UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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COMMISSION FILE 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
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(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
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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) 5,161,299
------------------------------ ----------------------------
(Title of Each Class) (Number of Shares Outstanding
as of May 1, 2005)
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
INDEX
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PAGE
PART 1. FINANCIAL INFORMATION NUMBER
- ------- --------------------- ------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 2005 and June 30, 2004 (Unaudited) 1
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2005 and 2004 (Unaudited) 2
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended March 31, 2005 and 2004 (Unaudited) 3
STATEMENTS OF OTHER COMPREHENSIVE INCOME
Three Months and Nine Months Ended March 31, 2005 and 2004 (Unaudited) 4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended March 31, 2005 and 2004 (Unaudited) 5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6 - 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 17 - 28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 28 - 31
ITEM 4. CONTROLS AND PROCEDURES 32
PART 2. OTHER INFORMATION
- --------------------------
ITEM 1. LEGAL PROCEEDINGS 33
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS 33
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 33
ITEM 5. OTHER INFORMATION 33
ITEM 6. EXHIBITS 34
SIGNATURES 35
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CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
MARCH 31, JUNE 30,
2005 2004
----------------------
(UNAUDITED)
ASSETS $ 14,003 $ 12,844
Cash in banks 2,541 15,352
Interest-bearing deposits
--------- ---------
TOTAL CASH AND CASH EQUIVALENTS 16,544 28,196
--------- ---------
Trading account securities 13 8
Investment securities available for sale 130,698 130,089
Investment securities held to maturity (fair value -
March 31, 2005, $60,341
June 30, 2004, $57,779) 61,352 59,384
Loans held for sale 747 538
Loans receivable 436,984 401,965
Deferred fees (420) (508)
Allowance for loan losses (6,793) (6,331)
--------- ---------
Loans receivable, net 429,771 395,126
--------- ---------
Accrued interest receivable 3,236 2,652
Property and equipment - net 14,083 13,009
Bank owned life insurance 5,579 5,414
Real estate owned 54 54
Goodwill 2,416 1,171
Intangible assets 806 384
Other assets 9,102 6,083
--------- ---------
TOTAL ASSETS $ 674,401 $ 642,108
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 456,936 $ 427,103
Securities sold under agreements to repurchase 21,875 27,216
Advance payments by borrowers for taxes and insurance 977 1,433
Federal Home Loan Bank advances 127,086 120,963
Trust preferred securities 10,310 10,310
Accrued interest payable 736 679
Other liabilities 2,249 2,147
--------- ---------
TOTAL LIABILITIES 620,169 589,851
--------- ---------
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;
5,161,911 and 4,876,484 shares issued and outstanding
at March 31, 2005 and June 30, 2004, respectively 5,162 4,876
Additional paid-in capital 41,527 36,247
Retained earnings - partially restricted 10,149 13,303
Treasury stock (612 and 583 shares at March 31, 2005 and June 30,
2004, respectively, at cost) (13) (13)
Accumulated other comprehensive loss, net (2,593) (2,156)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 54,232 52,257
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 674,401 $ 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 MARCH 31,
----------------------------
2005 2004
----------- -----------
(UNAUDITED)
INTEREST INCOME:
Loans $ 6,378 $ 5,690
Mortgage-backed securities 431 396
Interest-bearing deposits 39 16
Investment securities:
Taxable 1,300 844
Non-taxable 339 423
----------- -----------
TOTAL INTEREST INCOME 8,487 7,369
----------- -----------
INTEREST EXPENSE:
Deposits 1,419 1,258
Securities sold under agreements to repurchase 87 21
Short-term borrowings 65 70
Long-term borrowings 1,501 1,275
----------- -----------
TOTAL INTEREST EXPENSE 3,072 2,624
----------- -----------
NET INTEREST INCOME 5,415 4,745
Provision for loan losses 112 180
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,303 4,565
----------- -----------
OTHER INCOME:
Investment services income 1,014 1,096
Service charges and fees 1,037 716
Gain on the sale of:
Loans 129 15
Available for sale securities 32 378
Other 110 108
----------- -----------
TOTAL OTHER INCOME 2,322 2,313
----------- -----------
OPERATING EXPENSES:
Salaries and employee benefits 3,092 2,825
Occupancy and equipment 867 752
Data processing 272 278
Advertising 114 89
Deposit insurance premiums 15 15
Merger and integration charges 439 --
Debt prepayment fees 1,608 --
Other 1,173 785
----------- -----------
TOTAL OPERATING EXPENSES 7,580 4,744
----------- -----------
Income before income taxes 45 2,134
Income tax (benefit) expense (149) 528
----------- -----------
NET INCOME $ 194 $ 1,606
=========== ===========
EARNINGS PER SHARE (1)
Basic $ 0.04 $ 0.32
=========== ===========
Diluted $ 0.04 $ 0.30
=========== ===========
DIVIDENDS PER SHARE PAID DURING PERIOD (1) $ 0.11 $ 0.10
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING (1)
Basic 5,154,885 5,096,848
=========== ===========
Diluted 5,399,024 5,292,764
=========== ===========
(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.
See accompanying notes to unaudited consolidated financial statement.
