UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(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 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ________________ to _____________
Commission File Number: 0-16667
DNB Financial Corporation
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2222567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4 Brandywine Avenue - Downingtown, PA 19335
(Address of principal executive offices and Zip Code)
(610) 269-1040
(Registrant's telephone number, including area code)
Not Applicable
(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.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock ($1.00 Par Value) 1,894,375
(Class) (Shares Outstanding as of
May 14, 2004)
DNB FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
PART I - FINANCIAL INFORMATION
PAGE NO.
ITEM 1. FINANCIAL STATEMENTS (Unaudited):
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 2004 and December 31, 2003 3
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2004 and 2003 4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2004 and 2003 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004 and December 31, 2003 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 25
ITEM 4. CONTROLS AND PROCEDURES 26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 26
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS 26
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 26
SECURITY HOLDERS
ITEM 5. OTHER INFORMATION 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURES 30
2
ITEM 1 - FINANCIAL STATEMENTS (Unaudited)
DNB FINANCIAL CORPORATION
Consolidated Statements of Financial Condition (Unaudited)
(Dollars in thousands, except per share data) March 31, December 31,
2004 2003
- --------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 11,890 $ 10,283
Federal funds sold 16,813 5,299
--------- ---------
Total cash and cash equivalents 28,703 15,582
--------- ---------
Investment securities available for sale, at fair value 120,653 124,052
Investment securities held to maturity (market value $47,152
in 2004 and $49,706 in 2003) 47,087 50,342
Loans, net of unearned income 208,735 203,553
Allowance for loan losses (4,490) (4,559)
--------- ---------
Net loans 204,245 198,994
--------- ---------
Office property and equipment 7,356 7,604
Accrued interest receivable 1,673 1,744
Bank owned life insurance 5,989 5,937
Net deferred taxes 938 1,322
Other assets 3,691 3,436
--------- ---------
Total assets $ 420,335 $ 409,013
========= =========
Liabilities and Stockholders' Equity
Liabilities
Non-interest-bearing deposits $ 54,332 $ 52,788
Interest-bearing deposits:
NOW 62,162 67,158
Money market 50,050 55,412
Savings 67,551 46,630
Time 68,419 70,448
--------- ---------
Total deposits 302,514 292,436
--------- ---------
Borrowings 83,718 83,720
Junior subordinated debentures 5,155 5,000
--------- ---------
Total borrowings 88,873 88,720
--------- ---------
Accrued interest payable 839 900
Other liabilities 1,767 1,585
--------- ---------
Total liabilities 393,993 383,641
--------- ---------
Stockholders' Equity
Preferred stock, $10.00 par value;
1,000,000 shares authorized; none issued -- --
Common stock, $1.00 par value;
10,000,000 shares authorized; 2,048,206 and 2,041,079
issued, respectively 2,048 2,041
Treasury stock, at cost; 153,831 and 140,431 shares, respectively (3,472) (3,097)
Surplus 26,491 26,373
Retained earnings 1,513 1,092
Accumulated other comprehensive loss, net (238) (1,037)
--------- ---------
Total stockholders' equity 26,342 25,372
--------- ---------
Total liabilities and stockholders' equity $ 420,335 $ 409,013
========= =========
See accompanying notes to unaudited consolidated financial statements.
3
Consolidated Statements of Operations (Unaudited)
(Dollars in thousands, except per share data) Three Months Ended March 31
-------------------------------
2004 2003
- ----------------------------------------------------------------------------------------------
Interest Income:
Interest and fees on loans and leases $ 3,338 $ 3,299
Interest on taxable investment securities 1,202 1,209
Interest on tax-free investment securities 242 52
Interest on tax-preferred equity securities 85 139
Interest on Federal funds sold 16 30
---------- ----------
Total interest income 4,883 4,729
---------- ----------
Interest Expense:
Interest on time deposits 376 733
Interest on NOW, money market and savings 241 311
Interest on FHLB advances 976 921
Interest on junior subordinated debentures 64 66
Interest on lease obligations 24 25
Interest on Federal funds purchased 2 --
---------- ----------
Total interest expense 1,683 2,056
---------- ----------
Net interest income 3,200 2,673
Provision for loan losses -- --
---------- ----------
Net interest income after provision for loan losses 3,200 2,673
---------- ----------
Non-interest Income:
Service charges 312 299
Wealth management 212 141
Net gain on sales of investment securities 46 --
Increase in cash surrender value of BOLI 52 59
Other 166 175
---------- ----------
Total non-interest income 788 674
---------- ----------
Non-interest Expense:
Salaries and employee benefits 1,722 1,530
Furniture and equipment 323 353
Occupancy 223 195
Professional and consulting 157 116
Marketing 89 62
Printing and supplies 101 68
Other 550 437
---------- ----------
Total non-interest expense 3,165 2,761
---------- ----------
Income before income taxes 823 586
Income tax expense 154 94
---------- ----------
Net income $ 669 $ 492
========== ==========
Common Share Data:
Earnings Per Share:
Basic $ 0.35 $ 0.26
Diluted $ 0.34 $ 0.25
Cash dividends per share $ 0.13 $ 0.12
Weighted average number of common shares outstanding:
Basic 1,900,128 1,913,654
Diluted 1,944,688 1,954,715
See accompanying notes to unaudited consolidated financial statements
4
Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands) Three Months Ended March 31
-----------------------------
2004 2003
- -------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net income $ 669 $ 492
