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UNITED STATES
SECURlTIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________to__________
Commission File Number 0-49952
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
DELAWARE 06-1504091
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
12 E. BROAD STREET, HAZLETON, PENNSYLVANIA 18201-6591
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570) 459-3700
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Securities registered under Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share
(Title of class)
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 a check mark if the disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. __X____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes ___ No _X___
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (i.e. persons other than directors and executive officers of the
registrant) was $58,109,609 based upon the closing price of $16.45 on the Nasdaq
Stock Market as of the last business day of the registrant's most recently
completed second fiscal quarter.
The number of shares of common stock outstanding as of December 29, 2003 was
4,176,593.
(1) Portions of the 2003 Annual Report to Stockholders are incorporated by
reference into Parts I and II of this Form 10-K.
(2) Portions of the definitive Proxy Statement for the 2004 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
FORM 10-K
TABLE OF CONTENTS
Part I Page
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Item 1 Business 1
Item 2 Properties 13
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote of Security Holders 15
Part II
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Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 15
Item 6 Selected Financial Data 15
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 15
Operation
Item 7A Quantitative and Qualitative Disclosures About Market Risk 15
Item 8 Financial Statements and Supplementary Data 15
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 15
Item 9A Controls and Procedures 16
Part III
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Item 10 Directors and Executive Officers of the Registrant 16
Item 11 Executive Compensation 16
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 16
Item 13 Certain Relationships and Related Transactions 16
Part IV
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Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 17
SIGNATURES 19
Part I
Forward Looking Statements
In addition to historical information, our 10-K may include certain
"forward-looking statements" within the meaning of the federal securities laws.
Such forward-looking statements may be identified by the use of such words as
"intend," "believe," "expect," "anticipate," "should," "plan," "estimate" and
"potential." These forward-looking statements include, but are not limited to,
estimates and expectations of future performance based on current management
expectations. Northeast Pennsylvania Financial Corp.'s (the "Company" or the
"Registrant") actual results could differ materially from such management
expectations. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, monetary and fiscal policies of
the federal government, changes in tax policies, rates and regulation of
federal, state and local tax authorities, changes in interest rates, deposit
flows, the cost of funds, demand for loan products, demand for financial
services, competition, changes in the quality or composition of the Company's
loan and investment portfolios, changes in accounting principles, policies or
guidelines, and other economic, competitive, governmental and technological
factors affecting the Company's operations, markets, products, services and
prices. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them, whether
included in this report or made elsewhere from time to time by the Company or on
its behalf. Subject to applicable law and regulation, the Company assumes no
obligation to update any forward-looking statements.
Item 1. Business
General
The Company is a Delaware corporation and is a thrift holding company
for First Federal Bank (the "Bank"), a federally chartered capital stock savings
bank regulated by the Office of Thrift Supervision ("OTS"), Abstractors, Inc.,
which is a title insurance agency, Northeast Pennsylvania Trust Co. (the "Trust
Co."), which offers trust, estate and asset management services and products and
Higgins Insurance Associates, Inc. ("Higgins"), which provides insurance and
investment products to individuals and businesses. The Company's executive
offices are located at 12 East Broad Street, Hazleton, Pennsylvania 18201.
The Company's operations are primarily conducted through the Bank.
These operations have been and continue to be attracting retail deposits from
the general public in the areas surrounding its 16 full service community
offices and investing those deposits, together with funds generated from
operations and borrowings, primarily in one- to four-family mortgage loans,
consumer loans, commercial loans and multi-family and commercial real estate
loans. The Company has attempted to diversify and expand its loan products to
better serve its customer base by placing a greater emphasis on its consumer
lending and commercial lending, primarily to small businesses and
municipalities.
The Company's revenues are derived from four principal business
activities: banking, insurance, investments and trust services. First Federal
Bank's revenues are derived principally from interest on its loans, and to a
lesser extent, interest and dividends on its investment and mortgage-related
securities and through other non-interest income. Investment income is generated
through annuity sales and commissions on investment sales. Insurance premium
income has increased significantly over the past several years due to the
acquisition of Higgins in 2000 and the continued revenue growth of Abstractors,
Inc. The Trust Co. continues to expand its customer base with assets under
management of $159.2 million at September 30, 2003. The Company's primary
sources of funds are deposits, principal and interest payments on loans and
mortgage related securities, FHLB advances and other borrowings and proceeds
from the sale of loans.
Effective January 1, 2004, the Bank transferred the deposits and
property of its branch office located in Danville, Pennsylvania to the First
National Bank of Berwick, Berwick, Pennsylvania. For further information
regarding this sale and transfer, please see Note 22 to the Consolidated
Financial Statements included in the Annual Report to Stockholders, incorporated
herein by reference.
Market Area and Competition
The Company is a community-oriented banking institution offering a
variety of retail financial products and services to meet the needs of the
communities it serves. The Company's lending and deposit gathering is
concentrated in its market area consisting of a seven county region in
Northeastern and Central Pennsylvania.
The Company maintains its headquarters in Hazleton. The Company's six
banking offices in Luzerne County, including Hazleton, accounted for $175.4
million or 32% of the Company's total deposits at September 30, 2003. Hazleton
is situated approximately 100 miles from Philadelphia and New York City and
approximately 50 miles from Allentown and the Wilkes-Barre/Scranton area. The
Company also maintains two banking offices in Bloomsburg (Columbia County), one
each in Lehighton and Weatherly (both in Carbon County), one in Brodheadsville
(Monroe County) and one each in Frackville, Pottsville, Shenandoah, and
Schuylkill Haven (all in Schuylkill County). The Company also operates a banking
and a loan production office in Monroe County.
1
The economy of the greater Hazleton area is characterized by
diversified light manufacturing and is the site of production facilities for
several major manufacturers including Union Camp, Hershey-Cadbury Chocolates,
Quebecor and Hazleton Pumps, Inc. As a consequence, the manufacturing sector
employs more than one third of the area's work force. The Hazleton area has
excellent access to major highway transportation routes including Interstates 80
and 81 as well as rail transportation. The population of Luzerne County has
remained relatively static and has one of the oldest average ages for all
counties in the United States. The southern end of Schuylkill County is proving
to be a growth area as individuals and companies which were previously based in
the Allentown-Berks county areas are relocating to the southern end of
Schuylkill County. Notwithstanding such growth, the overall population in the
Company's market area is relatively small and, in recent years, has grown
slowly, and the unemployment rate in the area is greater than the national
average.
Monroe County, the location of the Pocono Pines loan production office
and the Brodheadsville banking branch, is dominated by the Pocono Mountains,
making the area one of the Mid-Atlantic's most popular resort areas. The Company
established its loan production office to take advantage of the market for
vacation properties existing in Monroe County as well as to be involved in the
growth in the number of permanent residents relocating to the area.
