FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2003
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: to
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Commission file number: 0-22537-01
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NATIONAL PENN BANCSHARES, INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2215075
------------------------------ ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Philadelphia and Reading Avenues, Boyertown, PA 19512
----------------------------------------------- --------
(Address of principal executive offices) (Zip Code)
(610) 367-6001
----------------
(Registrant's telephone number, including area code)
N/A
---------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
-----
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act.) Yes X No .
-----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at November 7, 2003
----- ------------------------------------------------
Common Stock (No.) 24,223,107 Shares
(no stated par value)
Page 1 of 39 pages
TABLE OF CONTENTS
- -----------------
Part I - Financial Information. Page
- ------------------------------ ----
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operation 12
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 30
Item 4. Controls and Procedures 30
Part II - Other Information.
- ----------------------------
Item 1. Legal Proceedings 32
Item 2. Changes in Securities 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of
Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 35
Exhibits 36
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET Sept. 30,
(Dollars in thousands, except per share data) 2003 Dec. 31,
(Unaudited) 2002
---------------- ---------------
ASSETS
Cash and due from banks $98,571 $73,518
Interest bearing deposits in banks 3,904 2,606
Federal funds sold 11,200 48,000
---------------- ---------------
Total cash and cash equivalents 113,675 124,124
Investment securities available for sale, at fair value 854,592 650,930
Loans and leases held for sale 88,927 52,992
Loans and leases, less allowance for loan and lease losses
of $45,990 and $40,578 in 2003 and 2002 respectively 1,999,006 1,691,837
Premises and equipment, net 42,183 28,448
Accrued interest receivable 13,193 13,944
Bank owned life insurance 66,053 58,360
Goodwill and other intangibles 68,754 8,947
Unconsolidated investments under the equity method 2,899 2,702
Assets from discontinued operations - 207,275
Other assets 19,938 18,703
---------------- ---------------
Total Assets 3,269,220 2,858,262
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Non-interest bearing deposits $372,557 $296,247
Interest bearing deposits 2,011,981 1,629,717
---------------- ---------------
Total Deposits 2,384,538 1,925,964
Securities sold under repurchase agreements
and federal funds purchased 321,977 252,096
Short-term borrowings 10,045 10,614
Long-term borrowings 163,332 169,703
Guaranteed preferred beneficial interests in
Company's subordinated debentures 63,250 63,250
Liabilities from discontinued operations - 190,684
Accrued interest payable and other liabilities 31,203 23,591
---------------- ---------------
Total Liabilities 2,974,345 2,635,902
Shareholders' equity
Preferred stock, no stated par value;
authorized 1,000,000 shares, none issued - -
Common stock, no stated par value;
authorized 62,500,000 shares; issued and outstanding
2003 - 24,222,377; 2002 - 20,699,782; net of shares
in Treasury: 2003 - 36,536; 2002 - 0 258,391 172,471
Retained earnings 20,387 30,593
Accumulated other comprehensive income 17,186 19,296
Treasury stock at cost (1,089) -
---------------- ---------------
Total Shareholders' Equity 294,875 222,360
---------------- ---------------
Total Liabilities and Shareholders' Equity $3,269,220 $2,858,262
================ ===============
The accompanying notes are an integral part of these condensed financial
statements.
3
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
(Dollars in thousands, except per share data) September 30, September 30,
----------------------------------------------------------------------
2003 2002 2003 2002
-------------- ---------------- --------------- --------------
INTEREST INCOME
Loans and leases, including fees $32,471 $31,120 $96,619 $94,542
Investment securities
Taxable 5,243 6,224 16,094 18,451
Tax-exempt 3,247 3,067 9,802 9,214
Federal funds sold 173 399 459 469
Deposits in banks 15 17 46 63
-------------- ---------------- --------------- --------------
Total interest income 41,149 40,827 123,020 122,739
-------------- ---------------- --------------- --------------
INTEREST EXPENSE
Deposits 8,186 10,414 25,571 32,913
Securities sold under repurchase agreements and
federal funds purchased 931 1,174 2,818 3,532
Short-term borrowings 13 29 30 83
Long-term borrowings 3,458 3,985 10,316 10,442
-------------- ---------------- --------------- --------------
Total interest expense 12,588 15,602 38,735 46,970
-------------- ---------------- --------------- --------------
Net interest income 28,561 25,225 84,285 75,769
Provision for loan and lease losses 2,286 4,410 6,896 10,860
-------------- ---------------- --------------- --------------
Net interest income after provision
for loan and lease losses 26,275 20,815 77,389 64,909
-------------- ---------------- --------------- --------------
OTHER INCOME
Trust income 1,314 1,298 3,967 4,036
Service charges on deposit accounts 3,141 2,768 8,850 7,916
Bank owned life insurance income 716 913 2,448 2,799
Other service charges and fees 2,221 2,520 8,135 8,116
Net gains (loses) on sale of investment securities (369) 367 (369) 117
Mortgage banking income 1,246 1,541 4,239 3,474
Insurance commissions and fees 1,430 146 1,892 157
Equity in undistributed net earnings of affiliates 82 81 197 202
-------------- ---------------- --------------- --------------
Total other income 9,781 9,634 29,359 26,817
-------------- ---------------- --------------- --------------
OTHER EXPENSES
Salaries, wages and employee benefits 14,055 11,273 40,211 33,207
Net premises and equipment 3,281 3,056 10,227 8,498
Advertising and marketing expenses 924 496 2,601 2,083
FHLB prepayment fee 7,002 - 7,002 -
Other operating expenses 5,424 4,820 15,783 15,855
-------------- ---------------- --------------- --------------
Total other expenses 30,686 19,645 75,824 59,643
-------------- ---------------- --------------- --------------
Income before income taxes 5,370 10,804 30,924 32,083
Income tax expense 951 2,075 6,690 6,589
-------------- ---------------- --------------- --------------
Net income from continuing operations 4,419 8,729 24,234 25,494
Net income from discontinued operations, net of taxes 6,585 482 7,923 1,520
-------------- ---------------- --------------- --------------
Net income $11,004 $9,211 $32,157 $27,014
============== ================ =============== ==============
Net income per share - basic $0.46 $0.42 $1.35 $1.24
Net income per share - diluted $0.45 $0.41 $1.32 $1.22
Dividends paid in cash $0.23 $0.20 $0.65 $0.60
The accompanying notes are an integral part of these condensed financial
statements.
4
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2003
(Dollars in thousands)
Accumulated
Common Stock other
------------------------- Retained conprehensiv Treasury Comprehensive
Shares Value earnings income stock Total income
----------------------------------------------------------------------------------------------
Balance at December 31, 2002 20,699,782 $ 172,471 $ 30,593 $ 19,296 $ -- 222,360
Net income -- -- 32,157 -- -- 32,157 $ 32,157
Cash dividends declared -- -- (10,661) -- -- (10,661)
5% stock dividend 1,152,796 31,702 (31,702)
Shares issued under stock-based
plans 795 13 -- -- -- 13
Shares issued for acquisition
of FirstService Bank 2,563,552 61,262 -- -- 1,924 63,186
Other comprehensive loss, net
of reclassification adjustment
and taxes -- -- -- (2,110) -- (2,110) (2,110)
-------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- -- $ 30,047
-------------------------------------------------------------------------------------------
Effect of treasury stock transactions (194,548) (7,057) -- -- (3,013) (10,070)
-------------------------------------------------------------------------------------------
Balance at September 30, 2003 24,222,377 $ 258,391 $ 20,387 $ 17,186 $ (1,089) $294,875
September 30, 2003
---------------------------------------------------------
Before Tax Net of
tax (expense) tax
amount benefit amount
---------------------------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period (3,752) 1,265 (2,487)
Less: Reclassification adjustment for losses
realized in net income (369) 129 (240)
Change in the fair value of cash flow hedges (137) - (137)
--------------------------------------------------------
Other comprehensive income, net (3,246) 1,136 (2,110)
========================================================
NINE MONTHS ENDED SEPTEMBER 30, 2002
(Dollars in thousands)
Accumulated
Common Stock other
------------------------- Retained conprehensive Treasury Comprehensive
Shares Value earnings income stock Total income
----------------------------------------------------------------------------------------------
Balance at December 31, 2001 19,926,863 $ 166,138 $ 29,333 $ 3,119 $ (2,908) 195,682
Net income -- -- 27,014 -- -- 27,014 $ 27,014
Cash dividends declared -- -- (13,261) -- -- (13,261)
Shares issued under stock-based
plans -- -- -- -- -- --
Other comprehensive income, net
of reclassification adjustment
and taxes -- -- -- 17,492 -- 17,492 17,492
-------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- -- $ 44,506
-------------------------------------------------------------------------------------------
Effect of treasury stock transactions (138,036) (3,101) (3,599) (6,700)
-------------------------------------------------------------------------------------------
Balance at September 30, 2002 19,788,827 $ 163,037 $ 43,086 $ 20,611 $ (6,507) 220,227
September 30, 2002
---------------------------------------------------
Before Tax Net of
tax (expense) tax
amount benefit amount
---------------------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period 27,028 (9,460) 17,568
Less: reclassification adjustment for losses realized in net income 117 (41) 76
---------------------------------------------------
Other comprehensive income, net 26,911 (9,419) 17,492
===================================================
The accompanying notes are an integral part of these statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Nine Months Ended September 30,
2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
- --------------------------------------------------------------------------------------------------------------------------------
Net income 32,157 27,014
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan and lease losses 6,896 11,250
Depreciation and amortization 4,786 3,610
Deferred tax (benefit) expense (3,053) (9,419)
Amortization of premiums and discounts on investment
securities, net (533) 1,627
Investment securities (gains) losses, net 369 (117)
Mortgage loans originated for resale (184,819) (95,549)
Sale of mortgage loans originated for resale 188,505 96,918
Changes in assets and liabilities
Decrease in accrued interest receivable 1,920 745
(Decrease) in accrued interest payable (3,927) (4,523)
(Increase) decrease in other assets (5,039) 14,997
Increase in other liabilities 10,196 2,525
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 47,458 49,078
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CASH FLOWS FROM INVESTING ACTIVITIES
- --------------------------------------------------------------------------------------------------------------------------------
Cash paid in excess of cash equivalents for business acquired (221) (8,624)
Cash received in excess of cash equivalents for business sold 12,732 -
Proceeds from sales of investment securities available for sale 34,663 2,260
Proceeds from maturities of investment securities available for sale 205,675 72,860
Purchase of investment securities available for sale (343,221) (128,862)
Net (increase) decrease in loans (133,348) (43,096)
Purchases of premises and equipment (5,747) (4,681)
Purchase of bank-owned life insurance (760) (1,803)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (230,227) (111,946)
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- --------------------------------------------------------------------------------------------------------------------------------
Net increase in interest and non-interest
bearing demand deposits and savings accounts 288,083 121,100
Net (decrease) in certificates of deposit (116,766) (71,196)
Net increase (decrease) in securities sold under
agreements to repurchase and federal funds purchased 28,097 (6,992)
Net (decrease) increase in short-term borrowings (569) 520
Proceeds from new long-term borrowings 70,000 70,000
Repayments of long-term borrowings (81,370) (38,953)
Cash proceeds from the issuance of subordinated debt - 63,250
Issuance of common stock under dividend
reinvestment and stock option plans 13 -
Effect of Treasury stock transactions (10,070) (6,700)
Cash dividends (15,421) (13,093)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in ) financing activities 161,997 117,936
- --------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents (20,772) 55,068
Cash and cash equivalents at beginning of year 134,447 107,798
- --------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at September 30 $113,675 $162,866
================================================================================================================================
The accompanying notes are an integral part of these statements.
