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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: March 31, 2004
------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: to
--------------------- ----------------------
Commission file number: 0-22537-01
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
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(Address of principal executive offices) (Zip Code)
(610) 367-6001
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(Registrant's telephone number, including area code)
N/A
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(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 May 6, 2004
----- --------------------------
Common Stock (no stated par value) (No.) Shares 24,325,327
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 14
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 30
Item 4. Controls and Procedures 30
Part II - Other Information.
- ----------------------------
Item 1. Legal Proceedings 30
Item 2. Changes in Securities, Use of Proceeds 31
And Issuer Repurchases of Equity Securities
Item 3. Defaults Upon Senior Securities 31
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 March 31 Dec. 31
(Dollars in thousands, except per share data) 2004 2003
(Unaudited)
------------------------------
ASSETS
Cash and due from banks $81,740 $96,164
Interest bearing deposits in banks 4,348 2,233
------------ ------------
Total cash and cash equivalents $86,088 $98,397
Investment securities available for sale, at fair value 941,761 934,375
Loans held for sale 40,050 29,344
Loans and leases, less allowance for loan and lease losses
of $50,154 and $49,265 in 2004 and 2003 respectively 2,237,259 2,192,090
Premises and equipment, net 43,877 43,653
Accrued interest receivable 14,002 14,309
Bank owned life insurance 70,664 69,937
Goodwill and other intangibles 110854 111210
Unconsolidated investments under the equity method 6,224 2,968
Other assets 16,412 16,291
------------ ------------
Total Assets $3,567,191 $3,512,574
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Non-interest bearing deposits $405,529 $386,620
Interest bearing deposits 1,977,912 2,048,676
------------ ------------
Total deposits 2,383,441 2,435,296
Securities sold under repurchase agreements
and federal funds purchased 561,556 500,038
Short-term borrowings 10,093 10,000
Long-term borrowings 152,470 164,037
Subordinated debt 106,444 -
Guaranteed preferred beneficial interests in
Company's subordinated debentures - 63,250
Accrued interest payable and other liabilities 24,326 22,140
------------ ------------
Total Liabilities 3,238,330 3,194,761
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
2004 - 24,356,838; 2003 - 24,285,506; net of shares
in Treasury: 2004 - 13,835; 2003 - 2,626 270,720 272,534
Retained earnings 31,330 25,770
Accumulated other comprehensive income 27,334 19,595
Treasury stock at cost (523) (86)
------------ ------------
Total Shareholders' Equity 328,861 317,813
------------ ------------
Total Liabilities and Shareholders' Equity $3,567,191 $3,512,574
============ ============
The accompanying notes are an integral part of these statements.
3
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF INCOME
Three Months Ended
(Dollars in thousands, except per share data) March 31
------------------------------
2004 2003
------------ ------------
INTEREST INCOME
Loans and leases, including fees $34,186 $31,163
Investment securities
Taxable 6,718 5,468
Tax-exempt 3,241 3,254
Federal funds sold 21 200
Deposits in banks 8 16
------------ ------------
Total interest income 44,174 40,101
------------ ------------
INTEREST EXPENSE
Deposits 8,099 8,580
Securities sold under repurchase agreements and
federal funds purchased 1,587 932
Short-term borrowings 10 8
Long-term borrowings 3,053 3,398
------------ ------------
Total interest expense 12,749 12,918
------------ ------------
Net interest income 31,425 27,183
Provision for loan and lease losses 1,763 2,255
------------ ------------
Net interest income after provision
for loan and lease losses 29,662 24,928
------------ ------------
NONINTEREST INCOME
Trust income 1,361 1,299
Service charges on deposit accounts 3,415 2,787
Bank owned life insurance income 731 652
Other service charges and fees 2,575 1,965
Net gains (losses) on sale of investment securities (196) -
Mortgage banking income 1,303 1,441
Insurance commissions and fees 832 462
Service charges cash management 640 498
Equity in earnings of unconsolidated subsidiaries 101 47
------------ ------------
Total noninterest income 10,762 9,151
------------ ------------
NONINTEREST EXPENSES
Salaries, wages and employee benefits 14,778 12,566
Net premises and equipment 3,954 3,269
Advertising and marketing expenses 1,132 639
Other operating 5,657 4,850
------------ ------------
Total noninterest expenses 25,521 21,324
------------ ------------
Income before income taxes and discontinued operations 14,903 12,755
Income tax expense 3,535 2,997
------------ ------------
Net income from continuing operations 11,368 9,758
Net income from discontinued operations, net of taxes - 632
------------ ------------
Net income $11,368 $10,390
============ ============
PER SHARE OF COMMON STOCK
Net income per share - basic $0.47 $0.44
Net income per share - diluted $0.46 $0.43
Dividends paid in cash $0.24 $0.21
The accompanying notes are an integral part of these statements.
4
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 2004
(Dollars in thousands)
Accumulated
Common Stock other
-------------------------- Retained conprehensive Treasury Comprehensive
Shares Value earnings income stock Total income
------------------------------------------------------------------------------------------------
Balance at December 31, 2003 24,284,506 $ 272,534 $ 25,770 $ 19,595 $ (86) 317,813
Net income - - 11,368 - - 11,368 $ 11,368
Cash dividends declared - - (5,808) - - (5,808)
Shares issued under stock-based
plans 251,271 (1,814) - - 5,481 3,667
Other comprehensive loss, net
of reclassification adjustment
and taxes - - - 7,739 - 7,739 7,739
------------------------------------------------------------------------------------------------
Total comprehensive income - - - - - - $ 19,107
------------------------------------------------------------------------------------------------
Treasury shares purchased (178,939) - - - (5,918) (5,918)
------------------------------------------------------------------------------------------------
Balance at March 31, 2004 24,356,838 $ 270,720 $ 31,330 $ 27,334 $ (523) $ 328,861
March 31, 2004
----------------------------------------
Before Tax Net of
tax (expense) tax
amount benefit amount
----------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period 11,946 (4,098) 7,848
Less: Reclassification adjustment for losses
realized in net income (196) 69 (127)
Change in the fair value of cash flow hedges 236 - 236
----------------------------------------
Other comprehensive income, net 11,906 (4,167) 7,739
========================================
THREE MONTHS ENDED MARCH 31, 2003
(Dollars in thousands)
Accumulated
Common Stock other
-------------------------- Retained comprehensive 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 - - 10,390 - - 10,390 $ 10,390
Cash dividends declared - - (5,307) - - (5,307)
Shares issued under stock-based
plans 5,895 (3,807) - - 4,550 743
Shares issued for acquisition
of FirstService Bank 2,563,552 61,262 - - 1,924 63,186
Other comprehensive income, net
of reclassification adjustment
and taxes - - - 4,239 - 4,239 4,239
------------------------------------------------------------------------------------------------
Total comprehensive income - - - - - - $ 14,629
------------------------------------------------------------------------------------------------
Treasury shares purchased (229,447) - - - (6,613) (6,613)
------------------------------------------------------------------------------------------------
Balance at March 31, 2003 23,039,782 $ 229,926 $ 35,676 $ 23,535 $ (139) 288,998
March 31, 2003
----------------------------------------
Before Tax Net of
tax (expense) tax
amount benefit amount
----------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period 8,813 (2,282) 6,531
Less: Reclassification adjustment for losses realized
in net income - - -
Change in the fair value of cash flow hedges 2,292 - 2,292
----------------------------------------
Other comprehensive income, net 6,521 (2,282) 4,239
========================================
