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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 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
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Commission File Number 0-16668
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WSFS FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 22-2866913
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
838 Market Street, Wilmington, Delaware 19801
- --------------------------------------- -----------------
Address of principal executive offices) (Zip Code)
(302) 792-6000
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 Exchange Act Rule 12b-2). YES X NO
----- ----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of November 1, 2004:
Common Stock, par value $.01 per share 7,044,734
- -------------------------------------- --------------------
(Title of Class) (Shares Outstanding)
WSFS FINANCIAL CORPORATION
FORM 10-Q
INDEX
PART I. Financial Information
Page
----
Item 1. Financial Statements
--------------------
Consolidated Statement of Operations for the Three and Nine Months
Ended September 30, 2004 and 2003 (Unaudited).............................. 3
Consolidated Statement of Condition as of September 30, 2004
(Unaudited) and December 31, 2003.......................................... 5
Consolidated Statement of Cash Flows for the Nine Months Ended
September 30, 2004 and 2003 (Unaudited).................................... 6
Notes to the Consolidated Financial Statements for the Three and Nine
Months Ended September 30, 2004 and 2003 (Unaudited)....................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations.................................................. 17
-------------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk................... 28
----------------------------------------------------------
Item 4. Controls and Procedures ..................................................... 28
--------------------------
PART II. Other Information
Item 1. Legal Proceedings............................................................ 28
-----------------
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ................. 28
-------------------------------------------------------------
Item 3. Defaults upon Senior Securities.............................................. 29
-------------------------------
Item 4. Submission of Matters to a Vote of Security Holders.......................... 29
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Item 5. Other Information ........................................................... 29
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Item 6. Exhibits .................................................................... 29
---------
Signatures ........................................................................... 30
Exhibit 31 Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .. 31
Exhibit 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ... 33
2
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
(In Thousands)
Interest income:
Interest and fees on loans...................... $ 19,882 $ 17,922 $ 56,204 $ 53,699
Interest on mortgage-backed securities.......... 5,468 2,759 14,884 10,306
Interest and dividends on investment securities. 1,090 284 3,438 713
Other interest income........................... 161 212 519 836
---------- ---------- ---------- ----------
26,601 21,177 75,045 65,554
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits............................ 2,320 1,882 5,945 6,473
Interest on Federal Home Loan Bank advances..... 6,011 5,167 17,452 14,593
Interest on federal funds purchased and securities
sold under agreements to repurchase 561 175 1,374 540
Interest on trust preferred borrowings.......... 551 489 1,550 1,478
Interest on other borrowings ................... 38 65 116 253
---------- ---------- ---------- ----------
9,481 7,778 26,437 23,337
---------- ---------- ---------- ----------
Net interest income.................................. 17,120 13,399 48,608 42,217
Provision for loan losses............................ 996 525 2,370 2,025
---------- ---------- ---------- ----------
Net interest income after provision for loan losses.. 16,124 12,874 46,238 40,192
---------- ---------- ---------- ----------
Noninterest income:
Credit/debit card and ATM income................ 3,277 2,498 8,917 7,200
Deposit service charges......................... 2,315 2,392 7,016 6,666
Investment advisory income...................... 584 - 1,671 -
Bank owned life insurance income................ 558 - 1,663 -
Loan servicing fee income....................... 518 796 1,676 2,225
Gain on sale of loans........................... 77 217 444 1,378
Securities(losses)gains......................... (15) 148 209 337
Other income.................................... 846 491 2,342 1,846
---------- ---------- ---------- ----------
8,160 6,542 23,938 19,652
---------- ---------- ---------- ----------
Noninterest expenses:
Salaries, benefits and other compensation....... 7,655 6,371 22,704 19,957
Occupancy expense............................... 1,151 1,006 3,422 2,978
Equipment expense............................... 969 927 2,759 2,783
Data processing and operations expenses......... 815 738 2,414 2,105
Professional fees............................... 607 457 1,438 1,822
Marketing expense............................... 465 433 1,526 1,254
Other operating expense......................... 2,505 1,594 6,331 5,956
---------- ---------- ---------- ----------
14,167 11,526 40,594 36,855
---------- ---------- ---------- ----------
Income from continuing operations before
minority interest and taxes....................... 10,117 7,890 29,582 22,989
Less minority interest............................... 66 - 158 -
---------- ---------- ---------- ----------
Income from continuing operations before taxes....... 10,051 7,890 29,424 22,989
Income tax provision................................. 3,499 2,562 10,423 7,944
---------- ---------- ---------- ----------
Income from continuing operations.................... 6,552 5,328 19,001 15,045
Gain on sale of businesses held-for-sale,
net of taxes...................................... - - - 41,389
---------- ---------- ---------- ----------
Net income........................................... $ 6,552 $ 5,328 $ 19,001 $ 56,434
========== ========== ========== =========
3
(Continued on next page)
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS (Continued)
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
Earnings per share:
Basic:
-----
Income from continuing operations.................... $ 0.93 $ 0.70 $ 2.64 $ 1.91
Gain on sale of businesses held-for-sale, net of taxes - - - 5.24
---------- ---------- ---------- ---------
Net income .......................................... $ 0.93 $ 0.70 $ 2.64 $ 7.15
========== ========== ========== =========
Diluted:
-------
Income from continuing operations.................... $ 0.88 $ 0.66 $ 2.49 $ 1.80
Gain on sale of businesses held-for-sale, net of taxes - - - 4.94
---------- ---------- ---------- ---------
Net income .......................................... $ 0.88 $ 0.66 $ 2.49 $ 6.74
========== ========== ========== =========
The accompanying notes are an integral part of these Financial Statements.
4
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CONDITION
September 30, December 31,
2004 2003
---- ----
(Unaudited)
(In Thousands)
Assets
Cash and due from banks................................................ $ 54,088 $ 46,709
Cash in non-owned ATMs................................................. 123,765 113,711
Federal funds sold..................................................... 15,000 -
Interest-bearing deposits in other banks............................... 539 1,095
Investment securities held-to-maturity................................. 8,172 10,410
Investment securities available-for-sale............................... 90,166 106,078
Mortgage-backed securities held-to-maturity............................ 8 1,814
Mortgage-backed securities available-for-sale.......................... 503,918 517,211
Mortgage-backed securities trading..................................... 11,906 11,527
Loans held-for-sale.................................................... 2,491 1,458
Loans, net of allowance for loan losses of $24,052
at September 30, 2004 and $22,386 at December 31, 2003............... 1,473,714 1,303,419
Bank owned life insurance.............................................. 51,663 -
Stock in Federal Home Loan Bank of Pittsburgh, at cost................. 46,958 43,676
Assets acquired through foreclosure.................................... 159 301
Premises and equipment................................................. 21,008 13,345
Accrued interest receivable and other assets........................... 30,715 26,849
Loans, operating leases and other assets of
discontinued operations.............................................. 1,873 9,474
----------- -----------
Total assets........................................................... $ 2,436,143 $ 2,207,077
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing demand......................................... $ 229,999 $ 215,819
Money market and interest-bearing demand........................... 174,547 118,151
Savings............................................................ 302,141 316,976
Time............................................................... 197,012 192,037
Jumbo certificates of deposit - retail............................. 51,787 40,076
----------- -----------
Total retail deposits.......................................... 955,486 883,059
Jumbo certificates of deposit - non-retail......................... 51,873 40,274
Brokered certificates of deposit................................... 124,884 -
----------- -----------
Total deposits................................................. 1,132,243 923,333
Federal funds purchased and securities sold under
agreements to repurchase............................................. 132,350 148,381
Federal Home Loan Bank advances........................................ 878,623 843,296
Trust preferred borrowings............................................. 51,547 50,000
Other borrowed funds................................................... 35,085 39,381
Accrued interest payable and other liabilities......................... 16,665 14,648
----------- -----------
Total liabilities...................................................... 2,246,513 2,019,039
----------- -----------
Minority Interest...................................................... 258 46
Stockholders' Equity:
Serial preferred stock $.01 par value, 7,500,000 shares
authorized; none issued and outstanding.............................. - -
Common stock $.01 par value, 20,000,000 shares authorized;
issued 15,162,803 at September 30, 2004 and 15,080,162
at December 31, 2003................................................. 152 151
Capital in excess of par value......................................... 66,957 64,738
Accumulated other comprehensive loss .................................. (2,466) (1,748)
Retained earnings ..................................................... 286,574 268,797
Treasury stock at cost, 8,127,269 shares at
September 30, 2004 and 7,758,869
shares at December 31, 2003 ......................................... (161,845) (143,946)
----------- -----------
Total stockholders' equity............................................. 189,372 187,992
----------- -----------
Total liabilities, minority interest and
stockholders' equity................................................. $ 2,436,143 $ 2,207,077
=========== ===========
The accompanying notes are an integral part of these Financial Statements.
