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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED 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 __________
COMMISSION FILE NO.: 0-18833
CHESTER VALLEY BANCORP INC.
---------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2598554
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 E. LANCASTER AVENUE, DOWNINGTOWN, PA 19335
---------------------------------------- ----------
(Address Of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 269-9700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK ($1.00 PAR VALUE) 5,138,553
------------------------------ -----------------------------
(Title of Each Class) (Number of Shares Outstanding
as of November 1, 2004)
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
INDEX
PAGE
PART 1. FINANCIAL INFORMATION NUMBER
- ------- --------------------- ------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2004 and June 30, 2004 (Unaudited) 1
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30, 2004 and 2003 (Unaudited) 2
STATEMENT OF OTHER COMPREHENSIVE INCOME
Three Months Ended September 30, 2004 and 2003 (Unaudited) 3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended September 30, 2004 and 2003 (Unaudited) 4
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 5 - 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 14 - 22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK 22 - 24
ITEM 4. CONTROLS AND PROCEDURES 25
PART 2. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 26
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS 26
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26
ITEM 5. OTHER INFORMATION 26
ITEM 6. EXHIBITS 26
SIGNATURES 27
- ----------
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
SEPTEMBER 30, JUNE 30,
2004 2004
-----------------------------------
(UNAUDITED)
ASSETS $ 9,977 $ 12,844
Cash in banks 12,410 15,352
Interest-bearing deposits
---------- ----------
TOTAL CASH AND CASH EQUIVALENTS 22,387 28,196
---------- ----------
Trading account securities 7 8
Investment securities available for sale 132,777 130,089
Investment securities held to maturity (fair value -
September 30, 2004, $57,938
June 30, 2004, $57,779) 57,740 59,384
Loans held for sale 963 538
Loans receivable 406,991 401,965
Deferred fees (476) (508)
Allowance for loan losses (6,386) (6,331)
---------- ----------
Loans receivable, net 400,129 395,126
---------- ----------
Accrued interest receivable 3,026 2,652
Property and equipment - net 13,041 13,009
Bank owned life insurance 5,472 5,414
Real estate owned 54 54
Goodwill 1,171 1,171
Intangible assets 645 384
Other assets 7,281 6,083
---------- ----------
TOTAL ASSETS $ 644,693 $ 642,108
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 429,049 $ 427,103
Securities sold under agreements to repurchase 18,265 27,216
Advance payments by borrowers for taxes and insurance 479 1,433
Federal Home Loan Bank advances 130,239 120,963
Trust preferred securities 10,310 10,310
Accrued interest payable 668 679
Other liabilities 1,609 2,147
---------- ----------
TOTAL LIABILITIES 590,619 589,851
---------- ----------
Stockholders' Equity:
Preferred stock - $1.00 par value;
5,000,000 shares authorized; none issued -- --
Common stock - $1.00 par value;
10,000,000 shares authorized;
5,139,165 and 4,876,484 shares issued and outstanding
at September 30, 2004 and June 30, 2004, respectively 5,139 4,876
Additional paid-in capital 41,166 36,247
Retained earnings - partially restricted 9,433 13,303
Treasury stock (612 and 583 shares at September 30, 2004 and June 30,
2004, respectively, at cost) (13) (13)
Accumulated other comprehensive loss (1,651) (2,156)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 54,074 52,257
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 644,693 $ 642,108
========== ==========
See accompanying notes to consolidated financial statements.
1
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except for Per Share Amounts)
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------
2004 2003
---------- ---------
(UNAUDITED)
INTEREST INCOME:
Loans $ 5,851 $ 6,094
Mortgage-backed securities 413 342
Interest-bearing deposits 19 8
Investment securities:
Taxable 1,288 546
Non-taxable 320 437
---------- ----------
TOTAL INTEREST INCOME 7,891 7,427
---------- ----------
INTEREST EXPENSE:
Deposits 1,317 1,430
Securities sold under agreements to repurchase 46 32
Short-term borrowings 86 27
Long-term borrowings 1,328 1,230
---------- ----------
TOTAL INTEREST EXPENSE 2,777 2,719
---------- ----------
NET INTEREST INCOME 5,114 4,708
Provision for loan losses 102 380
---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,012 4,328
---------- ----------
OTHER INCOME:
Investment services income 1,031 984
Service charges and fees 794 771
Gain on the sale of:
Loans 71 72
Available for sale securities 77 75
Other 116 112
---------- ----------
TOTAL OTHER INCOME 2,089 2,014
---------- ----------
OPERATING EXPENSES:
Salaries and employee benefits 2,931 2,440
Occupancy and equipment 736 709
Data processing 254 233
Advertising 81 29
Deposit insurance premiums 16 15
Other 1,041 961
---------- ----------
TOTAL OPERATING EXPENSES 5,059 4,387
---------- ----------
Income before income taxes 2,042 1,955
Income tax expense 520 441
---------- ----------
NET INCOME $ 1,522 $ 1,514
========== ==========
EARNINGS PER SHARE (1)
Basic $ 0.30 $ 0.30
========== ==========
Diluted $ 0.29 $ 0.29
========== ==========
DIVIDENDS PER SHARE PAID DURING PERIOD (1) $ 0.11 $ 0.10
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING (1)
Basic 5,122,108 5,044,667
========== ==========
Diluted 5,276,146 5,209,283
========== ==========
(1) Earnings per share, dividends per share and weighted average shares
outstanding have been restated to reflect the effects of the 5% stock
dividends paid in September 2004 and 2003
See accompanying notes to unaudited consolidated financial statements.
2
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
STATEMENT OF OTHER COMPREHENSIVE INCOME
(Dollars in Thousands)
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2004 2003
--------- ---------
(Unaudited)
NET INCOME $ 1,522 $ 1,514
Other comprehensive income, net of tax:
Net unrealized holding gains (losses) on securities available for sale
during the period 708 (1,129)
Reclassification adjustment for (gains)
included in net income (51) (50)
Net unrealized losses on cash flow hedge (152) --
--------- ---------
COMPREHENSIVE INCOME $ 2,027 $ 335
========= =========
See accompanying notes to unaudited consolidated financial statements.