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 368 910
Gain on sale of investments (46) --
Deferred taxes (26) (26)
Decrease in accrued interest receivable 71 59
Increase in investment in BOLI (52) (59)
Increase in other assets (254) (578)
Decrease in accrued interest payable (61) (116)
Increase in current taxes payables 155 87
Increase (decrease) in other liabilities 26 (283)
-------- --------
Net Cash Provided By Operating Activities 850 486
-------- --------
Cash Flows From Investing Activities:
Maturities & paydowns of available for sale securities 11,323 23,978
Maturities & paydowns of held to maturity securities 3,191 5,348
Purchase of available for sale securities (12,035) (59,143)
Purchase of held to maturity securities -- (794)
Proceeds from sale of securities 5,270 --
Net (increase) decrease in loans (5,251) 8,046
Disposition (purchase) of office property and equipment 39 (87)
-------- --------
Net Cash Provided (Used) By Investing Activities 2,537 (22,652)
-------- --------
Cash Flows From Financing Activities:
Net increase in deposits 10,078 849
Increase in FHLB advances -- 15,000
Decrease in lease obligations (2) (2)
Purchase of treasury stock (374) (301)
Proceeds from issuance of stock under stock option plan 125 184
Dividends paid (248) (237)
-------- --------
Net Cash Provided By Financing Activities 9,579 15,493
-------- --------
Net Change in Cash and Cash Equivalents 12,966 (6,673)
Cash and Cash Equivalents at Beginning of Period 15,582 22,024
-------- --------
Cash and Cash Equivalents at End of Period $ 28,548 $ 15,351
======== ========
Supplemental Disclosure Of Cash Flow Information:
Cash paid during the period for:
Interest $ 1,745 $ 2,215
Income taxes 3 15
Supplemental Disclosure Of Non-Cash Flow Information:
Change in unrealized gains (losses) on securities-AFS 1,209 (546)
Change in deferred taxes due to change in unrealized (gains)
losses on securities-AFS (410) 184
======== ========
See accompanying notes to unaudited consolidated financial statements.
5
DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements of DNB
Financial Corporation (referred to herein as the "Corporation" or "DNB") and its
subsidiary, Downingtown National Bank (the "Bank") have been prepared in
accordance with the instructions for Form 10-Q and therefore do not include
certain information or footnotes necessary for the presentation of financial
condition, statement of operations and statement of cash flows required by
generally accepted accounting principles. However, in the opinion of management,
the consolidated financial statements reflect all adjustments (which consist of
normal recurring adjustments) necessary for a fair presentation of the results
for the unaudited periods. Prior amounts not affecting net income are
reclassified when necessary to conform with current period classifications. The
results of operations for the three months ended March 31, 2004 are not
necessarily indicative of the results which may be expected for the entire year.
The consolidated financial statements should be read in conjunction with the
Annual Report and report on Form 10-K for the year ended December 31, 2003.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure ("SFAS 148"). This statement amends SFAS
123, Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. This statement is effective for fiscal years ending after December 15,
2002, except for financial reports containing condensed financial statements for
interim periods for which disclosure is effective for periods beginning after
December 15, 2002. This Statement announces that "in the near future, the
Financial Accounting Standards Board plans to consider whether it should propose
changes to the U.S. standards on accounting for stock-based compensation". There
was no impact of this statement on DNB's financial condition, equity or results
of operations for the year ended December 31, 2003 or quarter ended March 31,
2004. In addition, there was no expense recognized under APB Opinion No. 25. DNB
has complied with the disclosure requirements of this statement. It is expected
that SFAS No. 148 will require the expensing of all stock-based compensation at
some point in the future. Had DNB determined compensation cost based on the fair
value at the grant date for its stock options under SFAS No. 123, DNB's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:
6
(Dollars in thousands, except per share data) Three Months Ended
March 31
2004 2003
-------- --------
Net income as reported $ 669 $ 492
Total stock based employee compensation expense
determined under fair value based method for
all awards, net of related tax effects -- --
-------- --------
Pro forma net income $ 669 $ 492
Earnings per share:
Basic-as reported $ 0.35 $ 0.26
Basic-pro forma 0.35 0.26
Diluted-as reported $ 0.34 $ 0.25
Diluted-pro forma 0.34 0.25
NOTE 2: EARNINGS PER SHARE (EPS)
------------------------
Basic earnings per share is computed based on the weighted average number
of common shares outstanding during the period. Diluted earnings per share
reflect the potential dilution that could occur from the conversion of common
stock equivalents (i.e., stock options) and is computed using the treasury stock
method. For the three months ended March 31, 2004, 104,538 outstanding stock
options were not included because such options were antidilutive. For the three
months ended March 31, 2003, 173,956 outstanding stock options were not included
because such options were antidilutive. These shares may be dilutive in the
future. Earnings per share, dividends per share and weighted average shares
outstanding have been adjusted to reflect the effects of the 5% stock dividend
paid in December 2003. Net income and the weighted average number of shares
outstanding for basic and diluted EPS for the three months ended March 31, 2004
and 2003 are reconciled as follows:
(Dollars in thousands, except per share data) Three months ended Three months ended