5
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended September 30,
-------------------------------
2004 2003
---- ----
(Unaudited)
(In Thousands)
Operating activities:
Net income .......................................................... $ 19,001 $ 56,434
Adjustments to reconcile net income to net cash provided by
(used for) operating activities:
Provision for loan losses........................................ 2,370 2,025
Depreciation, accretion and amortization ........................ 4,767 9,554
Increase in accrued interest receivable and other assets......... (1,387) (8,908)
Origination of loans held-for-sale............................... (30,848) (62,967)
Proceeds from sales of loans held-for-sale....................... 27,142 53,639
Gain on sale of loans held-for-sale ............................. (185) (816)
Gain on sale of loans .......................................... (259) (562)
Gain on sale of investments ..................................... (209) (337)
Minority interest in net income ................................. 158 -
Increase (decrease) in accrued interest payable
and other liabilities .......................................... 2,017 (17,223)
Gain on businesses held-for-sale ................................ - (65,073)
Gain on assets acquired through foreclosure ..................... (56) -
Increase in value of bank owned life insurance................... (1,663) -
Increase in capitalized interest, net ........................... (1,409) (381)
----------- -----------
Net cash provided by (used for) operating activities................. 19,439 (34,615)
----------- -----------
Investing activities:
Net decrease in interest-bearing deposits in other banks ............ 556 4,453
Maturities of investment securities ................................. 2,610 460
Sale of investment securities available-for-sale..................... 25,059 10,957
Purchase of investments available for sale........................... (9,930) (62,040)
Sales of mortgage-backed securities available-for-sale............... 38,531 66,592
Repayments of mortgage-backed securities held-to-maturity ........... 1,810 21,286
Repayments of mortgage-backed securities available-for-sale ......... 125,867 278,125
Purchases of mortgage-backed securities available-for-sale........... (152,940) (744,605)
Repayments of reverse mortgages ..................................... 1,240 1,637
Disbursements for reverse mortgages ................................. (365) (670)
Purchase of Cypress Capital Management LLC .......................... (1,122) -
Sale of loans........................................................ 13,460 26,453
Purchase of loans ................................................... (11,569) (10,081)
Purchase of bank owned life insurance ............................... (50,000) -
Sale of businesses held-for-sale .................................... - 128,667
Net increase in loans ............................................... (171,798) (200,378)
Net increase in stock of Federal Home Loan Bank of Pittsburgh........ (3,282) (17,784)
Sales of assets acquired through foreclosure, net.................... 509 356
Purchase of land..................................................... (2,860) -
Purchase of office building.......................................... (3,507) -
Premises and equipment, net.......................................... (3,692) (1,506)
----------- -----------
Net cash used for investing activities............................... (201,423) (498,078)
----------- -----------
Financing activities:
Net increase in demand and savings deposits.......................... 51,444 72,474
Net increase (decrease) in time deposits ............................ 152,925 (38,146)
Receipts from FHLB borrowings ....................................... 5,006,301 2,643,870
Repayments of FHLB borrowings........................................ (4,970,974) (2,278,950)
Receipts from reverse repurchase agreements.......................... 2,287,714 478,354
Repayments of reverse repurchase agreements.......................... (2,303,745) (445,107)
Net increase in federal funds purchased.............................. - 50,000
Dividends paid on common stock....................................... (1,224) (1,211)
Issuance of common stock and exercise of
employee stock options ............................................ 2,220 4,739
Purchase of treasury stock, net of reissuance........................ (17,899) (51,860)
Minority interest.................................................... 54 (12,845)
----------- -----------
Net cash provided by financing activities............................ 206,816 421,318
----------- -----------
Increase (decrease) in cash and cash equivalents from
continuing operations. 24,832 (111,375)
Change in net assets from discontinued operations ................... 7,601 33,354
Cash and cash equivalents at beginning of period .................... 160,420 226,303
----------- -----------
Cash and cash equivalents at end of period .......................... $ 192,853 $ 148,282
=========== ===========
(Continued on next page)
6
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
Nine months ended September 30,
-------------------------------
2004 2003
---- ----
(Unaudited)
(In Thousands)
Supplemental Disclosure of Cash Flow Information:
- -------------------------------------------------
Cash paid for interest ....................................... $ 24,102 $ 21,324
Cash paid for income taxes, net............................... 7,916 56,895
Loans transferred to assets acquired through foreclosure ..... 311 486
Net change in other comprehensive income...................... 718 (1,746)
Transfer of loans held-for-sale to loans...................... 2,858 398
Deconsolidation of WSFS Capital Trust I....................... 1,547 -
The accompanying notes are an integral part of these Financial Statements.
7
WSFS FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated Financial Statements include the accounts of the
parent company (WSFS Financial Corporation), Wilmington Savings Fund Society,
FSB (Bank or WSFS) and Montchanin Capital Management, Inc. (Montchanin). WSFS
Financial Corporation (Company or Corporation) also has one unconsolidated
affiliate, WSFS Capital Trust I (the Trust). WSFS was founded in 1832 and is one
of the oldest financial institutions in the country. WSFS provides residential
and commercial real estate, commercial and consumer lending services, as well as
retail deposit and cash management services. Lending activities are funded
primarily with retail deposits and borrowings. Deposits are insured to their
legal maximum by the Federal Deposit Insurance Corporation (FDIC). WSFS serves
customers primarily from its main office and 23 retail banking offices, located
in Delaware and southeastern Pennsylvania. Montchanin was formed in late 2003 to
provide asset management services in the Corporation's primary market area. The
Trust was formed in 1998 to sell Trust Preferred Securities. The Trust invested
all of the proceeds from the sale of the Trust Preferred Securities in Junior
Subordinated Debentures of the Corporation.
Fully-owned and consolidated subsidiaries of WSFS include WSFS Credit
Corporation (WCC), WSFS Investment Group, Inc. and WSFS Reit, Inc. As discussed
in Note 3 of the Financial Statements, the results of WCC, the Corporation's
wholly owned indirect auto financing and leasing subsidiary, are presented as
discontinued operations. WSFS Investment Group, Inc. was formed in 1989. WSFS
Investment Group, Inc., with the Bank, markets various third-party investment
and insurance products, such as single-premium annuities, whole life policies
and securities primarily through WSFS' retail banking system. WSFS Reit, Inc. is
a real estate investment trust formed in 2002 to hold qualifying real estate
assets and may be used to raise capital in the future.
In addition to the wholly owned subsidiaries, WSFS had consolidated one
non-wholly owned subsidiary, Wilmington Finance, Inc. (WF). WF, a majority owned
subsidiary engaged in sub-prime residential mortgage banking, was sold in
January 2003. This subsidiary is therefore classified as businesses
held-for-sale in the Financial Statements. See Note 4 of the Financial
Statements for further discussion of Businesses Held-for-Sale.
Certain reclassifications have been made to the prior years' Financial
Statements to conform them to the current year's presentation. All significant
intercompany transactions are eliminated in consolidation. The accompanying
unaudited financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Corporation's 2003 Annual
Report.
Valuation of Stock Option Grants
At September 30, 2004, the Corporation had two stock-based employee
compensation plans. The Corporation accounts for these plans under the
recognition and measurement principles of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and Related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under these plans had an exercise price at least
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
had the Company applied the fair value recognition provision of the Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
8
For the three months For the nine months
ended September 30, ended September 30,
-------------------- -----------------------
2004 2003 2004 2003
--------- --------- ---------- ----------
(In Thousands, Except Per Share Data)
Income from continuing operations, as reported ............................ $ 6,552 $ 5,328 $ 19,001 $ 15,045
Less : Total stock-based employee compensation expense determined
under fair value based methods for all awards,
net of related tax effects ...................................... 150 182 457 535
--------- --------- ---------- ----------
Pro forma income from continuing operations ............................... $ 6,402 $ 5,146 $ 18,544 $ 14,510
Earnings per share:
Basic:
- -----
Income from continuing operations, as reported ............................ $ 0.93 $ 0.70 $ 2.64 $ 1.91
Less : Total stock-based employee compensation expense determined
under fair value based methods for all awards, net of related tax
effects ........................................................... 0.02 0.02 0.06 0.07
--------- --------- ---------- ----------
Pro forma income from continuing operations ............................... $ 0.91 $ 0.68 $ 2.58 $ 1.84
========= ========= ========== ==========
Diluted:
- -------
Income from continuing operations, as reported ............................ $ 0.88 $ 0.66 $ 2.49 $ 1.80
Less : Total stock-based employee compensation expense determined
under fair value based methods for all awards, net of related tax
effects ........................................................... 0.02 0.02 0.06 0.07
--------- --------- ---------- ----------
Pro forma income from continuing operations ............................... $ 0.86 $ 0.64 $ 2.43 $ 1.73
========= ========= ========== ==========
2. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
For the three months For the nine months
ended September 30, ended September 30,
------------------- --------------------
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands, Except Per Share Data)
Numerator:
- ---------
Income from continuing operations ..................................... $ 6,552 $ 5,328 $19,001 $15,045
Gain on sale of businesses held-for-sale, net of taxes ................ - - - 41,389
------- ------- ------- -------
Net income ............................................................ $ 6,552 $ 5,328 $19,001 $56,434
======= ======= ======= =======
Denominator:
- -----------
Denominator for basic earnings per share - weighted average shares .... 7,024 7,573 7,190 7,897
Effect of dilutive employee stock options ............................. 431 485 431 470
------- ------- ------- -------
Denominator for diluted earnings per share - adjusted weighted average
shares and assumed exercise ........................................ 7,455 8,058 7,621 8,367
======= ======= ======= =======
Earnings per share:
- ------------------
Basic:
Income from continuing operations ..................................... $ 0.93 $ 0.70 $ 2.64 $ 1.91
Gain on sale of businesses held-for-sale, net of taxes ................ - - - 5.24
------- ------- ------- -------
Net income ............................................................ $ 0.93 $ 0.70 $ 2.64 $ 7.15
======= ======= ======= =======
Diluted:
Income from continuing operations ..................................... $ 0.88 $ 0.66 $ 2.49 $ 1.80
Gain on sale of businesses held-for-sale, net of taxes ................ - - - 4.94
------- ------- ------- -------
Net income ............................................................ $ 0.88 $ 0.66 $ 2.49 $ 6.74
======= ======= ======= =======
Outstanding common stock equivalents having no dilutive effect ........ - 1 2 1
9
3. Discontinued Operations of a Business Segment
WSFS Financial Corporation discontinued the operations of WSFS Credit
Corporation (WCC) in 2000. WCC, which had 106 lease contracts and 293 loan
contracts at September 30, 2004, no longer accepts new applications but
continues to service existing loans and leases until their maturities.
Management estimates that substantially all loan and lease contracts will mature
by the end of 2004.
In accordance with APB 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, and
Related Interpretations, which was the authoritative literature in 2000,
accounting for discontinued operations of a business segment at that time
required that the Company forecast operating results over the wind-down period
and accrue any expected net losses. The historic results of WCC's operations,
the accrual of expected losses to be incurred over the wind-down period, and the
future reported results of WCC are required to be treated as Discontinued
Operations of a Business Segment, and shown in a summary form separately from
the Company's results of continuing operations in reported results of the
Corporation.
As a result, the Corporation has established a reserve to absorb
expected future net losses of WCC. Due to the uncertainty of a number of
factors, including residual values, interest rates, credit quality and operating
costs, this reserve is re-evaluated quarterly with adjustments, if necessary,
recorded as income/losses on wind-down of discontinued operations. At September
30, 2004, there were approximately $1.3 million of contract residuals
outstanding for which management has estimated that future residual losses may
range from approximately $247,000 to $397,000. Management has inherently
provided for these, and other expected future operating losses through $624,000
in total combined reserves.