The Company faces significant competition both in generating loans and
in attracting deposits. The Company's primary market area is highly competitive
and the Bank faces direct competition from a significant number of financial
institutions, many with a state wide or regional presence and, in some cases, a
national presence. Many of these financial institutions are significantly larger
and have greater financial resources than the Company. The Company's competition
for loans comes principally from commercial banks, savings banks, credit unions,
mortgage brokers, mortgage banking companies and insurance companies. Its most
direct competition for deposits has historically come from savings banks and
associations, commercial banks and credit unions. In addition, the Bank faces
increasing competition for deposits from non-bank institutions such as brokerage
firms and insurance companies in such instruments as short-term money market
funds, corporate and government securities funds, mutual funds and annuities.
Competition has also increased as a result of the lifting of restrictions on the
interstate operations of financial institutions, as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Technological advances, for example, have
lowered barriers to market entry, allowed banks to expand their geographic reach
by providing services over the Internet and made it possible for non-depository
institutions to offer products and services that traditionally have been
provided by banks. The Gramm-Leach-Bliley Act, which permits affiliation among
banks, securities firms and insurance companies also changed the competitive
environment in which the Bank conducts business.
In addition, the Company recognizes that its customer base increasingly
focuses on convenience and access to services. The Company has addressed these
customer needs through the implementation of electronic banking services and
enhanced voice response capabilities, a computerized loan origination and
document system and the issuance of debit cards. The Company continues to
evaluate and enhance its service and delivery systems in order to better serve
its retail and business customers.
LENDING ACTIVITIES
General. The information relating to the composition and maturity of
the Bank's loan portfolio appears in "Loans" in the Company's 2003 Annual Report
to Stockholders and is incorporated herein by reference.
Origination and Sale of Loans. The Bank's lending activities are
conducted primarily by its loan personnel operating at its branch and loan
origination offices. All loans originated by the Bank are underwritten pursuant
to the Bank's policies and procedures. The Bank originates both adjustable-rate
and longer-term and shorter-term fixed-rate loans. The Bank's ability to
originate fixed- or adjustable-rate loans is dependent upon the relative
customer demand for such loans, which is affected by the current and expected
future level of interest rates. It is currently the policy of the Bank to sell
newly originated fixed-rate one-to-four family mortgages with maturities greater
than 15 years with retained servicing. Additionally, the Bank from time to time
may sell certain loans to manage its interest-rate risk position in light of its
overall asset/liability management strategy.
2
One- to Four-Family Mortgage Lending. The Bank currently offers both
fixed-rate and adjustable-rate mortgage ("ARM") one- to four-family mortgage
loans with maturities up to 30 years. One- to four-family mortgage loan
originations are generally obtained from the Bank's in-house loan
representatives, from existing or past customers, and through referrals from
members of the Bank's local communities.
The origination of ARM loans, as opposed to fixed-rate residential
mortgage loans, helps reduce the Bank's exposure to increases in interest rates.
However, adjustable-rate loans generally pose credit risks not inherent in
fixed-rate loans, primarily because as interest rates rise, the underlying
payments of the borrower rise, thereby increasing the potential for default.
Periodic and lifetime caps on interest rate increases help to reduce the credit
risks associated with adjustable-rate loans but also limit the interest rate
sensitivity of such loans.
Most one-to-four family mortgage loans are underwritten according to
Fannie Mae and Freddie Mac guidelines. In recent years, the Bank began offering
to borrowers one- to four-family mortgage loans which, when underwritten, did
not fully meet established Fannie Mae or Freddie Mac standards, for example, the
standard regarding income to debt ratios for the borrower. Mortgage loans
originated by the Bank generally include due-on-sale clauses which provide the
Bank with the contractual right to deem the loan immediately due and payable in
the event the borrower transfers ownership of the property without the Bank's
consent. Due-on-sale clauses are an important means of adjusting the yields on
the Bank's fixed-rate mortgage loan portfolio and the Bank has generally
exercised its rights under these clauses. The Bank requires fire, casualty,
title and, in certain cases, flood insurance on all properties securing real
estate loans made by the Bank.
Multi-Family and Commercial Real Estate Lending. The Bank originates
fixed-rate and adjustable- rate multi-family and commercial real estate loans
that generally are secured by properties used for business purposes or a
combination of residential and retail purposes.
3
Pursuant to the Bank's underwriting policies a multi-family mortgage
and commercial real estate loan may be made in an amount up to 80% of the lower
of the appraised value or sales price of the underlying property with terms
generally ranging from 15 to 25 years.
The factors considered by the Bank in granting these loans include: the
net operating income of the mortgaged premises before debt service and
depreciation; the debt coverage ratio (the ratio of net earnings to debt
service); and the ratio of loan amount to appraised value. The Bank has
generally required that the properties securing commercial real estate loans
have debt service coverage ratios of at least 125%.
The Bank's largest multi-family and commercial real estate loan at
September 30, 2003 was a $6.9 million loan secured by real estate and was
performing according to its original terms. Loans secured by multi-family and
commercial real estate generally have larger loan values and involve greater
risks than one- to four-family residential mortgage loans. Payments on loans
secured by such properties are often dependent on successful management and
operation of the properties. Repayment of such loans may be subject to a greater
extent to adverse conditions in the real estate market or the economy. The Bank
seeks to minimize these risks in a variety of ways, including strict adherence
to its underwriting standards, limiting the size of such loans and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank also
obtains loan guarantees from financially capable parties. The Bank's lending
personnel or an agent of the Bank inspects all of the properties securing the
Bank's multi-family and commercial real estate loans before the loan is made.
The Bank also obtains appraisals on each property in accordance with applicable
regulations.
Construction Lending. The Bank also offers residential construction
loans. Such loans have been for presold one- to four-family residences for the
construction phase and convert into permanent financing. The Bank generates
residential construction loans primarily through direct contact with borrowers
or home builders, and these loans involve properties located in the Bank's
primary market area. Such loans require that the Bank review plans,
specifications and cost estimates and that the home builder be approved by the
Bank. The amount of construction advances, together with the sum of previous
disbursements, may not exceed the percentage of completion of the construction.
The maximum loan-to-value limit applicable to such loans is generally 80%.
