EAST PENN FINANCIAL CORP - 10-Q Quarterly Report

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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 June 30, 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 Identification
incorporation or organization) 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
July 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
June 30, 2004 (Unaudited) and December 31, 2003

Consolidated Statements of Income (Unaudited) 4
Three and six months ended June 30, 2004 and
June 30, 2003

Consolidated Statements of Stockholders' Equity 5
(Unaudited) Three and six months ended June 30,
2004 and June 30, 2003

Consolidated Statements of Cash Flows (Unaudited) 6
Six months ended June 30, 2004 and June 30, 2003

Notes to Interim Consolidated Financial Statements
(Unaudited) 7

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10

Item 3. Quantitative and Qualitative Disclosures About Market
Risk 19

Item 4. Controls and Procedures 19

Part II. OTHER INFORMATION

Item 1. Legal Proceedings 19

Item 2. Changes in Securities and Use of Proceeds and Issuer
Purchases of Equity Securities 19

Item 3. Defaults Upon Senior Securities 20

Item 4. Submission of Matters to a Vote of Security Holders 20

Item 5. Other Information 21

Item 6. Exhibits and Reports on Form 8-K 21

SIGNATURES 23

EXHIBIT INDEX 24

Page 2

ITEM 1. FINANCIAL STATEMENTS

EAST PENN FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS

June 30, December 31,
(In thousands, except per share data) 2004 2003
(Unaudited) (Audited)
----------- ------------

ASSETS
Cash and due from banks $ 7,206 $ 7,526
Interest bearing deposits 138 333
Federal funds sold -- 734
--------- ---------
Cash and cash equivalents 7,344 8,593
Interest bearing time deposits -- 200
Securities available for sale 96,336 106,230
Securities held to maturity 1,050 1,051
--------- ---------
Total securities 97,386 107,281
Mortgages held for sale 1,063 956
Loans, net of unearned income 227,104 207,016
Less: allowance for loan losses (2,654) (2,403)
--------- ---------
Total net loans 224,450 204,613

Bank premises and equipment, net 7,398 6,181
Other real estate owned 16 276
Bank owned life insurance 7,077 5,426
Accrued interest receivable and other assets 5,484 4,413
--------- ---------

Total assets $ 350,218 $ 337,939
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing $ 43,867 $ 36,961
Interest bearing 247,189 242,937
--------- ---------
Total deposits 291,056 279,898
Federal funds purchased and securities
sold under agreements to repurchase 5,626 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 966 986
--------- ---------

Total liabilities 330,896 318,396

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 8,702 7,645
Accumulated other comprehensive income (loss) (880) 400
Less: Treasury stock - at cost, 308,292 shares (1,850) (1,850)
--------- ---------

Total stockholders' equity 19,322 19,543
--------- ---------

Total liabilities and
stockholders' equity $ 350,218 $ 337,939
========= =========

See Notes to Consolidated Financial Statements

Page 3

EAST PENN
FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Months and Six Months Ended June 30, 2004 and 2003
(Unaudited)

Three Months Ended Six Months Ended
------------------ -----------------
(In thousands, except per share data) 2004 2003 2004 2003
------ ------ ------ ------

Interest income
Interest and fee income on loans $3,048 $2,876 $5,997 $5,727
Securities:
Taxable 903 564 1,892 1,118
Tax-exempt 132 143 259 279
Other 6 34 11 64
------ ------ ------ ------
Total interest income 4,089 3,617 8,159 7,188

Interest expense
Deposits 898 1,112 1,843 2,285
Federal funds purchased and securities
sold under agreements to repurchase 9 9 22 18
Other borrowed funds 199 -- 397 --
Junior subordinated debentures 136 -- 272 --
------ ------ ------ ------
Total interest expense 1,242 1,121 2,534 2,303
------ ------ ------ ------