2
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except for Per Share Amounts)
NINE MONTHS ENDED MARCH 31,
--------------------------
2005 2004
----------- -----------
(UNAUDITED)
INTEREST INCOME:
Loans $ 18,280 $ 17,682
Mortgage-backed securities 1,217 1,145
Interest-bearing deposits 74 47
Investment securities:
Taxable 3,905 2,040
Non-taxable 1,030 1,320
----------- -----------
TOTAL INTEREST INCOME 24,506 22,234
----------- -----------
INTEREST EXPENSE:
Deposits 4,075 3,996
Securities sold under agreements to repurchase 201 79
Short-term borrowings 270 130
Long-term borrowings 4,228 3,833
----------- -----------
TOTAL INTEREST EXPENSE 8,774 8,038
----------- -----------
NET INTEREST INCOME 15,732 14,196
Provision for loan losses 470 856
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 15,262 13,340
----------- -----------
OTHER INCOME:
Investment services income 3,202 3,204
Service charges and fees 2,644 2,243
Gain on the sale of:
Loans 282 100
Available for sale securities 290 1,012
Other 346 338
----------- -----------
TOTAL OTHER INCOME 6,764 6,897
----------- -----------
OPERATING EXPENSES:
Salaries and employee benefits 8,944 7,955
Occupancy and equipment 2,350 2,176
Data processing 796 737
Advertising 277 168
Deposit insurance premiums 47 46
Merger and integration charges 439 --
Debt prepayment fees 1,608 --
Other 3,260 2,961
----------- -----------
TOTAL OPERATING EXPENSES 17,721 14,043
----------- -----------
Income before income taxes 4,305 6,194
Income tax expense 984 1,476
----------- -----------
NET INCOME $ 3,321 $ 4,718
=========== ===========
EARNINGS PER SHARE (1)
Basic $ 0.65 $ 0.93
=========== ===========
Diluted $ 0.62 $ 0.90
=========== ===========
DIVIDENDS PER SHARE PAID DURING PERIOD (1) $ 0.32 $ 0.30
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING (1)
Basic 5,141,423 5,074,308
=========== ===========
Diluted 5,334,583 5,264,381
=========== ===========
(2) 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.
See accompanying notes to unaudited consolidated financial statement.
3
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
STATEMENTS OF OTHER COMPREHENSIVE INCOME
(Dollars in Thousands)
THREE MONTHS ENDED
MARCH 31,
---------------------------
2005 2004
----------- ---------
(Unaudited)
NET INCOME $ 194 $ 1,606
Other comprehensive income, net of tax:
Net unrealized holding (losses) gains on securities available for sale
during the period (834) 826
Reclassification adjustment for (gains)
included in net income (21) (249)
Net unrealized gain (loss) on cash flow hedge 230 (97)
----------- ----------
COMPREHENSIVE INCOME $ (431) $ 2,086
=========== =========
NINE MONTHS ENDED
MARCH 31,
---------------------------
2005 2004
----------- ---------
(Unaudited)
NET INCOME $ 3,321 $ 4,718
Other comprehensive income, net of tax:
Net unrealized holding (losses) gains on securities available for sale
during the period (371) 608
Reclassification adjustment for (gains)
included in net income (191) (668)
Net unrealized gain (losses) on cash flow hedge 125 (338)
---------- ---------
COMPREHENSIVE INCOME $ 2,884 $ 4,320
========== =========
See accompanying notes to unaudited consolidated financial statements.
4
CHESTER VALLEY BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
NINE MONTHS ENDED MARCH 31,
----------------------------
2005 2004
- ------------------------------------------------------------------------------------------------ -----------
(Unaudited)
Net income $ 3,321 $ 4,718
Add (deduct) items not affecting cash flows provided by operating activities:
Depreciation 758 748
Provision for loan losses 470 856
Gain on sale of securities available for sale (290) (1,012)
Originations of loans held for sale (13,739) (10,975)
Proceeds from sale of loans held for sale 13,812 14,565
Gain on sale of loans held for sale (282) (100)
Amortization of deferred loan fees, discounts and premiums (219) (33)
(Increase) in trading account securities (5) --
Increase in accrued interest receivable (564) (292)
Increase in value of bank owned life insurance (165) (193)
(Increase) decrease in other assets (2,453) (1,584)
(Decrease) increase in other liabilities 101 1,893
(Decrease) increase in accrued interest payable 25 11
- --------------------------------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 770 8,602
- --------------------------------------------------------------------------------------------------------------------
Cash flows used in investment activities:
Capital expenditures (1,219) (837)
Net increase in loans (29,278) (10,491)
Purchase of investment securities (11,854) (26,458)
Proceeds from maturities, payments and calls of investment securities 10,212 12,440
Purchase of securities available for sale (43,070) (91,822)
Proceeds from sales and calls of securities available for sale 41,795 86,401
Net cash and cash equivalents received from branch acquisition 7,216 13,437
- --------------------------------------------------------------------------------------------------------------------
Net cash flows used in investment activities (26,198) (17,330)
- --------------------------------------------------------------------------------------------------------------------
Cash flows provided by financing activities
Net (decrease) increase in deposits before interest credited 11,038 (3,509)
Interest credited to deposits 3,321 3,422
Decrease in securities sold under agreements to repurchase (5,341) (8,426)
Proceeds from FHLB advances 58,738 69,393
Repayments of FHLB advances (52,615) (39,873)
Decrease in advance payments by borrowers for taxes and insurance (456) (716)
Cash dividends on common stock (1,595) (1,477)
Payment for fractional shares (10) (7)
Stock options exercised 696 881
- --------------------------------------------------------------------------------------------------------------------
Net cash flows provided by financing activities 13,776 19,688
- --------------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (11,652) 10,960
CASH AND CASH EQUIVALENTS:
Beginning of period 28,196 25,749
------------ -----------
End of period $ 16,544 $ 36,709
============ ===========
SUPPLEMENTAL DISCLOSURES:
Cash payments during the year for:
Taxes $ 1,120 $ 1,025
Interest $ 8,717 $ 7,992
NON-CASH ITEMS:
Stock dividend issued $ 4,869 $ 5,075
Net unrealized (loss) gain on investment securities available for sale, net of tax $ (562) $ (60)
Net unrealized loss on cash flow hedge $ 125 $ (338)
ACQUISITIONS:
In conjunction with the branch acquisition, liabilities assumed and assets
acquired were as follows:
Assets acquired net of cash and cash equivalents received $ 8 291 $ 6,173
Cash and cash equivalents received $ 7,216 $ 13,437
Liabilities assumed $ 15,507 $ 19,610
See accompanying notes to unaudited consolidated financial statements.