March 31, 2004 March 31, 2003
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic EPS
Income available to common stockholders $ 669 1,900 $0.35 $ 492 1,914 $0.26
Effect of dilutive common stock equivalents-
stock options -- 45 (0.01) -- 41 (0.01)
----- ----- ----- ----- ----- -----
Diluted EPS
Income available to common stockholders
after assumed conversions $ 669 1,945 $0.34 $ 492 1,955 $0.25
===== ===== ===== ===== ===== =====
NOTE 3: OTHER COMPREHENSIVE INCOME (LOSS)
---------------------------------
Comprehensive income includes all changes in stockholders' equity during
the period, except those resulting from investments by owners and distributions
to owners. Comprehensive income for all periods consisted of net income and
7
other comprehensive income or loss relating to the change in unrealized gains or
losses on investment securities available for sale, as shown in the following
table:
(Dollars in thousands) For three months ended March 31
-------------------------------
2004 2003
------ ------
COMPREHENSIVE INCOME:
Net Income $ 669 $ 492
Other comprehensive income (loss), net of tax,
relating to unrealized gains (losses) on investments 799 (362)
------ ------
Total comprehensive income (loss) $1,468 $ 130
====== ======
NOTE 4: JUNIOR SUBORDINATED DEBENTURES
------------------------------
Included in other borrowings are floating rate junior subordinated
debentures (the "debentures") issued by DNB on July 20, 2001 to DNB Capital
Trust I (the "Trust"), a Delaware business trust in which DNB owns all of the
common equity. The Trust issued $5.0 million of floating rate (6 month Libor
plus 3.75%, with a cap of 12%) capital preferred securities ("TruPS") to a
qualified institutional buyer. The proceeds of these securities were used by the
Trust, along with DNB's capital contribution, to purchase the $5.2 million
principal amount of DNB's floating rate junior subordinated debentures. The
preferred securities are redeemable by DNB on or after July 25, 2006, or earlier
in the event of certain adverse tax or bank regulatory developments. The
preferred securities must be redeemed upon maturity of the debentures on July
25, 2031. Effective March 31, 2004, as a result of the adoption of FIN 46, DNB
deconsolidated the Trust, resulting in a change in the characterization of the
underlying consolidated debt obligations from the previous trust preferred
securities to junior subordinated debentures. The result was an increase in
junior subordinated debentures of $155,000. The junior subordinated debentures
qualify as a component of capital for regulatory purposes.
NOTE 5: RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS 146"). This Statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). The
provisions of this Statement are effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
adoption of this statement on January 1, 2003 had no material impact on DNB's
financial condition, equity, results of operations or disclosures for the year
ended December 31, 2003 or quarter ended March 31, 2004.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This is an interpretation of FASB Nos. 5,
57, and 107, and rescinds FASB Interpretation No. 34. The Interpretation
elaborates on the disclosures a guarantor is required to make in both its
8
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of the guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition and
measurement provisions are to be applied on a prospective basis to guarantees
issued or modified after December 31, 2002, irrespective of the guarantor's
year-end. Accounting for guarantees issued prior to the date of this
Interpretation's initial application will not be revised or restated to reflect
the effect of the recognition and measurement provisions of the Interpretation.
The adoption of Interpretation No. 45 on January 1, 2003 had no material impact
on DNB's financial condition, equity or results of operations for the year ended
December 31, 2003.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure ("SFAS 148"). This statement amends SFAS
123, Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. The Statement also amends the disclosure
requirements of Statement 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
This Statement announces that "in the near future, the Financial Accounting
Standards Board plans to consider whether it should propose changes to the U.S.
standards on accounting for stock-based compensation". There was no impact of
this statement on DNB's financial condition, equity or results of operations for
the year ended December 31, 2003 or quarter ended March 31, 2004. DNB has
complied with the annual disclosure requirements of this statement. It is
expected that SFAS No. 148 will require the expensing of all stock-based
compensation at some point in the future.
In April 2003, the FASB issued SFAS No. 149, Amendment to Statement 133 on
Derivative Instruments and Hedging Activities ("SFAS No. 149"). This statement
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133. The statement is applied prospectively and is effective for
contracts entered into or modified after June 30, 2003, except for SFAS No. 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 and certain provisions relating to forward purchases and
sales on securities that do not yet exist. The adoption on April 1, 2003 of the
components of this statement which address SFAS No. 133 implementation issues
that have been effective for fiscal quarters that began prior to June 15, 2003
did not have a material impact on the DNB's consolidated financial position and
results of operations for the year ended December 31, 2003. The adoption of the
remaining components of SFAS No. 149 on June 15, 2003 also had no material
9
impact on DNB's financial condition, equity or results of operations for the
year ended December 31, 2003 or quarter ended March 31, 2004.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity ("SFAS No.