The following table presents the operating leases, loans and other
non-cash assets of discontinued operations at September 30, 2004 and December
31, 2003:
At September 30, December 31
2004 2003
---------------------------------------
(In Thousands)
Vehicles under operating leases, net of reserves ..... $ 1,107 $ 6,542
Loans ................................................ 738 2,359
Other non-cash assets ................................ 79 573
Less:
Reserve for losses of discontinued operations ... 51 -
------- -------
Loans, operating leases and other non-cash assets of
discontinued operations ............................ $ 1,873 $ 9,474
======= =======
The following table presents the net income from discontinued
operations for the three and nine months ended September 30, 2004 and 2003:
For the three months ended For the nine months ended
September 30, September 30,
-------------------------- ----------------------------
2004 2003 2004 2003
---- ---- ---- -----
(In Thousands)
Interest income........................ $ 28 $ 93 $ 121 $ 353
Allocated interest expense (1)......... 27 186 150 881
---------- ------------ ---------- -----------
Net interest income (expense).......... 1 (93) (29) (528)
Loan and lease servicing fee income ... 68 68 253 253
Rental income on operating leases, net. 40 (469) 356 (519)
Other income........................... (2) (1) (2) 1
---------- ------------ ---------- -----------
Net revenues......................... 107 (495) 578 (793)
Noninterest expenses................. 84 153 292 518
---------- ------------ ---------- -----------
Income (loss) before taxes............. 23 (648) 286 (1,311)
(Credit) charge to reserve for losses on
discontinued operations ............ (23) 648 (286) 1,311
Income tax provision .................. - - - -
---------- ------------ ---------- -----------
Income from discontinued operations.... $ - $ - $ - $ -
========== ============ ========== ===========
(1) Allocated interest expense for the nine months ended September 30, 2004 and
2003 was based on a direct matched-maturity funding of the non-cash assets
of discontinued operations. The average borrowing rates for the three and
nine months ended September 30, 2004 were 3.93% and 3.87% compared to 3.51%
and 3.42% for the respective periods in 2003.
10
4. BUSINESSES HELD FOR SALE
In November 2002, the Corporation completed the sale of CustomerOne
Financial Network, Inc. (C1FN) and related interests in its Everbank Division.
In connection with that transaction, during the first nine months of 2003, WSFS
recognized an after tax-gain of $117,000 or $0.01 per diluted share.
In January 2003, WSFS sold its majority-owned subsidiary, Wilmington
Finance, Inc. (WF) and recognized an after tax-gain on the sale of $41.3 million
or $4.93 per diluted share during the first nine months of 2003. The sale
included $148.2 million in assets, of which $117.6 were residential mortgage
loans held-for-sale.
5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
The Corporation has an interest-rate cap with a notional amount of $50
million, which limits 3-month LIBOR to 6% for the ten years ending December 1,
2008. The cap is being used to hedge the cash flows on $50 million in trust
preferred floating rate debt. The cap was recorded at the date of purchase in
other assets, at a cost of $2.4 million. On July 1, 2002, the inception date of
the redesignated hedging relationship, using guidance from the Financial
Accounting Standards Board (FASB) for implementation of Statement 133,
Accounting for Derivative and Hedging Activities, the fair value of the interest
rate cap was $1.6 million. This amount was allocated to the respective multiple
"caplets" on a fair value basis. The change in each caplet's respective
allocated fair value amount is reclassified out of other comprehensive income
and into interest expense when each of the quarterly interest payments is made
on the Trust Preferred debt. The redesignation of the cash flow hedge has the
effect of providing a more systematic method for amortizing the cost of the cap
against earnings. The fair value of the cap is estimated using a standard option
model. The fair value of the interest rate cap at September 30, 2004 was
$402,000.
While not meeting the definition of a derivative under SFAS 133,
related to its sale of reverse mortgages, in November 2002, the Corporation also
received as consideration a series of options to acquire up to 49.9% of Class
"O" certificates issued in connection with mortgage-backed security SASCO RM-1
2002. The securitizer retained 100% of the Class "O" Certificates from the
securitization. The principal terms of the Class "O" Certificates and WSFS'
option follow. The Class "O" Certificates have no priority over other classes of
Certificates under the Trust. No distributions will be made on the Class "O"
Certificates until, among other conditions, the principal amount of each other
class of notes has been reduced to zero. The underlying assets, the reverse
mortgages, are very long-term assets. Hence, any cash flow that might inure to
the holder of the Class "O" Certificates is not expected to occur until many
years in the future. Additionally, the Company can exercise its option on 49.9%
of the Class "O" Certificates (in up to five separate increments) for an
aggregate purchase price of $1 million any time between January 1, 2004 and the
termination of the Securitization Trust.
Since these Certificates are unseasoned long-term interests in only
the second-ever securitization of reverse mortgages in the United States, there
is no active market for the securities, nor are there other comparable
securities that can be used as a basis for valuation. Therefore, in order to
value the option under SFAS 115, the Company calculated the net present value of
the expected cash flows from these Certificates and compared the estimate to the
option price of $1 million. For the periods presented, the expected cash flows
were determined using relevant assumptions (housing values, home price
appreciation, mortality, mobility and interest rates) that the Company
considered appropriate based on its analysis and its experience of owning
reverse mortgages. The rate used to discount the expected cash flows was the
Lehman Long U.S. High Yield Index, as it is believed to be the most appropriate
available independent published index that would most closely match the rate of
return required on the long-term uncertain cash flows of a Class "O" Certificate
interest.
Applying this method resulted in expected values of $448,579 and
$497,753 at December 31, 2003 and September 30, 2004, respectively, for outright
ownership of 49.9% of the Class "O" Certificates. Both values were significantly
less than the option exercise price of $1 million, therefore a zero valuation
was recorded at each reporting date. The option is so far out of the money and
the cash flows on the related securitization so unseasoned that any additional
analyses, beyond the one performed, were deemed not meaningful. As the
securitization matures, expected cash flows and the discount rate will be
updated and the valuation adjusted, if appropriate.
The following depicts the change in fair market value of the Company's
derivatives:
2004 2003
---------------------------------------- ---------------------------------------
At At At At
January 1, Change September 30, January 1, Change September 30,
---------- ------ ------------- ---------- ------ -------------
(In Thousands)
Interest Rate Cap................. $ 1,072(1) $ (670) $ 402(1) $ 1,012(1) $ (208) $ 804 (1)
(1) Included in other comprehensive income, net of taxes.
11
6. COMPREHENSIVE INCOME
The following schedule reconciles net income to total comprehensive
income as required by SFAS No. 130, Reporting Comprehensive Income:
For the three months For the nine months
ended September 30, ended September 30,
------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
(In Thousands)
Net income .......................................... $ 6,552 $ 5,328 $ 19,001 $ 56,434
Other Comprehensive Income:
Net unrealized holding gains (losses) on securities
available-for-sale arising during the period,
net of taxes..................................... 5,223 (620) (204) (1,399)
Net unrealized holding losses arising during
the period on derivatives used for
cash flow hedge, net of taxes.................... (296) (53) (380) (138)
Reclassification adjustment for losses
(gains) included in net
income, net of taxes............................. 8 (92) (134) (209)
---------- ---------- --------- --------
Total comprehensive income........................... $ 11,487 $ 4,563 $ 18,283 $ 54,688
========== ========== ========= ========
7. TAXES ON INCOME
The Corporation accounts for income taxes in accordance with SFAS No.
109, Accounting for Income Taxes, which requires the recording of deferred
income taxes that reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Management has assessed valuation
allowances on the deferred income taxes due to, among other things, limitations
imposed by Internal Revenue Code and uncertainties, including the timing of
settlement and realization of these differences.
8. SEGMENT INFORMATION
Under the definition of SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, the Corporation has two operating segments
at September 30, 2004: WSFS and CashConnect, the ATM division of WSFS.
The WSFS segment provides financial products through its banking
offices to commercial and retail customers. The CashConnect segment provides
turnkey ATM services through strategic partnerships with several of the largest
networks, manufacturers, and service providers in the ATM industry. The balance
sheet category "Cash in non-owned ATMs" includes cash in which fee income is
earned through bailment arrangements with customers of CashConnect. Bailment
arrangements are typically renewed annually.
Reportable segments are business units that are managed separately and
offer different services to distinct customer bases. The Corporation evaluates
performance based on pre-tax ordinary income relative to resources used, and
allocates resources based on these results. Segment information for the three
and nine month periods ended September 30, 2004 and 2003 follows:
12
For the Three Months Ended September 30,
------------------------------------------------------------------------------------------------
2004 2003
----------------------------------------------------- ---------------------------------------
(In Thousands)
Bank CashConnect Total Bank CashConnect Total
---- ----------- ----- ---- ----------- -----
External customer revenues:
Interest income $ 26,601 $ - $ 26,601 $ 21,177 $ - $ 21,177
Non-interest income 5,367 2,793 8,160 4,464 2,078 6,542
-------------- ------------- -------------- -------------- ------------ ------------
Total external customer revenues 31,968 2,793 34,761 25,641 2,078 27,719
-------------- ------------- -------------- -------------- ------------ ------------
Intersegment revenues:
Interest income 487 - 487 263 - 263
Non-interest income 176 186 362 151 185 336
-------------- ------------- -------------- -------------- ------------ ------------
Total Intersegment revenues 663 186 849 414 185 599
-------------- ------------- -------------- -------------- ------------ ------------
Total revenue 32,631 2,979 35,610 26,055 2,263 28,318
External customer expenses:
Interest expense 9,481 - 9,481 7,778 - 7,778
Non-interest expenses 13,389 1,004 14,393 10,806 439 11,245
Other depreciation and
amortization 691 79 770 730 76 806
-------------- ------------- -------------- -------------- ------------ ------------
Total external customer expenses 23,561 1,083 24,644 19,314 515 19,829
-------------- ------------- -------------- -------------- ------------ ------------
Intersegment expenses:
Interest expense - 487 487 - 263 263
Non-interest expenses 186 176 362 185 151 336
-------------- ------------- -------------- -------------- ------------ ------------
Total Intersegment expenses 186 663 849 185 414 599
-------------- ------------- -------------- -------------- ------------ ------------
Total expenses 23,747 1,746 25,493 19,499 929 20,428
-------------- ------------- -------------- -------------- ------------ ------------
Income before taxes and
minority interest $ 8,884 $ 1,233 10,117 $ 6,556 $ 1,334 7,890
Provision for income taxes 3,499 2,562
Minority Interest 66 -
Gain on sale of business
held-for-sale - -
-------------- --------------
Consolidated net income $ 6,552 $ 5,328
============== ==============
Segment assets $ 2,306,276 $ 129,867 $ 2,436,143 $ 2,014,392 $ 91,651 $ 2,106,043
Capital expenditures $ 7,284 $ 81 $ 7,365 $ 806 $ 27 $ 833
13
For the Nine Months Ended September 30,
------------------------------------------------------------------------------------------------
2004 2003
-------------------------------------------------- ------------------------------------------
(In Thousands)
Bank CashConnect Total Bank CashConnect Total
---- ----------- ----- ---- ----------- -----
External customer revenues:
Interest income $ 75,045 $ - $ 75,045 $ 65,554 $ - $ 65,554
Non-interest income 16,526 7,412 23,938 13,924 5,728 19,652
-------------- ------------- -------------- -------------- ----------- --------------
Total external customer revenues 91,571 7,412 98,983 79,478 5,728 85,206
-------------- ------------- -------------- -------------- ----------- --------------
Intersegment revenues:
Interest income 1,099 - 1,099 833 - 833
Non-interest income 514 552 1,066 485 560 1,045
-------------- ------------- -------------- -------------- ----------- --------------
Total Intersegment revenues 1,613 552 2,165 1,318 560 1,878
-------------- ------------- -------------- -------------- ----------- --------------
Total revenue 93,184 7,964 101,148 80,796 6,288 87,084
External customer expenses:
Interest expense 26,437 - 26,437 23,337 - 23,337
Non-interest expenses 38,127 2,568 40,695 34,448 1,960 36,408
Other depreciation
and amortization 2,036 233 2,269 2,233 239 2,472
-------------- ------------- -------------- -------------- ----------- --------------
Total external customer expenses 66,600 2,801 69,401 60,018 2,199 62,217
-------------- ------------- -------------- -------------- ----------- --------------
Intersegment expenses:
Interest expense - 1,099 1,099 - 833 833
Non-interest expenses 552 514 1,066 560 485 1,045
-------------- ------------- -------------- -------------- ----------- --------------
Total Intersegment expenses 552 1,613 2,165 560 1,318 1,878
-------------- ------------- -------------- -------------- ----------- --------------
Total expenses 67,152 4,414 71,566 60,578 3,517 64,095
-------------- ------------- -------------- -------------- ----------- --------------
Income before taxes
and minority interest $ 26,032 $ 3,550 29,582 $ 20,218 $ 2,771 22,989
Provision for income taxes 10,423 7,944
Minority Interest 158 -
Gain on sale of business
held-for-sale - 41,389
-------------- - ------------
Consolidated net income $ 19,001 $ 56,434
============== ==============
Segment assets $ 2,306,276 $ 129,867 $ 2,436,143 $ 2,014,392 $ 91,651 $ 2,106,043
Capital expenditures $ 9,841 $ 230 $ 10,071 $ 1,433 $ 70 $ 1,503
14
9. INDEMNIFICATIONS AND GUARANTEES
Secondary Market Loan Sales. The Company generally does not sell loans
with recourse except to the extent arising from standard loan sale contract
provisions covering violations of representations and warranties and, under
certain circumstances, first payment default by the borrower. These are
customary repurchase provisions in the secondary market for conforming mortgage
loan sales. The Company typically sells fixed-rate, conforming first mortgage
loans to Freddie Mac as part of its ongoing asset/liability management program.