5
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" and sometimes referred to as
"Chester Valley") 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. The Company also operates
a full service investment advisory and securities brokerage business through its
association with Philadelphia Corporation for Investment Services ("Phila.
Corp."). 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 thirteen 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 as 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- and
nine-month unaudited interim periods.
6
The results of operations for the three- and nine-month periods ended March 31,
2005 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.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in accordance with the purchase method of accounting. Other
intangibles represent primarily the net present value of the future economic
benefits to be derived from the purchase of core deposits ("core deposit
intangible"), which are being amortized on an accelerated basis over their
estimated useful lives of approximately eight years. Effective July 1, 2001, the
Company adopted certain provisions of Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," as required
for goodwill and intangible assets resulting from business combinations
consummated after June 30, 2001. For all business combinations completed after
June 30, 2001, such as the acquisition of the Coatesville and Avondale Branches
from PNC National Bank, goodwill is deemed to have an indefinite life and is
therefore not amortized, but is subject to annual impairment tests.
The Company adopted the remaining provisions of SFAS No. 142 on April 1, 2002.
Under these rules, all goodwill and intangible assets deemed to have indefinite
lives are no longer amortized, but are subject to annual impairment tests in
accordance with the provisions of SFAS No. 142. Other intangible assets continue
to be amortized over their estimated useful lives.
MORTGAGE SERVICING RIGHTS
The Company originates and sells real estate loans to investors in the secondary
mortgage market. After the sale, the Company may retain the right to service
these loans. When originated mortgage loans are sold and servicing is retained,
a servicing asset is capitalized based on relative fair value at the date of
sale. Servicing assets are amortized as an offset to other fees in proportion
to, and over the period of, estimated net servicing income. The unamortized cost
is included in other assets in the accompanying consolidated balance sheet. The
servicing rights are periodically evaluated for impairment based on their
relative fair value.
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.
7
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 NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------- ----------------------
2005 2004 2005 2004
--------------------- ----------------------
Net income, as reported $ 194 $ 1,606 $ 3,321 $ 4,718
Deduct: Total stock-based compensation expense
determined under fair value based method for all
awards, net of related tax effects (70) (71) (216) (195)
--------------------- ----------------------
Pro forma net income $ 124 $ 1,535 $ 3,105 $ 4,523
===================== ======================
Earnings per share:
Basic - as reported $ 0.04 $ 0.32 $ 0.65 $ 0.93
===================== ======================
Basic - pro forma $ 0.02 $ 0.30 $ 0.60 $ 0.89
===================== ======================
Diluted - as reported $ 0.04 $ 0.30 $ 0.62 $ 0.90
===================== ======================
Diluted - pro forma $ 0.02 $ 0.29 $ 0.58 $ 0.86
===================== ======================
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.
8
The following table sets forth the computation of basic and diluted earnings per
share (dollars in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------- -----------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Numerator:
Net income $ 194 $ 1,606 $ 3,321 $ 4,718
========== ========== ========== ==========
Denominator:
Denominator for basic per share-
weighted average shares 5,154,885 5,096,848 5,141,423 5,074,308
Effect of dilutive securities:
Stock options 244,139 195,916 193,160 190,073
---------- ---------- ---------- ----------
Denominator for diluted earnings
per share-adjusted weighted
Average shares and assumed
Exercise 5,399,024 5,292,764 5,334,583 5,264,381
========== ========== ========== ==========
Basic earnings per share $ 0.04 $ 0.32 $ 0.65 $ 0.93
========== ========== ========== ==========
Diluted earnings per share $ 0.04 $ 0.30 $ 0.62 $ 0.90
========== ========== ========== ==========
The number of anti-dilutive stock options excluded was 0 and 48,038 for the
three- and nine-month periods ended March 31, 2005 and 48,563 for the same
periods in 2004.
NOTE 2 - PENDING ACQUISITION
On January 20, 2005, Chester Valley Bancorp Inc. ("Chester Valley") and Willow
Grove Bancorp, Inc. ("Willow Grove") announced that they had entered into an
Agreement and Plan of Merger, dated as of January 20, 2005 (the "Merger
Agreement"), which sets forth the terms and conditions pursuant to which Chester
Valley will be merged with and into Willow Grove (the "Merger"). The Merger
Agreement provides, among other things, that as a result of the Merger each
outstanding share of common stock of Chester Valley, par value $1.00 per share
("Chester Valley Common Stock"), (subject to certain exceptions) will be
converted into the right to receive either $27.90 in cash or 1.4823 shares of
common stock of Willow Grove, par value $0.01 per share ("Willow Grove Common
Stock"), plus cash in lieu of any fractional share interest, subject to the
election and allocation procedures set forth in the Agreement which are intended
to ensure that approximately 64.8% of the outstanding shares of Chester Valley
Common Stock will be converted into the right to receive Willow Grove Common
Stock and 35.2% of the outstanding shares of Chester Valley Common Stock will be
converted into the right to receive cash. Outstanding Chester Valley stock
options will, at the election of the option holder, be cancelled in exchange for
a cash payment per option share based on the difference between $27.90 and the
applicable option exercise price, or converted into options to purchase an
equivalent number of shares of Willow Grove Common Stock, adjusted based on a
1.4823 per share exchange ratio.
9
Consummation of the Merger is subject to a number of customary conditions,
including but not limited to (i) the approval of the Agreement by the
shareholders of both Willow Grove and Chester Valley and (ii) the receipt of
requisite regulatory approvals of the Merger and the proposed merger of Chester
Valley's banking subsidiary, First Financial, with and into Willow Grove's
banking subsidiary, Willow Grove Bank, following consummation of the Merger. The
Merger is intended to qualify as a reorganization for federal income tax
purposes, such that the shares of Chester Valley exchanged for Willow Grove
Common Stock will be issued to Chester Valley shareholders on a tax-free basis.