6
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. The financial
information included herein is unaudited; however, such information reflects all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary to a fair statement of the results for the
interim periods. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002.
The results of operations for the nine-month period ended September 30, 2003 are
not necessarily indicative of the results to be expected for the full year.
2. ACQUISITIONS AND DISPOSITIONS
On September 11, 2003, the Company completed the cash sale of Panasia Bank N.A.,
its wholly owned subsidiary for $34.5 million, which resulted in a gain of $5.99
million after taxes of $2.5 million. In accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, the income of Panasia is
presented as discontinued operations for all periods presented. At the time of
the sale, Panasia had total assets of $213.5 million, net loans of $99.7
million, investments of $84.4 million, deposits of $188.2 million, and total
equity of $24.4 million. The Company has classified the results of operations of
Panasia from January 1, 2003 through September 11, 2003 as discontinued
operations in the consolidated statement of income. Net income from discontinued
operations, net of taxes of $3.4 million for the nine months ended September 30,
2003 was $7.9 million.
The following represents the components of net assets from discontinued
operations for the year ended December 31, 2002:
Cash and cash equivalents $10,323
Investments 82,844
Loans receivable, net 98,158
Goodwill 12,434
Other assets 3,516
--------
Total $207,275
========
Deposits $186,676
Other liabilities 4,008
--------
Total $190,684
========
Net assets from discontinued operations $ 16,591
========
7
The following represents the per share amounts for continuing and discontinued
operations for the three and nine months ended September 30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
------------ -------------
2003 2002 2003 2002
Net income per share - basic ---- ---- ---- ----
Continuing operations $0.18 $0.40 $1.02 $1.17
Discontinued operations 0.28 0.02 0.33 0.07
---- ---- ---- ----
Net income per share - basic $0.46 $0.42 $1.35 $1.24
Net income per share - diluted
Continuing operations $0.18 $0.39 $0.99 $1.15
Discontinued operations 0.27 0.02 0.33 0.07
---- ---- ---- ----
Net income per share - diluted $0.45 $0.41 $1.32 $1.22
==== ==== ==== ====
On April 30, 2003, the Company and its principal banking subsidiary, National
Penn Bank, entered into an agreement and plan of merger with HomeTowne Heritage
Bank which provides, among other things, for the merger of HomeTowne Heritage
Bank into National Penn Bank, with National Penn Bank surviving the merger as a
subsidiary of the Company. The merger agreement provides for the exchange of
$13.697 in cash for each outstanding share of common stock of HomeTowne Heritage
Bank, or total cash consideration of approximately $37.6 million. In addition,
outstanding stock options to purchase 984,332 shares of HomeTowne Heritage Bank
common stock will be converted into stock options to purchase shares of the
Company's common stock, as set forth in the merger agreement. The transaction
will be accounted for in accordance with SFAS No. 141, Business Combinations,
and, subject to various regulatory approvals and other closing conditions, is
expected to close in fourth quarter 2003.
On February 25, 2003, the Company completed its merger with FirstService Bank
(FirstService). Under the terms of the merger, 4,304,762 shares of FirstService
stock were each converted into 0.5954 share of the Company's common stock plus
$3.90, resulting in the issuance of 2,563,552 shares of the Company's common
stock and payment of approximately $16.8 million in cash. In addition,
outstanding stock options to purchase FirstService common stock were converted
into stock options to purchase 643,169 shares of the Company's common stock,
with an exercise price of either $6.69 or $13.38 per share. This transaction was
accounted for under the purchase method of accounting. Accordingly, the results
of operations of the Company include FirstService's results from and after
February 25, 2003. The acquisition resulted in the recording of approximately
$54.0 million of goodwill and other intangible assets. The Company acquired
assets, loans and deposits of $367.1 million, $219.2 million, and $288.9
million, respectively.
3. LOANS
The Company identifies a loan as impaired when it is probable that interest and
principal will not be collected according to the contractual terms of the loan
agreement. The balance of impaired loans was $14.1 million at September 30,
2003, all of which are non-accrual loans. The allowance for loan loss associated
with these impaired loans was $4.0 million at September 30, 2003. The Company
recognizes income on an impaired loan under the cash basis when the loan is
current and the collateral on the loan is sufficient to cover the outstanding
obligation to the Company. If these factors do not exist, the Company will not
recognize income on an impaired loan.
4. SHAREHOLDERS' EQUITY
On October 23, 2003, the Company's Board of Directors declared a cash dividend
of $0.24 per share payable on November 17, 2003, to shareholders of record on
October 31, 2003.
8
On September 24, 2003, the Company's Board of Directors authorized the
repurchase of up to one million shares of the Company's common stock to be used
to fund the Company's dividend reinvestment plan, stock option plans,
stock-based benefit plans and employee stock purchase plan. No timetable has
been set for these repurchases. The 2002 program (see below) will be completed
before commencement of this program.
On August 27, 2003, the Company's Board of Directors declared a 5% stock
dividend payable on September 30, 2003 to shareholders of record on September
12, 2003. All weighted average share and per share information has been
retroactively restated.
On June 25, 2003 the Company's Board of Directors declared a cash dividend of
$.23 per share payable on August 17, 2003, to shareholders of record on July 31,
2003.
On October 23, 2002, the Company's Board of Directors declared a 5% stock
dividend payable on December 27, 2002, to shareholders of record on December 6,
2002. All weighted average, share and per share information has been
retroactively restated.
On June 26, 2002, the Company's Board of Directors authorized the repurchase of
up to one million shares of the company's common stock to be used to fund the
Company's dividend reinvestment plan, stock option plans, stock-based benefit
plans and employee stock purchase plan. No timetable has been set for these
repurchases. As of September 30, 2003, 918,433 shares have been repurchased at
an average price of $27.32 under the 2002 repurchase program.
5. EARNINGS PER SHARE
Three months ended September 30, 2003
- -------------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
Basic earnings per share ------------- ------------- ---------------
Net income available to common stockholders $11,004 24,214 $0.46
Effect of dilutive securities
Options --- 554 (0.01)
Diluted earnings per share -------- ------- -------
Net income available to common stockholders
Plus assumed conversions $11,004 24,768 $0.45
======== ======= =======
Year To Date September 30, 2003
- -------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
Basic earnings per share ------------- ------------- ---------------
Net income available to common stockholders $32,157 23,813 $1.35
Effect of dilutive securities
Options --- 577 (0.03)
Diluted earnings per share -------- ------- -------
Net income available to common stockholders
Plus assumed conversions $32,157 24,390 $1.32
======== ======= =======
There were no stock options outstanding for the three and nine months ended
September 30, 2003 that were not included in the computation of diluted earnings
per share because the option exercise price was greater than the average market
price.
9
Three months ended September 30, 2002
Income Shares Per Share
(numerator) (denominator) Amount
Basic earnings per share ------------- ------------- ---------------
Net income available to common stockholders $9,211 21,856 $0.42
Effect of dilutive securities
Options --- 305 (0.01)
Diluted earnings per share -------- ------- -------
Net income available to common stockholders
Plus assumed conversions $9,211 22,161 $0.41
======== ======= =======
Year To Date September 30, 2002
Income Shares Per Share
(numerator) (denominator) Amount
Basic earnings per share ------------- ------------- ---------------
Net income available to common stockholders $27,014 21,850 $1.24
Effect of dilutive securities
Options --- 289 (0.02)
Diluted earnings per share -------- ------- -------
Net income available to common stockholders
Plus assumed conversions $27,014 22,139 $1.22
======== ======= =======
Options to purchase 273,965 shares of common stock at $24.76 per share were
outstanding for the three and nine months ended September 30, 2002. They were
not included in the computation of diluted earnings per share because the option
exercise price was greater than the average market price.
6. SEGMENT REPORTING
SFAS No. 131, Segment Reporting, identifies operating segments as components of
an enterprise which are evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and assess performance. The
Company's chief operating decision maker is the President and Chief Executive
Officer. The Company has applied the aggregation criteria set forth in SFAS No.
131 for its National Penn Bank and Panasia (the Banks) operating segments
through September 11, 2003, to create a reportable operating segment as
"Community Banking."
