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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 March 31, 2004
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to .
000-50330
Commission File Number
EAST PENN FINANCIAL CORPORATION
(Exact name of registrant as specified in it charter)
Pennsylvania 65-1172823
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
731 Chestnut Street, Emmaus, Pennsylvania 18049
(Address of principal executive offices)
Registrant's telephone number: 610-965-5959
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 requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |_| NO |X|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
6,299,460 shares of common stock, par value $0.625 per share, outstanding
as of April 30, 2004.
EAST PENN FINANCIAL CORPORATION
INDEX
QUARTERLY REPORT ON FORM 10-Q
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
March 31, 2004 (Unaudited) and December 31, 2003
Consolidated Statements of Income (Unaudited) 4
Three months ended March 31, 2004 and March 31, 2003
Consolidated Statements of Stockholders' Equity (Unaudited) 5
Three months ended March 31, 2004 and March 31, 2003
Consolidated Statements of Cash Flows (Unaudited) 6
Three months ended March 31, 2004 and March 31, 2003
Notes to Interim Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition 10
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 18
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases 18
of Equity Securities
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 21
EXHIBIT INDEX 22
Page 2
ITEM 1. FINANCIAL STATEMENTS
EAST PENN FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(In thousands) 2004 2003
(Unaudited) (Audited)
----------- ------------
ASSETS
Cash and due from banks $ 6,395 $ 7,526
Interest bearing deposits 1,585 333
Federal funds sold 6,642 734
----------- -----------
Cash and cash equivalents 14,622 8,593
Interest bearing time deposits -- 200
Securities available for sale 101,841 106,230
Securities held to maturity 1,051 1,051
----------- -----------
Total securities 102,892 107,281
Mortgages held for sale 2,184 956
Loans, net of unearned income 207,503 207,016
Less: allowance for loan losses (2,541) (2,403)
----------- -----------
Total net loans 204,962 204,613
Bank premises and equipment, net 7,434 6,181
Other real estate owned 149 276
Bank owned life insurance 7,002 5,426
Accrued interest receivable and other assets 4,149 4,413
----------- -----------
Total assets $ 343,394 $ 337,939
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing $ 39,456 $ 36,961
Interest bearing 243,974 242,937
----------- -----------
Total deposits 283,430 279,898
Federal funds purchased and securities
sold under agreements to repurchase 4,976 4,512
Long-term debt 25,000 25,000
Junior subordinated debentures 8,248 --
Mandatory redeemable capital debentures -- 8,000
Accrued interest payable and other liabilities 1,167 986
----------- -----------
Total liabilities 322,821 318,396
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized
16,000,000 shares; none issued -- --
Common stock, par value $0.625 per share
authorized 40,000,000 shares; issued 2004
6,607,752 shares; 2003 6,607,452 shares;
outstanding 2004 6,299,460 shares; 2003
6,299,160 shares 4,130 4,130
Surplus 9,220 9,218
Retained earnings 7,892 7,645
Accumulated other comprehensive income 1,181 400
Less: Treasury stock - at cost, 308,292 shares (1,850) (1,850)
----------- -----------
Total stockholders' equity 20,573 19,543
----------- -----------
Total liabilities and
stockholders' equity $ 343,394 $ 337,939
=========== ===========
See Notes to Consolidated Financial Statements
Page 3
EAST PENN
FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended
--------------------
(In thousands, except per share data) 2004 2003
-------- --------
Interest income
Interest and fee income on loans $ 2,949 $ 2,851
Securities:
Taxable 989 554
Tax-exempt 127 136
Other 5 30
-------- --------
Total interest income 4,070 3,571
Interest expense
Deposits 945 1,173
Federal funds purchased and securities
sold under agreements to repurchase 13 9
Other borrowed funds 198 --
Junior subordinated debentures 136 --
-------- --------
Total interest expense 1,292 1,182
-------- --------
Net interest income 2,778 2,389
Provision for loan losses 154 114
-------- --------
Net interest income after
provision for loan losses 2,624 2,275
Other income
Customer service fees 221 213
Mortgage banking activities, net 108 98
Net realized gains on sale of securities 17 --
Income from investment in life insurance 76 66
Other income 87 74
-------- --------
Total other income 509 451
Other expense
Salaries and wages 908 819
Employee benefits 278 271
Occupancy 177 167
Equipment 174 163
Other operating expenses 617 530
-------- --------
Total other expense 2,154 1,950
-------- --------
Income before income taxes 979 776
Federal income taxes 228 188
-------- --------
Net income $ 751 $ 588
======== ========
Basic earnings per share $ 0.12 $ 0.09
Diluted earnings per share $ 0.12 $ 0.09
Cash dividends per common share $ 0.08 $ 0.00
See Notes to Consolidated Financial Statements
Page 4
EAST PENN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Three Months Ended
March 31, 2004 and March 31, 2003
(Unaudited)
Accumulated
Other
Common Retained Comprehensive Treasury
(In thousands) Stock Surplus Earnings Income Stock Total
- ---------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $4,842 $12,402 $5,497 $ 849 ($3,926) $19,664
-------
Comprehensive income:
Net income -- -- 588 -- -- 588
Changes in net unrealized gains
on securities available
for sale, net of tax effect -- -- -- 226 -- 226
-------
Total comprehensive income 814
--------------------------------------------------------------------
Balance, March 31, 2003 $4,842 $12,402 $6,085 $1,075 ($3,926) $20,478
====================================================================
Balance, December 31, 2003 $4,130 $ 9,218 $7,645 $ 400 ($1,850) $19,543
Comprehensive income:
Net income -- -- 751 -- -- 751