Loans held-for-sale are carried at the lower of cost or market of the aggregate
or in some cases individual loans. Gains and losses on sales of loans are
recognized at the time of the sale.
As is customary in such sales, WSFS provides indemnifications to the
buyers under certain circumstances. These indemnifications may include the
repurchase of loans by WSFS. Repurchases and losses are rare, and no provision
is made for losses at the time of sale. During the third quarter of 2004, the
Company made one repurchase but did not incur any loss on loans sold in the
secondary market.
Swap Guarantees. The Company entered into an agreement with an
unrelated financial institution whereby that financial institution entered into
interest rate derivative contracts (interest rate swap transactions) with
customers referred to them by the Company. By the terms of the agreement, that
financial institution has recourse to the Company for any exposure created under
each swap transaction in the event the customer defaults on the swap agreement
and the agreement is in a paying position to the third-party financial
institution. This is a customary arrangement that allows smaller financial
institutions, such as WSFS, to provide access to interest rate swap transactions
for its customers without creating the swap itself.
At September 30, 2004 there were ten variable-rate to fixed-rate swap
transactions between the third party financial institution and customers of WSFS
with an initial notional amount aggregating approximately $30.4 million, and
with maturities ranging from two to ten years. The aggregate market value of
these swaps to the customers was a liability of $713,000 as of September 30,
2004.
Sale of C1FN/Everbank Segment. On November 5, 2002, the C1FN/Everbank
segment of WSFS was sold by WSFS and other shareholders of C1FN. In connection
with the sale, WSFS provided an indemnification to the buyer for damages, if
any, that may result from C1FN shareholders bringing claims against the buyer as
a result of the Services Agreement and amendments between WSFS and C1FN over the
life of those arrangements. This indemnification extends for two years from the
sale date and is capped at approximately $8.2 million. WSFS is not aware of any
claims under this indemnification, and management of WSFS believes the
likelihood of any payments under this indemnification is very remote. As a
result, no provision for loss has been made in WSFS' financial statements at
September 30, 2004.
Sale of Wilmington Finance, Inc. On January 2, 2003, WSFS completed the
sale of its majority-owned subsidiary, Wilmington Finance, Inc. (WF). As is
customary in the sale of a privately-held business, certain indemnifications
were provided by WSFS and the other shareholders of WF to the buyer.
Remaining indemnifications provided by the sellers, fall into three
separate categories. These include: (1) indemnification for sellers' ownership,
which indemnification extends indefinitely and is uncapped in amount; (2)
indemnification for tax, environmental, and benefit plan related issues, all of
which indemnifications extend for their respective statute of limitations and
are uncapped in amount; and (3) protection to the buyer in the event of
successful third-party claims that result from the operation of the business
prior to the sale date (third-party claims indemnification). The remaining
third-party claims indemnification includes a dollar limit of $32 million from
months 22 through 30 from the sale date. The buyer must exhaust any related
reserves provided in the closing balance sheet and then incur $2 million of
damages before an initial dollar claim may be made against the sellers for any
third-party claims indemnification. Dollar liability is uncapped for the
indemnifying party if damages are due to willful misconduct, fraud, or bad
faith.
Generally, WSFS is proportionately liable for its ownership share of WF
(which was 65%) of the related successful claims under indemnification
provisions, except that, in order to facilitate the sale, WSFS agreed to assume
a portion of the management shareholders' indemnification obligations.
WSFS is not aware of any claims to date, or any potential future claims
made under the WF indemnification provisions that could result in payment. As a
result, no provision for loss has been made in WSFS' financial statements at
September 30, 2004.
There can be no assurances that payments, if any, under all
indemnifications and guarantees provided by the Corporation will not be material
or exceed any reserves that the Company may have established for such
contingencies.
15
10. ASSOCIATE (EMPLOYEE) BENEFIT PLANS
Postretirement Benefits
The Corporation shares certain costs of providing health and life
insurance benefits to retired Associates (and their eligible dependents).
Substantially all Associates may become eligible for these benefits if they
reach normal retirement age while working for the Corporation.
The Corporation accounts for its obligations under the provisions of
SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than
Pensions. SFAS 106 requires that the costs of these benefits be recognized over
an Associate's active working career. Disclosures are in accordance with SFAS
No. 132 (Revised), Employer's Disclosure About Pensions and Other Postretirement
Benefits, that standardized the applicable disclosure requirements.
In December 2003, President Bush signed into law the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the "Act"). The
Act expanded Medicare to include, for the first time, coverage for prescription
drugs.
In May 2004, the FASB issued accounting guidance applicable to the Act
in the form of FASB Staff Position (FSP) 106-2. The guidance states, in part,
that it applies only to a health care plan for which the employer has concluded
that prescription drug benefits available under the plan to some or all
participants for some or all future years are "actuarially equivalent" to
Medicare Part D and thus qualify for subsidy under the Act. The Company, using
an analysis performed by an independent actuary, has determined that it is very
unlikely that its retiree medical plan would qualify as actuarially equivalent
to the Medicare Part D benefit now or in the future. The Company concluded ,
therefore, that it would be very unlikely to be eligible for the federal subsidy
provided by the Act. As a result, the benefits provided by the Company's retiree
medical plan would most likely not be affected by the Act in a significant
fashion and therefore the Act would have no impact on the Company's financial
position and results of operations.
The following disclosures of the net periodic benefit cost components
are in accordance with SFAS 132 (Revised) and were measured at January 1, 2004:
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost ................................. $ 25 $ 19 $ 73 $ 56
Interest cost................................. 29 29 91 89
Amortization of transition obligation ........ 16 16 46 46
Net loss recognition.......................... 5 3 15 9
------- ------- ------ -------
Net periodic benefit cost ... $ 75 $ 67 $ 225 $ 200
======= ======= ====== =======
16
ITEM 2. WSFS FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
WSFS Financial Corporation (Company or Corporation) is a thrift holding
company headquartered in Wilmington, Delaware. Substantially all of the
Corporation's assets are held by its subsidiary, Wilmington Savings Fund
Society, FSB (Bank or WSFS). Founded in 1832, WSFS is one of the oldest
financial institutions in the country. As a federal savings bank, which was
formerly chartered as a state mutual savings bank, WSFS enjoys broader
investment powers than most other financial institutions. WSFS has served the
residents of the Delaware Valley for 172 years. WSFS is the largest thrift
institution headquartered in Delaware and the fifth largest financial
institution in the state on the basis of total deposits traditionally garnered
in-market. The Corporation's primary market area is the mid-Atlantic region of
the United States, which is characterized by a diversified manufacturing and
service economy. The long-term strategy of the Corporation is to improve its
status as a high-performing financial services company by focusing on its core
community banking business.
WSFS provides residential and commercial real estate, commercial and
consumer lending services, as well as retail deposit and cash management
services. Lending activities are funded primarily with retail deposits and
borrowings. The Federal Deposit Insurance Corporation (FDIC) insures deposits to
their legal maximum. At September 30, 2004 WSFS conducted operations from, among
other locations, its main office, two operations centers and 23 retail banking
offices located in Delaware and southeastern Pennsylvania.
The Corporation has two consolidated subsidiaries, WSFS and Montchanin
Capital Management, Inc. The Corporation also has one unconsolidated affiliate,
WSFS Capital Trust I. Fully-owned and consolidated subsidiaries of WSFS include
WSFS Credit Corporation (WCC), which is engaged primarily in indirect motor
vehicle leasing; WSFS Investment Group, Inc. which, with the Bank, markets
various third-party insurance products and securities through WSFS' branch
system; and WSFS Reit, Inc., which holds qualifying real estate assets and may
be used to raise capital in the future.
WCC, which discontinued operations in 2000, no longer accepts new
applications but continues to service existing loans and leases until their
maturities. For a detailed discussion, see Note 3 to the Financial Statements.
In addition to the wholly owned subsidiaries, WSFS had consolidated a
non-wholly owned subsidiary, Wilmington Finance, Inc. (WF). WF, a majority owned
subsidiary, engaged in sub-prime residential mortgage banking and was sold in
January 2003. This subsidiary is therefore classified as businesses
held-for-sale in the Financial Statements. For a further discussion, see Note 4
to the Financial Statements.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the financial condition and results of
operations are based on the Consolidated Financial Statements, which are
prepared in conformity with U.S. generally accepted accounting principles. The
preparation of these financial statements requires management to make estimates
and assumptions effecting the reported amounts of assets, liabilities, revenue
and expenses. Management evaluates these estimates and assumptions on an ongoing
basis, including those related to the allowance for loan losses, investment in
reverse mortgages and reverse mortgage bonds, the reserve for discontinued
operations, contingencies (including indemnifications), and deferred taxes.