The Merger Agreement contains certain termination rights for each of Willow
Grove and Chester Valley and further provides that, upon termination of the
Merger Agreement under specified circumstances, Chester Valley may be required
to pay to Willow Grove a termination fee of $6.0 million.
The Boards of Directors of Willow Grove and Chester Valley have approved the
definitive agreement. The transaction is subject to all required regulatory
approvals, the approval by the shareholders of Chester Valley and Willow Grove
and other customary conditions. The transaction is expected to close in the
third calendar quarter of 2005 with operational integration to follow soon
after.
NOTE 3 - LOANS RECEIVABLE
Loans receivable are summarized as follows (in thousands):
MARCH 31, June 30,
2005 2004
--------- ---------
First mortgage loans:
Residential real estate $ 56,286 $ 74,004
Construction-residential 28,550 18,745
Land acquisition and development 29,387 13,928
Commercial real estate 154,506 140,721
Construction-commercial 14,393 16,187
Commercial business 66,435 49,142
Consumer 129,945 114,787
--------- ---------
TOTAL LOANS 479,502 427,514
--------- ---------
Less:
Undisbursed loan proceeds:
Construction-residential and land
acquisition and development (35,403) (16,223)
Construction-commercial (7,115) (9,326)
Deferred loan fees - net (420) (508)
Allowance for loan losses (6,793) (6,331)
--------- ---------
NET LOANS $ 429,771 $ 395,126
========= =========
NOTE 4 - 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
10
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.
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
March 31, 2005 and June 30, 2004, the recorded investment in impaired loans was
$3.0 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 5 - COMMITMENTS
Commitments to potential mortgagors of the Bank amounted to $2.0 million as of
March 31, 2005, all of which were fixed-rate loans (primarily consisting of
single-family residential mortgages) bearing interest rates of between 5.88% and
6.09%. At March 31, 2005, the Company had $42.5 million of undisbursed
construction loan funds as well as $100.1 million of undisbursed remaining
consumer and commercial line balances.
NOTE 6 - 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 March 31, 2004, the Company
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.
11
NOTE 7 - 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.
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 March 31, 2005 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
March 31, 2005 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 MARCH 31, 2005:
HOLDING COMPANY
Total risk-based capital ratio
(to risk-weighted assets) $69,930 13.71% $40,820 8.00% $51,025 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $63,547 12.45% $20,410 4.00% $30,615 6.00%
Tier 1 leverage ratio
(to average assets) $63,547 9.47% $26,833 4.00% $33,541 5.00%
BANK
Total risk-based capital ratio
(to risk-weighted assets) $67,916 13.38% $40,611 8.00% $50,764 10.00%
Tier 1 risk-based capital ratio
(to risk-weighted assets) $61,572 12.13% $20,305 4.00% $30,458 6.00%
Tier 1 leverage ratio
(to average assets) $61,572 9.28% $26,527 4.00% $33,158 5.00%
12
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------------- ------------------------ -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ---------- ----------- -------- ----------- ----------
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%
NOTE 8 - 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 March 31, 2005, 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 an
interest rate swap transaction aggregating $20.0 million notional amount to
hedge certain of its higher rate Federal Home Loan Bank Advances. The swap 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 March
31, 2005 was $828 thousand.
13
NOTE 9 - SEGMENT REPORTING
The Company has two reportable segments: First Financial and Phila. Corp. First
Financial operates a branch bank network with thirteen 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.
The following table highlights income statement and balance sheet information
for each of the segments at or for March 31, 2005 and 2004 (in thousands):
AT AND DURING THE THREE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------------
2005 2004
--------------------------------------- ------------------------------------------
PHILA. PHILA.
BANK CORP. TOTAL BANK CORP. TOTAL
----------- --------- ----------- ------------ --------- ----------
Net interest income $ 5,407 $ 8 $ 5,415 $ 4,743 $ 2 $ 4,745
Other income 1,396 926 2,322 1,326 987 2,313
Total net income 102 92 194 1,508 98 1,606
Total assets 672,370 2,031 674,401 628,295 2,065 630,360
Total interest-
bearing deposits 822 1,719 2,541 24,704 1,731 26,435
Total trading securities -- 13 13 -- 10 10
AT AND DURING THE NINE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------------
2005 2004
--------------------------------------- ------------------------------------------
PHILA. PHILA.
BANK CORP. TOTAL BANK CORP. TOTAL
----------- --------- ----------- ------------ --------- ----------
Net interest income $ 15,715 $ 17 $ 15,732 $ 14,190 $ 6 $ 14,196
Other income 3,981 2,783 6,764 4,073 2,824 6,897
Total net income 3,048 273 3,321 4,421 297 4,718
Total assets 672,370 2,031 674,401 628,295 2,065 630,360
Total interest-
bearing deposits 822 1,719 2,541 24,704 1,731 26,435
Total trading securities -- 13 13 -- 10 10
14
NOTE 10 - 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 March 31, 2005, 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 March 31, 2005 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.
ACCOUNTING FOR STOCK BASED COMPENSATION SFAS NO. 123R
In December 2004 the Financial Accounting Standards Board revised Statement No.
123, "Accounting for Stock Based Compensation" ("SFAS 123r"). SFAS 123r required
that the fair-value-based method of accounting for stock options be used for all
public entities and eliminates alternative accounting methods; consequently,
similar economic transactions will be accounted for similarly. Entities are
required to estimate the number of instruments for which the requisite service
is expected to be rendered as compared to the original statement which permitted
entities to account for forfeitures as they occur. In addition, SFAS 123r amends
SFAS No. 95, "Statement of Cash Flows," to require that excess tax benefits be
reported as a financing cash inflow rather than as a reduction of taxes paid.
