10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 ------------------ OR [_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _______________ Commission file Number 0-21720 ------- Slippery Rock Financial Corporation (Exact Name of registrant as specified in its charter) Pennsylvania 25-1674381 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 100 South Main Street Slippery Rock, Pennsylvania 16057 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (724) 794-2210 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. YES X NO _____ ----- As of November 1, 2002, there were 2,776,504 shares outstanding of the issuer's class of common stock. Slippery Rock Financial Corporation INDEX TO QUARTERLY REPORT ON FORM 10-Q

2 Slippery Rock Financial Corporation and Subsidiary CONSOLIDATED BALANCE SHEET (Unaudited - $ in 000)

See accompanying notes to the unaudited consolidated financial statements 3 Slippery Rock Financial Corporation and Subsidiary CONSOLIDATED STATEMENT OF INCOME (Unaudited - $ in 000 except per share amounts)

See accompanying notes to the unaudited consolidated financial statements 4 Slippery Rock Financial Corporation and Subsidiary CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (Unaudited - $ in 000)

See accompanying notes to the unaudited consolidated financial statements 5 Slippery Rock Financial Corporation and Subsidiary CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited - $ in 000)

See accompanying notes to the unaudited consolidated financial statements 6 Slippery Rock Financial Corporation and Subsidiary CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited - $ in 000)

See accompanying notes to the unaudited consolidated financial statements 7 Slippery Rock Financial Corporation and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information, which would be included in audited financial statements. The information furnished reflects all normal recurring adjustments, which are, in the opinion of management, necessary for fair statement of the results of the period. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. NOTE 2 - EARNINGS PER SHARE There were no convertible securities which would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

Options to purchase 39,050 shares of common stock at prices from $18.50 to $19.30 were outstanding for the periods ended September 30, 2002 and 2001, respectively, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS On October 1, 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 147, Acquisitions of Certain Financial Institutions, which amends FAS No.72 and No.144 and FAS Interpretation No.9. This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, except for a transaction between two or more mutual enterprises. The new requirement changes the accounting for goodwill from an amortization approach to an impairment-only approach as of the effective date that FAS No. 142 was adopted, which in Slippery Rock Financial Corporation's case was January 1, 2002. As a result of complying with FAS No. 147, the company is required to restate earnings for the first and second fiscal quarters of 2002. The following table details the changes on net income and earnings per share as a result of this restatement:

NOTE 4 - RECLASSIFICATION OF COMPARATIVE AMOUNTS Certain comparative amounts for the prior periods have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or stockholders' equity. 8 NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS In August 2001, the FASB issued FAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability be recognized when incurred for the retirement of a long-lived asset and the value of the asset be increased by that amount. The statement also requires that the liability be maintained at its present value in subsequent periods and outlines certain disclosures for such obligations. The new statement takes effect for fiscal years beginning after June 15, 2002. The adoption of this statement, which is effective January 1, 2003, is not expected to have a material effect on the Company `s financial statements. On January 1, 2002, the Company adopted FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. FAS 144 supercedes FAS 121 and applies to all long-lived assets (including discontinued operations) and consequently amends APB Opinion No. 30, Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business. FAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less costs to sell. The adoption of FAS No. 144 did not have a material effect on the Company's financial statements. In April 2002, the FASB issued FAS No. 145, "Recission of FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections". FAS No. 145 rescinds FAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. This statement also amends FAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This statement also makes technical corrections to existing pronouncements, which are not substantive but in some cases may change accounting practice. FAS No. 145 is effective for transactions occurring after May 15, 2002. The adoption of FAS No. 145 did not have a material effect on the