The Company's Community Banking segment consists of commercial and retail
banking. The Community Banking segment is managed as a single strategic unit,
which generates revenue from a variety of products and services provided by the
Banks. For example, commercial lending is dependent upon the ability of the
Banks to fund themselves with retail deposits and other borrowings and to manage
interest rate and credit risk. This situation is also similar for consumer and
residential mortgage lending.
Nonreportable operating segments of the Company's operations which do not have
similar characteristics to the Community Banking operations and do not meet the
quantitative thresholds requiring disclosure are included in the "Other"
category. These nonreportable segments include Investors Trust Company, Penn
Securities Inc., National Penn Leasing Company, FirstService Insurance Agency,
Inc., FirstService Capital Inc., National Penn Life Insurance Company, NPB
Capital Trust II, and the Company.
The accounting policies used in this disclosure of operating segments are the
same as those described in the summary of significant accounting policies. The
consolidating adjustments reflect certain eliminations of intersegment revenues,
cash and investment in subsidiaries.
10
Reportable segment-specific information and reconciliation to consolidated
financial information is as follows:
Community Banking Other Consolidated
(in thousands) ----------------- ----- ------------
As of, and for the nine months
Ended, September 30, 2003
Total Assets $2,898,650 $370,570 $3,269,220
Total Deposits 2,384,538 --- 2,384,538
Net interest income (loss) 87,493 (3,208) 84,285
Total noninterest income 20,908 8,451 29,359
Total noninterest expense 68,410 7,414 75,824
Net income from continuing
operations 26,394 (2,160) 24,234
Discontinued Operations 1,935 5,988 7,923
Net income (loss) $ 28,329 $ 3,828 $ 32,157
As of, and for the nine months
Ended, September 30, 2002
Total Assets $2,345,164 $340,005 $2,685,169
Total Deposits 1,950,632 --- 1,950,632
Net interest income (loss) 79,164 (3,395) 75,769
Total noninterest income 20,566 6,251 26,817
Total noninterest expense 53,911 5,732 59,643
Net income from continuing
operations 27,364 (1,870) 25,494
Discontinued Operations 1,520 --- 1,520
Net income (loss) $ 28,884 $(1,870) $ 27,014
7. STOCK BASED COMPENSATION
The Company accounts for stock options under SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair
value-based method of valuing stock-based compensation that entities may use,
which measures compensation cost at the grant date based on the fair value of
the award. Compensation is then recognized over the service period, which is
usually the vesting period. Alternatively, SFAS No. 123 permits entities to
continue accounting for employee stock options and similar equity instruments
under Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued
to Employees. Entities that continue to account for stock options using APB
Opinion 25 are required to make pro forma disclosures of net income and earnings
per share, as if the fair value-based method of accounting defined in SFAS No.
123 had been applied.
At September 30, 2003, the Company had two stock-based employee compensation
plans. The Company accounts for these plans under recognition and measurement
principles of APB No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Stock-based employee compensation costs are not reflected in
net income, as all options granted under the plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
11
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS No. 123
to stock-based employee compensation (in thousands, except per share amounts).
These results are not indicative of results for the year ended December 31,
2003.
Three Months Ended September 30,
--------------------------------
2003 2002
---- ----
Net income, as reported $11,004 $9,211
Less: stock based compensation costs determined under fair value-
Based method for all awards (170) (138)
------ ------
Net income, pro forma $10,834 $9,037
======= ======
Earnings per share of common stock - basic As reported 0.46 0.42
Pro forma 0.45 0.42
Earnings per share of common stock - diluted As reported 0.45 0.41
Pro forma 0.44 0.41
Year to Date Ended September 30,
--------------------------------
2003 2002
---- ----
Net income, as reported $32,157 $27,014
Less: stock based compensation costs determined under fair value-
Based method for all awards (582) (386)
---- ----
Net income, pro forma $31,575 $26,628
======= ======
Earnings per share of common stock - basic As reported 1.35 1.24
Pro forma 1.33 1.22
Earnings per share of common stock - diluted As reported 1.32 1.22
Pro forma 1.29 1.20
The Company granted options for 14,078 and 11,490 shares in the first nine
months of 2003 and 2002, respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes options-pricing model
with the following weighted average assumptions used for grants in 2003 and
2002, respectively: dividend yield of 2.90% and 3.85%; expected volatility of
25.0% and 35.1%; risk-free interest rates for each plan of 4.22% and 3.93% for
2003 and 5.50% and 3.93% for 2002; and expected lives of 8.50 years and 6.83
years for each plan in 2003 and 8.50 and 6.83 years for each plan in 2002.
8. DEBT
In September 2003, the Company refinanced approximately $77.5 million of
long-term debt with the Federal Home Loan Bank of Pittsburgh with a weighted
average rate of 5.13% and a weighted average remaining life of approximately 47
months. The Company paid a prepayment fee of $7.0 million before taxes and
included the penalty in other expenses. The Company obtained new debt of $70.0
million, which has a weighted average interest rate of 3.22% and a weighted
average life of approximately 54 months. In addition, this new debt also does
not include certain call provisions that applied to the retired debt.
Item 2. Management's Discussion and Analysis of Financial Condition and
- -------------------------------------------------------------------------
Results of Operations
- ---------------------
The following discussion and analysis is intended to assist in
understanding and evaluating the major changes in the earnings performance and
financial condition of the Company with a primary focus on an analysis of
operating results. Current performance does not guarantee and may not be
indicative of similar
12
performance in the future. These are unaudited financial statements and, as
such, are subject to year end examination. In addition to historical
information, this Form 10-Q contains forward-looking statements.
Forward-looking statements in this document are subject to risks and
uncertainty. Forward-looking statements include information concerning possible
or assumed future results of operations by the Company. When we use words such
as "believe", "expect", "anticipate", or similar expressions, we are making
forward-looking statements. Additional information concerning forward-looking
statements is contained later on within this discussion.
The Company recorded a 19.5% increase in third quarter net income and a
19.0% net income increase in nine months results compared to comparable periods
in 2002. Diluted earnings per share for the three and nine month periods of
$0.45 and $1.32 increased 9.8% and 8.2%, respectively, compared to comparable
periods in 2002. The change in the percentage increase in net income when
compared to the percentage increase in earnings per share is due to the larger
number of weighted average common shares outstanding, principally resulting from
the acquisition of FirstService Bank which was completed on February 25, 2003.
For the nine month period ended September 30, 2003, the annualized
return on average shareholders' equity and annualized return on average assets
were 15.9% and 1.33% compared to 17.5% and 1.30% for the comparable period in
2002.
The Company completed the cash sale of Panasia Bank, N.A. for $34.5
million on September 11, 2003. This transaction is presented in the financial
statements as discontinued operations. The sale resulted in a gain of $5.99
million after taxes of $2.5 million. At the time of the sale, Panasia had total
assets of $213.5 million, net loans of $99.7 million, and marketable securities
of $84.4 million. Panasia's deposits totaled $188.2 million, it had no other
borrowings. Panasia's total equity was $24.4 million. Panasia contributed after
tax net income of $1.94 million after taxes of $859,000 for the period January
1, 2003 through September 11, 2003.
The Company's strategic plan provides for a highly profitable,
independent financial services company within the markets it serves.
Specifically, management is focused on increased market penetration in selected
geographic areas, "client intimacy" and excellence in both retail and commercial
lines of business. The acquisition of FirstService Bank in first quarter 2003,
the sale of Panasia Bank, N.A. in third quarter 2003, and the pending
acquisition of HomeTowne Heritage Bank in the fourth quarter 2003, represent
strategic initiatives by the Company in furtherance of its focused goals.
The current economic climate and interest rate environment present
challenges for all financial institutions in achieving their business goals.
During this low interest rate environment, the Company pursued strategic balance
sheet opportunities.
o The Company refinanced $77.5 million in long-term Federal Home Loan
Bank (FHLB) borrowings, incurring a prepayment fee of $4.6 million
after taxes, under the terms of the FHLB borrowing agreements. The
Company lowered interest expense associated with borrowings from the
Federal Home Loan Bank by 191 basis points and will enjoy lower
borrowing costs for the next six years as a result of this
transaction.
o The Company sold approximately $35 million in investment securities
available for sale resulting in an after tax loss of $240,000. This
transaction allowed NPBC to re-deploy those funds into higher
yielding investments.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
-----------------------------------------------------
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services
13
industry. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated probable credit losses. Management's
determination of the adequacy of the allowance is based on periodic evaluations
of the loan portfolio and other relevant factors. However, this evaluation is
inherently subjective as it requires material estimates, including, among
others, expected default probabilities, loss given default, expected commitment
usage, the amounts and timing of expected future cash flows on impaired loans,
value of collateral, estimated losses on consumer loans and residential
mortgages, and general amounts for historical loss experience. The process also
considers economic conditions, uncertainties in estimating losses and inherent
risks in the loan portfolio. All of these factors may be susceptible to
significant change. To the extent actual outcomes differ from management
estimates, additional provisions for loan losses may be required that would
adversely impact earnings in future periods.
Goodwill is subject to impairment testing at least annually to
determine whether write-downs of the recorded balances are necessary. The
Company tests for impairment based on the goodwill maintained at each defined
reporting unit. A fair value is determined for each reporting unit based on at
least one of three various market valuation methodologies. If the fair values of
the reporting units exceed their book values, no write-down of recorded goodwill
is necessary. If the fair value of the reporting unit is less, an expense may be
required on the Company's books to write down the related goodwill to the proper
carrying value. Through its annual analysis as of June 30, 2003, the Company
determined that no impairment write-offs were necessary. No assurance can be
given that future goodwill impairment tests will not result in a charge to
earnings.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
RESULTS OF OPERATIONS
---------------------
Net income for the quarter ended September 30, 2003 was $11.0 million,
19.5% more than for the third quarter 2002. For the first nine months, net
income reached $32.2 million or 19.0% more than the $27.0 million reported for
the first nine months of 2002. The Company's performance has been and will
continue to be in part influenced by the strength of the economy and conditions
in the real estate market. The results of operation of FirstService Bank are
included from the date of its acquisition, February 25, 2003, through September
30, 2003.