The Bank's largest construction loan at September 30, 2003 was a $4.8
million loan secured by all of the improved and unimproved building lots and
amenities of a resort community located in Hazleton, Pennsylvania. This loan was
performing according to its original terms at September 30 2003. Construction
financing is generally considered to involve a higher degree of credit risk than
long-term financing on owner-occupied real estate. The risk of loss on
construction loans is dependent largely upon the accuracy of the value of the
property at completion of the construction compared to the estimated cost of
construction and other assumptions. If the estimate of construction costs proves
to be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to protect the value of the property.
Consumer Lending. The Bank offers consumer loans which include home
equity loans, home equity lines of credit, direct and indirect automobile loans,
education loans and other consumer loans. The Bank's home equity loans are
generated primarily through the Bank's retail branch offices. The Bank generally
offers home equity loans with a term of 180 months or less. The Bank also offers
home equity lines of credit with terms up to 20 years, the last 10 years of
which require full amortization of the principal balance. The maximum loan
amount for both home equity loans and home equity lines of credit, is subject to
a combined loans-to-value ratio of 80%.
The Bank also offers automobile loans, both on a direct and an indirect
basis (through new and used car dealers). The indirect automobile loans are
originated by dealers in accordance with underwriting standards pre-established
by the Bank and are serviced by the Bank. The Bank also offers loans on
recreational vehicles and boats and other consumer loans, including education
loans which are federally guaranteed and originated under regulations of the
Pennsylvania Higher Education Assistance Agency, deposit-secured loans, and
other personal and unsecured loans. The Bank's policy is to sell its education
loans upon origination to Sallie Mae with servicing released.
Consumer loans tend to bear higher rates of interest and have shorter
terms to maturity than first lien residential mortgage loans. Nationally,
consumer loans have historically tended to have a higher rate of default.
Additionally, consumer loans generally involve greater risk than residential
mortgage loans, particularly in the case of loans that are unsecured or secured
by rapidly depreciating assets such as automobiles. In these cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy.
4
Commercial Lending. The Bank makes commercial business loans primarily
in its market area to a variety of professionals, sole proprietorships and small
businesses. The Bank offers a variety of commercial lending products, including
term loans for fixed assets and working capital, revolving lines of credit,
letters of credit, and Small Business Administration guaranteed loans. Interest
rates charged generally are based on the prime rate as published in the Wall
Street Journal. Prior to making commercial business loans, the borrower is
required to provide the Bank with sufficient information to allow a prudent loan
decision to be made. Such information generally includes financial statements
and projected cash flows, and is reviewed to evaluate debt service capability.
Commercial business loans are generally secured by a variety of collateral,
including personal property and fixed assets and frequently are supported by
personal guarantees. In addition, the Bank actively participates in industrial
loans arranged through and with the Greater Wilkes-Barre Industrial Fund and
CanDo, Inc. a Hazleton area industrial fund.
The Bank's largest commercial business loan at September 30, 2003 was a
$2.6 million loan secured by the fixed assets at a manufacturing facility. This
loan was performing in accordance with its original terms at September 30, 2003.
Commercial business loans generally involve higher credit risks than loans
secured by real estate. Unlike mortgage loans, which generally are made on the
basis of the borrowers ability to make repayment from his or her employment or
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial loans are of higher risk and typically are
made on the basis of the borrower's ability to make repayment from the cash flow
of the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may be substantially dependent on the success of
the business itself. Further, any collateral securing such loans may depreciate
over time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
Loan Approval Procedures and Authority. The Board of Directors
establishes the lending policies and the levels of loan approval authority for
employees of the Bank and oversees the Bank's lending activities. The Board of
Directors has established a Risk Committee which, among other things, oversees
the lending activities of the Bank and manages a committee of loan officers that
have initial oversight over certain loans. All loans exceeding certain
prescribed limits are reported to the Risk Management Committee of the Board.
Nonperforming Assets and Allowance for Loan Losses. The information
relating to the Bank's nonperforming assets and allowance for loan losses
appears in the "Nonperforming Assets" and "Allowance for Loan Losses" sections
of Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Registrant's 2003 Annual Report to Stockholders and is
incorporated herein by reference.
Investment Activities
The above captioned information appears in the "Investment Activities"
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Registrant's 2003 Annual Report to Stockholders and
is incorporated herein by reference.
Source of Funds
Information relating generally to the Bank's source of funds and a
description of the Bank's deposits appears under "Sources of Funds" section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Registrant's 2003 Annual Report to Stockholders and is
incorporated herein by reference.
Borrowings. The Bank utilizes advances from the Federal Home Loan Bank
of Pittsburgh (the "FHLB") as well as other borrowings as a supplement to retail
deposits to fund its operations. Such advances are collateralized primarily by
the Bank's mortgage loans and mortgage-related securities and secondarily by the
Bank's investment in the capital stock of the FHLB of Pittsburgh. FHLB advances
are made pursuant to several different credit programs, each of which has its
own interest rate and range of maturities. The maximum amount that the FHLB of
Pittsburgh will advance to member institutions, including the Bank, fluctuates
from time to time in accordance with the policies of the FHLB of Pittsburgh. See
"Regulation-Federal Home Loan Bank System." At September 30, 2003, the Bank had
$258.9 million in outstanding FHLB advances, compared to $208.4 million at
September 30, 2002. The Bank had $66.4 million of additional borrowing capacity
from the FHLB at September 30, 2003. Other borrowings consist of overnight
retail repurchase agreements and for the periods presented were immaterial.
The following table sets forth certain information regarding the Bank's borrowed
funds on the dates indicated:
At or For the Fiscal Years Ended September 30,
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2003 2002 2001
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(Dollars in Thousands)
FHLB advances and other borrowings:
Average balance outstanding $210,360 $208,579 $192,981
Maximum amount outstanding at any month-end
during the period 259,430 215,855 216,110
Balance outstanding at end of period 259,430 211,605 210,258
Weighted average interest rate during the period 5.69% 5.69% 5.84%
Weighted average interest rate at end of period 4.78% 5.57% 5.53%
5
Subsidiary Activities
The Company has six active wholly-owned subsidiaries: the Bank,
incorporated under the laws of the United States; Abstractors, Inc., the Trust
Co., and Higgins, each of which are incorporated under Pennsylvania law; and NEP
Capital Trust I and NEP Capital Trust II, each of which is incorporated under
Delaware law. Abstractors, Inc. is a title insurance agency with total assets of
$441,000 at September 30, 2003. The Trust Co., offers trust estate and asset
management services and products and had total assets of $788,000 and $159.2
million of trust assets under management at September 30, 2003. Higgins provides
insurance and investment products to individuals and businesses and had total
assets of $1.6 million at September 30, 2003.
Personnel
As of September 30, 2003, the Company had 219 full-time equivalent
employees, none of whom were covered by a collective bargaining agreement.