The accompanying notes are an integral part of these statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Three Months Ended March 31,
2004 2003
- --------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
- --------------------------------------------------------------------------------------------------------------
Net income $ 11,368 $ 10,390
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan and lease losses 1,763 2,255
Depreciation and amortization 1,633 1,184
Deferred income tax expense -- (973)
Amortization of premiums and discounts on investment
securities, net 245 285
Losses on sales of investment securities, net (196) --
Mortgage loans originated for resale (27,664) (21,516)
Sale of mortgage loans originated for resale 28,839 22,581
Gain on sale of mortgage loans originated for resale (1,175) (1,065)
Changes in assets and liabilities
Decrease in accrued interest receivable 307 1,198
(Decrease) increase in accrued interest payable 102 (31)
(Increase) in other assets (2,632) (1,986)
Increase (decrease) in other liabilities 2,084 (135)
Decrease (increase) in assets from discontinued operations -- (2,766)
Increase (decrease) in liabilities from discontinued operations -- (2,167)
- -----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 14,674 7,254
- -----------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
- -----------------------------------------------------------------------------------------------------
Cash paid in excess of cash equivalents for business acquired -- (81)
Proceeds from sales of investment securities available for sale 40,896 --
Proceeds from maturities of investment securities available for sale 50,859 59,527
Purchase of investment securities available for sale (90,968) (71,615)
Net (increase) in loans (57,637) (6,520)
Purchases of premises and equipment (1,501) (2,027)
- -----------------------------------------------------------------------------------------------------
Net cash used in investing activities (58,351) (20,716)
- -----------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- -----------------------------------------------------------------------------------------------------
Net increase in interest and non-interest
bearing demand deposits and savings accounts (40,627) (31,935)
Net (decrease) increase in certificates of deposit (11,228) 47,787
Net increase in securities sold under
agreements to repurchase and federal funds purchased 61,518 15,102
Advances (Repayments) of short-term borrowings 93 (8,081)
Repayments of long-term borrowings (11,567) (1,237)
Proceeds from the issuance of subordinated debentures 41,238 --
Issuance of common stock under dividend
reinvestment and stock option plans 3,667 743
Purchase of treasury stock (5,918) (6,613)
Cash dividends (5,808) (5,307)
- -----------------------------------------------------------------------------------------------------
Net cash provided by financing activities 31,368 10,459
- -----------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (12,309) (3,003)
Cash and cash equivalents at beginning of year 98,397 124,124
- -----------------------------------------------------------------------------------------------------
Cash and cash equivalents at March 31 $ 86,088 $ 121,121
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, 2003.
The results of FirstService Bank, which was acquired February 25, 2003, are
included in the balance sheet and income statement for the quarter ended March
31, 2003 from February 25, 2003 through March 31, 2003. The results of
FirstService Bank and HomeTowne Heritage Bank (acquired December 12, 2003) are
included for the entire first quarter in 2004.
The results of operations for the three-month period ended March 31, 2004 are
not necessarily indicative of the results to be expected for the full year.
2. ACQUISITIONS AND DISPOSITIONS
Pending Acquisition of Peoples First, Inc.
------------------------------------------
On December 18, 2003, National Penn Bancshares, Inc. announced the
execution of a definitive agreement for National Penn to acquire Peoples First,
Inc. ("Peoples"), parent company of The Peoples Bank of Oxford in a stock and
cash transaction valued at approximately $148 million. The Peoples Bank of
Oxford is a $461 million bank headquartered in Oxford, Pennsylvania, operating
eight community offices in Chester and Lancaster Counties, Pennsylvania, and one
community office in Cecil County, Maryland.
Under the terms of the merger agreement, Peoples shareholders will be
entitled to select to receive either 1.505 shares of National Penn common stock,
$49.54 in cash, or a combination of both, for each share of Peoples common
stock. Peoples shareholder elections are subject to allocation procedures. The
application of these procedures will result in the exchange of 30 percent of the
Peoples shares for cash, and the remaining shares will be exchanged for shares
of National Penn common stock. Options to purchase shares of Peoples common
stock will be converted into options to purchase shares of National Penn common
stock. The merger is subject to a number of conditions, including approval by
the Board of Governors of the Federal Reserve System, the Pennsylvania
Department of Banking and the shareholders of Peoples First, Inc. No assurance
can be given that all required approvals will be obtained, that all other
closing conditions will be satisfied or waived, or that the transaction will in
fact be consummated.
Disposition of Panasia Bank, N.A.
------------------------------------------
On September 11, 2003, the Company completed the cash sale of Panasia Bank
N.A., a wholly owned subsidiary for $34.5 million, which resulted in a gain of
$6.68 million after taxes of $1.8 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 $232,000, for the three months ended
March 31, 2003 was $632,000.
7
The following represents the per share amounts for continuing and
discontinued operations for the quarter ended March 31, 2003:
March 31, 2003
--------------
Net income per share - basic
Continuing operations $0.41
Discontinued operations 0.03
----
Net income per share - basic $0.44
=====
Net income per share - diluted
Continuing operations $0.40
Discontinued operations 0.03
----
Net income per share - diluted $0.43
=====
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 $10.1 million at March 31, 2004,
all of which are non-accrual loans. The allowance for loan loss associated with
these impaired loans was $1.1 million at March 31, 2004. 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 January 28, 2004, the Company's Board of Directors declared a cash dividend
of $0.24 per share paid on February 17, 2004, to shareholders of record on
February 7, 2004.
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. As of March 31, 2004, 331,860 shares have been
repurchased at an average price of $32.16.
On August 27, 2003, the Company's Board of Directors declared a 5% stock
dividend paid on September 30, 2003 to shareholders of record on September 12,
2003. All weighted average share and per share information has been
retroactively restated.
8
5. EARNINGS PER SHARE
Year to Date March 31, 2004
- ---------------------------
Income Shares Per Share
(numerator) (denominator) Amount
---------- ------------- ---------
Basic earnings per share
Net income available to common stockholders $11,368 24,338 $ 0.47
Effect of dilutive securities
Options -- 639 (0.01)
------ ------ ---------
Diluted earnings per share
Net income available to common stockholders
Plus assumed conversions $11,368 24,977 $ 0.46
======= ======= ========
Options to purchase 338,364 shares of common stock at $32.35 to $32.67 per share
were outstanding for the three months ended March 31, 2004. They were not
included in the computation of diluted earnings per share because the option
exercise price was greater than the average market price.
Year to Date March 31, 2003
- ---------------------------
Income Shares Per Share
(numerator) (denominator) Amount
---------- ------------- ---------
Basic earnings per share
Net income available to common stockholders $10,390 23,778 $ 0.44
Effect of dilutive securities
Options -- 573 (0.01)
------ ------ ---------
Diluted earnings per share
Net income available to common stockholders
Plus assumed conversions $10,390 24,351 $ 0.43
======= ======= ========
Options to purchase 282,194 shares of common stock at $24.76 to $25.13 per share
were outstanding for the three months ended March 31, 2003. 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 Chairman and Chief Executive
Officer. The Company has applied the aggregation criteria set forth in SFAS No.