Incremental compensation cost for a modification of the terms or conditions of
an award is measured by comparing the fair value of the modified award with the
fair value of the award immediately before the modification. On April 14, 2005
the Securities and Exchange Commission amended the compliance dates for SFAS
123r. Under the amended compliance dates, SFAS 123r becomes effective for public
entities that do not file as small business issuers, as of the beginning of the
first fiscal reporting period that begins after June 15, 2005. SFAS 123r applies
to all awards granted after the required effective date and to awards modified,
repurchased, or cancelled after that date. As of the required effective date,
all public entities that used the fair-value-based method for either recognition
or disclosure under the original statement will apply SFAS 123r using a modified
version of prospective application. Under that transition
15
method, compensation cost is recognized on or after the required effective date
for the portion of outstanding awards for which the requisite service has not
yet been rendered, based on the grant-date fair value of those awards calculated
under the original statement for either recognition or pro forma disclosures.
For periods before the required effective date, those entities may elect to
apply a modified version of retrospective application under which financial
statements for prior periods are adjusted on a basis consistent with the pro
forma disclosures required for those periods by the original statement. Pro
forma disclosures under the original statement are presented in Note 1
"Stock-Based Compensation." The Company does not anticipate recording expense
significantly different than what is presented in Note 1.
NOTE 11 - 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.
Effective December 10, 2004, in order to further enhance its existing branch
network, First Financial Bank acquired the Avondale, Chester County,
Pennsylvania branch of PNC National Bank. As a result of the acquisition, First
Financial Bank assumed approximately $9.1 million of deposit liabilities and
acquired $5.8 million in consumer and commercial loans and buildings of $613
thousand. Additionally, the Company recorded an approximate $221 thousand Core
Deposit Intangible and $1.2 million in goodwill. The acquisition was accounted
for using the purchase method of accounting. The following table details the
assets acquired and liabilities assumed as a result of the branch acquisitions
(Dollars in thousands):
ASSETS ACQUIRED: FIRSTRUST AVONDALE TOTAL
--------------------------------------------------------------------------
Cash on hand $ 6,184 $ 1,032 $ 7,216
Loans -- 5,842 5,842
Premise and equipment -- 613 613
Goodwill -- 1,136 1,136
Core deposit intangible 273 221 494
Other assets -- 206 206
--------------------------------------------------------------------------
Total assets acquired $ 6,457 $ 9,050 $ 15,507
==========================================================================
Deposits $ 6,457 $ 9,050 $ 15,507
--------------------------------------------------------------------------
Total liabilities assumed $ 6,457 $ 9,050 $ 15,507
==========================================================================
16
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, whether and when the merger
transaction described in Note 2 of Item 1 above will occur and the effects of
such mergers, 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.
17
BUSINESS STRATEGY
GROWTH. The Company seeks to increase its assets primarily through internal
growth but may 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 $34.6 million,
or 8.8%, from $395.1 million at June 30, 2004 to $429.8 million at March 31,
2005. Excluding residential mortgage loans, which continued to decline, the loan
portfolio grew $52.4 million or 16.3% 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. In December 2004, the Company completed the
acquisition of the Avondale branch from PNC National Bank, which resulted in
increased consumer loans of $5.9 million and the assumption of approximately
$9.1 million in deposit liabilities. Core deposits increased by $17.2 million,
or 5.0% from $347.0 million at June 30, 2004 to $364.2 million at March 31,
2005. This increase is primarily due to inflows 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
61.2% of its total loan portfolio at March 31, 2005 compared to 55.8% at June
30, 2004. Single-family and multi-family residential loans comprised 11.7% of
the Company's loan portfolio at March 31, 2005 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
decreased to $3.4 million at March 31, 2005 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 $2.0 million at March 31, 2005 and $2.9 million at June
30, 2004. 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 the $2.9 million non-performing commercial
mortgage mentioned above. Additionally, the borrower prepaid interest as a
condition to the Bank's extension of the maturity date on the remaining balance
of the loan.
18
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, $192.1 million at March 31, 2005 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 $2.5 million
at March 31, 2005 compared to $15.4 million at June 30, 2004.
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 excluding securities sold under agreements to
repurchase, totaled $342.3 million or 74.9% of the Company's total deposits at
March 31, 2005, as compared to $319.7 million or 74.9% at June 30, 2004. This
increase in lower costing deposits is primarily attributable to the continuing
effort to grow core deposits, both internally and through the acquisitions of
branch deposits from Firstrust Bank and the Avondale branch from PNC Bank.
Pursuant to the Company's strategy, the major focus in 2005 is on increasing
commercial and consumer core deposits and relying less on higher rate
certificates of deposits, primarily municipal certificates of deposits.
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 March 31, 2005, 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 an
interest rate swap transaction aggregating $20.0 million notional amount to
hedge certain of its higher rate Federal Home Loan Bank Advances. The swap 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
19
$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.
As stated in prior announcements concerning our Company's combination with
Willow Grove Bancorp, Inc., it is intended that the combined companies would
de-leverage the balance sheet through a sale of certain assets and repayment of
FHLB borrowings. On February 15, 2005, the Company terminated an aggregate of
$21.0 million interest rate swap agreements with Morgan Keegan and received $109
thousand, which represented the current market value of the swap. The interest
rate swap was used to hedge $21.0 million in FHLB borrowings with an average
cost of 5.95%. On March 16, 2005, the Company prepaid the $21.0 million of
callable fixed rate borrowings resulting in a prepayment penalty of
approximately $1.6 million on a pre-tax basis ($1.1 million after tax). The
repayment was done with available cash on hand as well as the sale of certain
investment securities and fixed rate loans. The repayment is expected to
positively impact the Company's future net interest margin and operating results
as the cost of the borrowings was greater than the yield on the assets utilized
to fund the repayment.
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
March 31, 2005 is on Page 31.
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 31
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.