Management bases its estimates on historical experience and various other
factors and assumptions that are believed to be reasonable under the
circumstances. These form the bases for making judgments on the carrying value
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
The following are critical accounting policies that involve more
significant judgments and estimates:
Allowance for Loan Losses
The Corporation maintains allowances for credit losses and charges
losses to these allowances when realized. The determination of the allowance for
loan losses requires significant judgment reflecting management's best estimate
of probable loan losses related to specifically identified loans as well as
those in the remaining loan portfolio. Management's evaluation is based upon a
continuing review of these portfolios, with consideration given to evaluations
resulting from examinations performed by regulatory authorities.
17
Investment in Reverse Mortgages and Reverse Mortgage Bonds
The Corporation accounts for its investment in reverse mortgages in
accordance with the instructions provided by the staff of the Securities and
Exchange Commission entitled "Accounting for Pools of Uninsured Residential
Reverse Mortgage Contracts" which requires grouping the individual reverse
mortgages into "pools" and recognizing income based on the estimated effective
yield of the pool. In computing the effective yield, the Corporation must
project the cash inflows and outflows of the pool including actuarial
projections of the life expectancy of the individual contract holder and changes
in the collateral values of the residence. At each reporting date, a new
economic forecast is made of the cash inflows and outflows of each pool of
reverse mortgages; the effective yield of each pool is recomputed, and income is
adjusted retroactively and prospectively to reflect the revised rate of return.
Accordingly, because of this quasi-market-value based accounting, the recorded
value of reverse mortgage assets include significant risk associated with
estimations and income recognition can vary significantly from reporting period
to reporting period. Substantially all of WSFS' reverse mortgage portfolio was
sold in 2002.
The Corporation owns $11.9 million of SASCO RM-1 2002 securities,
including accrued interest, classified as "trading." These floating rate notes
represent the BBB traunche of the reverse mortgage securitization underwritten
by Lehman Brothers and carry a coupon rate of one-month LIBOR plus 300 basis
points. At the time of the acquisition of these securities, it was the
Corporation's intent to sell these securities in the near term. Therefore, based
on rules promulgated under Statement of Financial Accounting Standards (SFAS)
115, Accounting for Certain Investments in Debt and Equity Securities, the
securities were classified as "trading." An active market for these securities
has not developed since their issuance, but it continues to be the intent of the
Corporation to sell these securities if and when an active market develops.
Since there is no active market for these securities, the Corporation has used
the guidance under SFAS 115 to provide a reasonable estimate of fair value. The
Corporation used the combined weight of several methods to estimate a reasonable
fair value as of September 30, 2004, including matrix pricing, a fundamental
analysis of the actual cash flows of the underlying reverse mortgages, and a
fair value estimate from an independent securities dealer.
Reserve for Discontinued Operations
The Corporation discontinued the operations of WCC in 2000. In
accordance with Accounting Principles Board (APB) 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, and
Related Interpretations, which was the authoritative literature in 2000,
accounting for discontinued operations of a business segment required that the
Company forecast operating results over the wind-down period and accrue any
expected net losses. As a result, the Corporation has established a reserve to
absorb expected future net losses of WCC. Due to the uncertainty of a number of
factors, including residual values, interest rates, credit quality and operating
costs, this reserve, and others, are re-evaluated quarterly with adjustments, if
necessary, recorded as income/losses on wind-down of discontinued operations.
Contingencies (Including Indemnifications)
In the ordinary course of business, the Corporation and its
subsidiaries are subject to legal actions which involve claims for monetary
relief. Based upon information presently available to the Corporation and its
counsel, it is the Corporation's opinion that any legal and financial
responsibility arising from such claims will not have a material adverse effect
on the Corporation's results of operations.
The Bank, as successor to originators of reverse mortgages is, from
time to time, involved in arbitration or litigation with the various parties
including borrowers or the heirs of borrowers. Because reverse mortgages are a
relatively new and uncommon product, there can be no assurances about how the
courts or arbitrators may apply existing legal principles to the interpretation
and enforcement of the terms and conditions of the Bank's reverse mortgage
obligations.
Deferred Taxes
The Corporation accounts for income taxes in accordance with SFAS No.
109, Accounting for Income Taxes, which requires the recording of deferred
income taxes that reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Management has assessed the
Company's valuation allowances on deferred income taxes resulting from, among
other things, limitations imposed by Internal Revenue Code and uncertainties,
including the timing of settlement and realization of these differences.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Financial Condition
Total assets increased $229.1 million during the first nine months of
2004 to $2.4 billion at September 30, 2004. During the first nine months of 2004
loans grew $170.3 million to $1.5 billion reflecting the continued strong growth
in commercial and commercial real
18
estate loans, which amounted to $161.5 million. Consumer loans grew by $23.9
million during the same period. These increases were partially offset by a
decrease of $13.4 million in residential real estate loans. During the first
quarter of 2004, the Company purchased $50.0 million in Bank-Owned Life
Insurance (BOLI). This purchase enabled the Company to insure the lives of
certain senior managers. In addition to providing economic protection in the
event of the loss of key managers, the BOLI investment provides for the
possibility of better long-term investment yields, enhanced by tax-free build up
of value and tax free returns upon ultimate distribution of proceeds, both
provided for in the Internal Revenue Code. The initial premium of $50.0 million
was funded through the liquidation of mortgage-backed securities (MBS). MBS,
inclusive of the $50.0 million liquidation, decreased by $14.7 million during
the first nine months of 2004. Also, federal funds sold increased by $15.0
million during that same period. Finally, cash in non-owned ATMs increased $10.1
million during the first nine months of 2004 due to increased volume in the
CashConnect segment. Loans, operating leases and other assets of discontinued
operations decreased $7.6 million, due to the expected run-off in the WCC loan
and lease portfolios.
Total liabilities increased $227.5 million between December 31, 2003
and September 30, 2004, to $2.2 billion. This increase was due to the need to
fund asset growth, and was led by a $208.9 million increase in deposits. This
included a $124.9 million increase in brokered certificates of deposit, a $72.4
million increase in retail deposits and a $11.6 million increase in non-retail
deposits. In addition, there was a $35.3 million increase in Federal Home Loan
Bank (FHLB) advances, primarily used to fund loan growth. Finally, the
Corporation deconsolidated its trust preferred borrowings in the first quarter
of 2004 as a result of the implementation of SFAS Interpretation No. 46(R),
Consolidation of Variable Interest Entities, which resulted in an increase to
trust preferred borrowings of $1.5 million. Partially offsetting these increases
were federal funds purchased and securities sold under agreements to repurchase
which decreased by $16.0 million.
Capital Resources
Stockholders' equity increased $1.4 million between December 31, 2003
and September 30, 2004. This increase was mainly due to net income of $19.0
million and an increase of $2.2 million from the exercise of stock options and
the recognition of the related tax benefit. These increases were mostly offset
by the purchase of 373,900 shares of treasury stock for $18.0 million ($48.15
per share average). At September 30, 2004, the Corporation held 8,127,269 shares
of its common stock in its treasury at a cost of $161.8 million. In addition,
other comprehensive income decreased $718,000 during the first nine months of
2004 due, in part, to a decline in the fair value of mortgage-backed securities
available-for-sale. Finally, the Corporation declared cash dividends' totaling
$1.2 million during the nine months ended September 30, 2004.
Below is a table comparing the Bank's consolidated capital position to
the minimum regulatory requirements as of September 30, 2004 (dollars in
thousands):
To be Well-Capitalized
Consolidated For Capital Under Prompt Corrective
Bank Capital Adequacy Purposes Action Provisions
-------------------------- ----------------------- --------------------------
% of % of % of
Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------
Total Capital
(to Risk-Weighted Assets) ........ $249,848 15.53% $128,709 8.00% $160,887 10.00%
Core Capital (to Adjusted
Total Assets)..................... 235,000 9.65 97,425 4.00 121,781 5.00
Tangible Capital (to Tangible
Assets) .......................... 235,000 9.65 36,534 1.50 N/A N/A
Tier 1 Capital (to Risk-Weighted
Assets)........................... 235,000 14.61 64,355 4.00 96,532 6.00
Under Office of Thrift Supervision (OTS) capital regulations, savings
institutions such as the Bank must maintain "tangible" capital equal to 1.5% of
adjusted total assets, "core" capital equal to 4.0% of adjusted total assets,
"Tier 1" capital equal to 4.0% of risk weighted assets and "total" or
"risk-based" capital (a combination of core and "supplementary" capital) equal
to 8.0% of risk-weighted assets. Failure to meet minimum capital requirements
can initiate certain mandatory actions and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect
on the Bank's financial statements. At September 30, 2004 the Bank was in
compliance with regulatory capital requirements and is considered a
"well-capitalized" institution.
19
Liquidity
As a financial institution, the Bank has ready access to several
sources to fund growth and meet its liquidity needs. Among these are: net
income, deposit programs, loan repayments, borrowing from the FHLB, repurchase
agreements and the brokered CD market. The branch expansion the Company is
currently undertaking is intended to enter the Company into new, but contiguous,
markets, attract new customers and provide funding for its business loan growth.
In addition, the Corporation has a large portfolio of high-quality, liquid
investments, primarily short-duration, AAA-rated, mortgage-backed securities and
Agency notes that are positioned to provide a near-continuous source of cash
flow to meet current cash needs, or can be sold to meet larger discrete needs
for cash. Management believes these sources are sufficient to maintain the
required and prudent levels of liquidity.
The Company manages its liquidity risk and funding needs through its
treasury function and through its Asset/Liability Committee. The Company has a
policy that separately addresses liquidity, and management monitors the
Company's adherence to policy limits. One measure of the Company's liquidity is
the ratio of cash and qualified assets to net withdrawable deposits and
borrowings due within one year which was 7.5% at September 30, 2004, compared
with 6.1% at December 31, 2003. Both of these ratios were well in excess of the
policy minimum. Also, liquidity risk management is a primary area of examination
by the OTS. The Company complies with guidance promulgated under Thrift Bulletin
77 that requires thrift institutions to maintain adequate liquidity to assure
safe and sound operations.