Net interest income 2,847 2,496 5,625 4,885

Provision for loan losses 129 114 283 228
------ ------ ------ ------

Net interest income after
provision for loan losses 2,718 2,382 5,342 4,657

Other income
Customer service fees 239 239 460 452
Mortgage banking activities, net 102 113 210 211
Net realized gains on sale of securities 8 5 25 5
Income from investment in life insurance 75 68 151 134
Net realized gains on sale of other real estate 61 -- 61 --
Other income 67 55 154 129
------ ------ ------ ------
Total other income 552 480 1,061 931

Other expense
Salaries and wages 881 836 1,789 1,655
Employee benefits 282 260 560 531
Occupancy 180 159 357 326
Equipment 181 171 355 334
Other operating expenses 679 567 1,296 1,097
------ ------ ------ ------
Total other expense 2,203 1,993 4,357 3,943
------ ------ ------ ------

Income before income taxes 1,067 869 2,046 1,645

Federal income taxes 257 218 485 406
------ ------ ------ ------

Net income $ 810 $ 651 $1,561 $1,239
====== ====== ====== ======

Basic and diluted earnings per share $ 0.13 $ 0.10 $ 0.25 $ 0.19

Cash dividends per common share $ 0.00 $ 0.10 $ 0.08 $ 0.10

See Notes to Consolidated Financial Statements

Page 4

EAST PENN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Six Months Ended
June 30, 2004 and June 30, 2003
(Unaudited)

Accumulated
Other
Common Retained Comprehensive Treasury
(In thousands, except per share data) 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 -- -- 1,239 -- -- 1,239
Changes in net unrealized gains
on securities available
for sale, net of tax effect -- -- -- 607 -- 607
--------

Total comprehensive income 1,846
--------

Exercise of 1,600 stock options 1 8 -- -- -- 9

Cash dividend ($0.10 per share) -- -- (661) -- -- (661)
--------------------------------------------------------------------------------

Balance, June 30, 2003 $4,843 $12,410 $ 6,075 $ 1,456 ($3,926) $ 20,858
================================================================================

Balance, December 31, 2003 $4,130 $ 9,218 $ 7,645 $ 400 ($1,850) $ 19,543
Comprehensive income:
Net income -- -- 1,561 -- -- 1,561
Changes in net unrealized gains
(losses) on securities available
for sale, net of tax effect -- -- -- (1,280) -- (1,280)
--------

Total comprehensive income 281
--------

Exercise of 300 common stock
options -- 2 -- -- -- 2

Cash dividends ($0.08 per share) -- -- (504) -- -- (504)
--------------------------------------------------------------------------------

Balance, June 30, 2004 $4,130 $ 9,220 $ 8,702 ($ 880) ($1,850) $ 19,322
================================================================================

See Notes to Consolidated Financial Statements

Page 5

EAST PENN FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004 and 2003
(Unaudited)

Six Months Ended June 30,
(In thousands) 2004 2003
-------- --------

CASH FLOWS from OPERATING ACTIVITIES
Net income $ 1,561 $ 1,239
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 283 228
Provision for depreciation and amortization 318 271
Net amortization of securities premiums and discounts 160 212
Net realized gain on sale of foreclosed real estate (61) --
Net realized gain on sale of securities (25) (5)
Proceeds from sale of mortgage loans 15,918 24,531
Net gain on sale of loans (292) (388)
Loans originated for sale (15,733) (25,624)
Earnings on investment in life insurance (151) (134)
Increase in accrued interest receivable
and other assets (164) (177)
Decrease in accrued interest payable
and other liabilities (20) (29)
-------- --------

Net cash provided by operating activities 1,794 124
-------- --------

CASH FLOWS from INVESTING ACTIVITIES
Maturities of interest bearing time deposits 200 --
Purchases of available for sale securities (7,316) (33,057)
Proceeds from maturities of and principal repayments
on available for sale securities 10,796 11,575
Proceeds from sale of securities 4,340 4,422
Proceeds from maturities of and principal repayments
on held to maturity securities 1 750
Proceeds from the sale of other real estate owned 321 82
Net increase in loans (20,120) (11,741)
Purchases of bank premises and equipment (1,535) (416)
Purchase of life insurance (1,500) --
-------- --------