131 for its National Penn Bank operating segment through March 31, 2004, to
create a reportable operating segment as "Community Banking." Prior to its
disposition on September 11, 2003, Panasia Bank, N.A. was consolidated as part
of the Community Banking operating segment.
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. For example,
commercial lending is dependent upon the ability to fund it 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, and the
Company. The balances of NPB Capital Trust II were consolidated with National
Penn Bancshares, Inc. and are included in the "Other" category as of and for the
three months ended March 31, 2003.
9
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.
Reportable segment-specific information and reconciliation to consolidated
financial information is as follows:
Community Banking Other Consolidated
----------------- ----- ------------
(in thousands)
As of, and for the three months
- -------------------------------
Ended, March 31, 2004
---------------------
Total Assets $3,093,720 $ 473,471 $3,567,191
Total Deposits 2,383,441 -- 2,383,441
Net interest income (loss) 32,335 (910) 31,425
Total noninterest income 7,809 2,953 10,762
Total noninterest expense 22,593 2,928 25,521
Net income (loss) 11,973 (605) 11,368
As of, and for the three months
- -------------------------------
Ended, March 31, 2003
---------------------
Total Assets $2,914,846 $ 368,568 $3,283,414
Total Deposits 2,230,689 -- 2,230,689
Net interest income (loss) 28,357 (1,174) 27,183
Total noninterest income 6,807 2,344 9,151
Total noninterest expense 19,183 2,141 21,324
Net income from continuing
operations 10,426 (668) 9,758
Discontinued Operations 632 -- 632
Net income (loss) $ 11,058 $ (668) $ 10,390
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 March 31, 2004, 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.
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,
2004.
10
Year to Date March 31,
----------------------
2004 2003
---- ----
Net income, as reported $11,368 $10,390
Less: stock based compensation costs determined under fair value-
Based method for all awards (275) (213)
------- -------
Net income, pro forma $11,093 $10,177
======= =======
Earnings per share of common stock - basic As reported .47 .44
Pro forma .46 .43
Earnings per share of common stock - diluted As reported .46 .43
Pro forma .44 .42
The Company granted options for 12,639 and 10,341 shares in the first three
months of 2004 and 2003, 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 2004 and
2003, respectively: dividend yield of 3.02% and 3.28%; expected volatility of
27.0% and 35.1%; risk-free interest rates for each plan of 4.04% for 2004 and
3.93% for 2003; and expected lives of 6.00 years in 2004 and 6.83 years in 2003.
On March 31, 2004, the Financial Accounting Standards Board (FASB)
issued a proposed Statement, Share-Based Payment - an Amendment of FASB
Statements No. 123 and APB No. 95,that addresses the accounting for share-based
payment transactions in which an enterprise receives employee services in
exchange for (a) equity instruments of the enterprise or (b) liabilities that
are based on the fair value of the enterprise's equity instruments or that may
be settled by the issuance of such equity instruments. Under the FASB's
proposal, all forms of share-based payments to employees, including employee
stock options, would be treated the same as other forms of compensation by
recognizing the related cost in the income statement. The expense of the award
would generally be measured at fair value at the grant date. Current accounting
guidance requires that the expense relating to so-called fixed plan employee
stock options only be disclosed in the footnotes to the financial statements.
The proposed Statement would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25, Accounting for Stock Issued
to Employees. The Company is currently evaluating this proposed statement and
its effects on its results of operations.
8. SUBORDINATED DEBT
As of March 31, 2004, the Company has established three statutory
business trusts, NPB Capital Trust II, NPB Capital Trust III and NPB Capital
Trust IV. In each case, the Company owns all the common capital securities of
the trust. These trusts issued preferred capital securities to investors and
invested the proceeds in the Company through the purchase of junior subordinated
debentures issued by the Company. These debentures are the sole assets of the
trusts.
o The $65.206 million of debentures issued to NPB Capital Trust II
August 20, 2002 mature on September 30, 2032, and bear interest at the
annual fixed rate of 7.85%.
o The $20.619 million of debentures issued to NPB Capital Trust III
February 20, 2004 mature on April 23, 2034, and bear interest at a
floating rate (three month LIBOR plus a margin of 2.75%).
o The $20.619 million of debentures issued to NPB Capital Trust IV March
25, 2004 mature on April 7, 2034, and bear interest at a floating rate
(three month LIBOR plus a margin of 2.75%).
11
On April 7, 2004, the Company established an additional statutory
business trust, NPB Capital Trust V. The Company owns all the common capital
securities of the trust. Like the other trusts it issued preferred capital
securities to investors and invested the proceeds in junior subordinated
debentures of the Company. These debentures are its sole assets.
o The $20.619 million of debentures issued to NPB Capital Trust V April
7, 2004 mature on April 7, 2034, and bear interest at a floating rate
(three month LIBOR plus a margin of 2.75%).
Based on current interpretations of the banking regulators, all the
foregoing junior subordinated debentures qualify under the risk-based capital
guidelines of the Federal Reserve as Tier 1 capital, subject to certain
limitations. In each case, the debentures are callable by National Penn, subject
to any required regulatory approvals, at par, in whole or in part, at any time
after five years. In each case, the Company's obligations under the junior
subordinated debentures and related documents, taken together, constitute a
full, irrevocable and unconditional guarantee on a subordinated basis by the
Company of the obligations of the trusts under the preferred securities.
Management has determined that NPB Capital Trust II qualifies as a variable
interest entity under FIN 46, as revised. NPB Capital Trust II issued
mandatorily redeemable preferred capital securities to investors and loaned the
proceeds to the Company. NPB Capital Trust II is included in the Company's
consolidated balance sheet and statements of income as of and for the year ended
December 31, 2003. Subsequent to the issuance of FIN 46 in January 2003, the
FASB issued a revised interpretation, FIN 46(R) Consolidation of Variable
Interest Entities, the provisions of which must be applied to certain variable
interest entities by March 31, 2004.
The Company adopted the provisions under the revised interpretation in the
first quarter of 2004. Accordingly, the Company no longer consolidates NPB
Capital Trust II as of March 31, 2004. FIN 46(R) precludes consideration of the
call option embedded in the preferred capital securities when determining if the
Company has the right to a majority of NPB Capital Trust II's expected residual
returns. The de-consolidation results in the investment in the common capital
securities of NPB Capital Trust II being included in unconsolidated investments
under the equity method as of March 31, 2004 with a corresponding increase in
outstanding debt of $1.956 million. In addition, the income received on the
Company's common capital securities investment is included in equity in earnings
of unconsolidated subsidiaries. The adoption of FIN 46(R) did not have a
material impact on the financial position or results of operations. The banking
regulatory agencies have not issued any guidance that would change the
regulatory capital treatment for the trust-preferred securities issued by NPB
Capital Trust II based on the adoption of FIN 46(R). However, as additional
interpretations from the banking regulators related to entities such as NPB
Capital Trust II and similar entities become available, management will
reevaluate its potential impact to its Tier I capital calculation under such
interpretations. Further information is contained in Part II - Other
Information.