There were several structural changes to the Company in 2002 and 2003,
the direct and indirect impact of which were to affect cash flows in ways that
are not expected to continue. Specifically, in 2002 and in early 2003, the
Company generated excess capital from a variety of sources, including, but not
limited to: the sale of substantially all of the Company's reverse mortgage
portfolio; the sale of its branchless banking segment; the sale of certain
Pennsylvania branches; and the sale of its mortgage banking subsidiary. As a
result, in 2003, the Company increased its borrowings and repurchase agreements
in order to fund increased volumes of mortgage-backed security purchases.
Additionally, in 2002 and 2003, the Company repurchased $73.8 million of its
common stock which was well in excess of historical levels. Such discretionary
strategies were undertaken to optimize the significant capital generated from
the asset and business sales mentioned above. The Company carefully monitors
these capital management activities so that they align with other corporate
goals including: maintaining its status as a "well-capitalized" financial
institution as defined by the standards of its federal banking regulator, the
OTS; supporting asset growth; and funding other capital investments. While
management expects investment purchases and share repurchases to be a continuing
part of its capital management strategy, the increased levels of investment
purchases and share repurchases in 2002 and 2003 are not expected to continue.
During the nine months ended September 30, 2004, net loan growth
resulted in the use of $171.8 million in cash. The loan growth was primarily the
result of the successful implementation of specific strategies designed to
increase corporate and small business lending. Management expects this trend to
continue. While the Company's loan to deposit ratio has been well above 100% for
many years, management has significant experience managing its funding needs
through borrowings, primarily through the Federal Home Loan Bank of Pittsburgh.
Additionally, during the nine months ended September 30, 2004, $19.4
million in cash was provided by operating activities, while $51.4 million in
cash was provided through the net increase in demand and savings deposits and
$152.9 million through the net increase in time deposits. For the period, cash
and cash equivalents increased $32.4 million to $192.9 million.
20
NONPERFORMING ASSETS
The following table sets forth the Corporation's nonperforming assets
and past due loans at the dates indicated. Past due loans are loans
contractually past due 90 days or more as to principal or interest payments but
which remain on accrual status because they are considered well secured and in
the process of collection.
September 30 December 31,
2004 2003
--------------- -----------
(In Thousands)
Nonaccruing loans:
Commercial ................................... $ 1,251 $ 1,549
Consumer ..................................... 310 240
Commercial mortgage .......................... 960 941
Residential mortgage ......................... 1,847 2,513
Construction ................................. - -
------------- -------------
Total nonaccruing loans ........................... 4,368 5,243
Assets acquired through foreclosure ............... 159 301
------------- -------------
Total nonperforming assets ........................ $ 4,527 $ 5,544
============= =============
Past due loans:
Residential mortgages ........................ $ 176 $ 915
Commercial and commercial mortgages .......... - 129
Consumer ..................................... 152 148
------------- -------------
Total past due loans .............................. $ 328 $ 1,192
============= =============
Ratios:
Nonaccruing loans to total loans (1) ......... 0.29% 0.40%
Allowance for loan losses to gross loans (1).. 1.61% 1.69%
Nonperforming assets to total assets ......... 0.19% 0.25%
Loan loss allowance to nonaccruing loans (2).. 524% 422%
Loan and foreclosed asset allowance to total
nonperforming assets (2) ................... 505% 399%
(1) Total loans exclude loans held for sale.
(2) The applicable allowance represents general valuation allowances only.
Nonperforming assets decreased $1.0 million between December 31, 2003
and September 30, 2004. The decrease resulted primarily from a $666,000 decrease
in nonaccruing residential mortgage loans, a $298,000 decrease in commercial
loans, and a $142,000 decrease in assets acquired through foreclosure. These
were partially offset by increases in consumer and commercial mortgage loans. An
analysis of the change in the balance of nonperforming assets is presented
below:
For the Nine
Months Ended For the Year Ended
September 30, 2004 December 31, 2003
------------------ ------------------
(In Thousands)
Beginning balance............................. $ 5,544 $ 7,433
Additions ............................... 3,881 7,299
Collections.............................. (3,633) (6,992)
Transfers to accrual/restructured status. (879) (945)
Charge-offs / write-downs, net........... (386) (1,251)
---------- ---------
Ending balance................................ $ 4,527 $ 5,544
========== =========
The timely identification of problem loans is a key element in the
Corporation's strategy to manage its loan portfolios. Timely identification
enables the Corporation to take appropriate action and, accordingly, minimize
losses. An asset review system established to monitor the asset quality of the
Corporation's loans and investments in real estate portfolios facilitates the
identification of problem assets. In general, this system utilizes guidelines
established by federal regulation; however, there can be no assurance that the
levels or the categories of problem loans and assets established by the Bank are
the same as those which would result from a regulatory examination.
21
INTEREST SENSITIVITY
The matching of maturities or repricing periods of interest
rate-sensitive assets and liabilities to ensure a favorable interest rate spread
and mitigate exposure to fluctuations in interest rates is the Corporation's
primary tool for achieving its asset/liability management strategies. Management
regularly reviews the interest-rate sensitivity of the Corporation and adjusts
the sensitivity within acceptable tolerance ranges established by management. At
September 30, 2004, interest-bearing liabilities exceeded interest-earning
assets that mature or reprice within one year (interest-sensitive gap) by $15.8
million. The Corporation's interest-sensitive assets as a percentage of
interest-sensitive liabilities within the one-year window increased to 99% at
September 30, 2004 compared to 83% at December 31, 2003. Likewise, the one-year
interest-sensitive gap as a percentage of total assets changed to -0.65% at
September 30, 2004 from -7.95% at December 31, 2003. The change in sensitivity
since December 31, 2003 is the result of the current interest rate environment
and the Corporation's continuing effort to effectively manage interest rate
risk. Interest rate-sensitive assets of the Corporation excluded cash flows from
discontinued operations as well as the interest rate-sensitive funding for these
assets.
Market risk is the risk of loss from adverse changes in market prices
and rates. The Company's market risk arises primarily from interest rate risk
inherent in its lending, investing, and funding activities. To that end,
management actively monitors and manages its interest rate risk exposure. One
measure, required to be performed by OTS-regulated institutions, is the test
specified by OTS Thrift Bulletin No. 13a "Management of Interest Rate Risk,
Investment Securities and Derivative Activities." This test measures the impact
of an immediate change in interest rates in 100 basis point increments on the
net portfolio value ratio. The net portfolio value ratio is defined as the net
present value of the estimated cash flows from assets and liabilities as a
percentage of net present value of cash flows from total assets (or the net
present value of equity). The table below is the estimated impact of immediate
changes in interest rates on the Company's net interest margin and net portfolio
value ratio at the specified levels at September 30, 2004 and 2003, calculated
in compliance with Thrift Bulletin No. 13a:
At September 30,
--------------------------------------------------------------------
2004 2003
-------------------------------- ---------------------------------
Change in % Change in % Change in
Interest Rate Net Interest Net Portfolio Net Interest Net Portfolio
(Basis Points) Margin (1) Value Ratio (2) Margin (1) Value Ratio (2)
------------- ------------- -------------- ------------ ---------------
+300 1% 9.14% -9% 8.70%
+200 1% 9.29% -6% 9.05%
+100 0% 9.36% -3% 9.35%
0 0% 9.39% 0% 9.57%
-100 -1% 9.30% -2% 9.38%
-200 (3) -8% 9.01% -8% 9.49%
-300 (3) -17% 8.96% -19% 10.24%
(1) The percentage difference between net interest margin in a stable interest
rate environment and net interest margin as projected under the various
rate change environments.
(2) The net portfolio value ratio of the Company in a stable interest rate
environment and the net portfolio value ratio as projected under the
various rate change environments.
(3) Sensitivity indicated by a decrease of 200 and 300 basis points are not
deemed meaningful at September 30, 2004 and 2003 given the historically low
absolute level of interest rates at those times.
COMPARISON FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Results of Operations
The Corporation recorded net income of $6.6 million or $0.88 per
diluted share for the third quarter of 2004. This compares to $5.3 million or
$0.66 per diluted share for the same quarter last year.
Net income for the nine months ended September 30, 2004 was $19.0
million or $2.49 per diluted share. This compares to $56.4 million or $6.74 per
diluted share for the comparable period last year. The results for the nine
months ended September 30, 2003 include a $41.3 million or $4.93 per diluted
share gain on the sale of the Corporation's sub-prime mortgage banking
subsidiary, Wilmington Finance, Inc., (WF) and a $117,000 or $0.01 per diluted
share gain on the sale of the Corporation's subsidiary engaged in Internet and
branchless banking, CustomerOne Financial Network, Inc. and related interests in
its Everbank Division. Income from continuing operations was $19.0 million or
$2.49 per diluted share for the nine months ended September 30, 2004. Excluding
gains on the sale of businesses, income from continuing operations for the nine
months ended September 30, 2003 was $15.0 million or $1.80 per diluted share.
22
Net Interest Income
The following tables provide information concerning the balances,
yields and rates on interest-earning assets and interest-bearing liabilities
during the periods indicated.
Three Months Ended September 30,
--------------------------------------------------------------------------------
2004 2003
-------------------------------------- ------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
--------- ----------- --------- ---------- ------------ ---------
Assets: (Dollars in Thousands)
Interest-earning assets:
Loans (2) (3):
Commercial real estate loans..... $ 450,707 $ 6,409 5.69% $ 344,043 $ 4,798 5.58%
Residential real estate loans.... 445,748 5,830 5.23 452,826 6,548 5.78
Commercial loans ................ 350,263 4,254 5.07 260,972 3,106 5.08
Consumer loans................... 210,449 3,356 6.34 187,536 3,330 7.04
---------- --------- ---------- ---------
Total loans.................... 1,457,167 19,849 5.53 1,245,377 17,782 5.80
Mortgage-backed securities (4)........ 520,356 5,468 4.20 522,902 2,759 2.11
Loans held-for-sale (3)............... 2,349 33 5.62 9,416 140 5.95
Investment securities (4)............. 109,086 1,090 4.00 27,319 284 4.16
Other interest-earning assets ........ 48,784 161 1.31 46,116 212 1.82
---------- --------- ---------- ---------
Total interest-earning assets.... 2,137,742 26,601 5.03 1,851,130 21,177 4.64
--------- ---------
Allowance for loan losses............. (23,482) (22,485)
Cash and due from banks............... 54,439 48,397
Cash in non-owned ATMs................ 126,808 91,836
Loans, operating leases and other
assets of discontinued operations... 2,992 18,228
Bank owned life insurance............. 51,302 -
Other noninterest-earning assets...... 48,963 37,728
---------- ----------
Total assets..................... $2,398,764 $2,024,834
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Interest-bearing deposits:
Money market and interest-
bearing demand................. $ 146,665 $ 236 0.64% $ 112,220 $ 63 0.22%
Savings.......................... 316,910 318 0.40 318,515 359 0.45
Retail time deposits ............ 225,906 1,128 1.99 247,838 1,346 2.15
---------- --------- ---------- ---------
Total interest-bearing
retail deposits 689,481 1,682 0.97 678,573 1,768 1.03
Jumbo certificates of deposits .. 50,578 211 1.66 32,662 114 1.38
Brokered certificates of deposit. 102,067 427 1.66 - - -
---------- --------- ---------- ---------
Total interest-bearing deposits 842,126 2,320 1.10 711,235 1,882 1.05
FHLB of Pittsburgh advances........... 899,922 6,038 2.63 736,057 5,353 2.85
Trust preferred borrowings............ 51,547 551 4.18 50,000 489 3.83
Other borrowed funds.................. 177,392 599 1.35 112,537 240 0.85
Cost of funding discontinued operations - (27) - - (186) -
---------- --------- ---------- ---------
Total interest-bearing liabilities 1,970,987 9,481 1.92 1,609,829 7,778 1.93
--------- ---------
Noninterest-bearing demand deposits... 227,319 196,155
Other noninterest-bearing liabilities. 15,929 28,060
Minority interest .................... 259 50
Stockholders' equity.................. 184,270 190,740
---------- ----------
Total liabilities and
stockholders' equity $2,398,764 $2,024,834
========== ==========
Excess of interest-earning assets
over interest-bearing liabilities $ 166,755 $ 241,301
========== ==========
Net interest and dividend income...... $ 17,120 $ 13,399
========= =========
Interest rate spread.................. 3.11% 2.71%
==== ====
Net interest margin................... 3.26% 2.96%
==== ====
(1) Weighted average yields have been computed on a tax-equivalent basis.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale.