Net cash used in investing activities (14,813) (28,385)
-------- --------

CASH FLOWS from FINANCING ACTIVITIES
Net increase in deposits 11,158 24,799
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase 1,114 (1,789)
Proceeds from the exercise of stock options 2 9
Dividends paid (504) (661)
-------- --------

Net cash provided by financing activities 11,770 22,358
-------- --------

Increase (decrease) in cash and cash equivalents (1,249) (5,903)

Cash and cash equivalents:
Beginning of period 8,593 15,605
-------- --------

End of period $ 7,344 $ 9,702
======== ========

SUPPLEMENTAL DISCLOSURES of CASH FLOW INFORMATION
Cash payments for:
Interest $ 2,603 $ 2,436
======== ========

Federal income taxes $ 591 $ 380
======== ========

See Notes to Consolidated Financial Statements

Page 6

EAST PENN FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 six-month period ended June 30, 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 state chartered 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. Pursuant to Crown X Commitments
entered into by the Company in August 2003 and approved by the Federal
Reserve Bank of Philadelphia in September 2003, the Company currently owns
19.9% of Berkshire Bank common stock, but is authorized to go up to 24.9%.
This passive investment in Berkshire Bank is recorded 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:

Six Months Ended Three Months Ended
-------------------------- --------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------------------------- --------------------------

Net income applicable to common stock $1,561,000 $1,239,000 $ 810,000 $ 651,000
========================== ==========================
Weighted-average common shares outstanding 6,299,315 6,602,738 6,299,460 6,602,922
Effect of dilutive securities, stock options 18,041 6,692 19,490 11,790
-------------------------- --------------------------
Weighted-average common shares outstanding
used to calculate diluted earnings per share 6,317,356 6,609,430 6,318,950 6,614,712
========================== ==========================
Basic and diluted earnings per share $ 0.25 $ 0.19 $ 0.13 $ 0.10
========================== ==========================

Page 7

4. Comprehensive Income

The components of other comprehensive income and related tax effects
for the three and six months ended June 30, 2004 and 2003 are as follows:

Six Months Ended Three Months Ended
--------------------- ---------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
--------------------- ---------------------

(In thousands)

Unrealized holding gains (losses) on
available for sale securities ($1,914) $ 925 ($3,114) $ 582

Less reclassification adjustments for
gains (losses) included in net income 25 5 8 5
---------------------------------------------

Net unrealized gains (losses) (1,939) 920 (3,122) 577
Tax effect (659) (313) (1,061) (196)
---------------------------------------------

Net of tax amount ($1,280) $ 607 ($2,061) $ 381
=============================================

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". Accordingly, no compensation costs have been
recognized for options granted in 2004 and 2003. Had compensation costs
for stock options granted been determined based on the fair value at the
grant date for awards under the plan consistent with the provisions of
SFAS No. 123, the Company's net income and earnings per share for the
quarters ended June 30, 2004 and 2003, would have been reduced to the pro
forma amounts indicated below:

Six Months Ended Three Months Ended
------------------------ ------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------------------ ------------------------
(In Thousands, except Per Share Amounts)

Net income as reported $ 1,561 $ 1,239 $ 810 $ 651
Total stock-based compensation cost, net of tax,
that would have been included in the
determination of net income if the fair
value based method had been applied
to all awards 3 2 3 2
------------------------ ------------------------

Pro forma net income $ 1,558 $ 1,237 $ 807 $ 649
======================== ========================

Basic earnings per share:
As reported $ 0.25 $ 0.19 $ 0.13 $ 0.10
Pro forma $ 0.25 $ 0.19 $ 0.13 $ 0.10
Diluted earnings per share:
As reported $ 0.25 $ 0.19 $ 0.13 $ 0.10
Pro forma $ 0.25 $ 0.19 $ 0.13 $ 0.10

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 that are 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 $569,000 of standby letters of credit as of June 30, 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

Page 8

future payments required under the corresponding guarantees. The current
amount of the liability as of June 30, 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". For regulatory reporting purposes, the Federal Reserve
Board has indicated that the Trust 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 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
June 30, 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 11 and 14 of this report for the provision and allowance for loan losses.