20
FINANCIAL CONDITION
-------------------
The Company's total assets increased to $674.4 million at March 31, 2005 from
$642.1 million at June 30, 2004, principally due to a $34.6 million increase in
loans receivable to $429.8 million at March 31, 2005 from $395.1 million at June
30, 2004. Net loans other than residential loans increased by $52.4 million or
16.3% 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 11.7% at March 31, 2005. In addition to the loan growth, investment
securities increased by $2.6 million, primarily through the acquisition of
agency bonds and adjustable rate mortgage-backed securities. The loan growth was
funded through a reduction in interest-bearing deposits as well as deposits
assumed in the Avondale branch acquisitions along with Federal Home Loan Bank
advance borrowings.
Deposits increased by $29.8 million due primarily to the acquisition of the
Exton branch deposits of $6.4 million from Firstrust Bank, $9.1 million from the
Avondale branch acquisition from PNC Bank and the assumption of a $10.0 million
Pennsylvania Local Government Investment Trust CD through the Federal Home Loan
Bank. Federal Home Loan Bank Advances increased $6.1 million to fund the above
noted asset growth.
Stockholders' equity increased by $2.0 million at March 31, 2005 as compared to
June 30, 2004, primarily as a result of net income of $3.3 million, the issuance
of common stock as a result of the exercise of stock options and a change in
accumulated other comprehensive income of $437 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 $1.6 million.
21
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 MARCH 31,
-----------------------------------------------------------------
2005 2004
-----------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
(DOLLARS IN THOUSANDS)
Assets:
Residential (1) $ 65,029 $ 907 5.58% $ 81,868 $ 1,173 5.73%
Construction (2) 22,192 337 6.16% 17,905 214 4.81%
Commercial real estate (1) 156,463 2,476 6.33% 144,863 2,245 6.20%
Commercial business (2) 63,828 876 5.57% 46,870 585 5.02%
Installment (2) 126,909 1,760 5.62% 108,036 1,415 5.27%
Fees -- 51 -- 73
--------- -------- ----- --------- -------- -----
Total loans 434,421 6,407 5.90% 399,542 5,705 5.71%
Securities and other investments (1) 197,982 2,236 4.52% 169,669 1,837 4.33%
--------- -------- ----- --------- -------- -----
Total interest-earning assets 632,403 8,643 5.47% 569,211 7,542 5.30%
Non-interest earning assets 41,632 36,212
--------- ---------
Total Assets $ 674,035 $ 605,423
========= =========
Liabilities and Stockholders' Equity:
DDA (2) $ 144,331 $ 42 0.12% $ 120,678 $ 37 0.12%
Savings (2) 32,473 18 0.22% 31,203 16 0.21%
MMA (2) 152,740 638 1.69% 129,383 424 1.32%
CD (2) 115,828 721 2.52% 112,989 781 2.78%
--------- -------- ----- --------- -------- -----
Total deposits 445,372 1,419 1.29% 394,253 1,258 1.28%
--------- -------- ----- --------- -------- -----
FHLB advances and other borrowings (2) 149,177 1,566 4.26% 134,428 1,345 4.02%
Repo sweep (2) 17,577 87 2.01% 15,248 21 0.55%
--------- -------- ----- --------- -------- -----
Total interest-bearing liabilities 612,126 3,072 2.04% 543,929 2,624 1.94%
Non-interest-bearing liabilities 6,723 8,820
Stockholders' equity 55,186 52,674
--------- ---------
Total liabilities and stockholders' equity $ 674,035 $ 605,423
========= =========
Net interest income/interest rate spread $ 5,571 3.43% $ 4,918 3.36%
======== ===== ======== ====
Net yield on interest-earning assets 3.52% 3.48%
===== =====
Ratio of average interest-earning assets to
interest-bearing liabilities 104% 105%
===== =====
(1) Yield calculated using 30/360 day basis.
(2) Yield /rate calculated based on the actual number of days.
22
NINE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------
2005 2004
--------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
--------- -------- ---- --------- -------- ----
(DOLLARS IN THOUSANDS)
Assets:
Residential (1) $ 68,625 $ 2,910 5.65% $ 88,388 $ 3,790 5.72%
Construction (2) 19,470 827 5.66% 18,343 660 4.80%
Commercial real estate (1) 152,216 7,136 6.25% 146,038 6,918 6.32%
Commercial business (2) 58,188 2,372 5.43% 44,783 1,718 5.12%
Installment (2) 120,415 4,897 5.42% 105,059 4,161 5.28%
Fees -- 205 -- 480
--------- -------- ---- --------- -------- ----
Total loans 418,914 18,347 5.84% 402,611 17,727 5.87%
Securities and other investments (1) 197,368 6,610 4.47% 162,044 5,046 4.15%
--------- -------- ---- --------- -------- ----
Total interest-earning assets 616,282 24,957 5.40% 564,655 22,773 5.38%
Non-interest earning assets 41,232 36,339
--------- ---------
Total Assets $ 657,514 $ 600,994
========= =========
Liabilities and Stockholders' Equity:
DDA (2) $ 141,272 $ 127 0.12% $ 123,804 $ 112 0.12%
Savings (2) 33,021 53 0.21% 31,009 48 0.21%
MMA (2) 151,083 1,689 1.49% 118,026 1,135 1.28%
CD (2) 111,896 2,206 2.63% 125,982 2,701 2.85%
--------- -------- ---- --------- -------- ----
Total deposits 437,272 4,075 1.24% 398,821 3,996 1.33%
--------- -------- ---- --------- -------- ----
FHLB advances and other borrowings (2) 139,887 4,498 4.28% 125,883 3,963 4.19%
Repo sweep (2) 18,226 201 1.47% 18,549 79 0.57%
--------- -------- ---- --------- -------- ----
Total interest-bearing liabilities 595,385 8,774 1.96% 543,253 8,038 1.97%
Non-interest-bearing liabilities 7,913 6,723
Stockholders' equity 54,216 51,018
--------- ---------
Total liabilities and stockholders'equity $ 657,514 $ 600,994
========= =========
Net interest income/interest rate spread $ 16,183 3.44% $ 14,735 3.41%
======== ===== ======== =====
Net yield on interest-earning assets 3.50% 3.47%
===== =====
Ratio of average interest-earning assets to
interest-bearing liabilities 104% 104%
===== =====
The following details the tax equivalent adjustments in the above table:
THREE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------
2005 2004
------------------------------------ -------------------------------------
INTEREST TAX ADJUSTED INTEREST TAX ADJUSTED
INCOME ADJUSTMENT INCOME INCOME ADJUSTMENT INCOME
------------------------------------ -------------------------------------
(Dollars in thousands)
Loans $ 6,378 $ 29 $ 6,407 $ 5,690 $ 15 $ 5,705
Investments 2,109 127 2,236 1,679 158 1,837
------------------------------------ -------------------------------------
Total $ 8,487 $ 156 $ 8,643 $ 7,369 $ 173 $ 7,542
==================================== =====================================
23
NINE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------------
2005 2004
------------------------------------ -------------------------------------
INTEREST TAX ADJUSTED INTEREST TAX ADJUSTED
INCOME ADJUSTMENT INCOME INCOME ADJUSTMENT INCOME
------------------------------------ -------------------------------------
(Dollars in thousands)
Loans $ 18,280 $ 67 $ 18,347 $ 17,682 $ 45 $ 17,727
Investments 6,226 384 6,610 4,552 494 5,046
------------------------------------ -------------------------------------
Total $ 24,506 $ 451 $ 24,957 $ 22,234 $ 539 $ 22,773
==================================== =====================================
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.