Management believes that the Company has good relations with its employees and
there are no pending or threatened labor disputes.
Regulation and Supervision
As a savings and loan holding company, the Company is required by
federal law to file reports with and otherwise comply with, the rules and
regulations of the OTS. The Bank is subject to extensive regulation, examination
and supervision by the OTS, as its chartering agency, and the Federal Deposit
Insurance Corporation (the "FDIC"), as the deposit insurer. The Bank is a member
of the Federal Home Loan Bank ("FHLB") System. The Bank's deposit accounts are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the
FDIC concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings associations and
their holding companies set forth in this Form 10-K does not purport to be
complete descriptions of such statutes and regulations and their effects on the
Bank and the Company are qualified in its entirety by reference to such statutes
and regulations.
Federal Savings Institution and Regulations
Business Activities. The activities of federal savings institutions are
governed by the federal laws and regulations. These laws and regulations
delineate the nature and extent of the activities in which federal associations
may engage. In particular, many types of lending authority for federal
associations, e.g., commercial, non-residential real property loans and consumer
loans, are limited to a specified percentage of the institution's capital or
assets.
Loans-to-One-Borrower. Federal law provides that, savings institutions
are generally subject to the national bank limit on loans-to-one borrower.
Generally, this limit is 15% of the Bank's unimpaired capital and surplus, plus
an additional 10% of unimpaired capital and surplus, if such loan is secured by
specified readily marketable collateral. At September 30, 2003, the largest
aggregate amount of loans-to-one borrower was $7.5 million, which was less than
the Bank's general limit on loans-to-one borrower which was $9.6 million.
QTL Test. Federal law requires savings institutions to meet a qualified
thrift lending ("QTL") test. Under the test, a savings association is required
to either qualify as a "domestic building and loan association" under the
Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed and related
securities) in at least 9 months out of each 12-month period. A savings
association that fails the QTL test is subject to certain operating restrictions
and may be required to convert to a bank charter. As of September 30, 2003, the
Bank maintained 86.9% of its portfolio assets in qualified thrift investments
and, therefore, met the QTL test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered as "qualified thrift investments."
6
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by a savings institution, including cash
dividends, payments to repurchase its shares and payments to stockholders of
another institution in a cash-out merger. Under the regulations, an application
to and the prior approval of the OTS is required before any capital distribution
if the institution does not meet the criteria for "expedited treatment" of
applications under OTS regulations (generally, examination ratings in one of two
top categories), the total capital distributions for the calendar year exceed
net income for that year plus the amount of retained net income for the
preceding two years, the institution would be undercapitalized following the
distribution or the distribution would otherwise be contrary to a statute,
regulation or agreement with the OTS. If an application is not required, the
institution must still give advance notice to the OTS of the capital
distribution, if, like the Bank, it is a subsidiary of a holding company. If the
Bank's capital fell below its regulatory requirements or if the OTS notified it
that it was in need of more than normal supervision, the Bank's ability to make
capital distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution, which would otherwise be permitted by regulation,
if the OTS determines that the distribution would be unsafe or unsound practice.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are based upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
Thrift Financial Report. The assessments paid by the Bank for the year ended
September 30, 2003 totaled $176,000.
Branching. OTS regulations permit federally-chartered savings
associations to branch nationwide under certain conditions. Generally, federal
savings associations may establish interstate networks and geographically
diversify their loan portfolios and lines of business. The OTS authority
preempts any state law purporting to regulate branching by the federal savings
associations.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"),
as implemented by OTS regulations, a savings institution has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of a savings institution,
to assess the institution's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain applications
by such institution. The CRA also requires all institutions to make public
disclosure of their CRA ratings. The Bank received a "Satisfactory" CRA rating
in its most recent examination.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by federal law. The
aggregate amount of covered transactions with any individual affiliate is
limited to 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in federal law. The purchase of low quality assets from affiliates is
generally prohibited. The transactions with affiliates must be on terms and
under circumstances, that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The recently enacted Sarbanes-Oxley Act generally prohibits loans by
the Company to its executive officers and directors. However, the Act contains a
specific exception from such prohibitions for loans by the Bank to its executive
officers and directors in compliance with federal banking regulations
restrictions on such loans. The Bank's authority to extend credit to executive
officers, directors and 10% stockholders ("insiders"), as well as entities such
persons control, is also governed by federal law. Such loans are required to be
made on terms substantially the same as those offered to unaffiliated
individuals and not involve more than the normal risk of repayment. An exception
exists for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. The OTS has primary enforcement responsibility over
savings institutions and has the authority to bring action against the
institution and all "institution-affiliated parties," including stockholders,
and any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution. Formal enforcement action may range from the issuance of a capital
directive or cease and desist order to removal of officers or directors,
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
$1 million per day in especially egregious cases. The FDIC has the authority to
recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
7
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Standards for Safety and Soundness. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the OTS determines that a savings
institution fails to meet any standard prescribed by the guidelines, the OTS may
require the institution to submit an acceptable plan to achieve compliance with
the standard.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 4% leverage (core capital) ratio and an 8% risk-based capital ratio.
Core capital is defined as common stockholder's equity (including retained
earnings), certain non-cumulative perpetual preferred stock and related surplus,
minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights ("MSRs") and credit
card relationships. The OTS regulations require that, in meeting the leverage
ratio, tangible and risk-based capital standards institutions generally must
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank. In addition, the OTS prompt corrective action
standards discussed below also establish, in effect, a minimum 2% tangible
capital standard, a 4% leverage ratio, and, together with the risk-based capital
standards itself, a 4% Tier 1 risk-based capital standard.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off balance sheet assets, recourse obligations, direct credit
substitutes and other residual interests are multiplied by a risk-weight factor
of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS
believes are inherent in the type of asset. The components of core capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock, the allowance for loan and lease losses, limited to a maximum
of 1.25% of risk-weighted assets and up to 45% of unrealized gains on
available-for-sale equity securities with readily determinable fair market
value. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.
The OTS also has authority to establish minimum capital requirements in
appropriate cases upon a determination that an institution's capital levels are
or may become inadequate in light of the particular circumstances. At September
30, 2003, the Bank met each of its capital requirements. The following table
presents the Bank's capital position at September 30, 2003.