OVERVIEW

Net income for the six months ended June 30, 2004 and 2003 was $810,000
and $651,000. The increase of $159,000, or 24.4%, is due in part to an increase
of 15.1% in net interest income and a 14% increase in the Company's other
income, primarily due to an increase in customer service fees, income from
investment in life insurance, a $20,000 additional gain on sale of securities
and a $61,000 gain on sale of other real estate. On a basic and diluted per
share basis, net income for the six months ended June 30, 2004 was $0.25,
respectively, as compared with $0.19 for the six months ended June 30, 2003. Net
income as a percentage of average assets on an annualized basis, also known as
return on average assets, increased to 0.92% for the first six months of 2004
from 0.88% for the first six months of 2003 as a result of increased net income
which offset the 22% 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 12.4% for the first six months
of 2004 and 2003, respectively.

During the first six months of 2004, the Company's assets grew
$12,279,000, or 3.6%, to $350,218,000 as of June 30, 2004 from $337,939,000 as
of December 31, 2003. This increase is primarily

Page 10

attributable to gross loans, which increased to $227,104,000 as of June 30, 2004
from $207,016,000 as of December 31, 2003, offset by a decline of $9,895,000, or
9.2%, in the investment securities portfolio, the proceeds of which were
reinvested in funding loans. Total deposits increased by $11,158,000, or 4%,
during the first six months of 2004 to $291,056,000 as of June 30, 2004 from
$279,898,000 as of December 31, 2003. This compares to an increase of
$24,799,000, or 10.2%, to $268,439,000 at June 30, 2003. The increase in total
deposits during the first half of 2004 was less than the increase in deposits
during the same period in 2003 as a result of customers continued hesitation to
invest in deposits due to the uncertainty in this low interest rate environment.

RESULTS OF OPERATIONS

Net Interest Income

For the three months ended June 30, 2004, total interest income increased
by $472,000, or 13%, to $4,089,000 compared to $3,617,000 for the three months
ended June 30, 2003. This increase is due to growth of $57,228,000, or 21.9%, in
average interest earning assets, primarily attributed to loan growth.

Total interest expense increased by $121,000, or 10.8%, to $1,242,000 for
the three months ended June 30, 2004 from $1,121,000 for the three months ended
June 30, 2003. Interest expense increased due to the increased volume in average
interest bearing liabilities.

Net interest income increased by $351,000, or 14.1%, to $2,847,000 for the
three months ended June 30, 2004 from $2,496,000 for the three months ended June
30, 2003.

For the six months ended June 30, 2004, total interest income increased by
$971,000, or 13.5%, to $8,159,000, compared with $7,188,000 for the six months
ended June 30, 2003. This increase is the result of a 21.9% increase in average
interest-earning assets, which grew $57,228,000, to $318,069,000 for the first
six months of 2004, compared with $260,841,000 for the first six months of 2003.
The growth in average interest-earning assets was due to an increase in loans,
which were funded primarily from the growth in deposits and cash flow from the
investment securities portfolio. While the yield on average interest-earning
assets decreased to 5.16% for the six months ended June 30, 2004 from 5.56% for
the same period in 2003 as a result of historically low interest rates, the
overall growth in average interest-earning assets helped to minimize the impact
of the low interest rate environment.

Total interest expense increased by $231,000, or 10%, to $2,534,000 for
the six months ended June 30, 2004, from $2,303,000 for the six months ended
June 30, 2003. This increase is attributable to the growth of average interest
bearing liabilities, which increased $56,207,000, or 24.8%, to $283,166,000 for
the first six months of 2004 from $226,959,000 for the first six months of 2003.
Growth in deposits and long-term debt contributed to the increase in average
interest bearing liabilities. While cost of funds decreased to 1.80% for the
first six months of 2004 as compared with 2.05% 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 or "trust
preferred securities", which carry an annual cost of 6.8%.