3
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------ ------------
(Unaudited)
Net income $ 1,522 $ 1,514
Add (deduct) items not affecting cash flows provided by operating activities:
Depreciation 239 259
Provision for loan losses 102 380
Gain on sale of securities available for sale (77) (75)
Originations of loans held for sale (6,157) (7,123)
Proceeds from sale of loans held for sale 5,803 6,663
Gain on sale of loans held for sale (71) (72)
Amortization of deferred loan fees, discounts and premiums (274) 66
Decrease in trading account securities 1 --
Increase in accrued interest receivable (374) (33)
Increase in value of bank owned life insurance (58) (71)
Increase in other assets (1,679) (1,052)
Increase (decrease) in other liabilities (538) 41
Increase (decrease) in accrued interest payable (34) (31)
- -----------------------------------------------------------------------------------------------------------------
Net cash flows (used in) provided by operating activities (1,595) 466
- -----------------------------------------------------------------------------------------------------------------
Cash flows used in investment activities:
Capital expenditures (271) (231)
Net increase in loans (5,102) (15,607)
Purchase of investment securities (2,476) (5,328)
Proceeds from maturities, payments and calls of investment securities 4,450 2,516
Purchase of securities available for sale (15,935) (24,124)
Proceeds from sales and calls of securities available for sale 14,263 28,865
Net cash and cash equivalents received from branch acquisition 6,184 --
- -----------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investment activities 1,113 (13,909)
- -----------------------------------------------------------------------------------------------------------------
Cash flows provided by financing activities Net (decrease) increase in deposits
before interest credited (5,736) (3,147)
Interest credited to deposits 1,248 1,346
Decrease in securities sold under agreements to repurchase (8,951) (1,194)
Proceeds from FHLB advances 10,138 134,477
Repayments of FHLB advances (862) (116,771)
Decrease in advance payments by borrowers for taxes and insurance (954) (1,305)
Cash dividends on common stock (513) (458)
Payment for fractional shares (8) (7)
Stock options exercised 311 472
- -----------------------------------------------------------------------------------------------------------------
Net cash flows (used in) provided by financing activities (5,327) 13,413
- -----------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents (5,809) (30)
CASH AND CASH EQUIVALENTS:
Beginning of period 28,196 25,749
--------- ---------
End of period $ 22,387 $ 25,719
========= =========
SUPPLEMENTAL DISCLOSURES:
Cash payments during the year for:
Taxes $ -- $ 75
Interest $ 2,788 $ 2,750
NON-CASH ITEMS:
Stock dividend issued $ 4,869 $ 5,074
Net unrealized (loss) gain on investment securities available for sale,
net of tax $ 657 $ (1,179)
Net unrealized loss on cash flow hedge $ (152) $ --
ACQUISITIONS:
In conjunction with the branch acquisition, liabilities assumed and assets
acquired were as follows:
Assets acquired net of cash and cash equivalents received $ 273 $ --
Cash and cash equivalents received $ 6,184 $ --
Liabilities assumed
$ 6,457 $ --
See accompanying notes to unaudited consolidated financial statements.
4
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Chester Valley Bancorp Inc. (the "Holding Company") was incorporated in the
Commonwealth of Pennsylvania in August 1989. The business of the Holding Company
and its subsidiaries (collectively, the "Company") consists of the operations of
First Financial Bank ("First Financial" or the "Bank"), a Pennsylvania-chartered
commercial bank founded in 1922 as a Pennsylvania-chartered savings association,
and Philadelphia Corporation for Investment Services ("Phila. Corp."), a full
service investment advisory and securities brokerage firm. Effective September
1, 2001, the Bank converted to a Pennsylvania-chartered commercial bank. As a
consequence of such charter conversion and with the approval by the Federal
Reserve Bank of Philadelphia under delegated authority from the Board of
Governors of the Federal Reserve System ("FRB"), the Holding Company became a
bank holding company that has also been designated by the FRB as a financial
holding company. Prior to such conversion, the Holding Company was a unitary
thrift holding company.
The Bank provides a wide range of banking services to individual and corporate
customers through its twelve full-service branch offices in Chester County,
Pennsylvania. The Bank provides a wide range of lending products including
commercial real estate, commercial business, consumer as well residential real
estate. Its lending activities are funded primarily with retail and business
deposits and borrowings. Phila. Corp. is a registered broker/dealer in all 50
states and the District of Columbia and it is also registered as an investment
advisor with the Securities and Exchange Commission ("SEC"). It provides many
additional services, including self-directed and managed retirement accounts,
safekeeping, daily sweep money market funds, portfolio and estate valuations,
life insurance and annuities, and margin accounts, to individuals and smaller
corporate accounts. Phila. Corp.'s offices are located in Wayne and
Philadelphia, Pennsylvania.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The accompanying consolidated financial statements include the accounts of the
Holding Company, the Bank and Phila. Corp. The accounts of the Bank include its
wholly-owned subsidiaries, First Financial Investments Inc. and D & S Service
Corp., which owns D & F Projects and Wildman Projects, Inc., both of which are
wholly-owned subsidiaries thereof. All material inter-company balances and
transactions have been eliminated in consolidation. Prior period amounts are
reclassified when necessary to conform to the current period's presentation.
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles in the United States ("GAAP") for complete financial statements.
However, such information reflects all adjustments, which are, in the opinion of
management, necessary for a fair presentation of results for the three-month
unaudited interim periods.
5
The results of operations for the three-month period ended September 30, 2004
are not necessarily indicative of the results to be expected for the fiscal year
ending June 30, 2005. The consolidated financial statements presented herein
should be read in conjunction with the audited consolidated financial statements
and the notes thereto included in the Company's Annual Report to Stockholders
for the fiscal year ended June 30, 2004.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company, as permitted, has elected not to adopt the fair value accounting
provisions of SFAS No. 123 "Accounting for Stock-based Compensation", and has
instead continued to apply APB Opinion 25 and related Interpretations in
accounting for plans and provide the required pro-forma disclosures of SFAS
No.123; accordingly, no expense is recognized in the Consolidated Statement of
Operations.
In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends FASB Statement No. 123,
Accounting for Stock-Based Compensation. This statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results.
The requirements of Statement No. 148 are effective for financial statements for
fiscal years beginning after December 15, 2002; the disclosure requirements for
the interim period financial statements of the Statement are included in this
report.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation (dollars in thousands except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------
2004 2003
---------------------
Net income, as reported $ 1,522 $ 1,514
Deduct: Total stock-based compensation expense
determined under fair value based method for all
awards, net of related tax effects (76) (59)
---------------------
Pro forma net income $ 1,446 $ 1,455
=====================
Earnings per share:
Basic - as reported $ 0.30 $ 0.30
=====================
Basic - pro forma $ 0.28 $ 0.29
=====================
Diluted - as reported $ 0.29 $ 0.29
=====================
Diluted - pro forma $ 0.27 $ 0.28
=====================
6
The effects of pro-forma net income and diluted earnings per share of applying
the disclosure requirements of Statement No. 123 and Statement No. 148 for past
fiscal quarters may not be representative of the future pro-forma effects on net
income and earnings per share due to the vesting provisions of the options and
future awards that are available to be granted.
EARNINGS PER SHARE
The dilutive effect of stock options is excluded from the computation of basic
earnings per share but included in the computation of diluted earnings per
share. Earnings per share and weighted average shares outstanding for the
periods presented herein have been adjusted to reflect the effects of the 5%
stock dividends paid in September 2004 and 2003.
The following table sets forth the computation of basic and diluted earnings per
share (dollars in thousands, except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2004 2003
---------- ----------
Numerator:
Net income $ 1,522 $ 1,514
========== ==========
Denominator:
Denominator for basic per share-
weighted average shares 5,122,108 5,044,667
Effect of dilutive securities:
Stock options 154,038 164,616
---------- ----------
Denominator for diluted earnings
per share-adjusted weighted
Average shares and assumed
Exercise 5,276,146 5,209,283
========== ==========
Basic earnings per share $ 0.30 $ 0.30
========== ==========
Diluted earnings per share $ 0.29 $ 0.29
========== ==========
The number of anti-dilutive stock options excluded was 65,148 and 145,199 for
the three-month periods ended September 30, 2004 and 2003, respectively.