150"). This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Some of the
provisions of this Statement are consistent with the current definition of
liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements.
The remaining provisions of this Statement are consistent with the FASB's
proposal to revise that definition to encompass certain obligations that a
reporting entity can or must settle by issuing its own equity shares, depending
on the nature of the relationship established between the holder and the issuer.
This statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of this statement on
July 1, 2003 had no material impact on DNB's financial condition, equity or
results of operations for the year ended December 31, 2003 or quarter ended
March 31, 2004.
In December 2003, the FASB issued Revised SFAS No. 132, Employers'
Disclosures About Pensions and Other Postretirement Benefits ("SFAS No. 132").
This Statement revises employers' disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans required by FASB Statements No. 87, Employers' Accounting for
Pensions, No. 88, Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits, and No. 106,
Employers' Accounting for Postretirement Benefits Other Than Pensions. This
Statement retains the disclosure requirements contained in FASB Statement No.
132, Employers' Disclosures about Pensions and Other Postretirement Benefits,
which it replaces. It requires additional disclosures to those in the original
Statement 132 about the assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension plans and other defined benefit postretirement
plans. The required information should be provided separately for pension plans
and for other postretirement benefit plans. This Statement is effective for
financial statements with fiscal years ending after December 15, 2003, except
for disclosure of estimated future benefit payments, which become effective for
fiscal years ending after June 15, 2004. DNB has complied with the annual
disclosure requirements of this statement.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised
December 2003), Consolidation of Variable Interest Entities ("FIN 46R"), which
addresses how a business enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting rights and
accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation
10
No. 46, Consolidation of Variable Interest Entities ("VIE"), which was issued in
January 2003. For any VIEs that must be consolidated under FIN 46R that were
created before January 1, 2004, the assets, liabilities and noncontrolling
interests of the VIE initially would be measured at their carrying amounts with
any difference between the net amount added to the balance sheet and any
previously recognized interest being recognized as the cumulative effect of an
accounting change. If determining the carrying amounts is not practicable, fair
value at the date FIN 46R first applies may be used to measure the assets,
liabilities and noncontrolling interest of the VIE. The adoption of FIN 46R
resulted in the deconsolidation of DNB Capital Trust I. The result was an
increase in junior subordinated debentures of $155,000.
In December 2003, the Emerging Issues Task Force issued EITF 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. The EITF addresses disclosure requirements regarding information
about temporarily impaired investments. The requirements are effective for
fiscal years ending after December 15, 2003 for all entities that have debt or
marketable equity securities with market values below carrying values. The
requirements apply to investments in debt and marketable equity securities that
are accounted for under SFAS No. 115, Accounting for Certain Investments in Debt
and Equity Securities. The requirements apply only to annual financial
statements.
11
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
DESCRIPTION OF DNB'S BUSINESS
DNB Financial Corporation is a bank holding company whose bank subsidiary,
Downingtown National Bank, is a nationally chartered commercial bank with trust
powers, and a member of the FDIC. DNB provides a broad range of banking services
to individual and corporate customers through its nine full service community
offices located throughout Chester County, Pennsylvania. DNB is a community bank
that focuses its lending and other services on businesses and consumers in the
local market area. DNB funds all these activities with retail and business
deposits and borrowings. Through its DNB Advisors division, Downingtown National
Bank provides wealth management and trust services to individuals and
businesses. The Bank and its subsidiary, DNB Financial Services, Inc., make
available certain non-depository products and services, such as securities
brokerage, mutual funds, life insurance and annuities.
DNB has embarked on a strategy called "Helping Our Customers Succeed". The
key goal of this strategy is to become the "Bank of Choice" in Chester County by
delivering consistent, high quality customer service to businesses and
individuals. We focus our efforts on assisting our customers in ways that will
help them become successful. To that end, DNB continues to make appropriate
investments in all areas of our business, including people, technology,
facilities and marketing. Customers may also visit DNB on its website at
http://www.dnb4you.com.
On March 29, 2004, DNB announced that the Bank is changing its trading name
to "DNB First." A new logo, new signage, and new services are expected to be
unveiled at branches in May, when the Bank is scheduling a variety of "grand
opening" events. As of April 27, 2004, the legal name of the Bank was changed to
DNB First, National Association. Management believes that the new name will
allow the Bank, with a new logo and presentation, to promote itself more
effectively beyond DNB's traditional market area. Management also believes the
new name will allow the Bank to communicate the full range of its financial
services capabilities.
RECENT DEVELOPMENTS
National and local market indicators are showing signs that the economy,
which slipped into a recession in late 2001, may slowly be improving. Overall,
wages and prices of finished goods and services are stable and retail spending
is up year-over-year. Layoffs are slowing and there is a strong demand for
temporary workers. Manufacturing activity has picked up, and there has been
strong residential real estate activity, however commercial real estate markets
have been weak. The banking sector reports that overall lending activity has
slowed, particularly in commercial markets, with lackluster leasing activity and
declining rents. In the Philadelphia region, the outlook for 2004 is for
12
continued, steady residential sales, with commercial markets improving as
manufacturing activity increases.