(Dollars in thousands)
Capital
------------------------------------
Actual Required Excess
Capital Capital Amount Actual % Required %
------- ------- ------ -------- ----------
Tangible $54,053 $13,142 $40,911 6.17% >1.5%
Core (Leverage) 54,053 35,045 19,008 6.17 >4.0
Risk-based 59,441 45,205 14,236 10.52 >8.0
Prompt Corrective Regulatory Action. The OTS is required to take certain
supervisory actions against undercapitalized institutions, the severity of which
depends upon the institution's degree of under capitalization. Generally, a
savings institution that has a total risk-based capital of less than 8% or a
leverage ratio or a Tier 1 capital ratio that is less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
higher examination rating) is considered to be undercapitalized. A savings
institution that has a total risk-based capital less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the OTS is required to appoint a receiver or conservator for an institution that
is critically undercapitalized within specified time frames. The regulation also
provides that a capital restoration plan must be filed with the OTS within 45
days of the date an association receives notice that it is "undercapitalized,"
significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions may become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators, restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The FDIC maintains a risk-based assessment system
by which institutions are assigned to one of three categories based on the
institution's capitalization and one of three subcategories based on examination
ratings and other supervisory information. An institution's assessment rate
depends on the categories to which it is assigned. Assessment rates for SAIF
member institutions are determined semi-annually and range from 0 basis points,
for the healthiest institutions to 27 basis points, for the riskiest
institutions. The Bank's assessment rate for the fiscal year 2003 was 0 basis
points (not including the FICO payment discussed below) and the premium paid for
this period was $98,000. The FDIC has authority to increase insurance
assessments. A significant increase in SAIF insurance premiums would likely have
an adverse effect on the operating expenses and results of operations of the
Bank. Management cannot predict what insurance assessment rates will be in the
future.
8
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 2003,
FICO payments for SAIF members approximated 1.7 basis points.
Insurance of deposits may be terminated by the FDIC upon a finding that
the institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Federal Home Loan Bank System. The Bank is a member of the FHLB System, which
consists of 12 regional FHLBs. The FHLB provides a central credit facility
primarily for member institutions. The Bank, as a member of the FHLB, is
required to acquire and hold shares of capital stock in the FHLB in an amount at
least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the FHLB, whichever is greater. The Bank was in
compliance with this requirement with an investment in FHLB stock at September
30, 2003, of $13.0 million. FHLB advances must be secured by specified types of
collateral and all long-term advances may only be obtained for the purpose of
providing funds for residential housing finance. At September 30, 2003, the Bank
had $258.9 million in FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended September 30, 2003, 2002 and 2001
dividends from the FHLB to the Bank amounted to approximately $312,000, $439,000
and $673,000, respectively. If dividends were reduced, the Bank's net interest
income would likely also be reduced. Recent legislation has changed the
structure of the Federal Home Loan Banks' funding obligations for insolvent
thrifts, revised the capital structure of the Federal Home Loan Banks and
implemented entirely voluntary membership for Federal Home Loan Banks.
Management cannot predict the effect that these changes may have with respect to
its Federal Home Loan Bank membership.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally require
that reserves be maintained against aggregate transaction accounts as follows:
for accounts aggregating $45.4 million or less (subject to adjustment by the
Federal Reserve Board) the reserve requirement is 3%; and for accounts greater
than $45.4 million, the reserve requirement is 10%. The first $6.6 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with these requirements.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding
company within the meaning of federal law. Under prior law, a unitary savings
and loan holding company, such as the Company, was not generally restricted as
to the types of business activities in which it may engage, provided that the
Bank continues to be a qualified thrift lender, as previously described. The
Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a
savings institution after May 4, 1999 unless it engages only in the financial
activities permitted for financial holding companies under the law or for
multiple savings and loan holding companies as described below. Further, the
Gramm-Leach-Bliley Act specifies that existing savings and loan holding
companies may only engage in such activities. The Gramm-Leach-Bliley Act,
however, grandfathered the unrestricted authority of activities with respect to
unitary savings and loan holding companies existing prior to May 4, 1999, so
long as the holding company's savings institution subsidiary continues to comply
with the qualified thrift lender test. The Company qualifies for the
grandfathering. Upon any non-supervisory acquisition by the Company of another
savings institution, or savings bank that meets the qualified thrift lender test
and is deemed to be a savings institution by the Office of Thrift Supervision,
the Company would become a multiple savings and loan holding company (if the
acquired institution is held as a separate subsidiary) and would generally be
limited to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the
OTS, and certain activities authorized by OTS regulation. However, the OTS has
issued an interpretation concluding that multiple savings and loan holding
companies may also engage in activities permitted for financial holding
companies.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution, or holding company thereof, without prior written approval of the
OTS and from acquiring or retaining control of a depository institution that is
not insured by the FDIC. In evaluating applications by holding companies to
acquire savings institutions, the OTS must consider the financial and managerial
resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, except: (i) the approval of interstate supervisory acquisitions by
savings and loan holding companies, and (ii) the acquisition of a savings
institution in another state if the laws of the state of the target savings
institution specifically permit such acquisitions. The states vary in the extent
to which they permit interstate savings and loan holding company acquisitions.
9
Although savings and loan holding companies are not currently subject
to specific capital requirements or specific restriction on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The Bank
must notify the OTS 30 days before declaring any dividend to the Company. In
addition, the financial impact of a holding company on its subsidiary
institution is a matter that is evaluated by the OTS and the agency has
authority to order cessation of activities or divestiture of subsidiaries deemed
to pose a threat to the safety and soundness of the institution.
Acquisition of the Company. Under the Federal Change in Bank Control
Act ("CIBCA"), a notice must be submitted to the OTS if any person (including a
company), or group acting in concert, seeks to acquire "control" of a savings
and loan holding company. Under certain circumstances, a change of control may
occur, and prior notice is required, upon the acquisition of 10% or more of the
Company's outstanding voting stock, unless the OTS has found that the
acquisition will not result in a change of control of the Company. Under the
CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking
into consideration certain factors, including the financial and managerial
resources of the acquirer and the anti-trust effects of the acquisition. Any
company that so acquires control would then be subject to regulation as a
savings and loan holding company.
Trust Company Regulation
The Trust Co. is chartered under the laws of Pennsylvania and the
Pennsylvania Department of Banking is responsible for its regulation,
supervision and examination. Pennsylvania law governs the activities and
investments of the Trust Co. as well as its administration of trust accounts.
The Trust Co. limits its activities to trust, fiduciary and related activities
and is not insured by the FDIC. The Pennsylvania Department of Banking maintains
authority to issue orders and suspend directors, officers or employees for
violations of law or regulations or unsafe practices and to take possession as
receiver or conservator of any institution for violations, unsafe practices or
condition or insolvency. The Trust Co. pays assessments to the Pennsylvania
Department of Banking, which in fiscal 2003 amounted to $19,346.