Changes in net unrealized gains
on securities available
for sale, net of tax effect -- -- -- 781 -- 781
-------
Total comprehensive income 1,532
-------
Exercise of 300 common stock
options -- 2 -- -- -- 2
Cash dividends ($0.08 per share) -- -- (504) -- -- (504)
--------------------------------------------------------------------
Balance, March 31, 2004 $4,130 $ 9,220 $7,892 $1,181 ($1,850) $20,573
====================================================================
See Notes to Consolidated Financial Statements
Page 5
EAST PENN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended March 31,
(In thousands) 2004 2003
-------- --------
CASH FLOWS from OPERATING ACTIVITIES
Net income $ 751 $ 588
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 154 114
Provision for depreciation and amortization 156 129
Net amortization of securities premiums and discounts 68 73
Net realized (gain) on sale of securities (17) --
Proceeds from sale of mortgage loans 6,645 11,774
Net gain on sale of loans (108) (98)
Loans originated for sale (7,765) (12,719)
Earnings on investment in life insurance (76) (66)
(Increase) decrease in accrued interest receivable
and other assets 110 (269)
Increase (decrease) in accrued interest payable
and other liabilities 181 48
-------- --------
Net cash provided by (used in) operating activities 99 (426)
-------- --------
CASH FLOWS from INVESTING ACTIVITIES
(Increase) decrease in interest bearing time deposits 200 --
Purchases of available for sale securities (767) (8,054)
Proceeds from maturities of and principal repayments
on available for sale securities 2,946 6,061
Proceeds from sale of securities 3,342 --
Proceeds from maturities of and principal repayments
on held to maturity securities -- 80
Proceeds from the sale of other real estate owned 127 --
Net increase in loans (503) (1,895)
Purchases of bank premises and equipment (1,409) (255)
Purchase of life insurance (1,500) --
-------- --------
Net cash provided by (used in) investing activities 2,436 (4,063)
-------- --------
CASH FLOWS from FINANCING ACTIVITIES
Net increase in deposits 3,532 12,844
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase 464 (2,581)
Proceeds from the exercise of stock options 2 --
Dividends paid (504) --
-------- --------
Net cash provided by financing activities 3,494 10,263
-------- --------
Increase in cash and cash equivalents 6,029 5,774
Cash and cash equivalents:
Beginning of period 8,593 15,605
-------- --------
End of period $ 14,622 $ 21,379
======== ========
SUPPLEMENTAL DISCLOSURES of CASH FLOW INFORMATION
Cash payments for:
Interest $ 1,342 $ 1,254
======== ========
Federal income taxes $ 0 $ 200
======== ========
See Notes to Consolidated Financial Statements
Page 6
EAST PENN FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Unaudited)
1. Basis of Presentation
East Penn Financial Corporation (the "Company") was incorporated on
January 27, 2003 for the purpose of forming a bank holding company. On
July 1, 2003, the Company completed the reorganization and merger with
East Penn Bank (the "Bank") and its wholly owned subsidiary, East Penn
Mortgage Company, into the holding company form of ownership. In the
reorganization, the Bank became a wholly owned banking subsidiary of the
Company. On July 31, 2003, the Company formed East Penn Statutory Trust I
(the "Trust"), a Connecticut statutory business trust, for the purpose of
issuing $8 million in capital pass-through securities to investors.
The consolidated financial statements include the accounts of the
Company, and its wholly owned subsidiary, the Bank. All significant
intercompany accounts and transactions have been eliminated.
The accompanying unaudited consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
considered necessary for fair presentation have been included.
Operating results for the three-month period ended March 31, 2004,
are not necessarily indicative of the results that may be expected for the
year ended December 31, 2004. For further information, refer to the
financial statements and footnotes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2003.
2. Investment in Bank
On September 23, 2003, the Company purchased 141,300 shares of the common
shares outstanding of a newly formed de novo bank, named Berkshire Bank,
located in Wyomissing, Pennsylvania. The amount of the investment was
$1,413,000, at September 30, 2003. On October 22, 2003, the Company
purchased an additional 12,123 shares, for $121,230, of Berkshire Bank for
a total investment of $1,534,230. The investment is included in other
assets and is accounted for under the cost method of accounting.
3. Earnings per Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended
March 31,
2004 2003
-----------------------
Net income applicable to common stock $ 751,000 $ 588,000
=======================
Weighted-average common shares outstanding 6,299,170 6,602,552
Effect of dilutive securities, stock options 19,961 1,594
-----------------------
Weighted-average common shares outstanding
used to calculate diluted earnings per share 6,319,131 6,604,146
=======================
Basic earnings per share $ 0.12 $ 0.09
=======================
Diluted earnings per share $ 0.12 $ 0.09
=======================
Page 7
4. Comprehensive Income
The components of other comprehensive income and related tax effects
for the three months ended March 31, 2004 and 2003 are as follows:
Three Months Ended March 31,
2004 2003
--------- ---------
(In thousands)
Unrealized holding gains on
available for sale securities $ 1,200 $ 343
Less reclassification adjustments for
gains included in net income 17 --
--------- ---------
Net unrealized gains 1,183 343
Tax effect (402) (117)
--------- ---------
Net of tax amount $ 781 $ 226
========= =========
5. Stock Option Plan
The Company has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation". No stock options were issued or vested in the
three months ended March 31, 2004 and 2003. Therefore, no compensation
costs could have been recognized for options granted in 2004 and 2003.