Net interest income is the difference between interest income earned on
assets and interest expense paid on liabilities. Net interest income for the
third quarter of 2003 was $28.6 million, which increased $3.3 million or 13.2%
over the $25.2 million for the third quarter of 2002. For nine months ended
September 30, 2003, net interest income improved $8.5 million or 11.2% over the
nine months ended September 30, 2002. Interest income for the third quarter of
2003 increased $322,000 due to an increase in loan income of $1.4 million offset
by a decrease in investment and federal funds sold income of $1.0 million.
Interest expense for third quarter 2003 decreased $3.0 million due to a decrease
in interest on deposits of $2.2 million, with a $786,000 decrease in interest
paid on borrowed funds.
14
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the increase related to
higher outstanding balances and that due to the levels and volatility of
interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume). For purposes
of this table, changes attributable to both rate and volume, which cannot be
segregated, have been allocated proportionately to the change due to volume and
the change due to rate. The information is presented on a taxable equivalent
basis, using an effective rate of 35% (in thousands).
Net interest income, on a taxable equivalent basis, increased $8.8
million in the first nine months of 2003, as compared to the same period in
2002. This increase is due to a $12.1 million increase due to volume,
attributable mainly to the FirstService Bank acquisition, offset by a $3.3
million net interest margin compression.
Nine Months ended September 30, 2003 over 2002
----------------------------------------------
Volume Rate Total
Increase (decrease) in: ------ ---- -----
Interest income:
Interest bearing deposits in banks $18 ($35) ($17)
Federal Funds sold 205 (215) (10)
Investment Securities 4,486 (6,330) (1,844)
Total Loans 13,255 (11,023) 2,232
------- ------- -------
Total interest income $17,964 ($17,603) $ 361
------- ------- -------
Interest expense:
Interest bearing deposits $4,850 $ (12,562) $(7,712)
Short-term borrowings 909 (1,523) (614)
Long-term borrowings 111 (237) (126)
------- ------- -------
Total interest expense $5,870 $ (14,322) $(8,452)
Increase (decrease) in net interest
income $ 12,094 $ (3,281) $ 8,813
======= ======= =======
Net interest margin, defined as net interest income divided by total
interest earning assets, decreased to 4.17% during third quarter 2003 compared
to 4.31% during the third quarter of 2002, and 4.37% during the second quarter
of 2003. Six basis points of the decline in the net interest margin was
attributable to the sale of approximately $17.3 million of manufactured housing
loans, a line of business the Company has exited, as discussed in the 10-Q for
first quarter 2003. These loans involved high yield, high loss, and high
overhead. The remainder of the margin decline is due to the extended decreased
interest rate environment, in which interest bearing assets continue to reprice
and catch up to the lower costing interest-bearing liabilities that decreased at
a faster rate in the earlier period of this low rate cycle.
The flat interest income in third quarter 2003 compared to third
quarter 2002 reflects the margin compression experienced beginning second
quarter 2003. Despite the current low rate environment, the cost of attracting
and holding deposited funds is an ever-increasing expense in the banking
industry. These increases are the real costs of deposit accumulation and
retention, including FDIC insurance costs and branch overhead expenses. Such
costs are necessary for continued growth and to maintain and increase market
share of available deposits. The addition of interest income from FirstService
contributed to the increase in net interest income for first three quarters of
2003 compared to the same period in 2002.
During the quarterly review of the allowance for loan losses, the
Company considers a variety of factors that include: the persisting weak
economic conditions and market volatility, the continued concern that a slower
economy results in operating losses for the Company's commercial customers, and
the overall concerns of consumer confidence, including international concerns.
Despite these concerns,
15
the reduction in charge-offs for the first nine months of 2003 compared to the
same period in 2002 allowed the Company to reduce its provision for loan and
lease losses while maintaining the allowance for loan and lease losses at a
level believed adequate to absorb probable losses on existing loans. The
Company's net charge-offs of $5.4 million for the first nine months of 2003
decreased by $5.7 million compared to the $11.1 million in net charge-offs at
September 30, 2002. The higher net chargeoffs in 2002 were driven by two large
commercial real estate credits. The provision for loan and lease losses was $2.3
million for the three months ended September 30, 2003, and $6.9 million for the
nine months ended September 30, 2003 -- a decrease of $2.1 million compared to
the three months ended September 30, 2002 and $3.9 million compared to the nine
months ended September 30, 2002. The decrease in the provision reflects
management's analysis of the loan portfolio and the continued monitoring and
maintenance of the loan portfolio.
Other income increased $147,000 or 1.5% during the third quarter of
2003 compared to the same period in 2002, as a result of increased trust,
service charges on deposit accounts and insurance commissions and fees totaling
$1.7 million, offset by a decrease of $736,000 in gains on sale of securities, a
$299,000 decrease in other service charges and fees, a $295,000 decrease in
mortgage income, and a $197,000 decrease in bank-owned life insurance income.
The increase in insurance commissions and fees is due largely to the addition of
FirstService Insurance, which contributed $671,000 of the total $1.4 million in
third quarter 2003. The mortgage income decrease in third quarter 2003 compared
to third quarter 2002 is a result of slower refinancing volume in the quarter,
due to a rise in interest rates beginning in mid-June 2003. Insurance
commissions and fees increased $1.7 million, service charges on deposit accounts
increased $934,000, mortgage banking income increased $765,000, other service
charges and fees increased $19,000, while bank owned life insurance decreased
$351,000 and trust income decreased for the first nine months of 2003 compared
to the first nine months of 2002. FirstService Insurance contributed $1.7
million for the first nine months of 2003; total insurance income from all
subsidiaries totaled $1.9 million. The sale of approximately $35 million in
investment securities resulted in a loss of $369,000 in the first nine months of
2003, compared to $117,000 gain posted for the same period in 2002. Increased
mortgage banking income for the first nine months of 2003 is primarily due to
increased mortgage refinance volume, resulting from the low interest rate
environment in the first half of 2003. Mortgage banking income is vulnerable as
interest rates rise and mortgage refinance volume contracts. Management is
working to identify alternative strategies to replace the refinance volume.
Increased service charges on deposit accounts is due primarily to an increase in
the collection of fees on a larger deposit base, resulting from the FirstService
acquisition.
Other expenses increased $11.0 million or 56.2% during the third
quarter of 2003, primarily due to a $7.0 million prepayment fee paid to the
Federal Home Loan Bank of Pittsburgh in the refinancing of long-term debt. Also
during third quarter 2003, salaries, wages and benefits increased $2.8 million
or 24.7%, net premises and equipment increased $225,000 or 7.4%, other operating
expenses increased $604,000 or 12.5%, and advertising and marketing expenses
increased $428,000 or 86.3%. Salaries, wages and benefits increased due to
normal salary increases and the addition of 137 employees from the acquisition
of FirstService. The increase in net premises and equipment expense is also
partially associated with the acquisition of FirstService, which included a
community office network of seven offices. The increase in marketing expense is
attributable to additional advertising campaigns conducted in 2003. Year to date
in 2003, salaries and benefits increased $7.0 million or 21.1%, net premises and
equipment expense increased $1.73 million or 20.3%, marketing and advertising
expense increased $518,000 or 24.9% while other operating expenses decreased
$72,000 or 0.4% compared to the same period in 2002.
Income before income taxes from continuing operations decreased $5.4
million or 50.3% in the third quarter of 2003 compared to the same time period
in 2002, due primarily to the prepayment fee paid in the Federal Home Loan Bank
long term debt restructuring. Income taxes from continuing operations decreased
$1.1 million or 54.2% for the quarter ended September 30, 2003 due to the
decreased income before taxes. Income before income taxes decreased $1.2 million
or 3.6% in the first nine months of 2003 compared to the same time period in
2002. Income taxes increased $101,000 or 1.5% for nine months ended September
30, 2003 due to the higher proportion of taxable assets to total assets compared
to the same period in 2002. The Company's effective tax rate from continuing
operations dropped to 17.7% for
16
the third quarter of 2003 compared to 19.2% for 2002. The divestiture of the
Panasia assets - the majority of which were taxable - left a larger proportion
of tax-free to total assets for the third quarter 2003. The Company's effective
tax rate remained relatively stable at 21.6% for the first nine months of 2003
compared to 20.5% for 2002. The increase in the effective tax rate year to date
in 2003 is due to the decrease in tax-free income relative to total income.
FINANCIAL CONDITION
-------------------
At September 30, 2003, total assets were $3.269 billion, an increase of
$411.0 million or 14.4% from the $2.858 billion at December 31, 2002. The
increase in total assets excluding Panasia Bank's assets of $207.3 million at
December 31, 2002 was $618.2 million. The increase in assets as of September 30,
2003 is primarily due to the addition of FirstService Bank on February 25, 2003,
which had $367.1 million in assets. Net loans and leases, including loans held
for sale, which totaled $2.088 billion at September 30, 2003, increased $343.1
million. The Company gained $219.2 million in net loans due to the addition of
FirstService Bank, offset by the sale of $17.3 million in manufactured housing
loans and the securitization of $42.8 million in residential mortgages into
mortgage-backed securities. The Company does not retain the servicing on loans
sold. Adjusting for these transactions, core loan growth was 10.5% for the first
nine months of 2003. Loans continue to increase at a modest pace as a result of
the overall slow economy and the lack of capital goods spending by the Company's
business customers. Loans originated for immediate resale during the first nine
months of 2003 amounted to $184.8 million.
In second quarter 2000, the Company ceased originating loans
collateralized by manufactured housing. In April 2003, the Company sold
substantially all its manufactured housing loan portfolio of $17.3 million, some
of which were on non-accrual status. The future impact of this transaction is
not expected to be material to the Company's overall performance.