Company's financial position or results of operations. In July 2002, the FASB issued FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement replaces EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). The new statement will be effective for exit or disposal activities initiated after December 31, 2002, the adoption of which is not expected to have a material effect on the Company's financial statements. On October 1, 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 147, Acquisitions of Certain Financial Institutions, effective for all business combinations initiated after October 1, 2002. This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, except for a transaction between two or more mutual enterprises. This Statement removes acquisitions of financial institutions, other than transactions between two or more mutual enterprises, from the scope of FAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method. The acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with FAS No. 141, Business Combinations, and FAS No. 142, Goodwill and Other Intangible Assets. This Statement also provides guidance on the accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets (such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets), including those acquired in transactions between two or more mutual enterprises. Upon adoption of this statement, the Company ceased the amortization of $1,013,197 in goodwill associated with branch acquisitions. The Company will continue to review the remaining goodwill on an annual basis for impairment. However, $130,421 in core deposit intangible will continue to be amortized and reviewed for impairment in accordance with FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. 9 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Statement The Private Securities Litigation Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words "believes," "anticipates," "contemplates," "expects," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Comparison of the Three Months Ended September 30, 2002 and 2001 Total interest income of $5,095,000 for the three-month period ended September 30, 2002 compared to $5,710,000 for the same three-month period in 2001, a decrease of $615,000 or 10.8%. The overall decrease in total interest income is attributed principally to a decrease in interest and fees on loans of $797,000 or 15.7%. This is partially offset by an increase in taxable interest income from investments of $362,000. Income from interest and fees on loans decreased due to a decrease in yields within the loan portfolio. The tax equivalent yield on interest earning assets fell from 8.07% at September 30, 2001 to 6.89% at September 30, 2002. As a result of the Federal Reserve Board's action to manage interest rates in the U.S. economy, interest rates were decreased eleven times in 2001. Prime rate, the rate at which banks lend funds to their best commercial customers, was at 4.75% at September 30, 2002. This is 1.25% lower than the prime rate of 6.00% at September 30, 2001. As interest rates fell, the Bank's variable rate earning assets repriced downward, and continue to do so, while new loans with lower yields are being added to the portfolio. Although the tax equivalent yield on earning assets decreased during the three-month period ended September 30, 2002, the average volume of loans increased. Average gross loans, including loans available for sale, at September 30, 2002 were $241.1 million, an increase of $1.3 million or 0.5% from $239.8 million at September 30, 2001. Virtually all major segments within the loan portfolio reflected net increases in average balances from September 30, 2001. The most significant growth occurred within the dealer, commercial, and commercial real estate segments. Average dealer loans increased $2.1 million or 13.7%, average commercial loans increased $1.5 million or 7.0%, and average commercial real estate loans increased $1.1 million or 1.6%. These increases were partially offset by decreases of $2.0 million in student loans and $1.2 million in real estate mortgages. The increase within the average loan portfolio was brought about by general market activity. Taxable investment interest income increased due to an increase in volume within the investment portfolio. Average total investments were $66.9 million at September 30, 2002, an increase of $14.3 million from $52.6 million at September 30, 2001. Total interest expense of $2,094,000 for the three-month period ended September 30, 2002 represented a decrease of $762,000 from the $2,856,000 reported for the same three-month period in 2001. The change is comprised primarily of a decrease in interest expense on deposits of $760,000. Although average interest-bearing deposits increased $10.1 million, interest expense decreased for the period. This resulted from a general decline in the Bank's cost of funds. The Bank's cost of deposits decreased from 4.05% at September 30, 2001 to 2.80% at September 30, 2002. The Bank also saw a shift in consumer preference within the interest bearing deposits. Average time deposits decreased $14.4 million from September 30, 2001, while the average savings products increased $17.2 million or 52.0%. Due to the low interest rate environment, consumer preference has shifted towards the more liquid products and away from the fixed maturity products. 