6. Guarantees
The Company does not issue any guarantees that would require
liability recognition or disclosure, other than its standby letters of
credit. Standby letters of credit written are conditional commitments
issued by the Company to guarantee the performance of a customer to a
third party. Generally, all letters of credit, when issued, have
expiration dates within one year. The credit risk involved in issuing
letters of credit is essentially the same as those that are involved in
extending loan facilities to customers. The Company, generally, holds
collateral and/or personal guarantees supporting these commitments. The
Company had $626,000 of standby letters of credit as of March 31, 2004.
Management believes that the proceeds obtained through liquidation of
collateral and the enforcement of guarantees would be sufficient to cover
the potential amount of future payments required under the corresponding
guarantees. The current amount of the liability as of March 31, 2004 for
guarantees under standby letters of credit is not material.
7. New Accounting Standards
In January 2003, the Financial Accounting Standards Board issued
FASB Interpretation No. 46 ("FIN46"), "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51", which was revised in December
2003. This Interpretation provides guidance for the consolidation of
variable interest entities (VIEs). The Trust qualifies as a variable
interest entity under FIN 46. The Trust issued mandatory redeemable
preferred securities, "Trust Preferred Securities", to third party
investors and loaned the proceeds to the Company. The Trust holds, as its
sole asset, subordinated debentures issued by the Company.
FIN 46 required the Company to deconsolidate the Trust from the
consolidated financial statements as of March 31, 2004. There has been no
restatement of prior periods. The impact of this deconsolidation was to
increase junior subordinated debentures or long-term debt by $8,248,000
and reduce the mandatory redeemable capital debenture line item by
$8,000,000, which had represented the Trust Preferred Securities of the
Trust. The Company's equity interest in the Trust subsidiary of $248,000,
which had previously been eliminated in the consolidation, is now reported
in "other assets" as of March 31, 2004. For regulatory reporting purposes,
the Federal Reserve Board has indicated that the preferred securities will
continue to qualify as Tier I Capital subject to previously specified
limitations, until further notice. If regulators make a determination that
Trust Preferred Securities can no longer be considered in regulatory
capital, the
Page 8
securities become callable and the Company may redeem them. The adoption
of FIN 46 did not have an impact on the Company's results of operations or
liquidity.
Page 9
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
March 31, 2004
The following is management's discussion and analysis of the significant
changes in the consolidated results of operations, capital resources and
liquidity presented in the accompanying unaudited consolidated financial
statements for the Company. This discussion should be read in conjunction with
the preceding consolidated financial statements and related footnotes, as well
as, the Company's December 31, 2003 Annual Report on Form 10-K. Current
performance does not guarantee and may not be indicative of similar performance
in the future.
In addition to historical information, this quarterly report on Form 10-Q
contains forward-looking statements. The forward-looking statements contained in
this report are subject to certain risks, assumptions and uncertainties. Because
of the possibility of change in the underlying assumptions, actual results could
differ materially from those projected in the forward-looking statements.
Additional factors that might cause actual results to differ materially from
those expressed in the forward-looking statements include, but are not limited
to:
- operating, legal and regulatory risks,
- economic, political and competitive forces affecting the Company's
services, and
- the risk that management's analyses of these risks could be
incorrect and/or that the strategies developed to address them could
be unsuccessful.
The Company's forward-looking statements are relevant only as of the date
on which the statements are made. By making forward-looking statements, the
Company assumes no duty to update them to reflect new, changing or unanticipated
events or circumstances. Readers should carefully review the risk factors
described in other periodic reports and public documents that the Company files
from time to time with the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES
Disclosure of the Company's significant accounting policies is included in
Note 1 to the consolidated financial statements of the Company's Annual Report
on Form 10-K for the year ended December 31, 2003. Some of these policies are
particularly sensitive requiring significant judgments, estimates and
assumptions to be made by management. Additional information is contained on
pages 11and 13 of this report for the provision and allowance for loan losses.
OVERVIEW
Net income for the three months ended March 31, 2004 and 2003 was $751,000
and $588,000. The increase of $163,000, or 27.7%, is due in part to an increase
of 16.3% in net interest income and a 12.9% increase in the Company's other
income, primarily due to an increase in customer service fees, fees from
mortgage banking activities and a $17,000 gain on sale on securities. On a basic
and diluted per share basis, net income for the three months ended March 31,
2004 was $0.12, respectively, as compared with $0.09 for the three months ended
March 31, 2003. Net income as a percentage of average assets on an annualized
basis, also known as return on average assets, increased to 0.89% for the first
three months of 2004 from 0.86% for the first three months of 2003 as a result
of increased net income which offset the 23.9% increase in total average assets.
Net income as a percentage of total average stockholders' equity on an
annualized basis, also known as return on average equity, was 15.6% and 11.8%
for the first three months of 2004 and 2003.
During the first three months of 2004, the Company's assets grew
$4,425,000, or 1.4%, to $343,394,000 as of March 31, 2004 from $337,939,000 as
of December 31, 2003. This increase is
Page 10
primarily attributable to increased cash and cash equivalents, which increased
$6,029,000. This increased liquidity resulted from the proceeds of investment
security sales and prepayments, which caused the investment portfolio to decline
by $4,389,000. Gross loans increased to $207,503,000, or 0.2% during the first
three months of 2004 as compared with $207,016,000 as of December 31, 2003.
Total deposits increased by $3,532,000, or 1.3%, during the first three months
of 2004 to $283,430,000 as of March 31, 2004 from $279,898,000 as of December
31, 2003. This compares to an increase of $12,844,000, or 5.3%, to $283,202,000
at March 31, 2003.