12
9. EMPLOYEE BENEFIT PLANS
Net periodic defined benefit pension expense for the three months ended
March 31, 2004 and 2003 included the following components:
March 31, March 31,
2004 2003
--------- ---------
Service cost $ 392,944 $ 315,960
Interest cost 316,460 267,178
Expected return on plan assets (388,391) (320,547)
Amortization of prior service cost (6,382) (10,471)
Amortization of unrecognized net
actual loss 27,131 12,107
--------- ---------
Net periodic benefit expense $ 343,106 $ 291,334
========= =========
We currently expect to contribute approximately $1,328,876 to our pension
plan in 2004. We are currently evaluating the impact of the Pension Funding
Equity Act enacted in April 2004 on our projected funding. No contributions to
the plan were required in the three months ended March 31, 2004.
10. NEW ACCOUNTING PRONOUNCEMENTS
Staff Accounting Bulletin 105
-----------------------------
The Securities and Exchange Commission staff recently released Staff
Accounting Bulletin (SAB) 105, "Loan Commitments Accounted for as Derivative
Instruments." SAB 105 requires that a lender should not consider the expected
future cash flows related to loan servicing or include an internally developed
intangible assets, such as customer-related intangible assets, in determining
the fair value of loan commitments accounted for as derivatives. Companies will
be required to adopt SAB 105 effective for commitments entered into after March
31, 2004. The requirements of SAB 105 will apply to the Company's mortgage loan
interest rate lock commitments related to loans held for sale. At March 31,
2004, such commitments with a notional amount of approximately $73.5 million
were outstanding. The Company's current accounting policy is to not record the
fair value of these commitments because they are immaterial. The Company
anticipates that it will adopt SAB 105 at the beginning of its second quarter,
and that application of its guidance would not have a material impact on the
results of operations.
13
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 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 9.4% increase in first quarter 2004 net income
compared to first quarter 2003. Diluted earnings per share for the three-month
period of $0.46 increased 7.0% compared to $0.43 for first quarter 2003. 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. Per share results
for 2003 have been restated for the 5% stock dividend issued September 30, 2003.
For the three month period ended March 31, 2004, the annualized return
on average shareholders' equity and annualized return on average assets were
15.2% and 1.30% compared to 16.9% and 1.38 % for the comparable period in 2003.
This decrease is due primarily to the higher levels of average equity
outstanding resulting from the acquisition of FirstService Bank on February 25,
2003. The return on average tangible equity was 24.1% as of March 31, 2004 and
20.2% as of March 31, 2003.
Return on average tangible equity is supplemental financial information
determined by a method other than in accordance with Accounting Principles
Generally Accepted in the United Stated of America ("GAAP"). National Penn's
management uses this non-GAAP measure in its analysis of the company's
performance. Annualized net income return on average tangible equity excludes
the average balance of acquisition-related goodwill and intangibles in
determining average tangible shareholders' equity. Banking and financial
institution regulators also exclude goodwill and intangibles from shareholders'
equity when assessing the capital adequacy of a financial institution.
Management believes the presentation of this financial measure excluding the
impact of these items provides useful supplemental information that is essential
to a proper understanding of the financial results of National Penn, as it
provides a method to assess management's success in utilizing the company's
tangible capital. This disclosure should not be viewed as a substitute for
results determined in accordance with GAAP, nor is it necessarily comparable to
non-GAAP performance measures that may be presented by other companies.
The following table reconciles this non-GAAP performance measure to the
GAAP performance measure, return on average shareholders' equity.
Reconciliation Table for Non-GAAP Financial Measure
March 31, 2004 March 31, 2003
-------------- --------------
Return on average shareholders' equity 15.2% 16.9%
Effect of goodwill and intangibles 8.9% 3.3%
Return on average tangible equity 24.1% 20.2%
Average tangible equity excludes acquisition related average goodwill and intangibles:
Average shareholders' equity $299,338 $246,105
Average goodwill and intangibles (111,039) (40,597)
Average tangible equity 188,299 205,508
The Company's strategic plan provides for a highly profitable financial
services company within the markets it serves. Specifically, management is
focused on increased market penetration in selected geographic areas, and
excellence in both retail and commercial lines of business. The anticipated
acquisition of Peoples First, Inc. and its subsidiary, The Peoples Bank of
Oxford, in second quarter 2004 and the data conversion of HomeTowne Heritage
Bank in January 2004 represent strategic initiatives by the Company in
furtherance of its focused goals.
14
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 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 employs general industry practices in accordance with GAAP. A fair value
is determined for each reporting unit using 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. In the past, the
Company tested for impairment in June, but due to recent acquisitions, we
performed additional goodwill impairment tests as of March 31, 2004 and did not
identify any impairment on our outstanding goodwill. 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.
The Company has not substantively changed any aspect of its overall
approach in the application of the foregoing policies. There have been no
material changes in assumptions or estimation techniques utilized as compared to
prior periods.
RESULTS OF OPERATIONS
Net income for the quarter ended March 31, 2004 was $11.4 million, 9.4%
more than for the first quarter 2003. 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 first
15
quarter 2003 include FirstService Bank from its acquisition date, February 25,
2003 through March 31, 2003. The results of first quarter 2004 include
FirstService Bank and HomeTowne Heritage Bank (acquisition date of December 12,
2003) for the full quarter.
Net interest income is the difference between interest income earned on
assets and interest expense paid on liabilities. Net interest income for the
first quarter of 2004 was $31.4 million, which increased $4.2 million or 15.6%
over the $27.2 million for the first quarter of 2003. Interest income for the
first quarter of 2004 increased $4.1 million due to an increase in loan income
of $3.0 million and an increase in investment income of $1.24 million offset by
a decrease in federal funds sold and interest from deposits in banks of
$187,000. Interest expense for first quarter 2004 decreased $169,000 due to a
decrease in interest on deposits of $481,000, a decrease in interest on
long-term borrowings of $345,000, offset by an increase in interest on
securities sold under repurchase agreements and federal funds purchased and
short term borrowings of $657,000. The decrease in interest expense on deposits
is due to interest rate decreases, while interest expense on securities sold
under repurchase agreements rose as a result of increased balances. The decrease
in interest on long-term borrowings is a result of refinancing $77.5 million in
long-term Federal Home Loan Bank (FHLB) advances in third quarter 2003, offset
by the addition of $40.0 million of subordinated debentures.
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 $4.2
million in the first three months of 2004, as compared to the same period in
2003. This increase is due to a $7.5 million increase due to volume,
attributable mainly to the FirstService Bank and HomeTowne Heritage Bank
acquisitions, offset by a $3.3 million net interest margin compression.