23
Nine Months Ended September 30,
--------------------------------------------------------------------------------
2004 2003
------------------------------------- ------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
--------- ----------- --------- ---------- ------------ ---------
Assets: (Dollars in Thousands)
Interest-earning assets:
Loans (2) (3):
Commercial real estate loans .... $ 414,705 $ 17,044 5.40% $ 314,556 $ 13,670 5.73%
Residential real estate loans ... 448,215 17,819 5.30 447,719 20,291 6.04
Commercial loans ................ 330,619 11,499 4.91 239,244 9,203 5.54
Consumer loans................... 201,908 9,745 6.45 186,031 10,204 7.33
---------- -------- ---------- --------
Total loans.................... 1,395,447 56,107 5.44 1,187,550 53,368 6.09
Mortgage-backed securities (4)........ 509,518 14,884 3.89 464,853 10,306 2.96
Loans held-for-sale (3)............... 1,983 97 6.52 6,201 331 7.12
Investment securities (4)............. 114,892 3,438 3.99 21,818 713 4.36
Other interest-earning assets ........ 47,016 519 1.47 55,830 836 2.00
---------- -------- ---------- --------
Total interest-earning assets.... 2,068,856 75,045 4.89 1,736,252 65,554 5.10
-------- --------
Allowance for loan losses............. (23,006) (22,061)
Cash and due from banks............... 50,420 47,763
Cash in non-owned ATMs................ 114,208 86,279
Loans, operating leases and other
assets of discontinued operations.. 5,748 29,803
Bank-owned life insurance............. 47,241 -
Other noninterest-earning assets...... 43,549 33,421
---------- ----------
Total assets..................... $2,307,016 $1,911,457
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Interest-bearing deposits:
Money market and interest-
bearing demand................. $ 126,557 $ 387 0.41% $ 106,595 $ 250 0.31%
Savings.......................... 318,989 973 0.41 309,993 1,288 0.56
Retail time deposits ............ 224,845 3,218 1.91 259,940 4,603 2.37
---------- -------- ---------- --------
Total interest-bearing
retail deposits 670,391 4,578 0.91 676,528 6,141 1.21
Jumbo certificates of deposits .. 46,448 531 1.53 27,887 332 1.59
Brokered certificates of deposit. 68,366 836 1.63 - - -
---------- -------- ---------- --------
Total interest-bearing deposits 785,205 5,945 1.01 704,415 6,473 1.23
FHLB of Pittsburgh advances........... 863,102 17,602 2.68 632,776 15,474 3.22
Trust preferred borrowings............ 51,033 1,550 3.99 50,000 1,478 3.90
Other borrowed funds.................. 185,919 1,490 1.07 101,088 793 1.05
Cost of funding discontinued operations - (150) - - (881) -
---------- -------- ---------- --------
Total interest-bearing liabilities 1,885,259 26,437 1.87 1,488,279 23,337 2.09
-------- --------
Noninterest-bearing demand deposits... 218,122 183,943
Other noninterest-bearing liabilities. 14,219 35,063
Minority interest .................... 180 39
Stockholders' equity.................. 189,236 204,133
---------- ----------
Total liabilities and
stockholders' equity $2,307,016 $1,911,457
========== ==========
Excess of interest-earning assets
over interest-bearing liabilities $ 183,597 $ 247,973
========== ==========
Net interest and dividend income...... $ 48,608 $ 42,217
======== ========
Interest rate spread.................. 3.02% 3.01%
==== ====
Net interest margin................... 3.19% 3.31%
==== ====
(1) Weighted average yields have been computed on a tax-equivalent basis.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale
24
Net interest income for the third quarter of 2004 was $17.1 million.
This compares to $13.4 million for the same quarter of 2003. This increase in
net interest income was partially due to the growth in total average loans of
$211.8 million for the third quarter of 2004 compared to the same quarter of
2003. Additionally, the yield on mortgage-backed securities increased by 2.09%
and the yield on total interest earning assets increased by .39%. The yield on
interest bearing liabilities declined by 1 basis point. The net interest margin
of 3.26% for the third quarter of 2004 increased from 2.96% for the third
quarter of 2003. The margin benefited from the higher yield on mortgage-backed
securities investments and was negatively impacted by lower yields on loans. The
yield on loans has been declining due to the low interest rate environment
during the last year and the significant amount of loan growth at lower rates.
Net interest income for the nine months ended September 30, 2004 was
$48.6 million. This compares to $42.2 million for the same period of 2003. This
increase in net interest income was mainly due to higher loan and investment
volumes and increased yield on mortgage-backed securities. The net interest
margin of 3.19% declined from 3.31% for the first nine months of 2004. The
margin was compressed by the downward trend in loan yields during 2004.
Allowance for Loan Losses
The Corporation maintains allowances for credit losses and charges
losses to these allowances when such losses are realized. The determination of
the allowance for loan losses requires significant management judgment
reflecting management's best estimate of probable loan losses related to
specifically identified loans as well as probable loan losses in the remaining
loan portfolio. Management's evaluation is based upon a continuing review of
these portfolios, with consideration given to examinations performed by
regulatory authorities.
Management establishes the loan loss allowance in accordance with
generally accepted accounting principles in the United States and the guidance
provided in the Securities and Exchange Commission's Staff Accounting Bulletin
102 (SAB 102). Its methodology for assessing the appropriateness of the
allowance consists of several key elements which include: specific allowances
for identified problem loans; formula allowances for commercial and commercial
real estate loans; and allowances for pooled homogenous loans.
Specific reserves are established for certain loans in cases where
management has identified significant conditions or circumstances related to a
specific credit that management believes indicate the probability that a loss
has been incurred.
The formula allowances for commercial and commercial real estate loans
are calculated by applying loss factors to outstanding loans in each case based
on the internal risk grade of loans. Changes in risk grades of both performing
and nonperforming loans affect the amount of the formula allowance. Loss factors
by risk grade have a basis in WSFS' historical loss experience for such loans
and may be adjusted for significant factors that, in management's judgment,
affect the collectability of the portfolio as of the evaluation date. See
discussion of historical loss adjustment factors below.
Pooled loans are loans that are usually smaller,
not-individually-graded and homogenous in nature, such as consumer installment
loans and residential mortgages. Pooled loan loss allowances are based on
historical net charge-offs for six years which management believes approximates
an average business cycle. The average loss allowance per homogenous pool is
based on the product of average annual historical loss rate and the average
estimated duration of the pool multiplied by the pool balances. These separate
risk pools are then assigned a reserve for losses based upon this historical
loss information, as adjusted for historical loss adjustment factors. Historical
loss adjustment factors are based upon management's evaluation of various
current conditions. The evaluation of the inherent loss with respect to these
more current conditions is subject to a higher degree of uncertainty because
they are not identified with specific credits. The more current conditions,
evaluated in connection with the adjustment factors, include an evaluation of
the following:
* General economic and business conditions affecting WSFS' key lending areas,
* Credit quality trends (including trends in nonperforming loans expected to
result from existing conditions),
* Recent loss experience in particular segments of the portfolio,
* Collateral values and loan-to-value ratios,
* Loan volumes and concentrations, including changes in mix,
* Seasoning of the loan portfolio,
* Specific industry conditions within portfolio segments,
* Bank regulatory examination results, and
* Other factors, including changes in quality of the loan origination,
servicing and risk management processes.
WSFS' loan officers and risk managers meet quarterly to discuss and
review these conditions and risks associated with individual problem loans. By
assessing the probable estimated losses inherent in the loan portfolio
management is able to adjust specific and inherent loss estimates based upon the
availability of more recent information. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Corporation's allowance for such losses. The Company also gives
consideration to the results of these regulatory agency examinations. The
provision for loan losses from continuing operations increased
25
from $2.0 million for the first nine months of 2003 to $2.4 million for the
first nine months of 2004, primarily a result of growth in commercial loans and
commercial real estate loans from period to period.
The Corporation maintains allowances for credit losses and charges
losses to these allowances when such losses are realized. The allowances for
losses are maintained at a level which management considers adequate to provide
for losses based upon an evaluation of known and inherent risks in the
portfolios. Management's evaluation is based upon a continuing review of the
portfolios.
The following table represents a summary of the changes in the
allowance for loan losses during the periods indicated.
Nine months ended September 30,
-------------------------------
2004 2003
---- ----
(Dollars in Thousands)
Beginning balance ..................................... $ 22,386 $ 21,452
Provision for loan losses of continuing operations..... 2,370 2,025
Charge-offs:
Residential real estate .......................... 200 311
Commercial real estate (1) ....................... - -
Commercial........................................ 198 653
Consumer ......................................... 586 605
-------- --------
Total charge-offs.............................. 984 1,569
-------- --------
Recoveries:
Residential real estate .......................... 29 -
Commercial real estate (1) ....................... - 202
Commercial ....................................... 175 77
Consumer.......................................... 76 106
-------- --------
Total recoveries .............................. 280 385
-------- --------
Net charge-offs ....................................... 704 1,184
-------- --------
Ending balance......................................... $ 24,052 $ 22,293
======== ========
Net charge-offs to average gross loans
outstanding, net of unearned income (2).............. 0.07% 0.13%
======== ========
(1) Includes commercial mortgage and construction loans.