RESULTS OF OPERATIONS
Net Interest Income
For the three months ended March 31, 2004, total interest income increased
by $499,000, or 14%, to $4,070,000, compared with $3,571,000 for the three
months ended March 31, 2003. This increase is the result of a 24.2% increase in
average interest-earning assets, which grew $61,397,000, to $315,539,000 for the
first three months of 2004, compared with $254,142,000 for the first three
months of 2003. The growth in average interest-earning assets was due to
increases in investment securities and loans, which were funded primarily from
the growth in deposits and long-term debt. While the yield on average
interest-earning assets decreased to 5.19% for the three months ended March 31,
2004 from 5.70% for the same period in 2003 as a result of declining interest
rates, the overall growth in average interest-earning assets helped to minimize
the impact of declining interest rates.
Total interest expense increased by $110,000, or 9.3%, to $1,292,000 for
the three months ended March 31, 2004, from $1,182,000 for the three months
ended March 31, 2003. This increase is attributable to an increase of
$59,509,000, or 26.9%, in average interest bearing liabilities to $281,025,000
for the first quarter of 2004 from $221,516,000 for the first quarter of 2003.
Growth in deposits and long-term debt contributed to the increase in average
interest bearing liabilities. While cost of funds decreased to 1.85% for the
first three months of 2004 as compared with 2.16% for the same period in 2003,
the decline was somewhat limited by the added interest expense incurred as a
result of the issuance of $8.2 million in junior subordinated debentures, which
carry an annual cost of 6.8%.
Net interest income increased by $389,000, or 16.3%, to $2,778,000 for the
three months ended March 31, 2004 from $2,389,000 for the three months ended
March 31, 2003. This increase was primarily attributable to the growth in the
volume of interest sensitive assets and liabilities, as oppose to the net
interest rate spread, which decreased to 3.34% for the first three months of
2004 from 3.54% for the first three months in 2003. The net interest margin
decreased to 3.54% from 3.81% for the three-month periods ending March 31, 2004
and 2003. Although interest rates remained at their historic lows in 2004, the
Company continued to minimize the deterioration of its net interest rate spread
and net interest margin, considering the growth of its interest sensitive assets
and liabilities.
Provision for Loan Losses
For the three months ended March 31, 2004, the provision for loan losses
was $154,000, an increase of $40,000, or 35.1%, compared with $114,000 for the
three months ended March 31, 2003. The increase in the provision was the result
of an increase in loans accorded non-accrual status during the first quarter and
growth in commercial loan transactions which were not funded until early April
2004.
The allowance for loans losses represented 1.22% of total loans at March
31, 2004, compared with 1.16% as of December 31, 2003 and 1.27% as of March 31,
2003. Management performs ongoing assessments of the loan loss reserve in
relation to loan portfolio growth, credit exposure to individual borrowers,
overall trends in the loan portfolio and other relevant factors, and believes
the reserve is reasonable and adequate for the periods presented.
Other Income
Other income for the first quarter ended March 31, 2004 increased $58,000,
or 12.9%, to $509,000
Page 11
from $451,000 for the first quarter ended March 31, 2003. This increase is due
to a $10,000 increase in mortgage banking fees associated with the increased
volume in mortgages originated by the bank and sold in the secondary market, an
$8,000 increase in customer service fees, a $17,000 gain on the sale of
securities, an increase of $10,000 in income from investment in life insurance.
and an increase of $13,000 in other income.
Other Expenses
For the three months ended March 31, 2004, other expenses increased
$204,000, or 10.5%, to $2,154,000 from $1,950,000 for the three months ended
March 31, 2003. The impact of the increase was minimized as a result of
management's ongoing efforts to control non-interest expenses as the company
continues to grow.
Salary expenses and related employee benefits were $1,186,000 for the
three months ended March 31, 2004, an increase of $96,000, or 8.8%, compared
with $1,090,000 for the three months ended March 31, 2003. The increase is
attributable to staff additions and normal salary increases.
Occupancy expenses for the first three months of 2004 increased to
$177,000 from $167,000 for the first three months of 2003. The increase of
$10,000, or 6%, was not only attributable to increases in normal occupancy costs
but also to the snow removal costs incurred during the early part of 2004 as a
result of weather factors.
Equipment expenses increased $11,000, or 6.7%, to $174,000 for the first
three months of 2004 from $163,000 for the first three months of 2003. The
increase in this expense category was due to the added depreciation expense from
the additions made to furniture and equipment.
Other operating expenses increased $87,000, or 16.4%, to $617,000 for the
three months ended March 31, 2004 from $530,000 for the three months ended March
31, 2003. This increase was the result of the Company's growth as well as the
additional expenses associated with the implementation of a call center and
internet banking and the formation of the holding company and the issuance of
junior subordinated debentures.
Income Taxes
For the three months ended March 31, 2004, the tax provision was $228,000
compared with $188,000 for the three months ended March 31, 2003. This increase
of $40,000, or 21.3%, is the result of achieving a higher level of pre-tax net
income with a level amount of tax-exempt income.
Net Income
Net income for the first three months of 2004 was $751,000, an increase of
$163,000, or 27.7%, compared with $588,000 for the first three months of 2003.
This increase in net income was the result of increases of $389,000 in net
interest income and $58,000 in other income, which offset the increases of
$40,000 in the provision for loan losses, $204,000 in other operating expenses
and $40,000 in federal income tax expense. The increase in net income was
attributable to declining rates, where the cost of funds associated with
interest sensitive liabilities decreased more than the decline in yield derived
from interest sensitive assets, along with an increase in other income,
primarily derived from increased customer service fees, mortgage banking
activities and gains on sale of investment securities. Basic and diluted
earnings per share for the three months ended March 31, 2004 was $0.12 compared
with $0.09 for the three months ended March 31, 2003.