7
NOTE 2 - LOANS RECEIVABLE
Loans receivable are summarized as follows (in thousands):
SEPTEMBER 30, June 30,
2004 2004
------------ ------------
First mortgage loans:
Residential real estate $69,658 $74,004
Construction-residential 26,571 18,745
Land acquisition and development 14,695 13,928
Commercial real estate 142,653 140,721
Construction-commercial 10,812 16,187
Commercial business 53,721 49,142
Consumer 116,116 114,787
------------ ------------
TOTAL LOANS 434,226 427,514
------------ ------------
Less:
Undisbursed loan proceeds:
Construction-residential (23,681) (16,223)
Construction-commercial (3,554) (9,326)
Deferred loan fees - net (476) (508)
Allowance for loan losses (6,386) (6,331)
------------ -------------
NET LOANS $400,129 $395,126
============ =============
NOTE 3 - ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that represents
management's best estimate of known and inherent losses, which are probable and
reasonably determinable based upon an evaluation of the loan portfolio.
Homogeneous portfolios of loans, which include residential mortgage, home equity
and other consumer loans, and commercial business loans less than $100,000 are
evaluated as a group. Commercial business loans greater than $100,000,
commercial mortgage and construction loans are evaluated individually. Specific
portions of the allowance are developed by analyzing individual loans for
adequacy of collateral, cash flow and other risks unique to that particular
loan. General portions of the allowance are developed by grading individual
loans in the commercial and construction portfolios and applying loss factors by
grade. The general portion of the allowance also includes loss factors applied
to the homogeneous portfolios as a group. The loss factors applied to graded
loans were developed based on the Company's loss history for loans with similar
attributes as well as input from the Company's primary banking regulators. Loss
factors are applied to homogeneous loans based upon prior loss experience of the
portfolio, delinquency trends, economic conditions as well as the volume of
non-performing loans. Although management believes it has used the best
information available to it in making such determinations, and that the present
allowance for loan losses is adequate, future adjustments to the allowance may
be necessary, and net income may be adversely affected if circumstances differ
substantially from the assumptions used in determining the level of the
allowance. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for losses
on loans. Such agencies may require the Bank to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination. The allowance is increased by the provision for loan
losses, which is charged to operations. Loan losses, other than those incurred
on loans held for sale, are charged directly against the allowance and
recoveries on previously charged-off loans are added to the allowance.
8
For purposes of applying the measurement criteria for impaired loans, the
Company excludes large groups of smaller balance homogeneous loans, primarily
consisting of residential real estate loans and consumer loans as well as
commercial business loans with balances of less than $100,000. For applicable
loans, the Company evaluates the need for impairment recognition when a loan
becomes non-accrual or earlier if, based on management's assessment of the
relevant facts and circumstances, it is probable that the Company will be unable
to collect all proceeds under the contractual terms of the loan agreement. At
September 30, 2004 and June 30, 2004, the recorded investment in impaired loans
was $3.9 million and $4.0 million, respectively. The Company's policy for the
recognition of interest income on impaired loans is the same as for non-accrual
loans. Impaired loans are charged off when the Company determines that
foreclosure is probable and the fair value of the collateral is less than the
recorded investment of the impaired loan.
NOTE 4 - COMMITMENTS
Commitments to potential mortgagors of the Bank amounted to $814 thousand as of
September 30, 2004, all of which were fixed-rate loans (primarily consisting of
single-family residential mortgages) bearing interest rates of between 5.75% and
6.25%. At September 30, 2004, the Company had $27.2 million of undisbursed
construction loan funds as well as $86.7 million of undisbursed remaining
consumer and commercial line balances.
NOTE 5 - JUNIOR SUBORDINATED DEBENTURES
On March 26, 2002, the Company issued $10.3 million of Junior Subordinated
Debentures to Chester Valley Statutory Trust, a Pennsylvania Business Trust, in
which the Company owns all of the common equity. The Trust then issued $10.0
million of Trust Preferred Securities to investors, which are secured by the
Junior Subordinated Debentures and the guarantee of the Company. The Junior
Subordinated Debentures are treated as debt of the Company but they qualify as
Tier I capital, subject to certain limitations under the risk-based capital
guidelines of the Federal Reserve. The Trust Preferred Securities are callable
by the Company on or after March 26, 2007, or at any time in the event the
deduction of related interest for federal income taxes is prohibited, the
treatment as Tier I capital is no longer permitted or under certain other
circumstances. The Trust Preferred Securities must be redeemed by the Company
upon their maturity in the year 2032. Effective December 31, 2003, CVAL
deconsolidated the Trust, resulting in a change in the characterization of the
underlying consolidated debt obligations from the previous trust preferred
securities to junior subordinated debentures. The junior subordinated debentures
qualify as a component of capital for regulatory purposes.
NOTE 6 - REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's and the Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.
9
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
adjusted total assets (as defined). At September 30, 2004 and June 30, 2004 the
Bank was in compliance with all such requirements and is deemed a
"well-capitalized" institution for regulatory purposes. There are no conditions
or events since September 30, 2004 that management believes have changed the
institution's category.
The Holding Company and the Bank's regulatory capital amounts and ratios are
presented in the table as follows (dollars in thousands):
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
----------------------- ----------------------- ------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- -------- --------- ------- --------- --------
AS OF SEPTEMBER 30, 2004:
HOLDING COMPANY
Total risk-based capital ratio
(to risk-weighted assets) $69,837 14.74% $37,904 8.00% $47,380 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $63,909 13.49% $18,952 4.00% $28,428 6.00%
Tier 1 leverage ratio
(to average assets) $63,909 10.04% $25,471 4.00% $31,839 5.00%
BANK
Total risk-based capital ratio
(to risk-weighted assets) $67,068 14.15% $37,925 8.00% $47,406 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $61,137 12.90% $18,962 4.00% $28,444 6.00%
Tier 1 leverage ratio
(to average assets) $61,137 9.64% $25,368 4.00% $31,710 5.00%
AS OF JUNE 30, 2004:
HOLDING COMPANY
Total risk-based capital ratio
(to risk-weighted assets) $68,620 14.85% $36,960 8.00% $46,200 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $62,838 13.60% $18,480 4.00% $27,720 6.00%
Tier 1 leverage ratio
(to average assets) $62,838 9.95% $25,263 4.00% $31,578 5.00%
BANK
Total risk-based capital ratio
(to risk-weighted assets) $65,563 14.14% $37,101 8.00% $46,377 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $59,759 12.89% $18,551 4.00% $27,826 6.00%
Tier 1 leverage ratio
(to average assets) $59,759 9.50% $25,151 4.00% $31,439 5.00%
10
NOTE 7 - ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
The Company may from time to time utilize derivative instruments such as
interest rate swaps, interest rate collars, interest rate floors, interest rate
swaptions or combinations thereof to assist in its asset/liability management.
At September 30, 2004, the Company was positively gapped whereby its
interest-earning assets were re-pricing at a quicker rate than its
interest-bearing liabilities. To partially offset the negative impact of the
current low market interest rate environment, the Company entered into three
separate interest rate swap transactions aggregating $41.0 million notional
amount to hedge certain of its higher rate Federal Home Loan Bank Advances. The
swaps had the effect of converting the higher fixed rate advances to lower
adjustable rate borrowings, which positively impacts the Company's net interest
margin in the current interest rate environment. Further, since the Company is
positively gapped, if the balance sheet were to remain static, future increases
in interest rates would have similar impacts to the earnings and costs of the
interest-earning assets and interest-bearing liabilities. Additionally, in
August 2003, the Company purchased a $30.0 million notional amount 3.50% Three
Month LIBOR interest rate cap while simultaneously selling a $30.0 million
notional amount 6.00% Three Month LIBOR interest rate cap ("Interest Rate
Corridor"). The Company paid a net premium, which entitles it to receive the
difference between Three Month LIBOR from 3.50% up to 6.00% times the $30.0
million notional amount. The Interest Rate Corridor is being used to hedge the
cash flows of $10.0 million in floating rate Trust Preferred Securities as well
as the cash flows of certain borrowings, which could negatively impact earnings
in a rising interest rate environment.