NINE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------
2005 COMPARED TO 2004 2004 COMPARED TO 2003
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
-------------------------------- ---------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- ------- -------- --------- ------- ---------
(Dollars in thousands)
Interest income on interest-earning assets:
Residential $ (835) $ (45) $ (880) $ (1,666) $ (722) $ (2,388)
Construction 43 124 167 29 21 50
Commercial real estate 295 (77) 218 1,108 (1,076) 32
Commercial business 544 110 654 318 (235) 83
Installment 623 113 736 1,326 (461) 865
Fees -- (275) (275) -- (345) (345)
-------------------------------- ---------------------------------
Total loans 670 (50) 620 1,115 (2,818) (1,703)
Securities & other investments 1,155 409 1,564 (70) (179) (249)
-------------------------------- ---------------------------------
Total interest income 1,825 359 2,184 1,045 (2,997) (1,952)
-------------------------------- ---------------------------------
Interest expense on interest-bearing liabilities:
DDA 15 -- 15 38 (172) (134)
Savings 5 -- 5 4 (133) (129)
MMA 350 204 554 473 (373) 100
CD (293) (202) (495) (1,379) (721) (2,100)
-------------------------------- ---------------------------------
Total interest expense on deposits 77 2 79 (864) (1,399) (2,263)
FHLB advances & other borrowings 448 87 535 588 (1,000) (412)
Repo sweep (1) 123 122 2 (67) (65)
-------------------------------- ---------------------------------
Total interest expense 524 212 736 (274) (2,466) (2,740)
-------------------------------- ---------------------------------
Net change in net interest income $ 1,301 $ 147 $ 1,448 $ 1,319 $ (531) $ 788
================================ =================================
24
Net interest income, on a fully tax equivalent basis, increased $653 thousand
and $1.4 million for the three-and nine-month periods ended March 31, 2005,
respectively, compared to the same periods in 2004. The net interest margin
increased 4 basis points and 3 basis points over the same three- and nine-month
periods. Total interest income, on a fully tax equivalent basis, increased to
$8.6 million for the three-month period ended March 31, 2005 from $7.5 million
for the same period in 2004. Total interest income, on a fully tax equivalent
basis, increased to $25.0 million for the nine-month period ended March 31,
2005, from $22.8 million for the same period in 2004 due primarily as a result
of an increase in average interest-earning assets of $51.6 million.
Total interest expense increased to $3.1 million from $2.6 million for the
three-month period ended March 31, 2005 as compared to the three-month period
ended March 31, 2004. Total interest expense increased to $8.8 million from $8.0
million for the nine-month period ended March 31, 2005 as compared to the
nine-month period ended March 31, 2004. The increases are due largely to an
increase in market interest rates over the twelve month period and balances
outstanding offset by (a) a change in the mix of the deposit base from higher
costing certificates of deposits to core deposits (Demand deposits, Savings and
Money Market Accounts) and (b) the conversion of approximately $41.0 million of
high costing fixed rate Federal Home Loan Bank Advances to lower costing
variable rates through the use of interest rate swaps entered into during the
period June 2003 through August 2003. Offsetting part of the decrease was an
increase in the average balance of interest-bearing liabilities during both the
three- and nine-month periods.
PROVISION FOR LOAN LOSSES
The provision for loan losses decreased by $68 thousand and $386 thousand for
the three- and nine-months ended March 31, 2005 as compared to the same three-
and nine-months ended March 31, 2004. The decrease is due principally to the
change in classified assets and loan volumes during the three- and nine-months
ended March 31, 2005 and 2004, respectively.
OTHER INCOME
Total other income increased $9 thousand and decreased by $133 thousand for the
three- and nine-months ended March 31, 2005 compared to the same three- and
nine-months ended March 31, 2004. The decreases are due principally to decreased
gains on the sale of securities of $346 thousand and $722 thousand for the
three- and nine-month periods, respectively. Other components of other income
increased by $355 thousand and $589 thousand for the three- and nine-months
ended March 31, 2005. The increases occurred primarily in investment services
income, including trust fees along with increases in deposit fees resultant from
a growth in transaction type deposit accounts (i.e. Consumer and business
checking, money market and savings) as well as income realized upon the sale of
single-family residential mortgage loans available for sale.
