President, Chief February 20, - ------------------------------------- Operating Officer 1996 ROBERT L. FRYER, JR. and Director
/s/ Paul B. Shannon Vice Chairman and February 20, - ------------------------------------- Chief Credit Policy 1996 PAUL B. SHANNON Officer
/s/ Lawrence J. LaMaina, Jr. Vice Chairman and February 20, - ------------------------------------- Director 1996 LAWRENCE J. LAMAINA, JR.
/s/ Dennis L. Dinger Senior Executive February 20, - ------------------------------------- Vice President, 1996 DENNIS L. DINGER Chief Fiscal and Administrative Officer (Principal Financial Officer)
/s/ Joseph T. Lysczek, Jr. Senior Vice February 20, - ------------------------------------- President and 1996 JOSEPH T. LYSCZEK, JR. Treasurer
DAUPHIN DEPOSIT CORPORATION DATE
/s/ James O. Green Director February 20, 1996 - ------------------------------------- JAMES O. GREEN
/s/ Derek C. Hathaway Director February 20, 1996 - ------------------------------------- DEREK C. HATHAWAY
Director - ------------------------------------- ALFRED G. HEMMERICH
/s/ Lee H. Javitch Director February 20, 1996 - ------------------------------------- LEE H. JAVITCH
Director - ------------------------------------- WILLIAM J. KING
/s/ William T. Kirchhoff Director February 20, 1996 - ------------------------------------- WILLIAM T. KIRCHHOFF
/s/ Andrew Maier,II Director February 20, 1996 - ------------------------------------- ANDREW MAIER, II
Director - ------------------------------------- JAMES E. MARLEY
/s/ Robert F. Nation Director February 20, 1996 - ------------------------------------- ROBERT F. NATION
DAUPHIN DEPOSIT CORPORATION DATE
/s/ Elmer E. Naugle Director February 20, - ------------------------------------- 1996 ELMER E. NAUGLE
Director - ------------------------------------- WALTER F. RAAB
Director - ------------------------------------- PAUL C. RAUB
/s/ Henry W. Rhoads Director February 20, - ------------------------------------- 1996 HENRY W. RHOADS
/s/ Jean D. Seibert Director February 20, - ------------------------------------- 1996 JEAN D. SEIBERT
/s/ R. Champlin Sheridan, Jr. Director February 20, - ------------------------------------- 1996 R. CHAMPLIN SHERIDAN, JR.
DAUPHIN DEPOSIT CORPORATION EXHIBIT INDEX
DAUPHIN DEPOSIT CORPORATION