Total cash and cash equivalents decreased $10.4 million or 8.4% at
September 30, 2003 when compared to December 31, 2002. The merger of
FirstService added $16.6 million in cash and cash equivalents. Although cash and
due from banks and interest bearing deposits in banks increased by $25.1 million
and $1.3 million respectively, federal funds sold decreased by $36.8 million, as
this cash was deployed in the purchase of investment securities.
For the first nine months of 2003, approximately sixty-one percent of
the Company's gross revenue (total interest income plus total other income) was
derived from interest income on loans it makes to individuals and business
owners throughout its marketplace. The Company's total loan portfolio, including
loans held for sale, as of September 30, 2003 was $2.134 billion and consisted
of three broad categories of loans:
o Loans to individuals to finance the purchase of personal assets or
activities was $233.4 million or 10.9% of total loans.
o Residential mortgage loans for the purchase or financing of an
individual's private residence was $302.3 million or 14.2% of total
loans.
o Commercial loans of $1.598 billion or 74.9% of the total loan
portfolio. This includes commercial real estate, commercial
construction and commercial and industrial loans.
Loans to individuals consisted primarily of loans with fixed terms and
lines of credit secured by liens on the individual's residence. The principal
risk associated with these credits is the overall creditworthiness of the
individual borrower. Changes in an individual's employment or life circumstances
can have an effect on the repayment of these assets.
Residential mortgage loans are extended to individuals for the purchase
or financing of their residence. These loans are secured by a first lien title
insured mortgage on their home. Again, the primary risk in these credits is the
financial soundness of the individual borrower.
17
Commercial loans consist of lines of credit, term loans, mortgages, and
leases extended to business owners or to individuals for business purposes. The
types of business borrowers represented in the portfolio consist of
manufacturing companies, wholesalers, distributors and warehouses, professional
service providers, retailers, commercial real estate investors, and land
developers. The commercial portfolio has a concentration in loans to commercial
real estate investors and developers with loans outstanding to this group of
$281.0 million, which is 17.6% of the commercial loan portfolio and 13.2% of the
total loan portfolio.
There are numerous risks associated with commercial loans that could
impact the borrower's ability to repay on a timely basis. They include but are
not limited to: the owner's business expertise, changes in local, national, and
in some cases international economies, competition, governmental regulation, and
the general financial stability of the borrowing entity.
The Company attempts to mitigate these risks by making an analysis of
the borrower's business and industry history, its financial position, as well as
that of the business owner. The Company will also require the borrower to
provide financial information on the operation of the business periodically over
the life of the loan. In addition, most commercial loans are secured by assets
of the business or those of the business owner, which can be liquidated if the
borrower defaults, along with the personal surety of the business owner.
All of the aforementioned loan types can be made on a floating or fixed
rate basis, either of which can pose an interest rate risk to the Company as
financial markets change. Interest rate risk is discussed in further detail in
the Liquidity and Interest Rate Sensitivity section of this report.
The following table shows detailed information and ratios pertaining to
the Company's loans and asset quality (dollars in thousands):
September 30, 2003 December 31, 2002
------------------ -----------------
Nonaccrual loans $17,504 $14,046
Loans past due 90 or more days
as to interest or principal 541 928
---------- ---------
Total nonperforming loans 18,045 14,974
Other real estate owned 798 318
---------- ---------
Total nonperforming assets $18,843 $15,292
========== =========
Total loans and leases, including loans
18
held for sale $2,133,924 $1,784,290
Average total loans and leases $2,076,633 $1,753,098
Allowance for loan and lease losses $45,990 $40,578
For 9 months ended 9/30/2003 For 9 months ended 9/30/2002
---------------------------- ----------------------------
Net charge-offs $5,222 $11,073
Net charge-offs to: (annualized)
Total loans and leases .33% .63%
Average total loans and leases .34% .63%
Allowance for loan and lease losses 15.14% 27.52%
Nonperforming assets to:
Total loans and leases 0.88 % 1.52%
Allowance for loan and lease losses to:
Nonperforming assets 244.1% 149.9%
Total loans and leases 2.16% 2.28%
Average total loans and leases 2.21% 2.29%
The increase in nonperforming assets is due to a $3.5 million increase
in nonaccrual loans, from $14.0 million at December 31, 2002 to $17.5 million at
September 30, 2003. The increase in nonaccrual loans is due primarily to the
negative effects of the weak economy on the Company's commercial and industrial
borrowers, especially the manufacturing segment. While nonaccrual loans have
increased each quarter since December 2002, management expects nonaccruals to
stabilize by year-end 2003. The increase consists of several credits newly
identified as nonperforming during management's quarterly portfolio review.
Commercial real estate and commercial and industrial loans account for 95.5% of
the total nonaccrual loans.
The investment portfolio is primarily a secondary source of liquidity,
but it also serves as a source of income. As such, the investment portfolio
consists of shorter-term investments that provide current liquidity and
longer-term investments that provide higher income. Over the past two years, the
Company has worked to shorten the duration of the investment portfolio in
response to lower interest rates and to help improve liquidity. Regardless of
classification as to shorter-term or longer-term, the majority of the Company's
investments are readily marketable securities held as available for sale, and
the majority of the Company's investments qualify as collateral for deposit
pledging needs.
Investments increased $203.7 million or 31.3% to $854.6 million at
September 30, 2003 compared to December 31, 2002. The acquisition of
FirstService Bank, which added $105.0 million in securities and the
securitization of $42.8 million in residential mortgages into a mortgage-backed
security, servicing released, were offset by the sale of $35 million of
investments in the balance sheet restructuring. The primary purpose of the
securitization was to improve the liquidity of the assets, as the security
becomes immediately saleable on the bond market. The secondary purpose is to
provide collateral for the Company's cash management program. Investment
purchases during the first nine months of 2003 were $258.8 million, primarily
mortgage-backed securities. This increase was partially offset by investment
calls and maturities and the amortization of mortgage-backed securities totaling
$205.7 million.
19
Other assets on the balance sheet increased to $213.0 million, an
increase of $81.9 million from the $131.2 million at December 31, 2002. These
assets include net premises and equipment, accrued interest receivable, bank
owned life insurance, goodwill and other intangibles, unconsolidated
investments, and other assets. This increase is due primarily to an increase in
goodwill and other intangibles attributable to the FirstService acquisition of
approximately $59.5 million. In addition there was an increase in premises and
equipment of $13.7 million, of which $11.8 million is related to FirstService.
There was an increase in bank owned life insurance of $7.7 million, of which
$6.5 million is related to FirstService. The increase in other assets of $1.2
million is due primarily to an increase in prepaid expenses of $899,000, and an
increase in the deferred tax asset of $772,000. This increase was partially
offset by a decrease in miscellaneous assets of $519,000, which included the
change in market valuation of the interest rate swaps.
As the primary source of funds, aggregate deposits of $2.384 billion at
September 30, 2003 increased $458.6 million or 23.8% compared to December 31,
2002. The increase in deposits during the first nine months of 2003 was
primarily in interest bearing deposits, which increased $382.2 million, while
non-interest bearing deposits increased $76.3 million. Of the $288.9 million in
deposits acquired in the FirstService merger, $57.9 million were non-interest
bearing and $231 million were interest bearing.
In addition to deposits, earning assets are funded to some extent
through purchased funds and borrowings. These include securities sold under
repurchase agreements, federal funds purchased, short-term borrowings, long-term
debt obligations, and subordinated debentures. In the aggregate, these funds
totaled $589.8 million at September 30, 2003, and $519.2 million at December 31,
2002. The increase of $70.6 million is due primarily to an increase in
securities sold under repurchase agreements and federal funds purchased of $69.9
million, of which $40.6 million is related to FirstService. This increase was
partially offset by a decrease in long-term borrowings of $6.4 million and
short-term borrowings of $569,000. The decrease in long-term borrowings is
related to refinancing $77.5 million in long-term Federal Home Loan Bank (FHLB)
borrowings.
Shareholders' equity increased $72.5 million through September 30,
2003. This was due primarily to the issuance of 2,563,552 shares of common stock
in conjunction with the acquisition of FirstService, which resulted in an
increase of $63.2 million of shareholders' equity. Retained earnings decreased
$10.2 million due primarily to the payment of a 5% stock dividend on September
30, 2003 and cash dividends offset by net income. Accumulated other
comprehensive income decreased $2.1 million due to a decrease in market value of
available for sale securities and adjustments to the fair value of interest rate
swaps. Cash dividends paid during the first nine months of 2003 increased $2.3
million or 17.8% to $15.4 million compared to the cash dividends paid during the
first nine months of 2002. Earnings retained during the first nine months of
2003 were 52.0% compared to 51.5% during the first nine months of 2002.
REGULATORY/COMPLIANCE AND INTERNAL CONTROL
------------------------------------------
Management has anticipated changes in regulations and compliance and is
in the process of enhancing documentation of internal controls in preparation
for the additional corporate governance requirements of the Sarbanes Oxley Act
that become effective in 2004 as well as other new regulations. Management has
an effective means of monitoring existing and new regulatory developments. The
increased reporting and documentation requirements will likely result in
increased operating costs.
LIQUIDITY AND INTEREST RATE SENSITIVITY
---------------------------------------
The primary functions of asset/liability management are to assure
adequate liquidity and maintain an appropriate balance between interest-earning
assets and interest-bearing liabilities.
Liquidity management involves the ability to meet the cash flow
requirements of customers who may be either depositors wanting to withdraw funds
or borrowers needing assurance that sufficient funds will be available to meet
their credit needs. In the past twelve to twenty-four months, the Company's
liquidity has improved as people have removed money from the declining equity
market. During this time, many customers have preferred the safety of
FDIC-insured deposits compared to the uncertain equity
20
market, despite historically low interest rates. This has allowed the Company to
grow its core deposit base and significantly reduce reliance on non-core sources
of funds.
The Company's main liquidity concern is when the current environment
reverses course - that is, the economy and consequently the equity markets
strengthen and the Company suffers disintermediation back to the equity market.