Three Months ended March 31, 2004
over 2003
-----------------------------------------
Volume Rate Total
------ ---- -----
Increase (decrease) in:
Interest income:
Interest bearing deposits in banks $ (2) $ (6) $ (8)
Federal Funds sold (168) (11) (179)
Investment Securities 3,080 (1,843) 1,237
Total Loans 6,854 (3,841) 3,023
------- ------- -------
Total interest income $ 9,764 ($5,691) $ 4,073
------- ------- -------
Interest expense:
Interest bearing deposits $ 1,522 $(2,003) $ (481)
Short-term borrowings 886 (229) 657
Long-term borrowings (140) (205) (345)
------- ------- -------
Total interest expense $ 2,268 $(2,437) $ (169)
Increase (decrease) in net interest
income $ 7,496 $(3,254) $ 4,242
======= ======= =======
Net interest margin, defined as net interest income divided by total
interest earning assets, decreased to 4.20% during first quarter 2004 compared
to 4.52% during the first quarter of 2003. The net interest margin continues to
be a concern in future quarters as the Company anticipates continued margin
compression. The Company recently issued $60 million of trust preferred
securities, $40 million of which was issued in the first quarter 2004 and $20
million recently in the second quarter 2004. These securities bear an interest
rate of 2.75% over the three-month London InterBank Offered Rate ("LIBOR"). This
16
funding is expected to have an approximate 4 basis point negative effect on
National Penn's net interest margin in 2004.
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 a full quarter of net interest income from
FirstService and HomeTowne Heritage Bank contributed to the increase in net
interest income for the first three months of 2004 compared to the same period
in 2003.
Management conducts a quarterly analysis of the loan portfolio and
adjusts allowance for loan and lease losses accordingly. During our quarterly
analysis of the loan and lease loss allowance, we considered a variety of
factors, some of which included:
o General economic conditions.
o Trends in charge-offs.
o The level of non-performing assets, including loans over 90 days
delinquent.
o Levels of allowance for specific classified assets.
o A review of economic sectors, for example the manufacturing
industry, which may continue to create loan losses in the
manufacturing portfolio.
o The overall concerns of consumer confidence, including
international terrorism and the continued unrest in Iraq.
Based on the quarterly analysis, the Company provided $1.8 million to
its allowance for loan and lease losses, a decrease of $492,000 compared to the
three months ended March 31, 2003. The Company maintains 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 $873,000 million for the three
months of 2004 decreased by $1.2 million compared to the $2.1 million in net
charge-offs at March 31, 2003.
Non-interest income increased $1.6 million or 17.6% during the first
quarter of 2004 compared to the same period in 2003, as a result of increased
service charges on deposit accounts, cash management and other service charges
and fees of $1.4 million, insurance commissions and fees of $370,000, bank owned
life insurance income of $79,000, trust income of $62,000 and equity in earnings
of unconsolidated subsidiaries of $54,000. These increases totaling $1.9 million
were offset by $196,000 in losses on sales of investment securities, and a
decrease in mortgage income. Despite a $740,000 gain on the sale of servicing
related to mortgages that were securitized and now reside in the Company's
investment portfolio as mortgage backed securities, mortgage banking income was
down $138,000 in first quarter 2004 as compared to first quarter 2003.The
mortgage income decrease is a result of slower refinancing volume in the
quarter, reflecting the rise in interest rates beginning in mid-June 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 charge income is
due primarily to an increase in the collection of fees on a larger deposit base
and price increases.
Non-interest expenses increased $4.2 million or 19.6% during the first
quarter of 2004 compared to first quarter 2003, to $25.5 million. Salaries,
wages and benefits increased $2.2 million or 17.6%, other operating expenses
increased $807,000 or 16.6%, net premises and equipment increased $685,000 or
21.0%, and advertising and marketing expenses increased $493,000 or 77.2%.
Salaries, wages and benefits increased due to normal salary increases and a full
quarter of expenses in first quarter 2004, compared to 34 days of salary and
benefits expense from FirstService Bank in first quarter 2003. The FirstService
acquisition resulted in the addition of 137 employees, while the acquisition of
HomeTowne Heritage Bank added 30 employees. The increase in net premises and
equipment expense is also partially associated with the acquisitions of
FirstService and HomeTowne Heritage Bank, which included a community office
network of seven offices and three offices, respectively. The increase in
marketing expense is attributable to additional advertising campaigns conducted
in the first quarter of 2004. Other operating expenses increased $807,000 or
16.6% through March 31, 2004, compared to the same period last year. The
17
inclusion of a full quarter of expenses from FirstService and HomeTowne Heritage
Bank contributed to the increase.
Income before income taxes and discontinued operations increased $2.1
million or 16.8% in the first quarter of 2004 compared to the same time period
in 2003. Income taxes increased $538,000 or 17.9% for the quarter ended March
31, 2004 due to the higher proportion of taxable assets to total assets compared
to the same period in 2003. The Company's effective tax rate was relatively
stable, at 23.7% for the first quarter of 2004 compared to 23.5% for first
quarter 2003. 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. Net income after
tax from continuing operations increased $1.6 million, or 16.49% in first
quarter 2004 compared to first quarter 2003.
FINANCIAL CONDITION
-------------------
At March 31, 2004, total assets were $3.567 billion, an increase of
$54.6 million or 1.6% from the $3.513 billion at December 31, 2003. Net loans
and leases, including loans held for sale, which totaled $2.277 billion at March
31, 2004, increased $55.9 million, or 2.5% compared to the $2.221 billion in
loans December 31, 2003. Loans continue to increase at a modest pace as a result
of the improving economy and the increase of capital goods spending by the
Company's business customers. Loans originated for immediate resale during the
first three months of 2004 amounted to $27.7 million.
Total cash and cash equivalents decreased $12.3 million or 12.5% at
March 31, 2004 when compared to December 31, 2003. Cash and due from banks
decreased $14.4 million, due to an increase in loan fundings. This increase was
partially offset by a $2.2 million increase in interest bearing deposits in
banks.
For the first three months of 2004, approximately sixty-two percent of
the Company's gross revenue (total interest income plus total other income or
$54.9 million through March 31, 2004 ) was derived from interest income on loans
it makes to individuals and business owners throughout its marketplace, which
totaled $34.2 million. The Company's total loan portfolio, including loans held
for sale, as of March 31, 2004 was $2.277 billion and consisted of three broad
categories of loans:
o Loans to individuals to finance the purchase of personal assets
or activities was $235.1 million or 10.3% of total loans.
o Residential mortgage loans for the purchase or financing of an
individual's private residence was $247.8 million or 10.9% of
total loans.
o Commercial loans of $1.794 billion or 78.8% 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.