25
OPERATING EXPENSES
Total operating expenses increased by $2.8 million and $3.7 million for the
three- and nine- months ended March 31, 2005 as compared to the same period in
2004. This represents a 59.8% and 26.2% increases for the three- and nine-month
period. As previously disclosed in a Form 8-K filed with the Securities and
Exchange Commission, the Company prepaid approximately $21.0 million in Federal
Home Loan Bank Borrowings with an average cost of 5.95%, resulting in a
prepayment penalty of approximately $1.6 million. The repayment was done with
available cash on hand as well as the sale of certain investment securities and
fixed rate loans. The repayment is expected to positively impact the Company's
future net interest margin and operating results as the cost of the borrowings
was greater than the yield on the assets utilized to fund the repayment.
Additionally the Company incurred $439 thousand in merger and integration
charges related to the Company's previously announced merger with Willow Grove
Bancorp. In addition to normal salary increases for the year, the Company has
made a significant investment in its future. 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 and added an additional retail brokerage representative. In
addition the Bank expanded its branch network through the Avondale branch
acquisition from PNC National Bank in December 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 decreased by $677 thousand and $492 thousand for the three-
and nine-month periods ended March 31, 2005 as compared to the comparable
periods in 2004 due to a decrease in pre-tax income, as well as a lower relative
decline in tax exempt income, relative to the decrease in pre-tax income.
26
ASSET QUALITY
Non-performing loans totaled $3.4 million and $4.2 million at March 31, 2005 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 $2.0 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 the $2.9 million non-performing commercial mortgage
mentioned above reducing the loan balance to approximately $2.0 million.
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 March 31, 2005 and June 30, 2004, the Company's classified loans, which
consisted of loans classified as substandard, doubtful or loss, totaled $7.8
million and $9.8 million, respectively. Included in loans classified substandard
at March 31, 2005 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 March 31, 2005
were loans totaling $6.3 million, which are current but have been classified and
are being closely monitored.
At March 31, 2005, 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 March 31,
2005 was $5.8 million ($5.6 million at June 30, 2004). Two of the three bonds
with an aggregate book value of $5.1 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 March 31, 2005.
27
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 March
31, 2005, the Company had $2.0 million in commitments to fund loan originations.
In addition, at such date the Company had undisbursed loans in process for
construction loans of $42.5 million and $100.1 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. Additional cash dividends of $.105 per share were declared
and paid in December 2004 and March 2005. 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
March 31, 2005, the Company's management believes that the interest rate
exposure has not significantly changed since disclosed at June 30, 2004.
28
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.
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.
29
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 March 31, 2005, the Bank was servicing $21.3 million of loans
for others, of which $12.7 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 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.
The following is an interest rate sensitivity analysis for the Bank at March 31,
2005:
30
INTEREST RATE SENSITIVITY ANALYSIS AT MARCH 31, 2005
(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) $ 71,819 $ 16,838 $ 27,548 $ 74,571 $ 39,425 $ 10,731 $ 240,932
Commercial business 46,904 1,974 3,607 10,657 3,293 -- 66,435
Consumer 61,124 6,147 10,774 28,545 14,688 8,667 129,945
Securities and interest-bearing
deposits (3) 49,338 13,256 20,496 44,366 26,229 42,788 196,473
---------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS $229,185 $ 38,215 $ 62,425 $158,139 $ 83,635 $ 62,186 $ 633,785
---------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 1,644 $ 1,645 $ 3,293 $13,211 $ 13,274 $ -- $ 33,067
NOW accounts 1,625 1,626 3,256 13,065 13,134 33,136 65,842
Money market accounts 135,736 1,504 3,016 10,152 8,250 -- 158,658
Certificate accounts 32,126 10,669 14,709 37,954 18,003 1,160 114,621
Repo sweep 21,875 -- -- -- -- -- 21,875
Borrowings 25,913 6,043 2,650 34,796 28,038 29,646 127,086
---------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES $218,919 $ 21,487 $ 26,924 $109,178 $80,699 $ 63,942 $ 521,149
---------------------------------------------------------------------------------------
Cumulative (deficit) excess of
interest-earning assets to
interest-bearing liabilities $ 10,266 $ 26,994 $ 62,495 $111,456 $ 114,392 $ 112,636 $ 112,636
============ ======== ========= ======== ========= ========= =========
Cumulative ratio of interest
rate-sensitive assets to interest
rate-sensitive liabilities 104.7% 111.2% 123.4% 129.6% 125.0% 121.6% 121.6%
============ ======== ========= ======== ========= ========= =========
CUMULATIVE DIFFERENCE AS A PERCENTAGE OF
TOTAL ASSETS 1.5% 4.0% 9.3% 16.6% 17.0% 16.8% 16.8%
============ ======== ========= ======== ========= ========= =========
(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.
31
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-15 and 15d-15(c) 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 over financial reporting or in other
factors that could significantly affect internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
32
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.
On March 1, 2005, First Financial received a subpoena for the production of
documents from the Regional Municipal Securities Counsel in the
Philadelphia Office of the Securities and Exchange Commission (the "SEC").
The subpoena arises out of a non-public SEC investigation titled
"Hummelstown General Authority," which Authority issued non-rated revenue
bonds now in default, underwritten by the firm of a former director of
Chester Valley and First Financial. The SEC subpoena seeks documents
concerning First Financial's involvement with non-rated municipal
securities, including those issued to finance the Whitetail Golf Course by
the Dauphin County General Authority and the Hummelstown General Authority,
through the former director's firm, and related matters. First Financial is
working with SEC lawyers to assist the SEC in its investigation. First
Financial previously has produced documents to the SEC in response to the
SEC's voluntary request for assistance in this matter.
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.
33
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 May 10, 2005
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 May 10, 2005
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 May 10, 2005
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 May 10, 2005
34
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 05/10/05 /s/ Donna M. Coughey
------------------------- ---------------------------------------
Donna M. Coughey
President and Chief Executive Officer
Date 05/10/05 /s/ Joseph T. Crowley
------------------------- ---------------------------------------
Joseph T. Crowley
CFO and Treasurer
35