The Company is currently preparing for this potential disintermediation by
working to build its share of customers' banking business (on the theory that
even if some funds move back to the equity market, the Company will still retain
a larger share than it had two years ago), growing its government banking unit,
reviewing its deposit product offerings, establishing additional non-core
sources of funding, maintaining a more liquid investment portfolio, and
continuing to develop its capability to securitize assets.
The Company's acquisition of FirstService during the first quarter of
2003 did not have an immediate material impact on the Company's current
liquidity position. FirstService has retained its name and management.
Accordingly, the Company expects no material run-off in deposits over the long
term, and as a result, does not anticipate a negative material impact on the
Company's overall long-term liquidity position.
The Company has announced an agreement providing for its acquisition of
HomeTowne Heritage Bank for approximately $37.6 million in cash. The cash to be
paid to HomeTowne Heritage shareholders is expected to come primarily from the
cash derived from the Company's sale of Panasia Bank. Any further effect on the
liquidity
position of the Company is not expected to be material.
The goal of interest rate sensitivity management is to avoid
fluctuating net interest margins, and to enhance consistent growth of net
interest income through periods of changing interest rates. Such sensitivity is
measured as the difference in the volume of assets and liabilities in the
existing portfolio that are subject to repricing in a future time period.
The following table shows separately the interest rate sensitivity of
each category of interest-earning assets and interest-bearing liabilities at
September 30, 2003.
Repricing Periods (1)
---------------------------
Three Months One Year
Within Three Through One Through Five Over
Months Year Years Five Years
-------------------------------------------------------------------
(In Thousands)
Assets
Interest bearing deposits
at banks $ 3,904 $ - - $ - - $ --
Federal funds sold 11,200 - - - - - -
Investment securities 68,896 120,186 427,864 237,646
Loans (1) 758,737 354,665 789,582 184,949
Other assets - - - - - - 311,591
------- -------- --------- -------
842,737 474,851 1,217,446 734,186
------- -------- --------- -------
Liabilities and equity
21
Non-interest bearing deposits 372,557 - - - - - -
Interest bearing deposits (2) 820,378 211,650 354,690 625,263
Borrowed funds 181,018 10,000 67,916 236,420
Preferred securities - - - - - - 63,250
Other liabilities - - - - - - 31,203
Shareholders' equity - - - - - - 295,262
------- -------- --------- -------
1,373,953 221,650 422,606 1,251,011
------- -------- --------- -------
Interest sensitivity gap (531,216) 253,201 794,840 (516,825)
------- -------- --------- -------
Cumulative interest rate
sensitivity gap ($531,216) ($278,015) $516,825 $ - -
======= ======== ========= =======
(1) Adjustable rate loans are included in the period in which interest rates are
next scheduled to adjust rather than in the period in which they are due. Fixed
rate loans are included in the period in which they are scheduled to be repaid
and are adjusted to take into account estimated prepayments based upon
assumptions estimating prepayments in the interest rate environment prevailing
during the third calendar quarter of 2003. The table assumes prepayments and
scheduled principal amortization of fixed-rate loans and mortgage-backed
securities and assumes that adjustable rate mortgages will reprice at
contractual repricing intervals. There has been no adjustment for the impact of
future commitments and loans in process.
(2) Savings and NOW deposits are scheduled for repricing based on historical
deposit decay rate analyses, as well as historical moving averages of run-off
for the Company's deposits in these categories. While generally subject to
immediate withdrawal, management considers a portion of these accounts to be
core deposits having significantly longer effective maturities based upon the
Company's historical retention of such deposits in changing interest rate
environments. Specifically, 50.0% of these deposits are considered repriceable
within three months and 50.0% are considered repriceable in the over five years
category.
Interest rate sensitivity is a function of the repricing
characteristics of the Company's assets and liabilities. These characteristics
include the volume of assets and liabilities repricing, the timing of the
repricing, and the relative levels of repricing. Attempting to minimize the
interest rate sensitivity gaps is a continual challenge in a changing rate
environment. Based on the Company's gap position as reflected in the above
table, current accepted theory would indicate that net interest income would
increase in a falling rate environment and would decrease in a rising rate
environment. An interest rate gap table does not, however, present a complete
picture of the impact of interest rate changes on net interest income. First,
changes in the general level of interest rates do not affect all categories of
assets and liabilities equally or simultaneously. Second, assets and liabilities
which can contractually reprice within the same period may not, in fact, reprice
at the same time or to the same extent. Third, the table represents a one-day
position; variations occur daily as the Company adjusts its interest sensitivity
throughout the year. Fourth, assumptions must be made to construct such a table.
For example, non-interest bearing deposits are assigned a repricing interval
within three months, although history indicates a significant amount of these
deposits will not move into interest bearing categories regardless of the
general level of interest rates. Finally, the repricing distribution of interest
sensitive assets may not be indicative of the liquidity of those assets.
The Company uses financial simulation models to measure interest rate
exposure. These tools provide management with extensive information on the
potential impact of net income caused by changes in interest rates. Interest
rate related risks such as pricing spreads, the lag time in pricing administered
rate accounts, prepayments and other option risks are considered. Off-balance
sheet items are used in hedging the values of selected assets and liabilities
from changes in interest rates. The effect of these hedges is included in the
simulations of net income.
Management has estimated the potential effect of shifts in interest
rates on net income. The following table demonstrates the expected effect that a
parallel interest rate shift would have on the Company's net income.
22
September 30, 2003 September 30, 2002
-------------------------------------------------------------------------------------
Change in Interest $ Change in Net % Change in Net $ Change in Net % Change in Net
Rates Income Income Income Income
- -------------------------------------------------------------------------------------------------------------
(in basis points) (dollars in Thousands)
+200 $(1,657) (3.7%) $918 2.8%
+100 ( 833) (1.9%) 662 2.2%
- -100 (1,944) (4.3%) (1,818) (5.5%)
- -200 (4,386) (9.8%) (2,442) (7.3%)
The Company uses financial derivative instruments for management of
interest rate sensitivity. The Asset Liability Committee (ALCO) approves the use
of derivatives in balance sheet hedging. The most common derivative the Company
employs is interest rate swaps. The Company does not use any of these
instruments for trading purposes.
At the current level of interest rates, the Company has some exposure
to a movement in rates in either direction due to the optionality of the
financial instruments on both sides of the balance sheet. Optionality exists
because customers have choices regarding their deposit accounts or loans. For
example, if a customer has a fixed rate mortgage, he/she may choose to refinance
the mortgage if interest rates decline. One way to reduce this option risk is to
sell the Company's long-term fixed rate mortgages in the secondary market. The
impact of a rising or falling interest rate environment on net interest income
is not expected to be significant to the Company's results of operations.
Nonetheless, the Company's asset/liability management committee's priority is to
manage this optionality and therefore limit the level of interest rate risk.
The Company currently does not have any off-balance sheet special
purpose entities.
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
---------------------------------------------
The following table sets forth contractual obligations and other
commitments representing required and potential cash outflows as of September
30, 2003:
One to Four to
Less than Three Five After Five
(dollars in thousands) Total One Year Years Years Years
------- ---------- -------- ---------- -----------
Minimum annual rentals or noncancellable $ 19,021 $ 2,614 $ 4,393 $ 3,139 $ 8,875
Operating leases
Remaining contractual maturities of time
Deposits 692,134 333,501 299,775 54,915 3,943
Loan commitments 683,660 499,566 49,480 3,584 131,030
Long-term borrowed funds 163,332 15,333 32,500 35,416 80,083
Guaranteed preferred beneficial interests in
Company's subordinated debentures 63,250 --- --- --- 63,250
Standby letters of credit 40,119 27,067 12,977 75 ---
------- ---------- -------- ---------- -----------
Total $1,661,516 $878,081 $399,125 $97,129 $287,181
------- ---------- -------- ---------- -----------
The Company had no capital leases at September 30, 2003.
23
CAPITAL LEVELS
Tier 1 Capital to Tier 1 Capital to Risk- Total Capital to Risk-
Average Assets Ratio Weighted Assets Ratio Weighted Assets Ratio
------------------------------------------------------------------------
Sep. 30, Dec. 31, Sep. 30, Dec. 31, Sep.30 Dec. 31,
2003 2002 2003 2002 2003 2002
---- ---- ---- ---- ---- ----
The Company 8.34% 8.66% 11.50% 12.76% 12.76% 13.08%
National Penn Bank 6.81% 6.91% 8.95% 9.33% 10.21% 10.59%
"Well Capitalized" institution 5.00% 5.00% 6.00% 6.00% 10.00% 10.00%
(under banking regulations)
The Company's capital ratios above compare favorably to the minimum
required amounts of Tier 1 and total capital to "risk-weighted" assets and the
minimum Tier 1 leverage ratio, as defined by banking regulators. At September
30, 2003, the Company was required to have minimum Tier 1 and total capital
ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of
4.0%. In order for the Company to be considered "well capitalized", as defined
by banking regulators, the Company must have Tier 1 and total capital ratios of
6.0% and 10.0%, respectively, and a minimum Tier 1 leverage ratio of 5.0%. The
Company currently meets the criteria for a well capitalized institution, and
management believes that, under current regulations, the Company will continue
to meet its minimum capital requirements in the foreseeable future. At present,
the Company has no commitments for significant capital expenditures.
The Company's acquisition of FirstService Bank during the first quarter
of 2003 had the effect of lowering the Company's three regulatory capital
ratios. As seen in the above table, these three ratios at September 30, 2003
still remain in excess of regulatory "well capitalized" levels. The Company does
not expect a material impact on its future dividends. The dividend payout ratio
is expected to remain in the historical 45% to 50% range.
Regarding the Company's agreement to acquire HomeTowne Heritage Bank,
taken in conjunction with the Company's sale of Panasia Bank, no further
material change is expected in the Company's three regulatory capital ratios.
Because no additional shares of the Company's stock are to be issued in the
HomeTowne Heritage Bank acquisition, there should not be a negative impact on
the Company's dividend payout ratio.
The Company is not under any agreement with regulatory authorities nor
is the Company aware of any current recommendations by the regulatory
authorities, which, if such recommendations were implemented, would have a
material effect on liquidity, capital resources or operations of the Company.