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, farmers and agricultural related industries,
commercial real estate investors, and land developers. The commercial portfolio
has a concentration in loans to commercial real estate investors
18
and developers with loans outstanding to this group of $435.3 million. Loans
outstanding are 24.2% of the commercial loan portfolio and 19.1% 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):
March 31, 2004 December 31, 2003
---------- ----------
Nonaccrual loans $ 11,583 $ 13,673
Loans past due 90 or more days
as to interest or principal 258 318
---------- ----------
Total nonperforming loans 11,841 13,991
Other real estate owned 616 318
---------- ----------
Total nonperforming assets $ 12,457 $ 14,309
========== ==========
19
Total loans and leases, including loans
held for sale $2,327,463 $2,270,700
Average total loans and leases $2,284,094 $2,036,847
Allowance for loan and lease losses $ 50,154 $ 49,265
Allowance for loan and lease losses to:
Nonperforming assets 402.6% 344.3%
Total loans and leases 2.15% 2.17%
Average total loans and leases 2.20% 2.42%
For 3 months ended 3/31/2004 For 3 months ended 3/31/2003
---------------------------- ----------------------------
Net charge-offs $ 873 $ 2,070
Net charge-offs to: (annualized)
Total loans and leases .15% .41%
Average total loans and leases .15% .44%
Allowance for loan and lease losses 6.96% 18.53%
The decrease in nonperforming assets is due primarily to a $2.1 million
decrease in nonaccrual loans, from $13.7 million at December 31, 2003 to $11.6
million at March 31, 2004. The decrease in nonaccrual loans is due to the
improving condition of the Company's commercial and industrial borrowers, the
payoff of some nonaccruals, and the charge-off of some other loans that were
deemed no longer collectible. Management expects nonaccrual loans to remain
stable for the balance of 2004. Management reviews the loan portfolio quarterly
to identify nonperforming credits. As of March 31, 2004, loans secured by
non-farm, non-residential real estate and commercial and industrial loans
account for 67.0% of the total nonaccrual loans; residential real estate-secured
loans account for 28.3% of nonaccruals.
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 $7.4 million or 0.80% to $934.4 million at March
31, 2004 compared to December 31, 2003. Investment purchases during the three
months of 2004 were $91.0 million, primarily U.S. Government Agency securities.
This increase was partially offset by investment calls and maturities and the
amortization of mortgage-backed securities totaling $50.9 million. During the
first quarter 2004, the Company sold approximately $40.9 million in investment
securities available for sale resulting in a $196,000 loss. This transaction
allowed us to re-deploy those funds into higher yielding investments.
Other assets on the balance sheet increased to $262.0 million, an
increase of $3.7 million from the $258.4 million at December 31, 2003. 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
unconsolidated investments of $3.3 million, attributable to the issuance of $40
million in additional trust preferred securities and the adoption of FIN46(R).
The Company adopted FIN46(R) in the first quarter 2004 and de-consolidated NPB
Capital Trust II as of March 31, 2004 on the financial statements.
20
In 1998 and 1999, the Company invested in bank owned life insurance
(BOLI) policies that provide earnings to help cover the cost of employee benefit
plans. BOLI involves the purchasing of life insurance by the Company on a chosen
group of employees. The Company is the owner and beneficiary of the policies.
The Company has additional BOLI policies that have been received through several
of its bank acquisitions. Cashflow from these policies will occur over an
extended period of time. The Company periodically reviews the creditworthiness
of the insurance companies that have underwritten the policies. The insurance
companies are all highly rated by A.M. Best, and the earnings accruing to the
Company are derived from the general account investments of the insurance
companies. The policies appear on the Company's balance sheet and are subject to
full regulatory capital requirements.
As the primary source of funds, aggregate deposits of $2.383 billion at
March 31, 2004 decreased $51.9 million or 2.1% compared to December 31, 2003.
The decrease in deposits during the three months of 2004 was primarily due to a
$70.8 million decrease in interest bearing deposits, of which $11.3 million were
time deposits and $58.0 million were municipal interest bearing deposits.
Municipal deposits fluctuate as municipalities are required to move their
deposits to the institution that will provide the highest rate of return on
public funds. These deposits also fluctuate because municipalities receive tax
revenues once per year and balances run down until the next fiscal years'
receipts. This decrease was partially offset by an increase in non-interest
bearing deposits of $18.9 million.
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 debt. In the aggregate, these funds totaled
$830.6 million at March 31, 2004, and $737.3 million at December 31, 2003. The
increase of $93.3 million in purchased funds and borrowing is comprised
primarily of a $61.6 million increase in securities sold under repurchase
agreements and federal funds purchased, an increase in subordinated debt of
$43.2 million, offset by a decrease in long-term borrowings of $11.6 million.
Securities sold under repurchase agreements, which is a short-term investment
vehicle for our commercial clients, increased $74.5 million, while other
short-term borrowings decreased $13.0 million. Subordinated debt -- classified
as "guaranteed preferred beneficial interest in Company's subordinated
debentures" prior to the Company's adoption of FIN-46(R) as of March 31, 2004 --
increased due to two new trust preferred securities issues of $20.0 million
each. The decrease in long-term borrowings is related to the maturity of a $10.0
million FHLB advance and paydowns of amortizing long-term debt.
Shareholders' equity increased $11.0 million from December 31, 2003
through March 31, 2004. Common stock decreased $1.8 million related to treasury
stock transactions. Retained earnings increased $5.6 million due to the
retention of net income, partially offset by the payment of cash dividends.
Accumulated other comprehensive income increased $7.7 million due to an increase
in market value of available for sale securities and adjustments to the fair
value of interest rate swaps. Cash dividends paid during the first three months
of 2004 increased $507,000 or 9.4% to $5.8 million compared to the cash
dividends paid during the first three months of 2003. Earnings retained during
the first three months of 2004 were 48.9% compared to 50.2% during the first
three months of 2003.
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.
21
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 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 HomeTowne Heritage Bank during the fourth
quarter of 2003 did not have an immediate material impact on the Company's
current liquidity position. HomeTowne Heritage Bank, as a division of National
Penn Bank, 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.
On December 18, 2003, National Penn Bancshares, Inc. announced the
execution of a definitive agreement for National Penn to acquire Peoples First,
Inc. ("Peoples"), parent company of The Peoples Bank of Oxford in a stock and
cash transaction valued at approximately $148 million. As a division of National
Penn Bank, The Peoples Bank of Oxford will retain 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 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
March 31, 2004.
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 $ 4,348 $ -- $ -- $ --
Federal funds sold -- -- -- --
Investment securities 91,969 201,027 434,555 214,210
Loans (1) 1,047,869 276,868 760,639 191,933
22
Other assets -- -- -- 343,773
----------- ----------- ----------- -----------
1,144,186 _477,895 1,195,194 749,916
----------- ----------- ----------- -----------
Liabilities and equity
Non-interest bearing deposits 405,529 -- -- --
Interest bearing deposits (2) 781,728 286,753 268,741 640,690
Borrowed funds 385,639 17,500 67,265 253,715
Subordinated debt 41,268 -- -- 65,176
Other liabilities -- -- -- 24,326
Shareholders' equity -- -- -- 328,861
----------- ----------- ----------- -----------
1,614,164 304,253 336,006 1,312,768
----------- ----------- ----------- -----------
Interest sensitivity gap (469,978) 173,642 859,188 (562,852)
----------- ----------- -----------
Cumulative interest rate
sensitivity gap $ (469,978) $ (296,336) $ 562,852 $ --
=========== =========== =========== ===========
(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 first calendar quarter of 2004. 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.
Gap analysis is a useful measurement of asset and liability management;
however, it is difficult to predict the effect of changing interest rates based
solely on this measure. Therefore, the Company
23
supplements gap analysis with the calculation of the Economic Value of Equity.