FEDERAL AND STATE TAXATION
Federal Taxation General. The Company and the Bank report their income
on a September 30 fiscal year basis using the accrual method of accounting and
are subject to federal income taxation in the same manner as other corporations
with some exceptions, including particularly the Bank's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. Neither the Company nor the Bank has been
audited by the IRS in the past five years.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Bank's deductions with respect
to "qualifying real property loans," which are generally loans secured by
certain interest in real property, were computed using an amount based on the
Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable
income, computed with certain modifications and reduced by the amount of any
permitted addition to the non-qualifying reserve. Due to the Bank's loss
experience, the Bank generally recognized a bad debt deduction equal to 8% of
taxable income.
In August 1996, the provisions repealing the above thrift bad debt
rules were passed by Congress as part of "The Small Business Job Protection Act
of 1996." The new rules eliminated the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also required that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(the last taxable year beginning before January 1, 1988). The Bank had
previously recorded a deferred tax liability equal to the bad debt recapture and
as such, the new rules had no effect on net income or federal income tax
expense. For taxable years that began after December 31, 1995, the Bank's bad
debt deduction was equal to net charge-offs. The new rules allowed an
institution to suspend the bad debt reserve recapture for the 1996 and 1997 tax
years if the institution's lending activity for those years was equal to or
greater than the institution's average mortgage lending activity for the six
taxable years preceding 1996. For this purpose, only home purchase and home
improvement loans were included and the institution could have elected to have
the tax years with the highest and lowest lending activity removed from the
average calculation. If an institution was permitted to postpone the reserve
recapture, it had to begin its six year recapture no later than the 1998 tax
year. The unrecaptured base year reserves were not subject to recapture as long
as the institution continued to carry on the business of banking. In addition,
the balance of the pre-1988 bad debt reserves continued to be subject to a
provision of present law referred to below that required recapture in the case
of certain excess distributions to stockholders.
10
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made: (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method, or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock, and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not be
considered to result in a distribution from the Bank's bad debt reserve. Thus,
any dividends to the Company that would reduce amounts appropriated to the
Bank's bad debt reserve and deducted for federal income tax purposes would
create a tax liability for the Bank. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. Thus if
the Bank makes a "non-dividend distribution," then approximately one and
one-half times the amount so used would be includable in gross income for
federal income tax purposes, assuming a 34% corporate income tax rate (exclusive
of state and local taxes). The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on
alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI
can be offset by net operating loss carryovers of which the Company currently
has none. AMTI is increased by an amount equal to 75% of the amount by which the
Company's adjusted current earnings exceeds its AMTI (determined without regard
to this preference and prior to reduction for net operating losses). In
addition, for taxable years beginning after June 30, 1986 and before January 1,
1996, an environmental tax of 0.12% of the excess of AMTI (with certain
modifications) over $2.0 million is imposed on corporations, including the
Company, whether or not an Alternative Minimum Tax ("AMT") is paid. The Company
does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
11
State and Local Taxation
The Company and its non-thrift Pennsylvania subsidiaries are subject to
the Pennsylvania Corporation Net Income Tax and Capital Stock and Franchise Tax.
The state Corporate Net Income Tax rate for fiscal years ended 2003, 2002 and
2001 was 9.99% and was imposed on the Company's and its non-thrift subsidiaries'
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock Tax is a property tax imposed at the rate of .724% of
a corporation's capital stock value, which is determined in accordance with a
fixed formula. The Company is also required to file an annual report with and
pay an annual franchise tax to the State of Delaware.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax
Act (the "MTIT"), as amended, to include thrift institutions having capital
stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the
Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with generally accepted
accounting principles ("GAAP") with certain adjustments. The MTIT, in computing
GAAP income, allows for the exclusion of interest earned on Pennsylvania and
federal securities, while disallowing a percentage of a thrift's interest
expense deduction in the proportion of interest income on those securities to
the overall interest income of the Bank. Net operating losses, if any,
thereafter can be carried forward three years for MTIT purposes. Neither the
Company nor the Bank have been audited by the Commonwealth of Pennsylvania in
the last five years.
Additional Item. Executive Officers of the Registrant
- ---------------- ------------------------------------
The following table sets forth information regarding the
executive officers of the Company and its subsidiaries of September 30, 2003 who
are not directors.
Age as of
Name 9/30/03 Position
- ---- ------- --------
Jerry D. Holbrook 47 Chief Financial Officer and Secretary
of the Bank and Company since 2003.
From 2000 to 2002, Chief Financial Officer
of E-Duction, a financial services
start-up company located in the
metropolitan area of Philadelphia,
Pennsylvania. Prior to 2000, 15 years
of senior level banking experience at
First USA Bank (Bank One) and WSFS
Financial Corporation, both located in
Wilmington, Delaware.
Thomas Burns 53 Trust business line manager. President
and Trust Officer of the Trust Company
since May 2000. Trust Officer for a
financial institution in Hazleton,
Pennsylvania prior to current position.
12
Item 2. Properties
The Company currently conducts its business through 16 full service
community offices located in Luzerne, Carbon, Columbia, Montour and Schuylkill
counties, three financial centers and one loan origination office in Monroe
County in Northeast Pennsylvania. Abstractors, Inc. and Northeast Pennsylvania
Trust Co. conduct their business in the downtown Hazleton area. During fiscal
year 2003, three community offices were closed, two properties are listed for
sale and the other was a leased property that expires in 2004. The following
table sets forth the Company's offices as of September 30, 2003.
Net Book Value
of Property or
Leasehold
Original Year Improvements Total Deposits
Leased or Leased or Date of Lease at September at September
Location Owned Acquired Expiration 30, 2003 30, 2003
- -------- --------- ------------- ------------- -------------- --------------
(Dollars In Thousands)
Administrative/Home
Office:
12 E. Broad Street
Hazleton, PA 18201 Owned 1947 - $3,589 $175,428
Branch Offices:
Bloomsburg Office:
17 E. Main Street
Bloomsburg, PA 17815 Owned 1963 - 412 24,077
Shenandoah Office:
5 N. Main Street
Shenandoah, PA 17976 Owned 1968 - 395 44,360
Pottsville Office:
111 E. Norweigan Street
Pottsville, PA 17901 Owned 1968 - 675 30,977
Lehighton Office:
111 N. First Street
Lehighton, PA 18235 Owned 1977 - 65 35,581
Laurel Mall Office:
240 Laurel Mall
Hazleton, PA 18201 Leased 1994 2005 188 75,316
Mountaintop Office:
360 S. Mountain Boulevard
Mountaintop, PA 18707 Owned 1997 - 748 21,782
Scott Township Office:
2691 Columbia Blvd.
Bloomsburg, PA 17815 Owned 1998 - 931 18,002
Schuylkill Mall Office:
611 Schuylkill Mall
Frackville, PA 17976 Leased 1978 2004 255 20,857
13
Net Book Value
of Property or
Leasehold
Original Year Improvements Total Deposits
Leased or Leased or Date of Lease at September at September
Location Owned Acquired Expiration 30, 2003 30, 2003
- -------- --------- ------------- ------------- -------------- --------------
(Dollars In Thousands)
Gould's IGA Office:
669 State Route 93, Suite 5
Sugarloaf, PA 18249 Leased 1995 2005 52 20,379
Danville Office:(1)
1519 Bloom Road
Danville, PA 17821 Owned 1999 - 606 12,085
Back Mountain Office:
196 N. Main Street
Shavertown, PA 18708 Owned 2001 1,158 15,303
Brodheadsville Office:
760 Route 209 & Weirlake Road
Brodheadsville, PA 18322 Leased 2000 2005 43 8,141
Weatherly Office:
140 Carbon Street
Weatherly, PA 18255 Owned 2001 84 15,348
Drums Office:
Route 309, 24 S. Hunter Highway
Drums, PA 18222 Owned 2001 227 14,903
Schuylkill Haven Office:
333 Center Avenue
Schuylkill Haven, PA 17972 Owned 2002 369 14,766
Laurel Mall Drive-Thru:
345 Laurel Mall, Route 93
Hazleton, PA 18201 Leased 2001 2005 284 N/A
Loan Production
Origination Office:
Pocono L.P.O. Office
P.O. Box 1092
Pocono Pines, PA 18350 Leased 1997 month-to-month - N/A
Title Insurance Agency:
Abstractors, Inc.
25 W. Broad Street
Hazleton, PA 18201 Owned 2001 month-to-month - N/A
Trust Company:
Northeast Pennsylvania Trust Co.
31 W. Broad Street
Hazleton, PA 18201 Owned 2001 month-to-month - N/A
Insurance Agency:
Higgins Insurance Company
115 S. Centre Street
Pottsville, PA 17901 Leased 2001 2010 - N/A
(1) This office was sold and transferred effective January 1, 2004 to another
banking institution.
Item 3. Legal Proceedings
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings, in the aggregate, are believed by management to be
immaterial to the Company's financial condition or results of operation.
14
Item 4. Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The above-captioned information appears under "Market for Registrant's
Common Equity and Related Stockholder Matters" in the Registrant's 2003 Annual
Report to Stockholders and is incorporated herein by reference.
Item 6. Selected Financial Data
The above-captioned information appears under "Selected Consolidated
Financial and Other Data of the Company" in the Registrant's 2003 Annual Report
to Stockholders and is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The above-captioned information appears under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Registrant's 2003 Annual Report to Stockholders and is incorporated herein by
reference.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
The above-captioned information appears under the heading "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Management of Interest Rate Risk and Market Risk Analysis" in the
Registrant's 2003 Annual Report to Stockholders and is incorporated herein by
reference.
Item 8. Financial Statements and Supplementary Data
The Consolidated Financial Statements of Northeast Pennsylvania
Financial Corp. and its subsidiaries, together with the report thereon by KPMG
LLP appears in the Registrant's 2003 Annual Report to Stockholders and are
incorporated herein by reference.
Item 9. Changes and Disagreements with Accountants on Accounting and Financial
Disclosure
Not Applicable.
15
Item 9A. Controls and Procedures
During the initial preparation and review of the Form 10-Q for
the June 30, 2003 period, the Registrant discovered that its financial
statements for its fiscal years 1998 through 2002 and for the December 2002 and
March 2003 quarters required restatement. The Company believes that it
maintained effective controls and procedures designed to ensure that information
required to be disclosed in its reports filed under the Securities Exchange Act
of 1934 with respect to those prior periods, except that the individuals
responsible for implementing such controls and procedures, including reviewing
the work performed and authorizing the final results, failed to detect material
errors, including a computer coding error related to the Company's indirect
automobile loan portfolio, which required the restatement. Consequently, the new
management conducted an exhaustive analysis of the Company's accounting records.
This review discovered additional accounting errors, which were included in the
restatements. Subsequent to the discovery of these errors in June and September,
management implemented staffing, system and procedural changes designed to
improve the training of the individuals involved in implementing and reviewing
the controls and procedures to strengthen the review and authorization process
so that such errors do not occur in the future.
The Company's management, including the Company's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended,
(the "Exchange Act"). Based upon their evaluation, the principal executive
officer and principal financial officer concluded that, as of the end of the
period covered by this report, the Company's disclosure controls and procedures
were effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (the "SEC) (1) is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and (2) is accumulated and communicated to the Company's
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure.
Part III
Item 10. Directors and Executive Officers of the Registrant
The information relating to Directors of the Registrant is incorporated
herein by reference to the Section captioned "Proposal 1-Election of Directors"
in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be
held on February 19, 2004. Reference is made to the section captioned
"Additional Item. Executive Officers of the Registrant" in this Form 10-K for
information relating to Executive Officers of the Registrant. Reference is made
to the cover page of this Form 10-K and to the section captioned "Section 16(a)
Beneficial Ownership Reporting Compliance" in the registrant's Proxy Statement
for the Annual Meeting of Stockholders to be held on February 19, 2004 for
information regarding compliance with Section 16(a) of the Exchange Act.
For information concerning the Company's code of ethics, the
information under the section "Corporate Governance - Code of Business Conduct"
is incorporated herein by reference. A copy of the code of ethics is available,
without charge, upon written request to Jerry D. Holbrook, Corporate Secretary,
Northeast Pennsylvania Financial Corp., 12 E. Broad Street, Hazleton,
Pennsylvania 18201.
Item 11. Executive Compensation
The information relating to executive compensation is incorporated
herein by reference to the sections captioned "Executive Compensation" and
"Directors' Compensation" in the Registrant's Proxy Statement for the Annual
Meeting of Stockholders to be held on February 19, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the section
captioned "Stock Ownership" in the Registrant's Proxy Statement for the Annual
Meeting of Stockholders to be held on February 19, 2004. The Company is not
aware of any arrangements, including any pledge by any person of securities of
the Company, the operation of which may at a subsequent date result in a change
in control of the Company.
The information related to securities authorized for issuance under
equity compensation plans is incorporated by reference to the section captioned
"Proposal 2 - Approval of the Northeast Pennsylvania Financial Corp. 2004 Stock
Plan - Equity Compensation Plan Information" in the Registrant's Proxy Statement
for the Annual Meeting of Stockholders to be held on February 19, 2004.