Net interest income increased by $740,000, or 15.1%, to $5,625,000 for the
six months ended June 30, 2004 from $4,885,000 for the six months ended June 30,
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 3.36% for the first six months of 2004 from 3.51% for
the first six months in 2003. The net interest margin decreased to 3.56% from
3.78% for the six-month periods ending June 30, 2004 and 2003. Although interest
rates remained at their historic lows in 2004, the Company strived 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

The provision for loan losses was $129,000 for the three months ended June
30, 2004 compared

Page 11

with $114,000 for the six months ended June 30, 2003.

For the six months ended June 30, 2004, the provision for loan losses was
$283,000, an increase of $55,000, or 24.2%, compared with $228,000 for the six
months ended June 30, 2003. The increase in the provision was the result of the
growth in the loan portfolio, as well as an increase in loans accorded
non-accrual status during the first six months of 2004.

The allowance for loans losses represented 1.17% of total loans at June
30, 2004, compared with 1.16% as of December 31, 2003 and 1.25% as of June 30,
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

For the three months ended June 30, 2004, other income was $552,000, an
increase of $72,000, or 15%, compared with $480,000 for the six months ended
June 30, 2003. The increase was primarily due to a $61,000 gain realized from
the sale of other real estate.

Other income for the first six months ended June 30, 2004 increased
$130,000, or 14%, to $1,061,000 from $931,000 for the first six months ended
June 30, 2003. This increase was due to an $8,000 increase in customer service
fees, a $20,000 increase from the gain on sale of investment securities, a
$17,000 increase in income from the investment in life insurance, a $61,000
increase from the sale of other real estate, a $15,000 increase from mortgages
sold services retained, and an increase of $10,000 in other miscellaneous
income, offset by a decline of $1,000 in mortgage banking fees.

Other Expenses

Other expenses, which include salary, occupancy, equipment and all other
expenses incidental to the operation of the Company, increased to $2,203,000 for
the second quarter of 2004 from $1,993,000 for the second quarter of 2003. The
$210,000, or 10.5% increase is the result of the Company's continued growth.

Salaries and employee benefit expenses, which make up the largest
component of other expenses, increased $67,000, or 6.1%, to $1,163,000 for the
second quarter of 2004 from $1,096,000 for the second quarter in 2003. The
increase is primarily attributable to the increase in normal salary and medical
benefit costs.

Occupancy expenses increased $21,000, or 13.2%, to $180,000 for the three
months ended June 30, 2004 from $159,000 for the three months ended June 30,
2003. The increase was due to the cost associated with the purchase of a 3-story
brick building located at 18 South 2nd Street, Emmaus, Pennsylvania, which will
be use to house operational, administrative and executive departments of the
Company.

Equipment expense increased $10,000, or 5.8%, to $181,000 for the three
months ended June 30, 2004 from $171,000 for the three months ended June 30,
2003. This increase is the result of additional costs and depreciation
associated with equipment purchased to accommodate the Company's growth.

Other operating expenses during the second quarter of 2004 increased
$112,000, or 19.8%, to $679,000 from $567,000 during the second quarter of 2003.
The increase is associated with the continued growth of the Company.

For the six months ended June 30, 2004, total other expenses increased
$414,000, or 10.5%, to $4,357,000 from $3,943,000 for the six months ended June
30, 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.

Page 12

Salary expenses and related employee benefits were $2,349,000 for the six
months ended June 30, 2004, an increase of $163,000, or 7.5%, compared with
$2,186,000 for the six months ended June 30, 2003. The increase is attributable
to staff additions and increases in normal salary and benefit related expenses.

Occupancy expenses for the first six months of 2004 increased to $357,000
from $326,000 for the first six months of 2003. The increase of $31,000, or
9.5%, is particularly attributable to taxes and depreciation costs associated
with the purchase of a building that will be used for operational and
administrative purposes.

Equipment expenses increased $21,000, or 6.3%, to $355,000 for the first
six months of 2004 from $334,000 for the first six months of 2003. The increase
in this expense category was due to the added depreciation expense from the
additions made to equipment to support the growth of the Company.