FINANCIAL CONDITION
Securities
The Company's securities portfolio is comprised of securities, which not
only provide interest
Page 12
income, including tax-exempt income, but also provide a source of liquidity,
diversify the earning assets portfolio, allow for the management of risk and tax
liability, and provide collateral for repurchase agreements and public fund
deposits. Policies are in place to address various aspects of managing the
portfolio, including but not limited to, concentrations, liquidity, credit
quality, interest rate sensitivity and regulatory guidelines. Adherence to these
policies is monitored by the Company's Asset/Liability Committee on a monthly
basis.
Although the Company generally intends to hold its investment securities
to maturity, a significant portion of the securities portfolio is classified as
available for sale, with new purchases generally categorized as available for
sale. Securities in the available for sale category are accounted for at fair
value with unrealized appreciation or depreciation, net of tax, reported as a
separate component of stockholders' equity. Securities in the held to maturity
category are accounted for at amortized cost. The Company invests in securities
for the yield they produce and not to profit from trading. The Company holds no
trading securities in its portfolio.
The securities portfolio at March 31, 2004 was $102,892,000, compared to
$107,281,000 at December 31, 2003, a decrease of $4,389,000, or 4.1%. The
decline was attributable to the sale of investment securities and prepayments of
principal. A portion of the proceeds from the sale of securities, in the amount
of $1,500,000, were used to purchase additional bank owned life insurance
("BOLI"), which yields tax-exempt income for the Bank. Securities available for
sale decreased to $101,841,000 at March 31, 2004 from $106,230,000 at December
31, 2003, while securities held to maturity were $1,051,000 at March 31, 2004
and December 31, 2003.
The carrying value of the available for sale portion of the portfolio at
March 31, 2004 includes an unrealized gain of $1,789,000 (reflected as
accumulated other comprehensive income of $1,181,000 in stockholders' equity,
net of deferred income tax liability of $608,000). This compares with an
unrealized gain at December 31, 2003 of $606,000 (reflected as accumulated other
comprehensive income of $400,000 in stockholders' equity, net of deferred income
tax liability of $206,000).
Loans
The loan portfolio comprises the major component of the Company's earning
assets. Gross loans receivable, net of unearned fees and origination costs,
increased $487,000, or 0.2%, to $207,503,000 at March 31, 2004 from $207,016,000
at December 31, 2003. Loan growth appears to be limited as a result of
prepayments as well as the timing associated with the settlement and funding of
certain new loans. As a result of these issues, gross loans increased by almost
$9 million within the first two weeks after March 31, 2004. Gross loans
represented 73.2% of total deposits at March 31, 2004 as compared to 74% at
December 31, 2003.
Credit Risk and Loan Quality
The Company continues to be prudent in its efforts to minimize credit
risk. The Bank's written lending policy requires underwriting, loan
documentation and credit analysis standards to be met prior to the approval and
funding of any loan. In accordance with that policy, the internal loan review
process monitors the loan portfolio on an ongoing basis. The Credit
Administration area then prepares an analysis of the allowance for loan losses
on a quarterly basis, which is then submitted to the board of directors for its
assessment as to the adequacy of the allowance. The allowance for loan losses is
an accumulation of expenses that has been charged against past and present
earnings in anticipation of potential losses in the loan portfolio.
The allowance for loan losses at March 31, 2004 and December 31, 2003 was
$2,541,000 and $2,403,000, compared to $2,270,000 at March 31, 2003. The
increase in the allowance was attributable, in part, to the growth of the loan
portfolio and the shift in the loan mix, where there was continued growth in
commercial loans, which generally carry a higher level of credit risk. At March
31, 2004, the allowance for loan losses represented 1.22% of the gross loan
portfolio, compared with 1.16% at December 31, 2003. This compares to 1.27% at
March 31, 2003. At March 31, 2004, management believes the allowance for loan
loss reserve to be reasonable and adequate to meet potential losses.
Page 13
Table 1 - "Analysis of Allowance for Loan Loss" - details the activity,
which occurred in the allowance over the first three months of 2004 and 2003.
Table 1 - Analysis of Allowance for Loan Loss (1)
(in thousands)
2004 2003
-------- --------
Balance, beginning of year $ 2,403 $ 2,167
Provision charged to operating expense 154 114
Charge-offs:
Commercial 0 0
Real estate 0 0
Consumer (22) (12)
-------- --------
Total charge-offs (22) (12)
Recoveries:
Commercial 3 0
Consumer 3 1
-------- --------
Total recoveries 6 1
Net (charge-offs) (16) (11)
-------- --------
$ 2,541 $ 2,270
======== ========
Net (charge-offs) recoveries to average net
loans (0.01)% (0.01)%
(1) Bank's loan portfolio is entirely domestic
The Bank's lending policy is executed through the assignment of tiered
loan limit authorities to individual officers of the Bank, the Officer's Loan
Committee, the Board Loan Committee and the Board of Directors. Although the
Bank maintains sound credit policies, certain loans may deteriorate for a
variety of reasons. The Bank's policy is to place all loans on a non-accrual
status upon becoming 90 days delinquent in their payments, unless there is a
documented, reasonable expectation of the collection of the delinquent amount.
Loans are reviewed monthly as to their status, and on a quarterly basis, a Watch
List of potentially troubled loans is prepared and presented to the board of
directors. Management is not aware of any material potential loan problems that
have not been disclosed in this report.
Table 2 - "Asset Quality Ratios" - summarizes pertinent asset quality
ratios at March 31, 2004 and December 31, 2003.