Item 13. Certain Relationships and Related Transactions
The information relating to certain relationships and related
transactions is incorporated herein by reference to the section captioned
"Transactions with Management" in the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on February 19, 2004.
16
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as a part of this report
(1) Consolidated Financial Statements of the Company are incorporated by
reference to the following indicated pages of the 2003 Annual Report to
Stockholders:
Consolidated Statements of Financial Condition
as of September 30, 2003 and 2002*............................... 3
Consolidated Statements of Operations
For the Years Ended September 30, 2003, 2002* and 2001*.......... 4
Consolidated Statements of Comprehensive Income (Loss)
For the Years Ended September 30, 2003, 2002*, and 2001*......... 5
Consolidated Statements of Changes in Equity
For the Years Ended September 30, 2003, 2002* and 2001*.......... 6
Consolidated Statements of Cash Flows
For the Years Ended September 30, 2003, 2002* and 2001*.......... 7
Notes to Consolidated Financial Statements......................... 9
Independent Auditors' Report....................................... 2
*As Restated
(2) All schedules are omitted because they are not required or applicable,
or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Certificate of Incorporation of Northeast Pennsylvania
Financial Corp. (1)
3.2 Bylaws of Northeast Pennsylvania Financial Corp. (2)
4.0 Form of Stock Certificate of Northeast Pennsylvania Financial
Corp. (1)
10.1 Employment Agreement between Northeast Pennsylvania Financial
Corp., First Federal Bank and Thomas M. Petro
10.2 Employment Agreement between Northeast Pennsylvania Financial
Corp., First Federal Bank and Thomas L. Kennedy
10.3 Employment Agreement between Higgins Insurance Associates,
Inc. and Joseph P. Schlitzer (3)
10.4 Amendment to Employment Agreement between Higgins Insurance
Associates, Inc. and Joseph P. Schlitzer
10.5 Employment Agreement between Northeast Pennsylvania Financial
Corp., First Federal Bank and Jerry D. Holbrook
10.6 Form of First Federal Bank Supplemental Executive Retirement
Plan
10.7 Form of First Federal Bank Employee Severance Compensation
Plan (1)
10.8 Northeast Pennsylvania Financial Corp. 1998 Stock-Based
Incentive Plan (4)
10.9 Northeast Pennsylvania Financial Corp. 2000 Stock Option Plan
(5)
10.10 Registration Rights Agreement, dated as of December 31, 2000,
by and among Northeast Pennsylvania Financial Corp., James
Clark, James McCann, Joseph Schlitzer and John W. Sink (6)
10.11 Agreement and Release, by and among E. Lee Beard, Northeast
Pennsylvania Financial Corp. and First Federal Bank
11.0 Statement regarding Computation of Per Share Earnings (See
Notes to Consolidated Financial Statements)
13.0 2003 Annual Report to Stockholders
21.0 Subsidiary information is incorporated by reference to "Part I
- Subsidiaries"
23.0 Consent of KPMG LLP
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
32.1 Chief Executive Officer and Chief Financial Officer
Certifications Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
- ------------------
1. Incorporated herein by reference into this document from the Exhibits to
the Form S-1 Registration Statement, and any amendments thereto,
Registration No. 333-43281
2. Incorporated herein by reference into this document from the Exhibits to
the Company's Form 10-K/A for the year ended September 30, 2003.
17
3. Incorporated herein by reference into this document from the Exhibits to
the Company's Form 10-K for the year ended September 30, 2001.
4. Incorporated herein by reference into this document from the Proxy
Statement for the 1998 Special Meeting of Stockholders dated September 9,
1998
5. Incorporated herein by reference into this document from the proxy
statement for the 2000 Annual Meeting of Stockholders dated December 20,
1999.
6. Incorporated herein by reference into this document from the Exhibits to
the Company's Form 10-Q for the quarter ended March 31, 2002.
(b) Reports on Form 8-K
On July 22, 2003, the Company furnished a Form 8-K in which it
announced that it was restating its results of operations for the fiscal years
ended September 30, 1998 through September 30, 2002 and for the quarters ending
December 31, 2002 and March 31, 2003. The Registrant also announced early
guidance on its expected earnings for the quarter ending June 30, 2003. A press
release announcing the restatement and earnings guidance was attached by
exhibit.
On August 11, 2003, the Company furnished a Form 8-K in which it
announced: (1) its results of operations for the three and nine months ended
June 30, 2003; (2) that its results of operations for the fiscal years ended
September 30, 1998 through September 30, 2002, and for the quarters ending
December 31, 2002 and March 31, 2003 are being restated; and (3) its
expectations with respect to certain aspects of its financial operations for the
remainder of the 2003 fiscal year and for the 2004 fiscal year. The Company also
announced the declaration of a dividend. Press releases making these
announcements were attached by exhibit.
On September 17, 2003, the Company furnished a Form 8-K in which it
announced the appointment of a new President and Chief Executive Officer and
Chief Financial Officer of the Company and the Bank to replace E. Lee Beard, who
had resigned those positions, effective September 13, 2003. The Company also
announced that in connection with Ms. Beard's resignation, the Company, the Bank
and Ms. Beard entered into a severance agreement to resolve the obligation owed
Ms. Beard under her existing employment agreements. A press release was attached
by exhibit.
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Northeast Pennsylvania Financial Corp.
By /s/ Thomas M. Petro January 13, 2004
---------------------------------
Thomas M. Petro
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Thomas M. Petro January 13, 2004
- ------------------------------------
Thomas M. Petro
President, Chief Executive
Officer and Director
(Principal Executive Officer)
/s/ Paul Conard January 13, 2004
- ------------------------------------
Paul Conard
Director
/s/ William R. Davidson January 13, 2004
- ------------------------------------
Dr. William R. Davidson
Director
/s/ Barbara Ecker January 13, 2004
- ------------------------------------
Barbara Ecker
Director
/s/ R. Peter Haentjens, Jr. January 13, 2004
- ------------------------------------
R. Peter Haentjens, Jr.
Director
/s/ Thomas L. Kennedy January 13, 2004
- ------------------------------------
Atty. Thomas L. Kennedy
Chairman of the Board
/s/ John P. Lavelle January 13, 2004
- ------------------------------------
Honorable John P. Lavelle
Director
- ------------------------------------
Michael J. Leib
Director
/s/ William J. Spear January 13, 2004
- ------------------------------------
William J. Spear
Director
/s/ Joseph Schlitzer January 13, 2004
- ------------------------------------
Joseph Schlitzer
Director
/s/ Jerry D. Holbrook January 13, 2004
- ------------------------------------
Jerry D. Holbrook
Chief Financial Officer and Secretary
(Principal Accounting and
Financial Officer)
19