10 Net interest income of $3,001,000 for the three months ended September 30, 2002 compared to $2,854,000 for the same three-month period in 2001, an increase of $147,000. The provision for loan losses for the three months ended September 30, 2002 was $150,000, an increase of $45,000 from September 30, 2001. Management felt the increase in the provision expense was warranted as a result of its normal quarterly analysis of loan loss reserve adequacy. The details of the analysis and methodology are discussed further under the Risk Elements section that follows. Total other income for the three-month period ended September 30, 2002 of $624,000 compared to $852,000 for the three-month period ended September 30, 2001, a decrease of $228,000. This decrease consists primarily of a decrease in the gains on loan sales of $117,000 and a decrease in commission and fee income of $58,000. Gains of $177,000 were recorded on the sale of $4.6 million of fixed rate, 1-4 family residential mortgages to the Federal Home Loan Mortgage Corporation ("Freddie Mac") for the three-month period ended September 30, 2002. For the three-month period ended September 30, 2001, $9.2 million of fixed rated, 1-4 family residential mortgages were sold resulting in a gain of $211,000. In the third quarter of 2001, there were also sales of the credit card portfolio of $662,000 and student loans of $5.7 million, which resulted in gains of $26,000 and $57,000, respectively. Total other expense of $2,640,000 for the three months ended September 30, 2002 compared to $2,167,000 for the same three-month period in 2001. This represents an increase of $473,000 or 21.8%. The increase is primarily derived from an increase in salaries and employee benefits expense of $166,000 and an increase in other expense of $242,000. The increases in salaries and employee benefits resulted principally from additional personnel as well as an increase in the cost of employee benefits. Other expense increased primarily due to $89,000 of legal and professional fees and $78,000 of miscellaneous expense. Of these expenses, $117,000 were related to professional fees associated with the OCC exam, and $24,000 are due to charges on a deposit account held at another bank. Partially offsetting these increases was a decrease in intangible amortization expense due to FASB Statement No. 147. The Company adopted FASB Statement No. 142 on January 1, 2002 and due to FASB Statement No. 147 is required to restate earnings to reflect the discontinuation of amortization of goodwill effective January 1, 2002 resulting in a benefit of $26,000 to the Company for the three months ended September 30, 2002. Net income for the three-month period ended September 30, 2002 was $597,000, a decrease of $403,000 from the $1,000,000 reported at September 30, 2001. Earnings per share for the three-month period ended September 30, 2002 were $0.21, a decrease of $0.15 from $0.36 per share earned during the same three-month period in 2001. Comparison of the Nine Months Ended September 30, 2002 and 2001 Total interest income of $15.5 million for the nine-month period ended September 30, 2002 compared to $17.2 million for the same nine-month period in 2001, a decrease of $1.7 million or 10.2%. The overall decrease in total interest income is attributed principally to a decrease in interest and fees on loans of $2.0 million or 12.8%. Income from interest and fees on loans decreased due to a decrease in yields within the loan portfolio as discussed above. Total interest expense of $6.4 million for the nine-month period ended September 30, 2002 represented a decrease of $2.4 million from the $8.8 million reported for the same nine-month period in 2001. The decrease in interest expense is comprised primarily of a decrease in interest expense on deposits of $2.3 million. The decrease in interest expense on deposits was due to a general decline in the Bank's cost of funds. 11 Net interest income of $9.1 million for the nine months ended September 30, 2002 compared to $8.4 million for the same nine-month period in 2001, an increase of $672,000. The provision for loan losses for the nine months ended September 30, 2002 was $761,000, an increase of $446,000 from September 30, 2001. Management felt the increase in the provision expense was warranted as a result of its normal quarterly analysis of loan loss reserve adequacy. The details of the analysis and methodology are discussed further under the Risk Elements section that follows. Total other income for the nine-month period ended September 30, 2002 of $1.8 million compared to $2.1 million for the nine-month period ended September 30, 2001, a decrease of $269,000. The decrease is primarily due to a decrease in other income of $148,000, net gains on loan sales of $68,000, and net gains (losses) on the sale of investment securities of $44,000. Other income decreased primarily due to a decrease in