Other operating expenses increased $199,000, or 18.1%, to $1,296,000 for
the six months ended June 30, 2004 from $1,097,000 for the six months ended June
30, 2003. This increase was the result of the Company's growth as well as the
additional expenses associated with the formation of the holding company and the
issuance of junior subordinated debentures, or "trust preferred securities".

Income Taxes

Income tax expense was $257,000 for the three months ended June 30, 2004,
an increase of $39,000, or 17.9%, compared with $218,000 for the three months
ended June 30, 2003. This increase is due to a higher level of pre-tax income.

For the six months ended June 30, 2004, the tax provision was $485,000
compared with $406,000 for the six months ended June 30, 2003. This increase of
$79,000, or 19.5%, 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 three months ended June 30, 2004 was $810,000, an
increase of $159,000, or 24.4%, compared with $651,000 for the three months
ended June 30, 2003. This increase in net income is the result of increases of
$351,000 in net interest income and $72,000 in other income, which offset the
increases of $15,000 in the provision for loan losses, $210,000 in other
expenses and $39,000 in taxes. Basic and diluted earnings per share for the
three months ended June 30, 2004 were each $0.13 compared with $0.10 for the
three months ended June 30, 2003.

Net income for the first six months of 2004 was $1,561,000, an increase of
$322,000, or 26%, compared with $1,239,000 for the first six months of 2003.
This increase in net income was the result of increases of $740,000 in net
interest income and $130,000 in other income, which offset the increases of
$55,000 in the provision for loan losses, $414,000 in other operating expenses
and $79,000 in federal income tax expense. The increase in net income was
attributable to the historically low interest rate environment, where the
Company's cost of funds associated with interest sensitive liabilities decreased
more than the decline in yield derived from interest sensitive assets. Net
income was also appositively affected 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 six months ended June 30, 2004 was $0.25 compared
with $0.19 for the six months ended June 30, 2003.

FINANCIAL CONDITION

Securities

The Company's securities portfolio is comprised of securities, which not
only provide interest 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

Page 13

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 June 30, 2004 was $97,386,000, compared to
$107,281,000 at December 31, 2003, a decrease of $9,895,000, or 9.2%. The
decline was principally attributable to prepayments of principal and to a lesser
degree, the sale of investment securities. A portion of the proceeds from the
sale of securities, in the amount of $1,500,000, was used to purchase additional
bank owned life insurance ("BOLI"), which yields tax-exempt income for the Bank.
The remaining cash flow generated from the portfolio was used to fund loan
demand. Securities available for sale decreased to $96,336,000 at June 30, 2004
from $106,230,000 at December 31, 2003, while securities held to maturity were
$1,050,000 at June 30, 2004 as compared with $1,051,000 at December 31, 2003.

The carrying value of the available for sale portion of the portfolio at
June 30, 2004 includes an unrealized loss of $1,333,000 (reflected as
accumulated other comprehensive loss of $880,000 in stockholders' equity, net of
deferred income tax asset of $453,000). 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 and generally is the highest yielding category of asset. Gross loans
receivable, net of unearned fees and origination costs, increased $20,088,000,
or 9.7%, to $227,104,000 at June 30, 2004 from $207,016,000 at December 31,
2003. This increase is attributed to increased commercial loan and revolving
line of credit demand. Gross loans represented 78% of total deposits at June 30,
2003 as compared to 74% at December 31, 2003, since loan growth outpaced deposit
growth.

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 June 30, 2004 and December 31, 2003 was
$2,654,000 and $2,403,000, respectively, compared to $2,359,000 at June 30,
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 June 30, 2004, the allowance for loan losses represented 1.17% of the gross
loan portfolio, compared with 1.16% at December 31, 2003. This compares to 1.25%
at June 30, 2003. At June 30, 2004, management believes the allowance for loan
loss reserve to be reasonable and adequate to meet potential losses.