The fair market value of the cap has two components: the intrinsic value and the
time value of the option. The cap is marked-to-market quarterly, with changes in
the intrinsic value of the cap, net of tax, included as a separate component of
other comprehensive income and change in the time value of the option included
directly as interest expense as required under SFAS 133. In addition, the
ineffective portion, if any, would have been expensed in the period in which
ineffectiveness was determined. The fair value of the interest rate cap at
September 30, 2004 was $527 thousand.
NOTE 8 - SEGMENT REPORTING
The Company has two reportable segments: First Financial and Phila. Corp. First
Financial operates a branch bank network with twelve full-service banking
offices and provides primarily deposit and loan services to customers.
Additionally, the Bank offers trust services at its Downingtown headquarters and
at Phila. Corp. Phila. Corp. operates a full service investment advisory and
securities brokerage firm through two offices. Both segments operate in
southeastern Pennsylvania.
The Company evaluates performance based on the net income provided by each of
its reportable segments. There are no material intersegment sales or transfers.
Phila. Corp. was acquired by the Company on May 29, 1998. Since such time, the
Company's reportable segments have been its two independent financial services
institutions.
11
The following table highlights income statement and balance sheet information
for each of the segments at or for September 30, 2004 and 2003 (in thousands):
AT AND DURING THE THREE MONTHS ENDED SEPTEMBER 30,
2004 2003
---------------------------------------- ------------------------------------
PHILA. PHILA.
BANK CORP. TOTAL BANK CORP. TOTAL
--------- ----------- ------------ --------- -------- --------
Net interest
income $ 5,110 $ 4 $ 5,114 $ 4,706 $ 2 $ 4,708
Other income 1,212 877 2,089 1,134 880 2,014
Total net income 1,454 68 1,522 1,422 92 1,514
Total assets 642,970 1,723 644,693 596,017 2,269 598,286
Total interest-
bearing deposits 11,042 1,368 12,410 11,574 1,861 13,435
Total trading
securities -- 7 7 -- 10 10
NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - AMENDMENT OF STATEMENT NO. 133
In April 2003, the FASB issued Statement No.149, Amendment of Statement No.133
on Derivative Instruments and Hedging Activities, which establishes accounting
and reporting standards for derivative instruments, including derivatives
imbedded in other contracts and hedging activities. This Statement amends
Statement No. 133 for decisions made by the FASB as part of its Derivatives
Implementation Group process. This Statement also amends Statement No. 133 to
incorporate clarifications of the definition of a derivative. The Statement is
effective for contracts entered into or modified and hedging relationships
designated after June 30, 2004. The provisions of this Statement did not have a
material impact on the Company's consolidated earnings, financial condition or
equity.
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN
INVESTMENTS ("EITF 03-1")
On September 30, 2004, the FASB voted unanimously to delay the effective date of
Emerging Issues Task Force ("EITF") 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments." The delay applies to
both debt and equity securities and specifically applies to impairments caused
by interest rate and sector spreads. In addition, the provisions of EITF 03-1
that have been delayed relate to the requirements that a company declare its
intent to hold the security to recovery and designate a recovery period in order
to avoid recognizing an other-than-temporary impairment charge through earnings.
The financial statement disclosure provisions of EITF 03-1 were not affected by
the September 30, 2004 delay. The FASB will be issuing implementation guidance
related to this topic. Once issued, the Company will evaluate the impact of
adopting EITF 03-1.
12
NOTE 10 - ACQUISITIONS
Effective September 10, 2004, First Financial Bank acquired the Exton, Chester
County, Pennsylvania branch deposits of Firstrust Bank. As a result of the
acquisition, First Financial Bank assumed approximately $6.5 million of deposit
liabilities. Additionally, the Company recorded an approximate $273 thousand
Core Deposit Intangible. The acquisition was accounted for using the purchase
method of accounting.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
In this Form 10-Q, the Company has included certain "forward looking
statements", either express or implied, which concern anticipated future
operations of the Company. 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 Company of the
protections of such safe harbor with respect to all "forward looking statements"
contained in this Form 10-Q. The Company has used "forward looking statements"
to describe certain of its future plans and strategies including management's
current expectations of the Company's future financial results. Management's
ability to predict results or the effect of future plans and strategy involve
certain risks, uncertainties, estimates, and assumptions, which are subject to
factors beyond the Company's control. Consequently, the Company's actual results
could differ materially from management's expectations. Factors that could
affect results include, but are not limited to, interest rate trends, loan
delinquency rates, changes in federal and state banking regulations,
competition, the general economic climate in Chester County, the mid-Atlantic
region and the country as a whole, and other uncertainties described in the
Company's filings with the Securities and Exchange Commission, including this
Form 10-Q. These factors should be considered in evaluating the "forward looking
statements", and undue reliance should not be placed on such statements. The
Company undertakes no obligation to update or revise any forward-looking
statements, whether written or oral that may be made from time to time by or on
the Company's behalf.
GENERAL
The Company's results of operations depend largely on its net interest income,
which is the difference between interest income on interest-earning assets,
which consists principally of loans and investment securities, and interest
expense on interest-bearing liabilities, which consist primarily of deposits and
borrowings. Net interest income is determined by the Company's interest rate
spread (the difference between the yields earned on its interest-earning assets
and the rates paid on its interest-bearing liabilities) and the relative amounts
of interest-earning assets and interest-bearing liabilities.
The Company's results of operations also are affected by the provision for loan
losses resulting from management's assessment of the allowance for loan losses;
the level of its non-interest income, including investment service fees, loan
and deposit service fees and related income, and gains and losses from the sales
of loans and securities; the level of its non-interest expense, including
salaries and employee benefits, occupancy and equipment expense, data processing
services, deposit insurance premiums, advertising, other operating costs; and
income tax expense.
The Bank is a community-oriented bank, which emphasizes customer service and
convenience. As part of this strategy, the Bank offers products and services
designed to meet the needs of its customers. The Company generally has sought to
achieve long-term financial growth and strength by increasing the amount and
stability of its net interest income and non-interest income and by maintaining
a high level of asset quality. In pursuit of these goals, the Company has
adopted a business strategy emphasizing growth in basic financial services. The
focus is on expanding its commercial, construction and consumer lending
activities, increasing its commercial and consumer deposits, treasury management
as well as expanding its trust and investment management services.
14
BUSINESS STRATEGY
GROWTH. The Company seeks to increase its assets primarily through internal
growth but will pursue potential acquisition opportunities which would be
accretive to earnings and/or increase its market share in the regions it
operates.