During the second half of 2003, management announced that it had developed
a comprehensive plan designed to reposition its balance sheet and improve core
earnings. As part of the plan, management announced its intentions to
substantially reduce the size of its investment portfolio and expand its loan
portfolio through new originations, increased loan participations, as well as
strategic loan and lease receivable purchases. Management also intends to reduce
the absolute level of borrowings with cash flows from existing loans and
investments as well as from new core deposit growth.
DNB made significant strides to reposition its balance sheet during the
fourth quarter of 2003 as loans grew $14.4 million or 7.6%. The majority of the
growth was in the commercial loan and commercial mortgage portfolios, which grew
a combined $12.5 million or 9.0%. DNB also continued to promote its consumer
loans which grew by $3.2 million or 9.9%. During the fourth quarter, DNB also
reduced the size of its investment portfolio by $29.9 million or 14.7% to fund
loan growth and pay off $26.0 million of short-term borrowings. These changes in
the balance sheet contributed to a $172,000 or 5.8% fourth quarter over third
quarter increase in net interest income.
During the first quarter of 2004, DNB grew its loan portfolio, reduced its
investment portfolio and increased deposits in a continuing effort to reposition
its balance sheet. During the first quarter of 2004, loans grew $5.2 million
over the amount of total loans at December 31, 2003, with positive growth in
both the commercial and consumer sectors. During the first quarter of 2004 as
well, DNB reduced the size of its investment portfolio by $6.7 million and
increased its deposit base. Total deposits grew $10.0 million or 3.5% during the
quarter ended March 31, 2004. This growth emanated from a special Platinum
Savings account promotion that attracted a significant number of new customers
to the Bank. As a result of these balance sheet changes, total assets grew $11.3
million or 2.8% to $420 million at quarter end, as compared to $409.0 million at
year-end 2003.
DNB's financial objectives are focused on earnings per diluted share growth
and return on average equity. In order to achieve its financial objectives, DNB
recently completed a 5-Year Strategic Plan and has defined the following
strategies:
o Grow loans and diversify the mix
o Reduce the size of the investment portfolio
o Reduce long-term borrowings
o Enhance the branch network and alternative delivery options
o Focus on profitable customer segments
o Grow and diversify non-interest income
13
Management's strategies are designed to direct DNB's tactical investment
decisions and support financial objectives. DNB's most significant revenue
source continues to be net interest income, defined as total interest income
less interest expense, which in 2003 accounted for approximately 82% of our
total revenue. To produce net interest income and consistent earnings growth
over the long-term, DNB must generate loan and deposit growth at acceptable
economic spreads within its market area. To generate and grow loans and
deposits, DNB must focus on a number of areas including, but not limited to, the
economy, branch expansion, sales practices, customer satisfaction and retention,
competition, customer behavior, technology, product innovation and credit
performance of its customers.
Management has made a concerted effort to improve the measurement and
tracking of business lines and overall corporate performance levels. Improved
information systems has increased DNB's ability to track key indicators and
enhance corporate performance levels. Better measurement against goals and
objectives and increased accountability will be integral in attaining desired
loan, deposit and fee income production.
MATERIAL CHALLENGES, RISKS AND OPPORTUNITIES
The following is a summary of changes to material challenges, risks and
opportunities DNB has faced during the first quarter of 2004.
Interest Rate Risk Management - Interest rate risk is the exposure to
adverse changes in net interest income due to changes in interest rates. DNB
considers interest rate risk a predominant risk in terms of its potential impact
on earnings. Interest rate risk can occur for any one or more of the following
reasons: (a) assets and liabilities may mature or reprice at different times;
(b) short-term or long-term market rates may change by different amounts; or (c)
the remaining maturity of various assets or liabilities may shorten or lengthen
as interest rates change. One of the most critical challenges DNB faced during
the past few years has been the impact of historically low interest rates.
During the first quarter of 2004, management focused its efforts on positioning
the balance sheet for increased rates, in light of stronger employment data.
Recent government releases indicate a sharp turn in the labor numbers, which are
strong enough to support the beginning of a Fed rate hike. On top of the
stronger job data, inflation numbers have been above estimates. Consumer
confidence has remained weak during the last quarter, but should pick-up if the
job market looks stronger. In anticipation of higher rates, management
significantly shortened the duration of its investment portfolio and lengthened
the maturity of DNB's deposit base. In total, management reduced its one-year
GAP position from a negative 6.6% at December 31, 2003 to a positive 3.2% at
March 31, 2004. These balance sheet changes improved DNB's simulation results
14
and reduced the potential negative impact on the Economic Value of Portfolio
Equity (see discussion on page 25).