volume-based fees and to a decrease in insurance commissions generated from the sale of life and disability insurance on loans. Gains of $420,000 were recorded on the sale of $31.2 million of fixed rate, 1-4 family residential mortgages to the Federal Home Loan Mortgage Corporation ("Freddie Mac") for the nine-month period ended September 30, 2002. For the nine-month period ended September 30, 2001, $18.6 million of fixed rated, 1-4 family residential mortgages were sold resulting in a gain of $405,000. In addition to the sale of mortgages, the Company also sold its credit card portfolio and a portion of its student loans as discussed above. Total other expense of $7.3 million for the nine months ended September 30, 2002 compared to $6.3 million for the same nine-month period in 2001. This represented an increase of $1.0 million or 14.6%. The increase is primarily derived from an increase in salaries and employee benefits expense of $515,000 and an increase in other expense of $377,000. The increases in salaries and employee benefits resulted principally from additional personnel as well as an increase in the cost of employee benefits. The increase in other expense is primarily due to an increase in legal and professional fees of $138,000, collection expense of $88,000, and contributions expense of $50,000. Collection expense increased due to increased legal costs associated with various delinquency and foreclosure activities. Legal and professional fees increased due to various projects that the Bank is currently involved in, including the examination as discussed earlier, and are expected to remain higher throughout the remainder of the year 2002. Contribution expense has increased due to the Bank's contribution to a local community redevelopment project. These increases were partially offset by a decrease in loan servicing fees of $41,000. Loan servicing fees decreased due to the lower volume of student loans being serviced by a third party. A reduction of $78,000 was also seen in intangible amortization related to FASB Statement No. 147 as discussed earlier. Net income for the nine-month period ended September 30, 2002 was $2.0 million, a decrease of $720,000 from the $2.7 million reported at September 30, 2001. Earnings per share for the nine-month period ended September 30, 2002 were $0.71, a decrease of $0.26 from $0.97 per share earned during the same nine-month period in 2001. Financial Condition Total assets increased $23.9 million or 7.4% from $324.0 million at December 31, 2001 to $347.9 million at September 30, 2002. The increase in total assets is due to an increase in available for sale investment securities of $22.2 million. Total gross loans (including loans available for sale) decreased $8.1 million from December 31, 2001. The most significant decrease within the loan portfolio occurred within the residential real estate loans, which decreased $5.2 million. The sale of fixed rate mortgages to the Federal Home Loan Mortgage Corporation was the major contributor of this decrease. For the nine months ended September 30, 2002, the Company sold $31.2 million of fixed rate mortgages, which compared to sales of $25.2 million for the entire year of 2001. The increase in the volume of sold loans can be attributed to an all time low in interest rates, which has resulted in an increase in the demand for mortgage loans especially refinances. 12 Total deposits of $284.7 million at September 30, 2002 represented an increase of $22.8 million or 8.7% from $261.9 million at December 31, 2001. With the exception of time certificates, all deposit products had net increases during the period. The most significant increase was within savings accounts, which increased $18.8 million, followed by increases of $8.2 million in interest-bearing demand, $5.6 million in noninterest-bearing demand, and $4.2 million in money market accounts. With the recent decline in the economy and interest rates, many customers are taking advantage of savings products like the "Classic Plus Savings" product, which pays an attractive market rate while fulfilling customer liquidity needs. Classic Plus Savings had a balance of $31.5 million at September 30, 2002 an increase of $12.2 million from December 31, 2001. At September 30, 2002, the Company serviced approximately $78.6 million in sold fixed rate mortgages. Sales of fixed rate mortgages for the nine-month period ended September 30, 2002 totaled $31.2 million with net gains of $420,000. Management does anticipate future sales of fixed rate mortgages; however, the extent to which the Company participates in the secondary market will be dependent upon demand for fixed rate mortgages in the market place, liquidity needs of the Company and interest rate risk exposure. Management will continue to obtain the necessary documentation to allow loans to be sold in the secondary market, so that if liquidity or market conditions dictate, management will be able to respond to these conditions. At September 30, 2002, management has calculated and monitored risk-based and leverage capital ratios in order to assess compliance with regulatory guidelines. The