The two primary objectives of the Company's strategic plan are to increase
loans, in particular commercial business and real estate and construction loans,
consumer loans and core deposits (consisting of all deposits other than
certificates of deposits). The Company's net loans increased by $5.0 million, or
3.7%, from $395.1 million at June 30, 2004 to $400.1 million at September 30,
2004. Excluding residential mortgage loans, which continued to decline, the loan
portfolio grew $9.4 million or 2.9% from June 30, 2004. Additionally, in
anticipation of a rising rate environment, the Company focused its retail sales
personnel on variable rate home equity lines, rather than lock the Bank into
longer-term fixed rate loans. Core deposits decreased by $13.0 million, or a
negative 3.7%, from $347.0 million at June 30, 2004 to $333.9 million at
September 30, 2004. This decrease is primarily due to outflows in money market
balances as well as commercial DDAs of title companies.
EMPHASIS ON COMMERCIAL LENDING. The Company has been and will continue to seek
to increase its higher yielding portfolios of commercial real estate and
commercial business loans. The Company's commercial real estate, commercial
business and construction and land acquisition loans comprised in the aggregate
57.2% of its total loan portfolio at September 30, 2004 compared to 55.8% at
June 30, 2004. Single-family and multi-family residential loans comprised 16.0%
of the Company's loan portfolio at September 30, 2004 as compared to 17.3% at
June 30, 2004.
MAINTAIN LOAN QUALITY. Management believes that maintaining high loan quality is
key to achieving and sustaining long-term financial success. Accordingly, the
Company has sought to maintain a high level of loan quality and moderate credit
risk by using underwriting standards which management believes are conservative
and by generally limiting its lending activity to the origination of loans
secured by property located in its market area. The Company's non-accrual loans
increased to $4.3 million at September 30, 2004 compared to $4.2 million at June
30, 2004. Included in the totals at both dates is a single commercial real
estate loan in the amount of $2.9 million. Although the loan has always been
current in the payment of interest as it has been due, the loan was placed on
non-accrual as principal was not repaid in accordance with the original stated
maturity. The borrower has encountered financial difficulties, the underlying
real estate is outside the Bank's primary lending area and repayment is
dependent upon factors not under the complete control of the borrower. In
October 2004, the Company received a $750 thousand principal pay-down on an
approximate $2.9 million non-performing commercial mortgage. Additionally, the
borrower prepaid interest as a condition to the Bank's extension of the maturity
date on the remaining balance of the loan.
STABLE SOURCE OF LIQUIDITY. The Company purchases investment securities that
management believes to be appropriate for liquidity, yield and credit quality in
order to achieve a managed and more predictable source of liquidity to meet loan
demand and, to a lesser extent, a stable source of interest income. The
portfolio totaled, in the aggregate, $190.5 million at September 30, 2004
compared to $189.5 million at June 30, 2004. This increase was due largely to
the acquisition of agency bonds, and adjustable rate mortgage-backed securities.
In addition, the Company had short-term interest-bearing deposits of $12.4
million at September 30, 2004 compared to $15.4 million at June 30, 2004.
15
EMPHASIS ON DEPOSITS AND CUSTOMER SERVICE. The Company, as a community-based
financial institution, is largely dependent upon its base of core deposits (NOW,
Savings and Money Market) to provide a stable source of funding. The Company has
retained many loyal customers over the years through a combination of high
quality service, competitively priced service fees, customer convenience, an
experienced staff and a strong commitment to the communities in which it serves.
Lower costing core deposits totaled $315.6 million or 73.6% of the Company's
total deposits at September 30, 2004, as compared to $319.7 million or 74.9% at
June 30, 2004. This decrease in lower costing deposits is primarily attributable
to outflows in money market balances as well as commercial DDAs of title
companies.
ASSET/LIABILITY MANAGEMENT
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk of the bank subsidiary, thereby reducing its
exposure to fluctuations in interest rates, and achieving sustainable growth in
net interest income over the long term. Other objectives of asset/liability
management include: (1) ensuring adequate liquidity and funding, (2) maintaining
a strong capital base and (3) maximizing net interest income opportunities.
In general, interest rate risk is mitigated by closely matching the maturities
or re-pricing periods of interest-sensitive assets and liabilities to ensure a
favorable interest rate spread. Management regularly reviews the Bank's
interest-rate sensitivity, and uses a variety of strategies as needed to adjust
that sensitivity within acceptable tolerance ranges established by the Board of
Directors. Changing the relative proportions of fixed-rate and adjustable-rate
assets and liabilities is one of the primary strategies utilized by the Company
to accomplish this objective.
The Company may from time to time utilize derivative instruments such as
interest rate swaps, interest rate collars, interest rate floors, interest rate
swaptions or combinations thereof to assist in its asset/liability management.
At September 30, 2004, the Company was positively gapped whereby its
interest-earning assets were re-pricing at a quicker rate than its
interest-bearing liabilities. To partially offset the negative impact of the
current low market interest rate environment, the Company entered into three
separate interest rate swap transactions aggregating $41.0 million notional
amount to hedge certain of its higher rate Federal Home Loan Bank Advances. The
swaps had the effect of converting the higher fixed rate advances to lower
adjustable rate borrowings, which positively impacts the Company's net interest
margin in the current interest rate environment. Further, since the Company is
positively gapped, if the balance sheet were to remain static, future increases
should have similar impacts to the earnings and costs of the interest-earning
assets and interest-bearing liabilities. Additionally, in August 2003, the
Company purchased a $30.0 million notional amount 3.50% Three Month LIBOR
interest rate cap while simultaneously selling a $30.0 million notional amount
6.00% Three Month LIBOR interest rate cap ("Interest Rate Corridor"). The
Company paid a net premium, which entitles it to receive the difference between
Three Month LIBOR from 3.50% up to 6.00% times the $30.0 million notional
amount. The Interest Rate Corridor is being used to hedge the cash flows of
$10.0 million in floating rate Trust Preferred Securities as well as the cash
flows of certain borrowings, which could negatively impact earnings in a rising
interest rate environment.
16
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest-rate sensitive" and by
monitoring an institution's interest-sensitivity gap. An interest-sensitivity
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities re-pricing within a
defined period and is considered negative when the amount of interest-rate
sensitive liabilities exceeds the amount of interest-rate sensitive assets
re-pricing within a defined period.
To provide a more accurate one-year gap position of the Company, certain deposit
classifications are based on the interest-rate sensitive attributes and not on
the contractual re-pricing characteristics of these deposits. Management
estimates, based on historical trends of the Bank's deposit accounts, that money
market deposits are sensitive to interest rate changes. Accordingly, the
interest-sensitive portions of these deposits are classified in the less than
one-year categories with the remainder in the over five years category. Deposit
products with interest rates based on a particular index are classified
according to the specific re-pricing characteristic of the index. Deposit rates
other than time deposit rates are variable, and changes in deposit rates are
typically subject to local market conditions and management's discretion and are
not indexed to any particular rate. The Interest Rate Sensitivity Analysis at
September 30, 2004 is on Page 24.
Generally, during a period of rising interest rates, a positive gap would result
in an increase in net interest income while a negative gap would adversely
affect net interest income. However, the interest-sensitivity table on Page 24
does not provide a comprehensive representation of the impact of interest rate
changes on net interest income. Each category of assets or liabilities will not
be affected equally or simultaneously by changes in the general level of
interest rates. Even assets and liabilities, which contractually re-price within
the same period may not, in fact, re-price at the same price or the same time or
with the same frequency. It is also important to consider that the table
represents a specific point in time. Variations can occur as the Company adjusts
its interest-sensitivity position for the Bank throughout the year.