Page 14

Table 1 - "Analysis of Allowance for Loan Loss" - details the activity,
which occurred in the allowance over the first six 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 283 228
Charge-offs:

Commercial 0 0

Real estate 0 0

Consumer (42) (40)
------- -------

Total charge-offs (42) (40)

Recoveries:

Commercial 3 0

Consumer 7 4
------- -------

Total recoveries 10 4

Net (charge-offs) (32) (36)
------- -------
$ 2,654 $ 2,359
======= =======

Net (charge-offs) recoveries to average net
loans (0.02)% (0.02)%

(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 June 30, 2004 and December 31, 2003.

Table 2 -Asset Quality Ratios

--------------------------------------------------------------------------
6/30/04 12/31/03
------- --------

Non-accrual loans/Total loans 0.45% 0.19%

Non-performing assets (1) /Total loans 0.54% 0.34%

Net charge-offs/Average loans 0.02% 0.09%

Allowance/Total loans 1.17% 1.16%

Allowance/Non-accrual loans 259.94% 608.35%

Allowance/Non-performing loans (1) 220.07% 553.69%

(1) - Includes non-accrual loans.
--------------------------------------------------------------------------

At June 30, 2004, the Company had other real estate owned as acquired
through foreclosure, in the amount of $16,000, which decreased $260,000, from
$276,000 at December 31, 2003, as a result of the sale of two residential
property loans. The disposition of these properties resulted in a $61,000 gain ,
recorded as other income. 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 15

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 investment securities 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 $7,077,000 and $5,426,000 in BOLI, as of June 30, 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 state chartered 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 June 30, 2004 were $291,056,000, an
increase of $11,158,000, or 4%, from total deposits of $279,898,000 at December
31, 2003. The increase in deposits was due to increases of $5,632,000 in
interest bearing demand deposit accounts, $4,232,000 in savings accounts and
$6,906,000 in non-interest bearing demand deposit accounts, offset by a decline
of $5,612,000 in certificates of deposit. The reduction in certificates of
deposit was due to run-off of higher costing deposits into lower costing
deposits as a result of customers continued hesitation to invest in term
deposits in this uncertain interest rate environment. This resulted in reducing
the Bank's overall cost of funds to 1.80% at June 30, 2004 from 1.94% at
December 31, 2003 and 2.05% at June 30, 2003.

Federal Funds Purchased and Securities Sold under Agreements to Repurchase

There was an outstanding balance of $862,000 in federal funds purchased at
June 30, 2004 as compared with none at 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 $4,764,000 at June 30,
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 $155,657,000
with the Federal Home Loan Bank of Pittsburgh ("FHLB"), out of which $25 million
was outstanding at June 30, 2004 and December 31, 2003, resulting in an unused
borrowing capacity of $130,657,000. The $25 million borrowing is comprised of
the following fixed rate borrowings:

Page 16

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
$7,344,000 at June 30, 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
June 30, 2004, management indicated that there was $80,973,000 in liquid
securities as compared with $90,642,000 at December 31, 2003.

Liability liquidity sources include attracting deposits at competitive
rates. Deposits at June 30, 2004 were $291,056,000, 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. Off-balance sheet arrangements are discussed in
detail below.

Management is of the opinion that its liquidity position, at June 30,
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

Page 17

Company's inability to meet anticipated or unexpected liquidity needs.

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 June 30, 2004 were
$68,864,000, which consisted of $59,804,000 in unfunded commitments to existing
loans, $8,491,000 to grant new loans and $569,000 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

The following Table 3 presents the risk-based and leverage capital amounts
and ratios at June 30, 2004 for the Company and the Bank.

To be Well
Capitalized
under Prompt
For Capital Adequacy Corrective Action
Actual Purposes Provisions
-------------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- --------- ----- -------- ------
(Dollars in Thousands)

As of June 30, 2004:
Total capital (to risk-weighted assets):
Consolidated $30,855 12.62% $>=19,566 >=8.0% N/A N/A%
East Penn Bank 28,954 11.94 >=19,396 >=8.0 >=24,246 >=10.0
Tier 1 capital (to risk-weighted assets):
Consolidated 26,936 11.01 >=9,783 >=4.0 N/A N/A
East Penn Bank 26,301 10.85 >=9,698 >=4.0 >=14,547 >= 6.0
Tier 1 capital (to average assets):
Consolidated 26,936 7.80 >=13,805 >=4.0 N/A N/A
East Penn Bank 26,301 7.67 >=13,723 >=4.0 >=17,153 >= 5.0