following schedule presents certain regulatory capital ratio requirements along with the Company's position at September 30, 2002: Actual Minimum Well -------------------- Amount Ratio Ratio Capitalized -------------------- --------- ------------- Tier 1 risk - based capital $ 29,586 12.93% 4.00% 6.00% Total risk - based capital 32,451 14.18 8.00 10.00 Leverage capital 29,586 8.73 4.00 5.00 As the above table illustrates, the Company exceeds both the minimum and well-capitalized regulatory capital requirements at September 30, 2002. On October 18, 2002, the Company announced that its subsidiary bank had entered into an agreement with the Bank's primary regulator, the Office of the Comptroller of the Currency ("OCC"). The agreement is designed to evaluate and enhance certain areas of the Bank's operations, including management, credit administration, audit, information technology and regulatory compliance. There are no stipulations that limit or restrict the Bank's ability to pay dividends or require the Bank to increase its capital position. The Company does anticipate incurring additional operating expenses in connection with complying with the agreement. Potentially impacted areas would include: staffing levels, legal and consulting fees and higher deposit insurance premiums. A copy of the agreement is included as an exhibit to a Form 8-K filed by Slippery Rock Financial Corporation on October 18, 2002. LIQUIDITY The principal functions of the Company's asset/liability management program are to provide adequate liquidity and to monitor interest rate sensitivity. Liquidity represents the ability to meet the cash flow requirements of both depositors and customers requesting bank credit. Asset liquidity is provided by repayments and the management of maturity distributions for loans and securities. An important aspect of asset liquidity lies in 13 maintaining adequate levels of adjustable rate, short term, or relatively risk free interest earning assets. Management evaluates the Company's liquidity position over 30 day, 60 day, and 90+ day time horizons. The analysis not only identifies liquidity within the balance sheet, but off balance sheet as well. It identifies anticipated sources and uses of funds as well as potential sources and uses. Anticipated needs would include liquidity for credit demand, commitments to purchase assets, and anticipated deposit decreases. Anticipated sources would include cash (net of reserve requirements), maturing investment securities, daily fed funds sold, anticipated deposit increases, and the repayment of loans. Potential uses would include unfunded loan commitments available on lines of credit. Potential sources would include borrowing capacity available to the Company through the Federal Home Loan Bank ("FHLB"). At September 30, 2002, for the 30-day horizon, the Company had a net anticipated funding position of 5.8% of total assets. This ratio was 3.5% as of December 31, 2001. Management views this ratio to be at an adequate level. Management also monitors its liquidity by the loans to deposits ratio. The loans (including loans held for sale) to deposits ratio was 82.9% at September 30, 2002 as compared to 93.2% at December 31, 2001 and 92.2% at September 30, 2001. The Company's liquidity plan allows for the use of long-term advances or short-term lines of credit with the FHLB as a source of funds. Borrowing from the FHLB not only provides a source of liquidity for the Company, but also serves as a tool to reduce interest rate risk. The Company may structure borrowings from FHLB to match those of customer credit requests, and therefore, lock in interest rate spreads over the lives of the loans. At September 30, 2002, the Company continued to have three such matched funding loans outstanding totaling $143,000. The Company continues to also have short-term borrowing availability through FHLB "RepoPlus" advances. "RepoPlus" advances are short-term borrowings maturing within one year, bearing a fixed rate of interest and subject to prepayment penalty. At September 30, 2002 and 2001, the Company had no "RepoPlus" advances outstanding. The Company's remaining borrowing capacity with FHLB was $86.6 million at September 30, 2002. In addition to borrowing from the FHLB as a source for liquidity, as mentioned earlier, the Company also continued activity in the secondary mortgage market. Specifically, the Company sold fixed rate residential real estate mortgages to Freddie Mac. The sales to Freddie Mac not only provide an opportunity for the Company to remain competitive in the market place by allowing it to offer a fixed rate mortgage product, but also provide an additional source of liquidity. Loan sales on the secondary market also provide management an additional tool to use in managing interest rate risk exposure within the balance sheet. The Company continues to service all loans sold to Freddie Mac. The Statement of Cash Flows, for the nine-month period ended September 30, 2002, indicates an increase in cash and cash equivalents of $8.3 million. Cash was provided from proceeds from sales of mortgage loans of $31.3 million, proceeds from sales, maturities, and repayments of available for sale and held to maturity securities of $13.8 million, and a net increase in deposits of $22.8 million. Cash was used during the period for the origination of loans held for sale of $29.5 million, the purchase of available for sale investments of $32.4 million, and the purchase of held to maturity investments of $4.0 million. Cash dividends paid during the nine-month period ended September 30, 2002 totaled $1,250,000. Cash and cash equivalents totaled $30.9 million at September 30, 2002, an increase of $8.3 million from $22.6 million at December 31, 2001. Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely affect its liquidity or ability to meet its funding needs in the normal course of business. 14 RISK ELEMENTS The following schedule presents the non-performing assets for the last six quarters:

(1) Excludes loans held for sale. The non-performing schedule above reflects increases in non-accrual loans, from previously reported filings, of approximately $1.7 million for each of the periods ended 2002 and for increases of approximately $1.9 million for each of the periods ended 2001. The increases resulted principally as a result of recent regulatory examination for four specific loan credits involving three customer relationships. Perceived regulatory concerns were raised for documentation and credit administration issues for these credits. Accordingly, management has complied with the regulatory mandate to place the four loans in non-accrual status. Although the loans have performed in the past and continue to perform in accordance with the contractual agreements, there has been deterioration of the financial strength and performance of the individuals and/or entities. Management has enhanced the Bank's collateral positions thereby further minimizing the risk of loss on these credits. Since the loans had no delinquency issues, income recorded on an accrual basis would approximate that recognized on a cash basis respective to the date of non-accrual for these particular credits. It is anticipated that three of the loans totaling $1.7 million will be placed back in accrual status subsequent to a six-month performance review period, which ends in December 2002. The allowance for loan losses at September 30, 2002 totaled $3,172,000 or 1.34% of total loans (including loans held for sale) as compared to $2,766,000 or 1.13% at December 31, 2001. Provisions for loan losses were $761,000 and $315,000 for the nine-month periods ended September 30, 2002 and 2001. Based on the Bank's methodology for evaluating the level of the loan loss allowance, growth in the loan portfolio over the past two 15 years, and the uncertainties in the current economic and financial markets; management felt it prudent to further bolster the allowance in 2002. This action not only enhances financial strength and stability in the current environment, but for subsequent periods as well. In determining the level at which the allowance for loan losses should be maintained, management relies on in-house quarterly reviews of significant loans and commitments outstanding, including a continuing review of problem or non-performing loans and overall portfolio quality. Commercial and commercial real estate loans are risk-rated by individual loan officers and a loan review committee. Consumer and residential real estate loans are generally reviewed in the aggregate due to their relative smaller dollar size and homogeneous nature. Specific provision and allowance allocations are made for risk-rated loans that have gone before the loan review committee. These allocations are based upon specific borrower data, such as non-performance, delinquency, financial performance, capacity to repay, and collateral valuation. Non-account specific allocations are made for all remaining loans within the portfolio based on recent charge-off history, other known trends and expected losses. In addition, allocations are made for qualitative factors such as changes in the local, regional and national economies, industry trends, loan growth, and loan administration. A quarterly report and recommendation is presented to and approved by the Board of Directors. Management believes the allowance is adequate to cover known losses within the loan portfolio. However, no assurances can be made concerning the future financial condition of borrowers, the deterioration of which would require additional provisions in subsequent periods. A loan is considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. At September 30, 2002, the Company had nonaccrual loans of $5,297,000. Impaired loans at September 30, 2002 were $5,499,000, of which, $5,032,000 were also classified as nonaccrual. The average balance in 2002 of impaired loans was $5,449,000. Impaired loans had a related allowance allocation of $1,374,000 and income recognized in 2002 for impaired loans totaled $169,000. Exclusive of the impaired loans identified from the recent regulatory exam, impaired loans at September 30, 2002 were comprised principally of two borrowers. These borrowers accounted for $2.4 million of total