FINANCIAL CONDITION
-------------------
The Company's total assets increased to $644.7 million at September 30, 2004
from $642.1 million at June 30, 2004, principally due to a $5.0 million increase
in loans receivable to $400.1 million at September 30, 2004 from $395.1 million
at June 30, 2004. Net loans other than residential loans increased by $9.3
million or 2.9% for the same period in 2004. In line with its strategy, the
growth occurred principally in the consumer and commercial loan portfolios.
Residential mortgage loans as a percentage of total loans was reduced from 17.3%
at June 30, 2004 to 16.0% at September 30, 2004. In addition to the loan growth,
investment securities increased by $1.0 million, primarily through the
acquisition of agency bonds and adjustable rate mortgage-backed securities.
These increases were offset in part by decreases in cash and cash equivalents of
$5.8 million.
Deposits increased by $1.9 million due primarily to the acquisition of the Exton
branch deposits of $6.4 million from Firstrust Bank. This partially offset a
reduction in money market and DDA balances. Federal Home Loan Bank Advances
increased $9.0 million to fund the above noted asset growth.
Stockholders' equity increased by $1.8 million at September 30, 2004 as compared
to June 30, 2004, primarily as a result of net income of $1.5 million, the
issuance of common stock as a result of the exercise of stock options and a
change in accumulated other comprehensive income of $505 thousand related to
unrealized losses on securities available for sale as well as the change in the
market value of the cash flow hedge, net of tax. These were partially offset by
the payment of cash dividends of $513 thousand
17
RESULTS OF OPERATIONS
---------------------
INTEREST INCOME AND INTEREST SPREAD ANALYSIS
- --------------------------------------------
The following table sets forth, for the periods indicated, information on a tax
equivalent basis regarding (1) the total dollar amount of interest income of the
Company from interest-earning assets and the resultant average yields; (2) the
total dollar amount of interest expense on interest-bearing liabilities and the
resultant average cost; (3) net interest income; (4) interest rate spread; and
(5) net interest-earning assets and their net yield. Average balances are
determined on a daily basis.
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
(Dollars in Thousands)
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
------------------------------- --------------------------------
ASSETS:
Loans and loans held for sale (1) $ 404,179 $ 5,870 5.81% $ 398,650 $ 6,108 6.13%
Securities and other investments (1) 200,745 2,160 4.30% 154,281 1,496 3.88%
------------------------------- --------------------------------
Total interest-earning assets (1) 604,924 8,030 5.31% 552,931 7,604 5.50%
------------------------------- --------------------------------
Non-interest earning assets 42,009 41,552
---------- ----------
TOTAL ASSETS $ 646,933 $ 594,483
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits and repurchase agreements (2) $ 452,442 1,363 1.20% $ 422,610 1,462 1.38%
FHLB advances and other borrowings (2) 131,181 1,414 4.28% 111,551 1,257 4.48%
------------------------------- --------------------------------
TOTAL INTEREST-BEARING LIABILITIES (2) 583,623 2,777 1.89% 534,161 2,719 2.03%
------------------------------- --------------------------------
Non-interest-bearing liabilities 10,329 10,886
Stockholders' equity 52,981 49,436
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 646,933 $ 594,483
========== ==========
NET INTEREST INCOME/INTEREST RATE SPREAD $ 5,253 3.42% $ 4,885 3.47%
================= =================
NET INTEREST INCOME/AVERAGE
INTEREST-EARNING ASSETS (2) 3.47% 3.51%
====== ======
RATIO OF AVERAGE INTEREST-EARNING ASSETS TO
INTEREST-BEARING LIABILITIES 104% 104%
====== ======
(1) Yield calculated using 30/360 day basis.
(2) Yield /rate calculated based on the actual number of days.
18
The following details the tax equivalent adjustments in the above table:
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------
2004 2003
------------------------------------- --------------------------------------
INTEREST TAX ADJUSTED INTEREST TAX ADJUSTED
INCOME ADJUSTMENT INCOME INCOME ADJUSTMENT INCOME
------------------------------------- --------------------------------------
(Dollars in thousands)
Loans $ 5,851 $ 19 $ 5,870 $ 6,094 $ 14 $ 6,108
Investments 2,040 120 2,160 1,333 163 1,496
------------------------------------- -------------------------------------
Total $ 7,891 $ 139 $ 8,030 $ 7,427 $ 177 $ 7,604
===================================== =====================================
RATE/VOLUME ANALYSIS
The following table presents certain information regarding changes in interest
income and interest expense of the Company for the periods indicated. Interest
income and the annual rate are calculated on a taxable equivalent basis using
the Federal marginal income tax rate of 34% adjusted for the 20% interest
expense disallowance resulting in an effective tax rate of 27.2%. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided with respect to changes attributable to (1) changes in
volume (change in volume multiplied by old rate), (2) changes in rate (change in
rate multiplied by old volume) and (3) changes in rate/volume (change in rate
multiplied by change in volume). The changes in rate/volume are allocated to the
change in volume variance and the change in the rate variance on a pro rata
basis.
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------------------
2004 COMPARED TO 2003 2003 COMPARED TO 2002
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
---------------------------------- -----------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
----------------------------------------------------------------------------
(Dollars in thousands)
Interest income on interest-earning assets:
Loans and loans held for sale $ 486 $(724) $ (238) $ 2,256 $(2,779) $ (523)
Securities and other investments 481 183 664 (207) (279) (486)
---------------------------------- -----------------------------------
Total interest income 967 (541) 426 2,049 (3,058) (1,009)
---------------------------------- -----------------------------------
Interest expense on interest-bearing liabilities:
Deposits and repurchase
agreements 500 (599) (99) 443 (1,273) (830)
FHLB advances and other
borrowings 480 (323) 157 (12) (216) (228)
---------------------------------- -----------------------------------
Total interest expense 980 (922) 58 431 (1,489) (1,058)
---------------------------------- -----------------------------------
Net change in net interest income $ (13) $ 381 $ 368 $ 1,618 $(1,569) $ 49
================================== ===================================
Net interest income, on a fully tax equivalent basis, increased $368 thousand or
7.5% for the three-month period ended September 30, 2004, compared to the same
period in 2003. Total interest income, on a fully tax equivalent basis,
increased 5.6% to $8.0 million for the three-month period ended September 30,
2004, from $7.6 million for the same period in 2003, primarily as a result of an
increase in average interest-earning assets of $52.0 million.
19
Total interest expense increased 2.0% to $2.8 million from $2.7 million for the
three-month periods ended September 30, 2004 and September 30, 2003,
respectively. The increase is due largely to an increase in the average balance
of interest-bearing liabilities of $49.5 million to $583.6 million.
PROVISION FOR LOAN LOSSES
The provision for loan losses decreased by $278 thousand, or 73.2%, for the
three-months ended September 30, 2004 to $102 thousand as compared to $380
thousand for the three-months ended September 30, 2003. The decrease is due
principally to the change in classified assets and loan volumes during the
quarters ended September 30, 2004 and September 30, 2003, respectively.