RELATED PARTY TRANSACTIONS
-----------------------------
The Company has no material transactions with related parties as
defined in SFAS No. 57 Related Party Disclosures or with any other persons who,
because of a prior relationship with the Company, i.e. former members of senior
management or individuals with former management relationships with the Company,
had the ability to negotiate transactions with the Company on more favorable
terms to themselves than had they not had such prior relationships with the
Company.
ACQUISITION OF FIRSTSERVICE BANK
--------------------------------
On February 25, 2003, the Company completed a merger with FirstService
Bank (FirstService). This transaction was accounted for under the purchase
method of accounting and the results of operations
of the Company include FirstService's results from and after February 25, 2003.
The acquisition resulted in the recording of approximately $54 million of
goodwill and other intangibles. The Company believes that
24
the FirstService Bank acquisition will be dilutive to the Company's earnings in
2003, but will be accretive to earnings in 2004.
SALE OF PANASIA BANK, N.A.
---------------------------
On September 11, 2003, the Company, Panasia Bank, N.A., and Woori
America Bank, a New York banking institution, completed the sale of Panasia to
Woori America Bank for $34.5 million in cash and the subsequent merger of
Panasia into Woori America Bank. At the time of the sale, Panasia Bank had total
assets of $213.5 million, net loans of $99.7 million, investments of $84.4
million, deposits of $188.2 million, and total equity of $24.4 million. Net
income from discontinued operations, net of taxes of $3.4 million, totaled $7.9
million. Panasia's intangible assets of $12.4 million included $12.3 million of
goodwill.
PENDING ACQUISITION OF HOMETOWNE HERITAGE BANK
----------------------------------------------
As previously reported, on April 30, 2003, the Company and its
principal banking subsidiary, National Penn Bank, entered into an Agreement and
Plan of Merger with HomeTowne Heritage Bank which provides, among other things,
for the merger of HomeTowne Heritage Bank into National Penn Bank, with National
Penn Bank surviving the merger as a subsidiary of the Company. This transaction
is anticipated to close in fourth quarter 2003.
HomeTowne Heritage Bank is a commercial bank headquartered in Lancaster
County, Pennsylvania with three community offices. Total assets are $154.9
million, net loans are $141.4 million, and deposits total $124.9 million as of
September 30, 2003.
The Merger Agreement provides for the exchange of $13.697 in cash for
each outstanding share of common stock of HomeTowne Heritage Bank, or total cash
consideration of approximately $37.6 million.
The merger is subject to a number of conditions, including approval by
the Office of the Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Pennsylvania Department of Banking, and the shareholders of
HomeTowne Heritage Bank. Applications have been filed for all required
regulatory approvals. Hometowne's shareholders approved the merger at a special
meeting of shareholders held on November 4, 2003. No assurance can be given that
all required regulatory approvals will be obtained, that all other closing
conditions will be satisfied or waived, or that the transaction will in fact be
consummated.
The foregoing description does no purport to be complete and is
qualified in its entirety by reference to the Merger Agreement and related
letter agreements. Additional information is provided in the Company's Report on
Form 8-K dated April 30, 2003, including copies of the Merger Agreement and the
form of related letter agreement filed as exhibits to the 8-K Report.
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
Off Balance Sheet Commitments
- -----------------------------
The Company adopted FIN 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of Indebtedness of
Others, on January 1, 2003. FIN 45 requires a guarantor entity, at the inception
of a guarantee covered by the measurement provisions of the interpretation, to
record a liability for the fair value of the obligation undertaken in issuing
the guarantee. The Company issues financial and performance letters of credit.
Financial letters of credit require the Company to make payment if the
customer's financial condition deteriorates, as defined in the agreements.
Performance letters of credit require the Company to make payments if the
customer fails to perform identified non-financial contractual obligations. The
Company previously did not record an initial liability
25
when guaranteeing obligations unless it became probable that the Company would
have to perform under the guarantee. FIN 45 applies prospectively to guarantees
the Company issues or modifies subsequent to December 31, 2002.
The Company defines the initial fair value of these letters of credit
as the fee received from the customer. The maximum potential undiscounted amount
of future payments on these letters of credit as of September 30, 2003 is $40.1
million and they expire through 2008. The amounts due under these letters of
credit would be reduced by any proceeds that the Company would be able to obtain
in liquidating the collateral for these loans. The adoption of FIN 45 did not
have a material impact on the Company's consolidated financial position or
results of operations.
Acquired Loans
- --------------
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. Management is currently evaluating the provisions of SOP 03-3.
Variable Interest Entities
- --------------------------
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application of
Accounting Research Bulletin 51, Consolidated Financial Statements, for certain
entities that do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both.
The Company has evaluated the impact of FIN 46 on variable interest
entities consolidated by the Company prior to the issuance of FIN 46. Management
has determined that NPB Capital Trust II qualifies as a variable interest entity
under FIN 46. NPB Capital Trust II issued mandatorily redeemable preferred stock
to investors and loaned the proceeds to the Company. NPB Capital Trust II holds,
as its sole asset, subordinated debentures issued by the Company in 2002. The
timing and amount of payments on the subordinated debentures are the same as the
timing and amount of payments by NPB Capital Trust II on the mandatorily
redeemable preferred stock. NPB Capital Turst II is currently included in the
Company's consolidated balance sheet and statements of income. Management
believes that NPB Capital Trust II should continue to be included in the
Company's consolidated financial statements after the effective date of FIN 46.
However, as additional interpretations related to entities such as NPB Capital
Trust II become available, management will reevaluate its conclustion that NPB
Capital Trust II should be included in the consolidated financial statements and
its potential impact to its Tier I capital calculation under such
interpretations.
Amendment to SFAS 133 on Derivative Instruments and Hedging Activities
- ----------------------------------------------------------------------
26
The Company adopted Statement of Financial Accounting Standard 149
(SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, on July 1, 2003. SFAS No. 149 clarifies or amends SFAS No. 133 for
implementation issues raised by constituents or includes the conclusions reached
by the FASB on certain FASB Staff Implementation Issues. Statement 149 also
amends paragraph SFAS No. 133 to require a lender to account for loan
commitments related to mortgage loans that will be held for sale as derivatives.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003. The Company periodically enters into commitments with its customers, which
it intends to sell in the future. The adoption of SFAS No. 149 did not have a
material impact on the Company's financial position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
- -------------------------------------------------------------------------
The FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, on May 15,
2003. SFAS No. 150 changes the classification in the statement of financial
position of certain common financial instruments from either equity or mezzanine
presentation to liabilities and requires an issuer of those financial statements
to recognize changes in fair value or redemption amount, as applicable, in
earnings. SFAS No. 150 is effective for public companies for financial
instruments entered into or modified after May 31, 2003 and is effective at the
beginning of the first interim period beginning after June 15, 2003. Management
has not entered into any financial instruments that would qualify under SFAS No.
150. The Company currently classifies its Guaranteed Preferred Beneficial
Interest in the Company's Subordinated Debt as a liability. As a result,
management does not anticipate the adoption of SFAS No. 150 will have a material
impact on the Company's financial position or results of operations.
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. Management is currently evaluating the provisions of SOP 03-3.
FUTURE OUTLOOK
--------------
On October 23, 2003, the Company's board of directors declared a cash
dividend of $0.24 per share, payable on November 17, 2003 to shareholders of
record on October 31, 2003.
On July 26, 2002, the Company's Board of Directors authorized the
repurchase of up to one million shares of the company's common stock to be used
to fund the Company's dividend reinvestment plan, stock option plans,
stock-based benefit plans, and employee stock purchase plan. No timetable has
been set for these repurchases. As of September 30, 2003, 918,433 shares have
been repurchased at an average price of $27.32.
On September 24, 2003, the Board of Directors authorized the repurchase
of an additional one million shares of the Company's common stock, for the same
purposes as before in 2002. The program has no specific timetable for completion
and will begin when the repurchases authorized in 2002 are completed.
The Company's market area, while diverse, is subject to many of
the same weakened economic forces being experienced regionally and nationally:
27
o The continuing softness in the general economy will likely generate
only modest loan growth in 2003, possibly in the range of three to
eight percent.
o In third quarter 2003, net charge-offs increased by $318,000 over
those in second quarter 2003. The Company anticipates that net
charge-offs for all of 2003 will likely be in line with its
historical levels.
The Company, like many of its peers, continues to be concerned about
current and near term economic conditions and their continued negative effect on
its loan volume as well as its overall credit quality.
FORWARD-LOOKING STATEMENTS
------------------------------
From time to time, National Penn or its representatives make written or
oral statements that may include "forward-looking statements" with respect to
its:
* Financial condition.
* Results of operations.
* Asset quality.
* Product, geographic and other business expansion plans and
activities.
* Investments in new subsidiaries and other companies.
* Capital expenditures, including investments in technology.
* Pending or completed mergers with or acquisitions of financial or
non-financial companies or their assets, loans, deposits and
branches, including the pending National Penn/HomeTowne Heritage
Bank merger, and the revenue enhancements, cost savings and other
benefits anticipated in those transactions.
* Pending or completed sales of businesses or assets, and the benefits
anticipated in those transactions.
* Other matters.
Many of these statements can be identified by looking for words such as
"believes," "expects," "anticipates," "estimates", "projects" or similar words
or expressions.
These forward-looking statements involve substantial risks and
uncertainties. There are many factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements. These
factors include, among other things, the following possibilities:
* National Penn's unified branding campaign and other marketing
initiatives may be less effective than expected in building name
recognition and greater customer awareness of National Penn's
products and services. Use of non-National Penn brands may be
counter-productive.
* National Penn may be unable to differentiate itself from its
competitors by a higher level of customer service, as intended by
its business strategy.
28
* Expansion of National Penn's products and services offerings may
take longer, and may meet with more effective competitive resistance
from others already offering such products and services, than
expected.