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 its first semi-annual cash dividend for 2004 in the
amount of $0.08 per share, paid on February 28, 2004 to all shareholders of
record as of January 31, 2004. The payment of this semi-annual cash dividend
decreased retained earnings by $504,000. In addition, on July 26, 2004, the
Board authorized and declared a cash dividend for the second half of 2004 of
$0.08 per share, payable on August 31, 2004 to all shareholders of record as of
August 4, 2004. This is the first year that the Company paid a dividend two
times in a year as compared with prior years' cash dividend payments, which were
paid once a year.

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 36.6% at June 30, 2004, as compared with 29.6% at June
30, 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,

Page 18

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.

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 June 30, 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 June 30, 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.

Page 19

Item 3. Defaults upon Senior Securities

Nothing to report.

Item 4. Submission of Matters to a Vote of Security Holders

The bank held its annual meeting of stockholders on May 6,
2004 at the Allen Organ Company located at 3370 Route 100,
Macungie, PA 18062. The Judges of Election reported that the
results of the balloting revealed that holders of 5,072,282
shares of common stock, representing 80.52% of the total
number of shares outstanding, were represented in person or by
proxy at the 2004 annual meeting of shareholders.

The following outlines the items voted on at the meeting as
well as the votes cast for, against and non-vote for each
item.

I. Election of Class A directors to serve for a one-year
term expiring 2005.

Withhold
For Authority
--------- ---------

Gordon K. Schantz 5,052,697 19,585

Donald R. Schneck 5,037,780 34,502

Konstantinos A. Tantaros 5,051,737 20,545

Dr. F. Geoffrey Toonder 5,054,934 17,348

Election of Class B directors to serve for a two-year
term expiring 2006.

Withhold
For Authority
--------- ---------

Dale A. Dries 5,037,553 34,729

Thomas R. Gulla 5,055,353 16,929

Linn H. Schantz 5,052,662 19,620

Donald S. Young 5,056,088 16,194

Election of Class C directors to serve for a three-year
term expiring 2007.

Withhold
For Authority
--------- ---------

Allen E. Kiefer 4,870,072 202,210

Brent L. Peters 5,040,252 32,030

Forrest A. Rohrbach 5,040,252 32,030

Peter L. Shaffer 4,857,145 215,137

Page 20

II. Ratification of the selection of Beard Miller Company,
LLP, Certified Public Accountants, as independent
auditors of the Company for 2004.

For Against Abstain
--------- ------- -------
5,036,985 29,826 5,471

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.

10.5 East Penn Financial Corporation's Dividend Reinvestment
and Stock Purchase Plan is incorporated by reference to
the Registrant's Registration Statement on Form S-3
(Registration No. 333-116754) as filed with the
Securities and Exchange Commission on June 23, 2004.

11 Statement re: Computation of per share earnings is
incorporated by reference herein to Note 3 on page 7 of
this Form 10-Q.

Page 21

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.

(b) Reports on Form 8-K

No Form 8-K's were "filed" during the second quarter of 2004.

Page 22

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 /s/ Brent L. Peters
-------------------------------
Brent L. Peters
President and Chief Executive Officer
(Principal Executive Officer)

Date: August 10, 2004

By /s/ Theresa M. Wasko
-------------------------------
Theresa M. Wasko
Treasurer and Chief Financial Officer
(Principal Financial and Accounting
Officer)

Date: August 10, 2004

Page 23

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.

10.5 East Penn Financial Corporation's Dividend Reinvestment and Stock Purchase
Plan is incorporated by reference to the Registrant's Registration
Statement on Form S-3 (Registration No. 333-116754) as filed with the
Securities and Exchange Commission on June 23, 2004.

11 Statement re: Computation of per share earnings is incorporated by
reference herein to Note 3 on page 7 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.

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