OTHER INCOME
Total other income increased $75 thousand for the three-months ended September
30, 2004 compared to the same period in 2003. The increases occurred primarily
in investment services income, including trust fees along with an increase in
deposit fees resultant from a growth in transaction type deposit accounts (i.e.
Consumer and business checking, money market and savings).
OPERATING EXPENSES
Total operating expenses increased by $672 thousand for the three-months ended
September 30, 2004 as compared to the same period in 2003. This represents a
15.3% increase for the three-month period. The increase occurred primarily in
compensation and benefits. In addition to normal salary increases for the year,
the Company has made a significant investment in its future. The Company
expanded its retail brokerage business personnel in September 2004. On a yearly
comparison, the Bank hired seven lending and private-banking relationship
managers who became available as a result of the recent consolidation within the
local community banking market. In addition the Bank expanded its branch network
through the Coatesville branch acquisition from PNC National Bank in March 2004
and the purchase of the Firstrust deposits in Exton. Thirdly, the Bank opened a
loan production office in Plymouth Meeting, Montgomery County, Pennsylvania, an
area that was largely impacted by the afore-mentioned consolidation; and a
Private Client office in West Chester Borough to better serve the complex needs
of affluent clients and the professionals who handle their business affairs.
INCOME TAX EXPENSE
Income tax expense increased by $79 thousand for the three-month period ended
September 30, 2004 as compared to the same period in 2003 due to an increase in
pre-tax income, combined with the sale and/or redemption of a number of tax-free
investments.
20
ASSET QUALITY
Non-performing loans totaled $4.3 million and $4.2 million at September 30, 2004
and June 30, 2004, respectively. It is the policy of the Company to discontinue
the accrual of interest when principal or interest payments are delinquent 90
days or more (unless the loan principal and interest are determined by
management to be fully secured and in the process of collection), or earlier, if
the financial condition of the borrower raises significant concern with regard
to the ability of the borrower to service the debt in accordance with the
current loan terms. Interest income is not accrued until the financial condition
and payment record of the borrower clearly demonstrates the borrower's ability
to service the debt. Included in the totals at both dates is a single commercial
real estate loan in the amount of $2.9 million. Although the loan is current in
the payment of interest as it has been due and the next six months payment of
interest has been prepaid, the loan was placed on non-accrual as principal was
not repaid in accordance with the original stated maturity. The borrower has
encountered financial difficulties, the underlying real estate is outside the
Bank's primary lending area and repayment is dependent upon factors not under
the complete control of the borrower. In October 2004, the Company received a
$750 thousand principal pay-down on an approximate $2.9 million non-performing
commercial mortgage. Additionally, the borrower prepaid interest as a condition
to the Bank's extension of the maturity date on the remaining balance of the
loan.
At September 30, 2004 and June 30, 2004, the Company's classified loans, which
consisted of loans classified as substandard, doubtful or loss, totaled $10.4
million on both dates. Included in loans classified substandard at September 30,
2004 and June 30, 2004, were all loans 90 days past due and loans which were
less than 90 days delinquent but inadequately protected by the current paying
capacity of the borrower or of the collateral pledged, or which were subject to
one or more well-defined weaknesses which may jeopardize the satisfaction of the
debt. Also included in classified loans at September 30, 2004 were loans
totaling $9.1 million, which are current but have been classified and are being
closely monitored.
At September 30, 2004, in addition to classified loans, classified assets
included three Non-rated Pennsylvania Municipal Authority Bonds that have been
classified as substandard. These bonds were originally purchased during the
period from June 1998 through June 2000. The aggregate book value of the bonds
at September 30, 2004 was $5.7 million ($5.6 million at June 30, 2004). Two of
the three bonds with an aggregate book value of $5.0 million are zero coupon
bonds with maturities extending up to 2034. Both bonds are secured by the
revenue streams of commercial office buildings, which are leased to various
agencies of the Commonwealth of Pennsylvania under long-term lease arrangements
with renewal options.
The third bond was issued by the Housing Authority of Chester County and had a
book balance of $720 thousand at an interest rate of 6% and final maturity in
June 2019. This bond involves low-income scattered housing in Chester County
under a program of the Office of Housing and Urban Development ("HUD"). HUD has
provided additional funds to build additional houses, on land which was donated
to this bond issue. The retirement of the bond issue is dependent upon proceeds
from either the rental or sale of the existing and additional houses. Although
all principal and interest have been paid per the terms of the bond indenture,
this bond is on non-accrual at September 30, 2004.
21
LIQUIDITY AND CAPITAL RESOURCES
Management monitors liquidity daily and maintains funding sources to meet
unforeseen changes in cash requirements. The Company's primary sources of funds
are deposits, borrowings, repayments, prepayments and maturities of outstanding
loans and mortgage-backed securities, sales of assets available for sale,
maturities of investment securities and other short-term investments, and funds
provided from operations. While scheduled loan and mortgage-backed securities
repayments and maturing investment securities and short-term investments are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by the movement of interest rates in general, economic
conditions and competition. The Company manages the pricing of its deposits to
maintain a deposit balance deemed appropriate and desirable. Although the
Company's deposits represent the majority of its total liabilities, the Company
has also utilized other borrowing sources, namely Federal Home Loan Bank
advances.
Liquidity management is both a daily and long-term function. Excess liquidity is
generally invested in short-term investments such as Federal Home Loan Bank
overnight deposits. On a longer-term basis, the Company maintains a strategy of
investing in various lending and investment securities products. The Company
uses its sources of funds to primarily fund loan commitments and maintain a
substantial portfolio of investment securities, and to meet its ongoing
commitments to pay maturing savings certificates and other deposits. At
September 30, 2004, the Company had $814 thousand in commitments to fund loan
originations. In addition, at such date the Company had undisbursed loans in
process for construction loans of $27.2 million and $86.7 million in undisbursed
lines of credit. Management of the Company believes that the Company has
adequate resources, including principal prepayments and repayments of loans and
investment securities and borrowing capacity, to fund all of its commitments to
the extent required.
The Company's current dividend policy is to declare a regular quarterly dividend
with the intent that the level of the dividend per share be reviewed and
determined by the Board of Directors on a quarterly basis. Dividends will be in
the form of cash and/or stock after giving consideration to all aspects of the
Company's performance for the current and prior quarter and other relevant
aspects. On August 25, 2004, the Board of Directors declared a 5% stock dividend
and a quarterly cash dividend of $.105 per share, both of which were paid on
September 30, 2004. Cash dividends from the Holding Company are primarily
dependent upon dividends paid to it by First Financial and/or Phila. Corp.,
which, in turn, are subject to certain restrictions established by federal
regulators and Pennsylvania law.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises primarily from the interest rate risk inherent
in its lending, investments and deposit taking activities. To that end,
management actively monitors and manages its interest rate risk exposure. At
September 30, 2004, the Company's management believes that the interest rate
exposure has not significantly changed since disclosed at June 30, 2004.
The primary asset/liability management goal of the Company is to manage and
control its interest rate risk, thereby reducing its exposure to fluctuations in
interest rates, and achieving sustainable growth in net interest income over the
long term. Other objectives of asset/liability management include: (1) ensuring
adequate liquidity and funding, (2) maintaining a strong capital base and (3)
maximizing net interest income opportunities.