Liquidity and Market Risk Management - The objective of DNB's
asset/liability management function is to maintain consistent growth in net
interest income within DNB's policy limits. This objective is accomplished
through the management of liquidity and interest rate risk, as well as customer
offerings of various loan and deposit products. DNB maintains adequate liquidity
to meet daily funding requirements, anticipated deposit withdrawals, or asset
opportunities in a timely manner. Liquidity is also necessary to meet
obligations during unusual, extraordinary and adverse operating circumstances,
while avoiding a significant loss or cost. DNB's foundation for liquidity is a
stable deposit base as well as a marketable investment portfolio that provides
cash flow through regular maturities or that can be used for collateral to
secure funding in an emergency. As part of its liquidity management, DNB
maintains assets which comprise its primary liquidity (Federal funds sold,
investments and interest-bearing cash balances, less pledged securities) which
totaled $161.2 million and $129.8 million as of March 31, 2004 and December 31,
2003, respectively. DNB's primary liquidity ratio (primary liquidity as a
percent of assets) was 38.3% and 31.7% for the same respective dates. Management
increased its primary liquidity levels during the last quarter in anticipation
of a rising rate environment.
Credit Risk Management - DNB defines credit risk as the risk of default by
a customer or a counterparty. The objective of DNB's credit risk management
strategy is to quantify and manage credit risk on an aggregate portfolio basis
as well as to limit the risk of loss resulting from an individual customer
default. Credit risk is managed through a combination of underwriting,
documentation and collection standards. DNB's credit risk management strategy
calls for regular credit examinations and quarterly management reviews of large
credit exposures and credits experiencing credit quality deterioration. DNB's
Loan Review procedures provide objective assessments of the quality of
underwriting, documentation, risk grading and charge-off procedures, as well as
an assessment of the ALLL reserve analysis process. During the first quarter of
2004, management continued to improve its credit quality monitoring by refining
its exception tracking system, which will allow DNB's loan officers to monitor
their individual portfolio more effectively.
Competition - In addition to the challenges related to the interest rate
environment, community banks in Chester County have been experiencing increased
competition from large regional and international banks entering DNB's
marketplace through mergers and acquisitions. Competition for loans and deposits
has negatively affected DNB's net interest margin. To compensate for the
increased competition, DNB, along with other area community banks, has
15
aggressively sought and marketed customers who have been disenfranchised by
these mergers. To attract these customers, DNB has introduced new deposit
products, such as "Platinum Savings" and "Money Market IRAs." In addition, DNB
has introduced Market Managers and Personal Bankers to serve the special banking
needs of its clients. During the first quarter of 2004, DNB attracted $19.3
million into its new Platinum Savings account. In addition, DNB is in the
process of introducing new packaged accounts to attract new retail and business
customers.
Material Trends and Uncertainties - The industry is experiencing an
on-going and widespread trend of consolidation in response to shrinking margins,
as well as competitive and economic challenges. In an effort to broaden market
share by capitalizing on operational efficiencies, larger institutions have been
acquiring smaller regional and community banks and thrifts. Chester County has
witnessed many recent mergers due to attractive demographics, commercial
expansion and other growth indicators. As a result of these factors, the
operating environment is very competitive as Chester County hosts over 40 banks,
thrifts and credit unions. In addition, brokerage firms, mutual fund companies
and boutique investment firms are prevalent, given the county's attractive
demographics. This intensive competition continually puts pressures on DNB's
margins and operating results as competitors offer a full range of loan, deposit
and investment products and services. In addition, many of these competitors are
much larger than DNB and consistently outspend the Bank in marketing to attract
new customers and buy market share. DNB anticipates these pressures will
continue to adversely affect operating results.
Other Material Challenges, Risks and Opportunities - As a financial
institution, DNB's earnings are significantly affected by general business and
economic conditions. These conditions include short-term and long-term interest
rates, inflation, monetary supply, fluctuations in both debt and equity capital
markets, and the strength of the United States economy and local economics in
which we operate. For example, an economic downturn, increase in unemployment,
or other events that negatively impact household and/or corporate incomes could
decrease the demand for DNB's loan and non-loan products and services and
increase the number of customers who fail to pay interest or principal on their
loans.
Geopolitical conditions can also affect DNB's earnings. Acts or threats of
terrorism, actions taken by the United States or other governments in response
to acts or threats of terrorism and our military conflicts including the
aftermath of the war with Iraq, could impact business conditions in the United
States.
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of our financial condition and
results of operations is based upon our consolidated financial statements, which
have been prepared in accordance with accounting principals generally accepted
in the United States of America. Generally accepted accounting principles are
complex and require management to apply significant judgment to various
accounting, reporting and disclosure matters. Management must use assumptions
16
and estimates to apply these principles where actual measurement is not possible
or practical. Actual results may differ from these estimates under different
assumptions or conditions.
In management's opinion, the most critical accounting policies and
estimates impacting DNB's consolidated financial statements are listed below.
These policies are critical because they are highly dependent upon subjective or
complex judgments, assumptions and estimates. Changes in such estimates may have
a significant impact on the financial statements. For a complete discussion of
DNB's significant accounting policies, see the footnotes to DNB Consolidated
Financial Statements for the fiscal year ended December 31, 2003 (the "Annual
Financial Statements"), incorporated in DNB's 10-K for the year ended December
31, 2003.