Table 2 -Asset Quality Ratios
3/31/04 12/31/03
------- --------
Non-accrual loans/Total loans 0.43% 0.19%
Non-performing assets (1) /Total loans 0.52% 0.34%
Net (charge-offs) recoveries/Average loans 0.01% 0.09%
Allowance/Total loans 1.22% 1.16%
Allowance/Non-accrual loans 282.96% 608.35%
Allowance/Non-performing loans (1) 275.60% 553.69%
(1) - Includes non-accrual loans.
At March 31, 2004, the Company had other real estate owned as acquired
through foreclosure, in the amount of $149,000, which decreased $127,000, from
$276,000 at December 31, 2003, as a result of the sale of two residential
property loans. The Company expects to dispose of the remaining properties with
minimal or no loss.
Loan concentrations are considered to exist when the total amount of loans
to any one or a multiple number of borrowers engaged in similar activities or
having similar characteristics exceeds 10% of loans outstanding in any one
category. The majority of the Bank's lending is made within its primary market
Page 14
area, which includes Emmaus and the East Penn community in Lehigh County,
Pennsylvania.
Bank Owned Life Insurance
The Company has BOLI for a chosen group of employees, namely officers,
where the Bank is the owner and beneficiary of the policies. The Bank's deposits
and proceeds from the sale of security investments funded the BOLI. Earnings
from the BOLI are recognized as other income. The BOLI is profitable from the
appreciation of the cash surrender values of the pool of insurance, and its tax
advantage to the Company. This profitability is used to offset a portion of
current and future employee benefit costs and a Nonqualified Supplemental
Executive Retirement Plan for the Company's Chief Executive Officer.
The Company had $7,002,000 and $5,426,000 in BOLI, as of March 31, 2004
and December 31, 2003. Although the BOLI is an asset that may be liquidated, it
is the Company's intention to hold this pool of insurance because it provides
tax-exempt income that lowers the Company's tax liability, while enhancing its
overall capital position. Because of the benefits derived from investing in
BOLI, an additional $1,500,000 BOLI investment was made during the first quarter
of 2004.
Investment in Bank
During the fourth quarter of 2003, the Company purchased 153,423 shares
for $1,534,230 of common stock outstanding of a newly formed de novo bank, named
Berkshire Bank, located in Wyomissing, Berks County, Pennsylvania. The
investment, which represents 18.3% of the de novo bank's outstanding common
shares, is carried at cost and included in the other assets category on the
balance sheet.
Deposits
Deposits are the major source of the Company's funds for lending and
investment purposes. Total deposits at March 31, 2004 were $283,430,000, an
increase of $3,532,000, or 1.3%, from total deposits of $279,898,000 at December
31, 2003. The increase in deposits was due to increases of $616,000 in interest
bearing demand deposit accounts, $2,927,000 in savings accounts and $2,494,000
in non-interest bearing demand deposit accounts, offset by a decline of
$2,505,000 in certificates of deposit. The reduction in certificates of deposit
was due to a managed run-off of higher costing deposits into lower costing
deposits, which resulted in reducing the Bank's overall cost of funds to 1.85%
at March 31, 2004 from 1.94% at December 31, 2003 and 2.16% at March 31, 2003
Federal Funds Purchased and Securities Sold under Agreements to Repurchase
There were no outstanding balances in federal funds purchased at March 31,
2004 and December 31, 2003. The Bank has a $5,000,000 federal funds line of
credit with its main correspondent bank, Atlantic Central Bankers Bank, Camp
Hill, Pennsylvania ("ACBB").
Securities sold under agreements to repurchase were $4,976,000 at March
31, 2004, compared to $4,512,000 at December 31, 2003. Securities sold under
agreements to repurchase generally mature in one business day and roll over
under a continuing contract.
Long-Term Debt and Borrowing Capacity
The Bank has a maximum borrowing capacity of approximately $159,228,000
with the Federal Home Loan Bank of Pittsburgh ("FHLB"), out of which $25 million
was outstanding at March 31, 2004 and December 31, 2003, resulting in an unused
borrowing capacity of $134,228,000. The $25 million borrowing is comprised of
the following fixed rate borrowings:
Page 15
Maturity Amount Rate
----------------- -------- --------
November 28, 2005 $ 5,000 2.20%
November 28, 2006 6,000 2.80
November 28, 2007 7,000 3.43
November 28, 2008 7,000 3.78
-------- ------
Total $ 25,000 3.13%
======== ======
Asset/Liability Management
The management of interest rate risk involves measuring and analyzing the
maturity and repricing of interest-earning assets and interest bearing
liabilities at specific points in time. The imbalance between interest-earning
assets and interest bearing liabilities is commonly referred to as the interest
rate gap. The interest rate gap is one measure of the risk inherent in the
existing balance sheet as it relates to potential changes in net interest
income. Maintaining an appropriate balance between interest-earning assets and
interest bearing liabilities is a means of monitoring and possibly avoiding
material fluctuations in the net interest margin during periods of changing
interest rates.
The Company's overall sensitivity to interest rate risk is low due to its
non-complex balance sheet. The Company manages its balance sheet with the intent
of stabilizing net interest income and net economic value under a broad range of
interest rate environments. The Company has the ability to effect various
strategies to manage interest rate risk, which include, but are not limited to,
selling newly originated residential mortgage loans, controlling the volume mix
of fixed/variable rate commercial loans and securities, increasing/ decreasing
deposits via interest rate changes, borrowing from the FHLB, and buying/selling
securities. Adjustments to the mix of assets and liabilities are made
periodically in an effort to give the Company dependable and steady growth in
net interest income, while at the same time, managing the related risks.