impaired loans. One credit, totaling $1.6 million, was classified as impaired during the fourth quarter of 2001 as a result of the borrower's deteriorating financial condition. The borrower has subsequently filed for bankruptcy relief. The second largest borrower within the impaired loan accounts, exclusive of those identified during the regulatory exam, has a balance of $801,000 and pertains to a participated loan for a dairy operation. The Company was cross-collateralized on cattle, feed, and real estate, including facilities. In 1999, the Bank recorded a $300,000 charge off pertaining to the cattle portion of the loan. The borrower has subsequently filed for bankruptcy relief, and the Company continues foreclosure proceedings on the real estate portion of the loan through the bankruptcy courts. As a result of prudent collateral valuations subsequent to the original charge off, the Company has recorded charge offs of $100,000 and $190,000 in 2000 and 2001, respectively, resulting principally from valuations on the remaining feed stored on the property. Based on an evaluation performed in November 2002, the Company anticipates an additional $101,000 charge off in the fourth quarter of 2002. Management will continue its collateral valuations until final resolution of the matter, which may result in additional chargeoffs. The Company now anticipates possession of the real estate in 2003. Management does not consider any of the remaining non-performing loans to pose any significant risk to the capital position or future earnings of the Company. Management believes none of the non-performing assets, including other real estate owned, at September 30, 2002, pose any significant risk to the operations, liquidity or capital position of the Company. 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Market risk for the Company is comprised primarily from interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and paying liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Bank does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the immediate trade area. One of the principal functions of the Company's asset/liability management program is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability program is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates. Interest rate sensitivity is the result of differences in the amounts and repricing dates of a bank's rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing "gap", provide an indication of the extent that the Company's net interest income is affected by future changes in interest rates. During a period of rising interest rates, a positive gap, a position of more rate sensitive assets than rate sensitive liabilities, is desired. During a falling interest rate environment, a negative gap is desired, that is, a position in which rate sensitive liabilities exceed rate sensitive assets. At September 30, 2002, the Company had a cumulative negative gap of $44.5 million at the one-year horizon. The gap analysis indicates that if interest rates were to rise 100 basis points (1.00%), the Company's net interest income would decline at the one-year horizon because the Company's rate sensitive liabilities would reprice faster than rate sensitive assets. Conversely, if rates were to fall 100 basis points, the Company would earn more in net interest income. Management also manages interest rate risk with the use of simulation modeling which measures the sensitivity of future net interest income as a result of changes in interest rates. The analysis is based on repricing opportunities for variable rate assets and liabilities and upon contractual maturities of fixed rate instruments. The simulation also calculates net interest income based upon rate increases or decreases of + or- 300 basis points (or 3.00%) in 100 basis point (or 1.00%) increments. The analysis reprices the balance sheet and forecasts future cash flows over a one-year horizon at the new interest rate levels. The cash flows are then totaled to calculate net interest income. Assumptions are made for loan and investment pre-payment speeds and are incorporated into the simulation as well. Loan and investment pre-payment speeds will increase as interest rates decrease and slow as interest rates rise. The current analysis indicates that, given a 300 basis point overnight decrease in interest rates, the Company would experience a potential $2,679,000 or 20.4% decline in net interest income. If rates were to increase 300 basis points, the analysis indicates that the Company's net interest income would increase $763,000 or 5.8%. It is important to note, however, that this exercise would be of a worst-case scenario. It would be more likely to have incremental changes in interest rates, rather than a single significant increase or decrease. When management believes interest rate movements will occur, it can restructure the balance sheet and thereby the ratio of rate sensitive assets to rate sensitive liabilities which in turn will effect the net interest income. It is important to note; however, that in gap analysis and simulation modeling not all assets