1. Determination of the allowance for loan losses. Loan loss allowance
policies involve significant judgments and assumptions by management which may
have a material impact on the carrying value of net loans and, potentially, on
the net income recognized by DNB from period to period. For a description of
DNB's accounting policies in connection with its allowance for loan losses, see,
"Allowance for Loan Losses," in Management's Discussion and Analysis.
2. Realization of deferred income tax items. Estimates of deferred tax
assets and deferred tax liabilities make up the asset category titled "net
deferred taxes". These estimates involve significant judgments and assumptions
by management, which may have a material impact on the carrying value of net
deferred tax assets for financial reporting purposes. For a more detailed
description of these items, see Footnote 11 (Federal Income Taxes) to DNB's
audited consolidated financial statements for the fiscal year ended December 31,
2003.
The Footnotes to DNB's Consolidated Financial Statements set forth herein
and in DNB's Annual Financial Statements identify other significant accounting
policies used in the development and presentation of its financial statements.
This discussion and analysis, the significant accounting policies, and other
financial statement disclosures identify and address key variables and other
qualitative and quantitative factors that are necessary for an understanding and
evaluation of DNB and its results of operations.
FINANCIAL CONDITION
DNB's total assets were $420.3 million at March 31, 2004 compared to $409.0
million at December 31, 2003. During the same period, investment securities
(Available-For-Sale and Held-To-Maturity) declined $6.7 million or 3.8% to
$167.7 million at March 31, 2004. As a continuation of its previously announced
comprehensive plan designed to reposition its balance sheet and improve core
earnings, DNB continued to restructure its portfolio during the most recent
quarter in anticipation of a higher rate environment by selling $4.9 million of
longer term securities and reinvesting the proceeds in securities with 3-5 year
average lives. These securities provide increased cash flow for reinvestment and
reduce the potential for market depreciation in a higher rate environment.
17
One of DNB's primary strategic goals is to grow loans and reduce the size
of its investment portfolio. Management made progress during the first quarter
of 2004 as loans grew $5.2 million over the amount of total loans at December
31, 2003, with positive growth in both the commercial and consumer sectors. The
commercial and commercial mortgage portfolio grew a combined $1.8 million or
1.5%, while consumer loans increased $2.3 million or 6.6%. The growth of the
consumer portfolio can be attributed, in part, to product redesign and
enhancements, coupled with increased advertising and more aggressive pricing in
some of the shorter-term and adjustable rate products.
Total deposits grew $10.0 million or 3.5% during the quarter ended March
31, 2004. This growth emanated from a special Platinum Savings account promotion
that attracted a significant number of new customers to the Bank. During the
quarter, savings grew $20.9 million or 4.5% and non-interest bearing deposits
grew $1.5 million or 2.8%, while NOW accounts, money market accounts and time
deposits declined $5.0 million, $5.4 million and $2.0 million, respectively.
FHLB advances totaled $83.0 million at March 31, 2004 and December 31,
2003. During the quarter ended March 31, 2004, DNB paid off $6 million of
borrowings that would have matured on various dates in 2004 and replaced these
borrowings with 3-month borrowings. DNB paid an $81,000 prepayment penalty and
reduced its anticipated interest expense for the remainder of 2004 by roughly
the same amount.
Stockholders' equity was $26.3 million or $13.91 per share at March 31,
2004, compared to $25.4 million or $13.35 per share at December 31, 2003. The
increase in stockholders' equity was the result of a $799,000 increase in the
fair market value of available-for-sale securities, net of taxes, as well as net
income of $669,000 for the three months ended March 31, 2004. These increases
were partially offset by the purchase of 13,400 shares of treasury stock
($375,000) and dividends paid of approximately $248,000 or $.13 per share. The
increase in the per-share equity value from $13.35 to $13.91 was also
attributable in minor part to reductions in the number of shares outstanding due
to stock repurchases. The Corporation's common equity position at March 31, 2004
exceeds the regulatory required minimums.
RESULTS OF OPERATIONS
NET INTEREST INCOME
DNB's earnings performance is primarily dependent upon its level of net
interest income, which is the excess of interest revenue over interest expense.
Interest revenue includes interest earned on loans (net of interest reversals on
non-performing loans), investments, Federal funds sold and interest-earning
cash, as well as net loan fee amortization and dividend income. Interest expense
18
includes the interest cost for deposits, FHLB advances, Federal funds purchased
and other borrowings.
On a tax-equivalent basis, net interest income increased $506,000 or 18.7%
to $3.3 million, for the three month period ended March 31, 2004, compared to
the same period in 2003. As shown in the following table, the $506,000 increase
in net interest income is attributable to favorable variances in both rate
($46,000 or 9.1% of increase) and volume ($460,000 or 90.9% of increase). As a
result of the Bank's strategic decision to increase the size of its loan
portfolio and reduce the absolute size of its investment portfolio, loans
increased $20.4 million on average during the first quarter of 2004, over the
first quarter of 2003, and investments declined $5.4 million when comparing the
same two quarters. Although DNB attained the desired shift in assets, the
$458,000 tax-equivalent increase in income due to volume changes was largely
negated by a $326,000 unfavorable change due to rate, resulting in a $132,000
overall increase in interest revenue. The significant factor that contributed to
the $506,000 increase in net interest income was a $374,000 reduction in the
cost of funds, largely attributable to favorable rate changes ($372,000).