Liquidity
Liquidity represents the Company's ability to efficiently manage cash
flows at reasonable rates to support possible commitments to borrowers or the
demands of depositors. Liquidity is essential to compensate for fluctuations in
the balance sheet and provide funds for growth and normal operating
expenditures. Liquidity needs may be met by converting assets into cash or
obtaining sources of additional funding.
Liquidity from asset categories is provided through cash, amounts due from
banks, interest-bearing deposits with banks and federal funds sold, which were
$14,622,000 at March 31, 2004, compared to $8,593,000 at December 31, 2003.
Additional asset liquidity sources include principal and interest payments from
securities in the Company's investment portfolio and cash flow from its
amortizing loan portfolio. Longer-term liquidity needs may be met by selling
securities available for sale, selling loans or raising additional capital. At
March 31, 2004, available for sale securities of $87,633,000 were readily
available for liquidity purposes, compared to $90,642,000 at December 31, 2003.
Liability liquidity sources include attracting deposits at competitive
rates. Deposits at March 31, 2004 were $283,430,000, compared to $279,898,000 at
December 31, 2003. In addition, the Bank has federal fund lines of credit with
its main correspondent bank, ACBB, and with the FHLB, which are reliable sources
for short and long-term funds.
The Company's financial statements do not reflect various off-balance
sheet commitments that are made in the normal course of business, which may
involve some liquidity risk.
Management is of the opinion that its liquidity position, at March 31,
2004, is adequate to respond to fluctuations "on" and "off" the balance sheet.
In addition, management knows of no trends, demands, commitments, events or
uncertainties that may result in, or that are reasonably likely to result in the
Company's inability to meet anticipated or unexpected liquidity needs.
Page 16
Off-Balance Sheet Arrangements
The Company's financial statements do not reflect various off-balance sheet
arrangements that are made in the normal course of business. These commitments
consist mainly of loans approved but not yet funded, unused lines of credit and
letters of credit made in accordance with the same standards as on-balance sheet
instruments. Unused commitments at March 31, 2004 were $74,438,000, which
consisted of $61,284,000 in unfunded commitments to existing loans, $12,528,000
to grant new loans and $626,000 in letters of credit. Because these instruments
have fixed maturity dates, and because many of them will expire without being
drawn upon, they do not generally present a significant liquidity risk to the
Company. Management believes that any amounts actually drawn upon can be funded
in the normal course of operations. The Company has no investment in or
financial relationship with any unconsolidated entities that are reasonably
likely to have a material effect on liquidity or the availability of capital
resources.
Capital
Pertinent capital information and ratios as of March 31, 2004 are
presented as follows:
------------------------------------------------
Table 3 - Capital Ratios
------------------------------------------------
Tier I Capital $25,856,000
------------------------------------------------
Total Capital $29,933,000
------------------------------------------------
------------------------------------------------
Capital Ratios:
------------------------------------------------
Tier I Risk-Based Capital 11.3%
------------------------------------------------
Minimum Required 4.0%
------------------------------------------------
------------------------------------------------
Total Risk-Based Capital 13.1%
------------------------------------------------
Minimum Required 8.0%
------------------------------------------------
------------------------------------------------
Tangible Tier I Capital Ratio 7.7%
------------------------------------------------
Minimum Required 3% to 5%
------------------------------------------------
These capital ratios continue to remain at levels, which are considered to
be "well-capitalized" as defined by regulatory guidelines.
Banking laws and regulations limit the amount of cash dividends that may
be paid without prior approval from the Company's regulatory agencies. In
abidance with such requirements, on January 15, 2004, the board of directors
authorized and declared a semi-annual cash dividend for 2004 in the amount of
$0.08 per share, payable on February 28, 2004 to all shareholders of record on
January 31, 2004. The payment of this semi-annual cash dividend decreased
retained earnings by $504,000.
Restrictions under the Pennsylvania Banking Code of 1965 are placed on the
size of a Bank's investment in fixed assets as a percentage of equity.
Presently, the Bank exceeds the allowable limit of 25% of equity, as defined by
the Pennsylvania Department of Banking. The Bank's fixed assets as a percentage
of equity increased to 38.3 % at March 31, 2004, as compared with 31.7% at March
31, 2003. This increase was primarily the result of the purchase of a
three-story, 20,000 square foot brick office building that was purchased for
$1,440,000 on February 27, 2004 to house administrative and operational offices.
Generally, the Bank contacts the Department of Banking prior to the acquisition
of material dollar fixed asset additions to obtain the Department's approval. On
an ongoing basis, compliance with this section of the Banking Code is expected
to occur through normal depreciation adjustments and retention of earnings.
Page 17
ITEM 3
Quantitative and Qualitative Disclosures About Market Risk
In the normal course of conducting business activities, the Company is
exposed to market risk, principally interest risk. Interest risk arises from
market driven fluctuations in interest rates that affect cash flows, income,
expense and values of financial instruments. The asset/liability committee,
using policies and procedures approved by the board of directors, is responsible
for managing the rate sensitivity position.
No material changes in the market risk strategy occurred during the
current period. No material changes have been noted in the Company's equity
value at risk. A detailed discussion of market risk is provided in the Form 10-K
for the period ended December 31, 2003.
ITEM 4
Controls and Procedures
(a) Evaluation of disclosure controls and procedures
As of March 31, 2004, the Company carried out an evaluation, under
the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and
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-15(e). Based upon that evaluation,
the Chief Executive Officer and 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 subsidiary) required to be
included in the Company's periodic filings.
(b) Changes in internal controls.