(2) Ratios for the nine months ended September 30, 2004 and 2003 are
annualized.
Noninterest Income
Noninterest income for the quarter ended September 30, 2004 was $8.2
million compared to $6.5 million for the third quarter of 2003. The increase was
primarily due to increases of $779,000 in card and ATM fee income, $525,000 of
which was due to growth in the CashConnect segment, during the third quarter of
2004 compared to the third quarter of 2003. In addition, the increase was due to
fee income of $584,000 from Montchanin Capital Management, Inc. for the quarter
ended September 30, 2004. This fee increase is a direct result of the 60%
ownership in Cypress Capital Management Inc., purchased January 1, 2004.
Finally, there was additional fee income of $558,000 in the third quarter 2004
from the January 2004 investment in BOLI. Income from this long-term illiquid
investment is shown as noninterest income in accordance with generally accepted
accounting principles in the United States. These increases were partially
offset by lower loan fee income of $278,000 and lower gains on the sale of loans
and securities of $303,000. These decreases resulted primarily from generally
higher interest rates and reduced refinancing activity during the third quarter
of 2004 as compared to the third quarter of 2003.
Noninterest income for the nine months ended September 30, 2004 was
$23.9 million compared to $19.7 million for the same period in 2003. The
increase was primarily due to credit/debit card and ATM income, which increased
$1.7 million, $1.3 million of which was due to growth in the CashConnect
segment, over the same period in 2003. In addition, consistent with the quarter,
the increase was due to year to date fee income of $1.7 million from Montchanin
Capital Management, Inc. This fee increase is a direct result of the 60%
ownership in Cypress Capital Management Inc., purchased January 1, 2004. This
improvement was also due to fee income of $1.7 million from the January 2004
investment in BOLI. The remainder of the growth in noninterest income for the
nine months ended September 30, 2004 was in deposit service charges, which
increased $350,000 from the same period in 2003. Partially offsetting these
increases was a $1.1 million decrease in gain on the sale of loans and
securities for the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003. These decreases resulted primarily from
generally higher interest rates and reduced refinancing activity during the nine
months ended September 30, 2004 as compared to the same period of 2003.
26
Noninterest Expense
Noninterest expenses for the quarter ended September 30, 2004 were
$14.2 million, or $2.6 million above the $11.5 million for the same period of
2003. Included in the third quarter 2004 results were $477,000 in operating
expenses related to Montchanin Capital Management, Inc. This expense increase is
a direct result of the 60% ownership in Cypress Capital Management Inc.,
purchased January 1, 2004. In addition, salaries, benefits, & other compensation
increased $908,000 (excluding Montchanin Capital Management) during the third
quarter 2004 as compared to the third quarter 2003. This increase was primarily
due to normal salary increases and the Company's continued branch expansion
efforts during the third quarter 2004. Also, other operating expenses increased
$891,000 during the third quarter 2004 as compared to the same period of 2003
(excluding Montchanin Capital Management). This change in operating expenses was
partially due to an additional $418,000 of expenses incurred at the Cash Connect
segment. These expenses were mainly due to underlying growth in volumes at
CashConnect.
Noninterest expenses for the nine months ended September 30, 2004 were
$40.6 million or $3.7 million above the $36.9 million for the same period of
2003. Consistent with the quarter, this increase was primarily due to $1.5
million in operating expenses related to Montchanin Capital Management Inc., for
the nine months ended September 30, 2004. This expense increase is a direct
result of the 60% ownership in Cypress Capital Management Inc., purchased
January 1, 2004. Included in the nine-months ended September 30, 2003 were $1.3
million of expenses recorded in connection with the sale of WF, the
Corporation's sub-prime mortgage banking subsidiary and $303,000 of expenses
related to the Corporation's Technology, Organizational and Process
Simplification Plan (TOPS). Excluding the above-mentioned items, operating
expenses increased $3.9 million, primarily in salaries, benefits and other
compensation. This increase was a direct result of the Company's continued
growth and branch expansion efforts.
Income Taxes
The Corporation and its subsidiaries file a consolidated Federal income
tax return and separate state income tax returns. Income taxes are accounted for
in accordance with SFAS 109, which requires the recording of deferred income
taxes for tax consequences of "temporary differences." The Corporation recorded
a provision for income taxes from continuing operations during the three and
nine months ended September 30, 2004 of $3.5 million and $10.4 million,
respectively, compared to an income tax provision from continuing operations of
$2.6 million and $7.9 million, for the same periods in 2003. The effective tax
rates from continuing operations for the three and nine months ended September
30, 2004 were 35% and 35%, compared to 32% and 35% for the respective comparable
periods in 2003.
The effective tax rates reflect the recognition of certain tax benefits
in the financial statements including those benefits from tax-exempt interest
income, BOLI income in 2004, a fifty-percent interest income exclusion on a loan
to an Employee Stock Ownership Plan, and a provision for state income tax
expense. The income tax provision for the nine months ended September 30, 2004
includes $280,000 as a result of additional state taxes WCC is expected to owe
due to tax law changes in the State of New Jersey. While the operations of WCC
are reflected as discontinued operations, the additional tax provision resulting
from the change in tax law has been reflected in income from continuing
operations in accordance with SFAS 109.
The Corporation analyzes its projections of taxable income on an
ongoing basis and makes adjustments to its provision for income taxes
accordingly.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2004, the Emerging Issues Task Force (EITF) issued
Financial Accounting Standards Board (FASB) Staff Position (FSP) EITF Issue No.
03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments.
The proposed FSP would provide implementation guidance with respect to debt
securities that are impaired solely due to interest rates and/or sector spreads
and analyzed for other-than-temporary impairment under paragraph 16 of EITF
Issue No. 03-1. The Board has directed the FASB staff to delay the effective
date for the measurement and recognition guidance contained in paragraphs 10-20
of EITF Issue No. 03-1. This delay does not suspend the requirement to recognize
other-than-temporary impairments as required by existing authoritative
literature. The delay of the effective date for paragraphs 10-20 of EITF Issue
No. 03-1 will be superseded concurrent with the final issuance of proposed FSP
EITF Issue No. 03-1-a, Implication Guidance for the Application of Paragraph 16
of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments. The disclosure guidance in paragraphs 21 and
22 of EITF Issue No. 03-1 remains effective. The Corporation will evaluate any
potential impact of this revised proposed statement when it is available.
In March 2004, the FASB issued an exposure draft, Share-Based Payment -
An Amendment of Statements No. 123 and 95 that addresses the accounting for
equity-based compensation arrangements, including employee stock options. Upon
implementation
27
of the changes proposed in this statement, entities would no longer be able to
account for equity-based compensation using the intrinsic value method under
Opinion No. 25. Entities would be required to measure the cost of employee
services received in exchange for awards of equity instruments at the grant date
of the award using a fair value based method. The comment period for this
proposed statement ended on June 30, 2004. In October 2004, FASB announced that
for public entities, this proposed statement would apply prospectively for
reporting periods beginning after June 15, 2005 as if all equity-based
compensation awards granted, modified or settled after December 15, 1994 had
been accounted for using a fair value based method of accounting. The
Corporation is currently evaluating the potential impact of the proposed
statement. See Note 1 to the Financial Statements for the Company's disclosure
of the retrospective impact of fair value accounting for stock options.
FORWARD-LOOKING STATEMENTS
Within this report and financial statements, management has included
certain "forward-looking statements" concerning the future operations of the
Corporation. It is management's desire to take advantage of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. This
statement is for the express purpose of availing the Corporation of the
protections of such safe harbor with respect to all "forward-looking statements"
contained in our financial statements. Management has used "forward-looking
statements" to describe the future plans and strategies including expectations
of the Corporation's future financial results. Management's ability to predict
results or the effect of future plans and strategy is inherently uncertain.
Factors that could affect results include interest rate trends, competition, the
general economic climate in Delaware, the mid-Atlantic region and the country as
a whole, loan delinquency rates, operating risk, uncertainty of estimates in
general, and changes in federal and state regulations, among other factors.
These factors should be considered in evaluating the "forward-looking
statements," and undue reliance should not be placed on such statements. Actual
results may differ materially from management expectations. WSFS Financial
Corporation does not undertake, and specifically disclaims any obligation, to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
-----------------------------------------------------------
Incorporated herein by reference from Item 2, of this quarterly report
on Form 10-Q.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures (as
defined in Rules 13a-15(e) under the Securities Exchange Act of 1934
(the "Exchange Act")), the Company's principal executive officer and
the principal financial officer have concluded that as of the end of
the period covered by this Quarterly Report on Form 10-Q such
disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.
(b) Changes in internal control over financial reporting. During the
quarter under report, there was no change in the Company's internal
control over financial reporting that has materially affected, or is
reasonably likely to materially affect, the Company's internal control
over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Company is not engaged in any legal proceedings of a material
nature at September 30, 2004. From time to time, the Company is party
to legal proceedings in the ordinary course of business wherein it
enforces its security interest in loans.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table lists purchases of the Company's Common Stock
during the third quarter of 2004.
Total Number of Maximum Number
Total Number Average Shares Purchased of Shares that May
of Shares Price Paid as Part of Publicly Yet Be Purchased
Purchased per Share Announced Plans Under Plans
-------------- ---------- ----------------- -------------------
July 1, to July 31, 2004 0 $0.00 0 755,505
August 1, to August 31, 2004 0 $0.00 0 755,505
September 1, to September 30, 2004 170(1) $50.32 0 755,505
---
Total for the quarter ended September 30, 2004 170 $50.32
28
(1) 170 shares of Common Stock were purchased by the Company in a
private transaction resulting from the exercise of stock options.
On August 7, 2003 the Board of Directors approved an authorization to
repurchase 10% of the Company's outstanding shares, or 748,841
shares. In addition, on June 24, 2004 the Board of Directors approved
an authorization to repurchase 10% of the Company's outstanding
shares, or 701,564 shares.
There is no expiration date under either Plan.
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not applicable
Item 5. Other Information
-----------------
Not applicable
Item 6. Exhibits
--------
(a) Exhibit 31 - Certifications pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
(b) Exhibit 32 - Certifications pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WSFS FINANCIAL CORPORATION
Date: November 9, 2004 /s/ MARVIN N. SCHOENHALS
----------------------------------
Marvin N. Schoenhals
Chairman and President
Date: November 9, 2004 /s/ MARK A. TURNER
----------------------------------
Mark A. Turner
Chief Operating Officer
and Chief Financial Officer