* New product development by new and existing competitors may be more
effective, and take place more quickly, than expected.
* Competitors with substantially greater resources may enter product
market, geographic or other niches currently served by National
Penn.
* Geographic expansion may be more difficult, take longer, and present
more operational and management risks and challenges, than expected.
* Business development in newly entered geographic areas, including
those entered by mergers and acquisitions, may be more difficult,
and take longer, than expected.
* Competitive pressures may increase significantly and have an adverse
effect on National Penn's pricing, spending, third-party
relationships and revenues.
* Customers may substitute competitors' products and services for
National Penn's products and services, due to price advantage,
technological advantages, or otherwise.
* National Penn may be less effective in cross-selling its various
products and services, and in utilizing alternative delivery systems
such as the Internet, than expected.
* Projected business increases following new product development,
geographic expansion, and productivity and investment initiatives,
may be lower than expected, and recovery of associated costs may
take longer than expected.
* National Penn may be unable to retain key executives and other key
personnel due to intense competition for such persons or otherwise.
* Increasing interest rates may increase funding costs and reduce
interest margins, and may adversely affect business volumes,
including mortgage origination levels.
* Growth and profitability of National Penn's non-interest income or
fee income may be less than expected.
* General economic or business conditions, either nationally or in the
regions in which National Penn will be doing business, may be less
favorable than expected, resulting in, among other things, a
deterioration in credit quality or a reduced demand for credit,
including the resultant effect on National Penn's loan portfolio and
allowance for loan losses.
* Expected synergies and cost savings from mergers and acquisitions,
including reductions in interest and non-interest expense, may not
be fully realized or realized as quickly as expected.
* Revenues and loan growth following mergers and acquisitions, may be
lower than expected.
* Loan losses, deposit attrition, operating costs, customer and key
employee losses, and business disruption following mergers and
acquisitions may be greater than expected.
29
* Business opportunities and strategies potentially available to
National Penn after mergers and acquisitions may not be successfully
or fully acted upon.
* Costs, difficulties or delays related to the integration of
businesses of acquired companies with National Penn's business may
be greater or take longer than expected.
* Technological changes may be harder to make or more expensive than
expected or present unanticipated operational issues.
* Recent and proposed legislative or regulatory changes, including
changes in accounting rules and practices, and customer privacy and
data protection requirements, and intensified regulatory scrutiny of
the financial services industry in general, may adversely affect
National Penn's costs and business.
* Market volatility may continue in the securities markets, with an
adverse effect on National Penn's securities and asset management
activities.
* There may be unanticipated regulatory rulings or developments.
* Changes in consumer spending and savings habits could adversely
affect National Penn's business.
* Negative publicity with respect to any National Penn product or
service, whether legally justified or not, could adversely affect
National Penn's reputation and business.
* Various domestic or international military or terrorist activities
or conflicts may have a negative impact on National Penn's business
as well as the foregoing and other risks.
* National Penn may be unable to successfully manage the foregoing and
other risks and to achieve its current short-term and long-term
business plans and objectives.
Because such statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by such
statements. National Penn cautions shareholders not to place undue reliance on
such statements.
All written or oral forward-looking statements attributable to National
Penn or any person acting on its behalf made after the date of this Report are
expressly qualified in their entirety by the cautionary statements contained in
this Report. National Penn does not undertake any obligation to release publicly
any revisions to such forward-looking statements to reflect events or
circumstances after the date of this Report or to reflect the occurrence of
unanticipated events.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
- -------------------------------------------------------------------
The information presented in the Liquidity and Interest Rate Risk
section of the Management's Discussion and Analysis of Financial Condition and
Results of Operations, which begins on page 12, is incorporated herein by
reference.
Item 4. Controls and Procedures
- --------------------------------
National Penn's chief executive officer and chief financial officer
evaluated National Penn's "disclosure controls and procedures" as of September
30, 2003. Disclosure controls and procedures are defined in SEC Rule 13a-15(e)
as controls and other procedures of an issuer that are designed to ensure that
information required to be disclosed by the issuer in the reports that it files
or submits under the Securities
30
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms. For National Penn, these
reports are its annual reports on Form 10-K, its quarterly reports on Form 10-Q
(including this report), and its reports on Form 8-K. These officers concluded
that such controls and procedures are adequate and effective.
There were no changes in the registrant's internal control over
financial reporting during the fiscal quarter ended September 30, 2003 that
materially affected, or are reasonably likely to materially affect, National
Penn's internal control over financial reporting.
31
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings.
- ---------------------------
None.
Item 2. Changes in Securities.
- -------------------------------
None.
Item 3. Defaults Upon Senior Securities.
- -----------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
None.
Item 5. Other Information.
- ---------------------------
Stock Dividend
--------------
As previously reported, on August 27, 2003, the Board of Directors of
National Penn Bancshares, Inc. declared a 5% stock dividend payable on September
30, 2003 to shareholders of record as of September 12, 2003.
Stock Repurchase Program
------------------------
As previously reported, on September 24, 2003, the Board of Directors
of National Penn approved a stock repurchase program for 1 million shares of
National Penn common stock.
Cash Dividend
--------------
On October 23, 2003, the Board of Directors of National Penn declared a
cash dividend of $.24 per share payable on November 17, 2003 to shareholders of
record as of October 31, 2003.
Sale of Panasia Bank, N.A.
--------------------------
As previously reported, on September 11, 2003, National Penn completed
the sale of banking subsidiary Panasia Bank, N.A. to Woori America Bank, a New
York banking institution, for $34.5 million in cash.
Best Places to Work in Pennsylvania
-----------------------------------
National Penn was recently named one of the Best Places to Work in PA.
National Penn ranked within the top 50 large-sized businesses (251-plus
employees). This program is a public/private partnership of the Pennsylvania
Department of Community and Economic Development, Team Pennsylvania Foundation,
Kuntz Lesher LLP, Central Penn Business Journal, the Great Place to Work(R)
Institute and the Pennsylvania Chamber of Business and Industry.
32
Pending Acquisition of HomeTowne Heritage Bank
----------------------------------------------
As previously reported, on April 30, 2003, National Penn and its
principal banking subsidiary, National Penn Bank, entered into an Agreement and
Plan of Merger with HomeTowne Heritage Bank which provides, among other things,
for the merger of HomeTowne Heritage Bank with National Penn Bank, with National
Penn Bank surviving the merger as a subsidiary of National Penn.
The Merger Agreement provides for the exchange of $13.697 in cash for
each outstanding share of common stock of HomeTowne Heritage Bank, or total cash
consideration of approximately $37.6 million.
The merger is subject to a number of conditions, including approval by
the Office of the Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Pennsylvania Department of Banking, and the shareholders of
HomeTowne Heritage Bank. Applications have been filed for all required
regulatory approvals. HomeTowne's shareholders approved the merger at a special
meeting of shareholders held on November 4, 2003. No assurance can be given that
all required regulatory approvals will be obtained, that all other closing
conditions will be satisfied or waived, or that the transaction will in fact be
consummated.
The foregoing description does not purport to be complete and is
qualified in its entirety by reference to the Merger Agreement and related
letter agreements. Additional information is provided in National Penn's Report
on Form 8-K dated April 30, 2003, including copies of the Merger Agreement and
the form of related letter agreement filed as exhibits to the 8-K Report.
Wayne Weidner - Exercise of Stock Options
-----------------------------------------
On October 17, 2003, Wayne R. Weidner, Chairman, President and Chief
Executive Officer of National Penn, exercised stock options for 20,677 shares of
National Penn common stock under a plan adopted in February 2003. The plan was
adopted in accordance with SEC Rule 10b5-1(c), and was approved by National
Penn's board of directors under its insider trading policy.
Office and ATM Openings and Closings
------------------------------------
On September 26, 2003, National Penn Bank opened a community office,
including an ATM facility, at 3670 MacArthur Road, Whitehall, Lehigh County,
Pennsylvania. National Penn Bank closed an office in Horsham, Montgomery County,
Pennsylvania on July 31, 2003.
Item 6. Exhibits and Reports on Form 8-K.
- ------------------------------------------
a) Exhibits.
31.1 Certification of Chairman, President and Chief Executive
Officer of National Penn Bancshares, Inc., pursuant to
Commission Rule 13a-14(a) and Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Treasurer and Chief Financial Officer of
National Penn Bancshares, Inc., pursuant to Commission Rule
13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman, President and Chief Executive
Officer of National Penn Bancshares, Inc., pursuant to
Commission Rule 13a-14(b) and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002. (Furnished, not filed.)
32.2 Certification of Treasurer and Chief Financial Officer of
National Penn Bancshares, Inc., pursuant to Commission Rule
13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. (Furnished, not
filed.).
33
(b) Reports on Form 8-K. During the quarter ended September 30, 2003,
National Penn filed the following Reports on Form 8-K:
* Report dated July 15, 2003. The Report provided information
under Items 9 and 12 on National Penn's earnings for second
quarter 2003. The Report did not contain any financial
statements.
* Report dated August 27, 2003. The Report provided information
under Item 5 on National Penn's declaration of a 5% stock
dividend and amendments adopted to National Penn's pension
plan and capital accumulation plan (401(k) plan). The Report
did not contain any financial statements.
* Report dated September 11, 2003. The Report provided
information under Item 5 on the completion of National Penn's
sale of Panasia Bank, N.A. to Woori America Bank. The Report
did not contain any financial statements.
* Report dated September 24, 2003. The Report provided
information under Item 5 on National Penn's adoption of a new
stock repurchase program for 1 million shares of National Penn
common stock. The Report did not contain any financial
statements.
34
SIGNATURES
----------
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
NATIONAL PENN BANCSHARES, INC.
(Registrant)
Dated: November 10, 2003 By /s/ Wayne R. Weidner
-------------------------------
Wayne R. Weidner, Chairman,
President and Chief Executive
Officer
Dated: November 10, 2003 By /s/ Gary L. Rhoads
--------------------------------
Gary L. Rhoads, Principal
Financial Officer
35