The Company made no significant changes in its internal controls or
in other factors that could significantly affect these controls
during the quarter ended March 31, 2004, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the opinion of the Company, after review with legal
counsel, there are no proceedings pending to which the Company is a
party or to which its property is subject, which, if determined
adversely to the Company, would be material in relation to the
Company's financial condition. There are no proceedings pending
other than ordinary, routine litigation incident to the business of
the Company. In addition, no material proceedings are pending or are
known to be threatened or contemplated against the Company by
governmental authorities.
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases of Equity
Securities
Nothing to report.
Item 3. Defaults upon Senior Securities
Nothing to report.
Page 18
Item 4. Submission of Matters to a Vote of Security Holders
Nothing to report.
Item 5. Other Information
Nothing to report.
Item 6.
Exhibits and Reports on Form 8-K
(a) Exhibits:
3(i) Registrant's Articles of Incorporation, as amended, are
incorporated herein by reference to Annex B to the
Registrant's Registration Statement on Form S-4
(Registration No. 333-103673) as filed with the
Securities and Exchange Commission on March 7, 2003.
3(ii) Registrant's By-Laws are incorporated herein by
reference to Annex C to the Registrant's Registration
Statement on Form S-4 (Registration No. 333-103673) as
filed with the Securities and Exchange Commission on
March 7, 2003.
10.1 East Penn Financial Corporation's 1999 Stock Incentive
Plan for the benefit of officers and key employees is
incorporated by reference to Exhibit 10.3 to the
Registrant's Registration Statement on Form S-4
(Registration No. 333-103673) as filed with the
Securities and Exchange Commission on March 7, 2003.
10.2 East Penn Financial Corporation's 1999 Independent
Directors Stock Option Plan for the benefit of
non-employee directors is incorporated by reference to
Exhibit 10.2 to the Registrant's Registration Statement
on Form S-4 (Registration No. 333-103673) as filed with
the Securities and Exchange Commission on March 7, 2003.
10.3 Executive Employment Agreement between East Penn Bank
and Brent L. Peters, dated April 12, 2001, is
incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form S-4
(Registration No. 333-103673) as filed with the
Securities and Exchange Commission on March 7, 2003.
10.4 The Supplemental Executive Retirement Plan ("SERP")
between East Penn Bank and Brent L. Peters, dated May
31, 2001, is incorporated herein by reference to Exhibit
10.4 to the Registrant's Registration Statement on Form
S-4 (Registration No. 333-103673) as filed with the
Securities and Exchange Commission on March 7, 2003.
11 Statement re: Computation of per share earnings is
incorporated by reference herein to Note 5 on page 8 of
this Form 10-Q.
31.1 Certification of Chief Executive Officer pursuant to
Rule 13a-15(e)/15d-15(e).
31.2 Certification of Chief Financial Officer pursuant to
Rule 13a-15(e)/15d-15(e).
Page 19
32.1 Certification of Chief Executive Officer pursuant to
Section 1350 of the Sarbanes Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to
Section 1350 of the Sarbanes Oxley Act of 2002.
(b) Reports on Form 8-K
On January 22, 2004, the Registrant filed a Current Report on
Form 8-K to submit a copy of the Registrant's press release,
dated January 20, 2004, to disclose its earnings for the
fourth quarter and year ended December 31, 2003.
On January 27, 2004, the Registrant filed a Current Report on
Form 8-K to submit a copy of the Registrant's press release,
dated January 26, 2004, to announce the board of director's
approval of a semi-annual dividend payable February 28, 2004.
Page 20
SIGNATURES
Pursuant to the requirements of Section 12 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.
EAST PENN FINANCIAL CORPORATION
(Registrant)
By
-------------------------------------
Brent L. Peters
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 11, 2004
By
-------------------------------------
Theresa M. Wasko
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: May 11, 2004
Page 21
Exhibit Index
3(i) Registrant's Articles of Incorporation, as amended, are incorporated by
reference to Annex B to the Registrant's Registration Statement on Form
S-4 (Registration No. 333-103673) as filed with the Securities and
Exchange Commission on March 7, 2003.
3(ii) Registrant's By-Laws are incorporated by reference to Annex C to the
Registrant's Registration Statement on Form S-4 (Registration No.
333-103673) as filed with the Securities and Exchange Commission on March
7, 2003.
10.1 East Penn Financial Corporation's 1999 Stock Incentive Plan for the
benefit of officers and key employees is incorporated by reference to
Exhibit 10.3 to the Registrant's Registration Statement on Form S-4
(Registration No. 333-103673) as filed with the Securities and Exchange
Commission on March 7, 2003.
10.2 East Penn Financial Corporation's 1999 Independent Directors Stock Option
Plan for the benefit of non-employee directors is incorporated by
reference to Exhibit 10.2 to the Registrant's Registration Statement on
Form S-4 (Registration No. 333-103673) as filed with the Securities and
Exchange Commission on March 7, 2003.
10.3 Executive Employment Agreement between East Penn Bank and Brent L. Peters,
dated April 12, 2001, is incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form S-4 (Registration No.
333-103673) as filed with the Securities and Exchange Commission on March
7, 2003.
10.4 Supplemental Executive Retirement Plan ("SERP") between East Penn Bank and
Brent L. Peters, dated May 31, 2001, is incorporated by reference to
Exhibit 10.4 to the Registrant's Registration Statement on Form S-4
(Registration No. 333-103673) as filed with the Securities and Exchange
Commission on March 7, 2003.
11 Statement re: Computation of per share earnings is incorporated by
reference herein to Note 5 on page 8 of this Form 10-Q.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-15(e)/15d-15(e).
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-15(e)/15d-15(e).
32.1 Certification of Chief Executive Officer pursuant to Section 1350 of the
Sarbanes Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 1350 of the
Sarbanes Oxley Act of 2002.
Page 22