and liabilities with similar maturities and repricing opportunities will reprice at the same time or to the same degree and therefore, could effect forecasted results. Much of the Bank's deposits have the ability to reprice immediately; however, deposit rates are not tied to an external index. As a result, although changing market interest rates impact repricing, the Bank retains much of the control over repricing by determining itself the extent and timing of repricing of deposit products. In addition, the Bank maintains a significant portion of its investment portfolio as available for sale securities 17 and also has a significant variable rate loan portfolio, which is used to offset rate sensitive liabilities. Changes in market interest rates can also affect the Bank's liquidity position through the impact rate changes may have on the market value of the available for sale portion of the investment portfolio. Increases in market rates can adversely impact the market values and therefore, make it more difficult for the Bank to sell available for sale securities needed for general liquidity purposes without incurring a loss on the sale. This issue is addressed by the Bank with the use of borrowings from the Federal Home Loan Bank ("FHLB") and the selling of fixed rate mortgages as a source of liquidity to the Bank. The Company's liquidity plan allows for the use of long-term advances or short-term lines of credit with the FHLB as a source of funds. Borrowing from FHLB not only provides a source of liquidity for the Company, but also serves as a tool to reduce interest risk as well. The Company may structure borrowings from FHLB to match those of customer credit requests, and therefore, lock in interest rate spreads over the lives of the loans. In addition to borrowing from the FHLB as a source for liquidity, the Company also participates in the secondary mortgage market. Specifically, the Company sells fixed rate, residential real estate mortgages to the Federal Home Loan Mortgage Corporation ("Freddie Mac"). The sales to Freddie Mac not only provide an opportunity for the Bank to remain competitive in the market place, by allowing it to offer a fixed rate mortgage product, but also provide an additional source of liquidity and an additional tool for management to limit interest rate risk exposure. The Bank continues to service all loans sold to Freddie Mac. Item 4. Controls and Procedures Within the 90 days prior to the date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. PART II - OTHER INFORMATION Item 1. Legal Proceedings (none) Item 2. Changes in Securities and Use of Proceeds (none) Item 3. Defaults Upon Senior Securities (none) Item 4. Submission of Matters to a Vote of Security Holders (none) Item 5. Other Information (none) 18 Item 6. Exhibits and Reports on Form 8 - K (a) Exhibits required by Item 601 of Regulation S - K: Exhibit Number 2 N/A 3(i) Articles of Incorporation filed on March 6, 1992 as Exhibit 3(i) to Registration Statement on Form S-4 (No. 33-46164) and incorporated herein by reference. 3(ii) By - laws filed on March 6, 1992 as Exhibit 3(ii) to Registration Statement on Form S-4 (No.33-46164) and incorporated herein by reference. 4 N/A 10 N/A 11 N/A 15 N/A 18 N/A 19 N/A 22 N/A 23 N/A 24 N/A 99.0 Independent Auditor's Review 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Chief Executive Officer 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Chief Financial Officer (b) Reports on Form 8-K - "Press Release, dated October 18, 2002, of Slippery Rock Financial Corporation" and "Agreement, dated October 15, 2002, between The First National Bank of Slippery Rock and the Office of the Comptroller of the Currency" filed October 18, 2002. 19 SIGNATURES Pursuant to the requirements 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. Slippery Rock Financial Corporation (Registrant) Date: November 14, 2002 By: /s/ William C. Sonntag ---------------------- William C. Sonntag President & CEO Date: November 14, 2002 By: /s/ Mark A. Volponi ----------------------- Mark A. Volponi Treasurer 20 SECTION 302 CERTIFICATION I, William C. Sonntag, President and Chief Executive Officer of Slippery Rock Financial Corporation (the "Company"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of Slippery Rock Financial Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Company's other certifying officer and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ William C. Sonntag ----------------- -------------------------------- President & Chief Executive Officer 21 SECTION 302 CERTIFICATION I, Mark A. Volponi, Chief Financial Officer of Slippery Rock Financial Corporation (the "Company"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of Slippery Rock Financial Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have: a. designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Company's other certifying officer and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors: a. all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Mark A. Volponi ----------------- ------------------- Chief Financial Officer 22

SLIPPERY ROCK FINANCIAL CORP 10-Q