This report forecasts changes in the company's market value of portfolio equity
(MVPE") under alternative interest rate environments. The MVPE is defined as the
net present value of the Company's existing assets, liabilities, and off-balance
sheet instruments. The calculated estimates of change in MVPE at March 31, 2004
are as follows:
MVPE
Change in Interest Rate Amount % Change
- ----------------------- -------------- ---------
(In Thousands)
+300 Basis Points 412,791 2.14
+200 Basis Points 421,449 4.29
+100 Basis Points 422,540 4.56
Flat Rate 404,124 ----
- -100 Basis Points 394,873 -2.29
- -200 Basis Points 370,563 -8.3
- -300 Basis Points 341,733 -15.44
Management also estimates 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.
March 31, 2004 March 31, 2003
-------------------------------------------------------------------------------
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 $(1,002) (2.1%) $1,759 4.3%
+100 ( 417) (0.9%) 1,473 3.6%
- -100 (2,306) (4.3%) (2,082) (5.1%)
- -200 (4,650) (9.86) (3,377) (8.3%)
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 derivatives employed by the Company
include interest rate swaps and forward sales of mortgage commitments. 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.
OFF-BALANCE SHEET ARRANGEMENTS AND OTHER CONTRACTUAL OBLIGATIONS AND
--------------------------------------------------------------------
COMMITMENTS
-----------
The Company consolidates all of its majority-owned subsidiaries. Other
entities, in which there is greater than 20% ownership, but upon which the
Company does not possess, nor cannot exert, significant influence or control,
are accounted for by the equity method of accounting and not consolidated; those
in which there is less than 20% ownership are generally carried at cost.
The Company no longer consolidates NPB Capital Trust II on the balance
sheet as of March 31, 2004. For additional information, see Footnote #8 to the
financial statements included herein.
24
The following table sets forth the contractual obligations and other
commitments representing required and potential cash outflows as of March 31,
2004:
One to Four to
Less than Three Five After Five
(dollars in thousands) Total One Year Years Years Years
----- -------- ----- ----- -----
Minimum annual rentals or noncancellable $ 21,709 $ 2,766 $ 4,636 $ 3,436 $ 10,871
Operating leases
Remaining contractual maturities of time
Deposits 647,377 374,964 212,661 56,111 3,641
Loan commitments 760,826 508,135 60,471 23,863 168,357
Long-term borrowed funds 152,470 15,125 21,859 45,406 70,080
Subordinated debt 106,444 -- -- -- 106,444
Standby letters of credit 61,240 27,262 22,907 10,938 133
---------- ---------- ---------- ---------- ----------
Total $1,750,066 $ 928,252 $ 322,534 $ 139,754 $ 359,526
---------- ---------- ---------- ---------- ----------
The Company currently does not have any off-balance sheet special
purpose entities. The Company had no capital leases at March 31, 2004.
CAPITAL LEVELS
--------------
The following table sets forth the Company's capital ratios:
Tier 1 Capital to Tier 1 Capital to Risk- Total Capital to Risk-
Average Assets Ratio Weighted Assets Ratio Weighted Assets Ratio
------------------------------------------------------------------------
Mar. 31, Dec. 31, Mar. 31, Dec. 31, Mar. 31, Dec. 31,
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
The Company 9.20% 7.84% 11.12% 9.74% 12.38% 11.08%
National Penn Bank 6.81% 7.06% 8.76% 8.88% 10.01% 10.14%
"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 March 31,
2004, 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's commitments for significant capital expenditures are within its
historical norms.
The recent issuance of trust preferred securities temporarily
improved the Company's capital ratios in first quarter 2004. We expect the
ratios will return to historic levels after closing of Peoples First, Inc.
acquisition, expected in second quarter 2004. The banking regulators have not
issued any guidance that would change the regulatory capital treatment for the
various trust preferred securities that are now outstanding, based on the
adoption of FIN46(R). However, as additional interpretations from the banking
regulators become available, management will re-evaluate the potential impact to
its Tier 1 capital calculation of such interpretations. We do not anticipate
that the Peoples First acquisition will have a negative impact on the Company's
dividend payout ratio.
25
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.
PENDING ACQUISITION OF PEOPLES FIRST, INC.
------------------------------------------
On December 18, 2003, National Penn Bancshares, Inc. announced the
execution of a definitive agreement for National Penn to acquire Peoples First,
Inc. ("Peoples"), parent company of The Peoples Bank of Oxford in a stock and
cash transaction valued at approximately $148 million. The Peoples Bank of
Oxford is a $461 million bank headquartered in Oxford, Pennsylvania, operating
eight community offices in Chester and Lancaster Counties, Pennsylvania, and one
community office in Cecil County, Maryland.
Under the terms of the merger agreement, Peoples shareholders will be
entitled to select to receive either 1.505 shares of National Penn common stock,
$49.54 in cash, or a combination of both, for each share of Peoples common
stock. Peoples shareholder elections are subject to allocation procedures. The
application of these procedures will result in the exchange of 30 percent of the
Peoples shares for cash, and the remaining shares will be exchanged for shares
of National Penn common stock. Options to purchase shares of Peoples common
stock will be converted into options to purchase shares of National Penn common
stock.
The merger is subject to a number of conditions, including approval by
the Board of Governors of the Federal Reserve System, the Pennsylvania
Department of Banking and the shareholders of Peoples First. No assurance can be
given that all required 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. Additional
information is provided in the Company's Report on Form 8-K dated December 17,
2003, filed with the Securities and Exchange Commission. This report includes a
copy of the Merger Agreement. Additional information is also provided in the
Company's registration statement on Form S-4, filed with the SEC on April 9,
2004, and amended on April 26, 2004.
FUTURE OUTLOOK
---------------
The Company's market area, while diverse, is subject to many of
the same economic forces being experienced regionally and nationally:
o The recovery in the general economy, although slow, will likely
generate loan growth in 2004, possibly in the range of eight to
twelve percent.
o In first quarter 2004, net charge-offs decreased by $753,000
compared to those in fourth quarter 2004. The Company anticipates
that net charge-offs for all of 2004 will likely be in line with
its historical levels.
o The principal challenge faced by the Company today is to grow our
earnings in light of the
26
compression of our net interest margin due to current and
anticipated interest rate levels. In this environment, we seek to
increase our net interest income principally through increased
volume, including volume from mergers and acquisitions, and to
increase our non-interest income.
The Company, like many of its peers, continues to be concerned about
current and near term uncertain economic conditions and their 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, 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.
* 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.
27
* 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.
* Internal organization realignments may be unsuccessful in
accomplishing their objectives.
* 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, including income from
mortgage banking activities.
* 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
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.
* Business opportunities and strategies potentially available to
National Penn after mergers and acquisitions may not be
successfully or fully acted upon.
28
* 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 14, 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 March 31,
2004. 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
29
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 March 31, 2004 that
materially affected, or are reasonably likely to materially affect, National
Penn's internal control over financial reporting.
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings.
- --------------------------
None.
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of
Equity Securities.