In general, interest rate risk is mitigated by closely matching the maturities
or repricing periods of interest-sensitive assets and liabilities to ensure a
favorable interest rate spread. Management regularly reviews the Company's
interest-rate sensitivity, and uses a variety of strategies as needed to adjust
that sensitivity within acceptable tolerance ranges established by management.
Changing the relative proportions of fixed-rate and adjustable-rate assets and
liabilities is one of the primary strategies utilized by the Company to
accomplish this objective.
22
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest-rate sensitive" and by
monitoring an institution's interest-sensitivity gap. An interest-sensitivity
gap is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities repricing within a
defined period and is considered negative when the amount of interest-rate
sensitive liabilities exceeds the amount of interest-rate sensitive assets
repricing within a defined period.
To provide a more accurate one-year gap position of the Company, certain deposit
classifications are based on the interest-rate sensitive attributes and not on
the contractual repricing characteristics of these deposits. Management
estimates, based on historical trends of the Bank's deposit accounts, that money
market deposits are sensitive to interest rate changes. Accordingly, some of the
interest sensitive portions of such liabilities are classified in the less than
one-year categories with the remainder placed in the other categories. Deposit
products with interest rates based on a particular index are classified
according to the specific repricing characteristic of the index. Deposit rates
other than time deposit rates are variable, and changes in deposit rates are
typically subject to local market conditions and management's discretion and are
not indexed to any particular rate.
Generally, during a period of rising interest rates, a positive gap would result
in an increase in net interest income while a negative gap would adversely
affect net interest income. However, the interest sensitivity table does not
provide a comprehensive representation of the impact of interest rate changes on
net interest income. Each category of assets or liabilities will not be affected
equally or simultaneously by changes in the general level of interest rates.
Even assets and liabilities, which contractually reprice within the same period
may not, in fact, reprice at the same price or the same time or with the same
frequency. It is also important to consider that the table represents a specific
point in time. Variations can occur as the Company adjusts its interest
sensitivity position throughout the year. Although interest rate sensitivity gap
is a useful measurement and contributes towards effective asset/liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure. An alternative methodology is to estimate the changes in
the Company's portfolio equity over a range of interest rate scenarios.
The Company periodically identifies certain loans as held for sale at the time
of origination, primarily consisting of fixed-rate, single-family residential
mortgage loans which meet the underwriting characteristics of certain
government-sponsored enterprises (conforming loans). The Company regularly
re-evaluates its policy and revises it as deemed necessary. The majority of
loans sold to date have consisted of sales of long-term, fixed-rate,
single-family residential mortgage loans in furtherance of the Company's goal of
better matching the maturities and interest-rate sensitivity of its assets and
liabilities. At September 30, 2004, the Bank was servicing $11.8 million of
loans for others, of which $2.3 million consisted of whole loans sold by the
Bank to Freddie Mac. Sales of loans produce future servicing income and provide
funds for additional lending and other purposes.
The following is an interest rate sensitivity analysis for the Bank at September
30, 2004:
23
INTEREST RATE SENSITIVITY ANALYSIS AT SEPTEMBER 30, 2004
(Dollars in thousands)
MORE THAN MORE THAN MORE THAN MORE THAN
THREE MONTHS SIX MONTHS ONE YEAR THREE YEARS
THREE MONTHS THROUGH THROUGH THROUGH THROUGH MORE THAN
OR LESS SIX MONTHS ONE YEAR THREE YEARS FIVE YEARS FIVE YEARS TOTAL
----------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Loans: (1)
Real estate (2) $ 63,768 $ 15,284 $ 30,337 $ 73,833 $ 41,895 $ 12,524 $237,641
Commercial business 40,095 1,419 2,592 7,644 1,971 -- 53,721
Consumer 52,449 4,335 7,882 23,060 13,599 14,791 116,116
Securities and interest-bearing deposits (3) 55,584 9,792 18,212 49,279 39,158 31,014 203,039
----------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS $211,896 $ 30,830 $ 59,023 $153,816 $ 96,623 $ 58,329 $610,517
----------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 1,628 $ 1,629 $ 3,261 $ 13,083 $ 13,144 $ -- $ 32,745
NOW accounts 1,571 1,572 3,147 12,627 12,693 32,021 63,631
Money market accounts 126,171 1,693 3,396 10,440 7,289 -- 148,989
Certificate accounts 22,673 12,785 24,669 35,473 15,942 1,858 113,400
Repo sweep 18,265 -- -- -- -- -- 18,265
Borrowings 40,000 8,535 1,085 11,746 34,195 34,678 130,239
----------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES $210,308 $ 26,214 $ 35,558 $ 83,369 $ 83,263 $ 68,557 $507,269
----------------------------------------------------------------------------------
Cumulative (deficit) excess of interest-earning
assets $ 1,588 $ 6,204 $ 29,669 $100,116 $113,476 $103,248 $103,248
======== ======== ======== ======== ======== ======== ========
to interest-bearing liabilities
Cumulative ratio of interest rate-sensitive
assets to interest rate-sensitive liabilities 100.8% 102.6% 110.9% 128.2% 125.9% 120.4% 120.4%
======== ======== ======== ======== ======== ======== ========
CUMULATIVE DIFFERENCE AS A PERCENTAGE OF
TOTAL ASSETS 0.2% 1.0% 4.6% 15.6% 17.7% 16.1% 16.1%
======== ======== ======== ======== ======== ======== ========
(1) Net of undisbursed loan proceeds.
(2) Includes commercial mortgage loans.
(3) Excludes SFAS 115 available for sale adjustment.
Certain shortcomings are inherent in the method of analysis presented in the
table above. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features, which restrict changes in interest rates both on a short-term basis
and over the life of the asset. Further, in the event of changes in interest
rates, prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the table. Finally, the ability of many
borrowers to service their adjustable-rate loans may decrease in the event of an
interest rate increase.
24
ITEM 4. CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" ("Disclosure Controls") in accordance with
the provisions of Rules 13a-14 and 13a-15 of the Securities Exchange Act of
1934. This evaluation ("Controls Evaluation") was done under the supervision and
with the participation of management, including the Chief Executive Officer and
Chief Financial Officer.
Disclosure Controls are the Company's controls and other procedures that are
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by the Company in the reports that it files under the Exchange
Act is accumulated and communicated to the Company's management, including its
CEO and CFO, as appropriate to allow timely decisions regarding required
disclosure.
Based upon the Controls Evaluation, the CEO and CFO have concluded that the
Disclosure Controls are effective to timely alert management to material
information relating to the Company, including its consolidated subsidiaries,
during the period for which its periodic reports are being prepared.
In accord with SEC requirements, the CEO and CFO note that, since the date of
the Controls Evaluation to the date of this Quarterly Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
25
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in legal proceedings occurring in the ordinary
course of business which management believes will not have a material
adverse effect on the financial condition or operations of the Company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
(a) The following exhibits are filed as part of this Form 10-Q.
INDEX TO EXHIBITS
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as amended, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 dated November 9, 2004
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as amended, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 dated November 9, 2004
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 9, 2004
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 9, 2004
26
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.
Chester Valley Bancorp Inc.
Date 11/09/04 /s/ Donna M. Coughey
------------------------------ -----------------------------------------
Donna M. Coughey
President and Chief Executive Officer
Date 11/09/04 /s/ Joseph T. Crowley
------------------------------ -----------------------------------------
Joseph T. Crowley
CFO and Treasurer
27