- --------------------------------------------------------------------------------
The following table provides information on repurchases by National
Penn of its common stock in each month of the quarter ended March 31, 2004:
Total Maximum
Number of Number of
Shares Shares
Purchased that may
as Part of yet be
Total Average Publicly Purchased
Number of Price Announced Under the
Shares Paid per Plan or Plans or
Period Purchased Share Programs Programs
- ------ --------- ----- -------- --------
January 1, 2004
through
January 31, 2004 5,550 $ 30.60 5,550 841,529
February 1, 2004
through
February 29, 2004 130,245 $ 33.70 130,245 711,284
March 1, 2004
through
March 31, 2004 43,144 $ 31.96 43,144 668,140
30
1. Transactions are reported as of settlement dates.
2. National Penn's current stock repurchase program was approved
by its Board of Directors and announced on September 24, 2003.
3. The number of shares approved for repurchase under National
Penn's current stock repurchase program is 1,000,000.
4. National Penn's current stock repurchase program does not have
an expiration date.
5. No National Penn stock repurchase plan or program expired
during the period covered by the table.
6. National Penn has no stock repurchase plan or program that it
has determined to terminate prior to expiration or under which
it does not intend to make further purchases.
Item 3. Defaults Upon Senior Securities.
- ----------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------------------------------------------------------------
None.
Item 5. Other Information.
- --------------------------
Cash Dividend
-------------
On April 28, 2004, the Board of Directors of National Penn declared a
cash dividend of $.24 per share payable on May 17, 2004 to shareholders of
record as of May 8, 2004.
Election of National Penn Director
----------------------------------
Effective March 1, 2004, National Penn's Board of Directors elected
Donald P. Worthington to the Board, filling the vacancy in Class II of the Board
created by the resignation of John C. Spier. Mr. Worthington is Executive Vice
President of National Penn Bank and Chairman of the Bank's FirstService
Division.
Asset and Wealth Management Businesses
--------------------------------------
During fourth quarter 2003, we engaged an outside consulting firm to
review structural alternatives for the organization of our various asset and
wealth management businesses. We anticipate considering the consultant's
recommendations in second quarter 2004.
31
Enterprise-Wide Risk Management
-------------------------------
In April 2004, National Penn established an Enterprise-Wide Risk
Management function to be led by Garry D. Koch, Group Executive Vice President
of National Penn Bank.
Middle Market Lending Group
---------------------------
In March 2004, National Penn Bank established a new Middle Market
Lending Group to be located at 30 Commerce Drive, Wyomissing, Pennsylvania. The
Middle Market Lending Group will service companies with annual sales in the
range between $25 million and $250 million, with substantial business operations
within National Penn's nine-county southeastern Pennsylvania marketplace. This
group may also expand NPB's involvement in the syndicated commercial market
focusing on transactions originated within our expanded market.
Wayne R. Weidner - Exercise of Stock Options
--------------------------------------------
During first quarter 2004, Wayne R. Weidner, Chairman and Chief
Executive Officer of National Penn, exercised stock options for 63,770 shares of
National Penn common stock under a plan adopted in January 2004. 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
------------------------------------
During first quarter 2004, National Penn Bank relocated a Community
Office from 4445 Kutztown Road to 5220 Kutztown Road, Reading (Berks County) and
installed a remote automated teller machine (ATM) at the Valley Farm Market
located on Steffko Boulevard in Bethlehem (Northampton County).
Item 6. Exhibits and Reports on Form 8-K.
- -----------------------------------------
(a) Exhibits.
4.1 Form of Declaration of Trust between National Penn Bancshares,
Inc., as sponsor, and Chase Manhattan Bank USA, National
Association. (Incorporated by reference to Exhibit 4.1 to
National Penn's Report on Form 8-K dated February 20, 2004, as
filed on February 24, 2004.)
4.2 Form of Amended and Restated Trust Agreement among National
Penn Bancshares, Inc., as sponsor, Chase Manhattan Bank USA,
National Association, as Delaware Trustee, JPMorgan Chase
Bank, as Institutional Trustee, and Gary L. Rhoads and Sandra
L. Spayd, as Administrators. (Incorporated by reference to
Exhibit 4.2 to National Penn's Report on Form 8-K dated
February 20, 2004, as filed on February 24, 2004.)
4.3 Form of Indenture between National Penn Bancshares, Inc. and
JPMorgan Chase Bank. (Incorporated by reference to Exhibit 4.3
to National Penn's Report on Form 8-K dated February 20, 2004,
as filed on February 24, 2004.)
4.4 Form of Guarantee Agreement between National Penn Bancshares,
Inc., as Guarantor, and JPMorgan Chase Bank, as Guarantee
Trustee. (Incorporated by reference to Exhibit 4.4 to National
Penn's Report on Form 8-K dated February 20, 2004, as filed on
February 24, 2004.)
32
4.5 Form of Declaration of Trust between National Penn Bancshares,
Inc., as sponsor, and Wilmington Trust Company. (Incorporated
by reference to Exhibit 4.1 to National Penn's Report on Form
8-K dated March 25, 2004, as filed on March 31, 2004.)
4.6 Form of Amended and Restated Trust Agreement among National
Penn Bancshares, Inc., as sponsor, Wilmington Trust Company,
as Delaware Trustee, Wilmington Trust Company, as
Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd,
as Administrators. (Incorporated by reference to Exhibit 4.2
to National Penn's Report on Form 8-K dated March 25, 2004, as
filed on March 31, 2004.)
4.7 Form of Indenture between National Penn Bancshares, Inc. and
Wilmington Trust Company, as Trustee. (Incorporated by
reference to Exhibit 4.3 to National Penn's Report on Form 8-K
dated March 25, 2004, as filed on March 31, 2004.)
4.8 Form of Guarantee Agreement between National Penn Bancshares,
Inc., as Guarantor, and Wilmington Trust Company, as Guarantee
Trustee. (Incorporated by reference to Exhibit 4.4 to National
Penn's Report on Form 8-K dated March 25, 2004, as filed on
March 31, 2004.)
31.1 Certification of Chairman 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 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.)
(b) Reports on Form 8-K. During the quarter ended March 31, 2004,
National Penn filed the following Reports on Form 8-K:
* Report dated January 21, 2004. The Report provided information
under Item 12 on National Penn's earnings for fourth quarter
2003 and full-year 2003. The Report did not contain any
financial statements.
* Report dated January 26, 2004. The Report provided information
under Item 5 on the repurchase of 124,100 shares of National
Penn common stock from a director, under National Penn's stock
repurchase program. The Report did not contain any financial
statements.
* Report dated February 20, 2004. The Report provided
information under Item 5 on National Penn's issuance on
February 20, 2004 of 20,000 shares of floating rate (three
33
month LIBOR plus a margin of 2.75%) Capital Securities with an
aggregate offering price of $20 million. The Report did not
contain any financial statements.
* Report dated March 25, 2004. The Report provided information
under Item 5 on National Penn's issuance on March 25, 2004 of
20,000 shares of floating rate (three month LIBOR plus a
margin of 2.75%) Capital Securities with an aggregate offering
price of $20 million. 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: May 7, 2004 By /s/ Wayne R. Weidner
--------------------------------------
Wayne R. Weidner, Chairman and
Chief Executive Officer
Dated: May 7, 2004 By /s/ Gary L. Rhoads
--------------------------------------
Gary L. Rhoads, Principal
Financial Officer