Declines in the cost of time deposits accounted for $201,000 or 54.0% of the
favorable rate change, while the cost of NOW, MMDA and savings deposits
accounted for $128,000 or 34.4% of the favorable rate change.
The following tables sets forth, among other things, the extent to which
changes in interest rates and changes in the average balances of
interest-earning assets and interest-bearing liabilities have affected interest
income and expense during the three months ended March 31, 2004 compared to the
same period in 2003 (tax-exempt yields and yields on agency-preferred stock that
have a 70% dividend received deduction have been adjusted to a tax equivalent
basis using a 34% tax rate). For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (i) changes in rate (change in rate multiplied by old volume)
and (ii) changes in volume (change in volume multiplied by old rate). The net
change attributable to the combined impact of rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
Three Months Ended March 31, 2004
Compared to 2003
Increase (Decrease) Due to
(Dollars in Thousands) Rate Volume Total
---- ------ -----
Interest-earning assets:
Loans $(127) $ 166 $ 39
Investment securities-taxable 4 252 256
Investment securities-tax exempt (131) (10) (141)
Investment securities-tax preferred (66) 57 (9)
Federal funds sold (6) (7) (13)
----- ----- -----
Total $(326) $ 458 $ 132
----- ----- -----
Interest-bearing liabilities:
Savings, NOW and money market deposits $(128) $ 58 $ (70)
Time deposits (201) (156) (357)
Federal funds purchased -- -- --
Lease obligations (1) -- (1)
Junior subordinated debentures (1) -- (1)
FHLB advances (41) 96 55
----- ----- -----
Total (372) (2) (374)
----- ----- -----
Net interest income/interest rate spread $ 46 $ 460 $ 506
===== ===== =====
19
PROVISION FOR LOAN LOSSES
To provide for known and inherent losses in the loan portfolio, DNB
maintains an allowance for loan losses. Provisions for loan losses are charged
against income to increase the allowance when necessary. Loan losses are charged
directly against the allowance and recoveries on previously charged-off loans
are added to the allowance. In establishing its allowance for loan losses,
management considers the size and risk exposure of each segment of the loan
portfolio, past loss experience, present indicators of risk such as delinquency
rates, levels of nonaccruals, the potential for losses in future periods, and
other relevant factors. Management's evaluation of the loan portfolio generally
includes reviews, on a sample basis, of individual borrowers regardless of size
and reviews of problem borrowers of $100,000 or greater. Consideration is also
given to examinations performed by regulatory agencies, primarily the Office of
the Comptroller of the Currency ("OCC").
In determining the allowance, DNB utilizes a methodology which includes an
analysis of historical loss experience for the commercial real estate,
commercial, residential real estate, home equity and consumer installment loan
pools to determine a historical loss factor. The historical loss factors are
then applied to the current portfolio balances to determine the required reserve
percentage for each loan pool based on risk rating. In addition, specific
allocations are established for loans where loss is probable and reasonably
identifiable, based on management's judgment and an evaluation of the individual
credit, which includes various factors mentioned above. The allocated portion of
the reserve is then determined as a result of an analysis of the loan pools and
specific allocations.
In establishing and reviewing the allowance for adequacy, emphasis has been
placed on utilizing the methodology prescribed in the OCC's Handbook (which
utilizes BC 201 qualitative risk factors). As a result, management has taken
into consideration factors and variables which may influence the risk of loss
within the loan portfolio, including: (i) trends in delinquency and nonaccrual
loans; (ii) changes in the nature and volume of the loan portfolio; (iii)
effects of any changes in lending policies; (iv) experience, ability, and depth
of management/quality of loan review; (v) national and local economic trends and
conditions; (vi) concentrations of credit; and (vii) effect of external factors
on estimated credit losses. The unallocated portion of the allowance is intended
to provide for probable losses that are not otherwise identifiable using the
BC201 risk factors such as (i) the effect of expansion into new markets or lines
of business that are not as familiar as DNB's current market or business lines;
(ii) the risk that the information we receive from our borrowers is inaccurate
or misleading and (iii) the non-quantifiable impact that a terrorist action or
threat of action may have on a particular industry.
There were no provisions made during the three months ended March 31, 2004
based on management's analysis of the loan portfolio and the level of net
charge-offs compared to the total allowance. Net loan charge-offs were $69,000
20
for the three months ended March 31, 2004, compared to net loan recoveries of
$13,000 for the year ended December 31, 2003 and net loan charge-offs of $74,000
for the three months ended March 31, 2003. The percentage of net recoveries
(charge-offs) to total average loans was (0.03)%, 0.01% and (0.04)% for the same
respective periods.
The following table summarizes the changes in the allowance for loan losses
for the periods indicated. Real estate includes both residential and commercial
real estate.
3 Months Year 3 Months
Ended Ended Ended
(Dollars in thousands) 3/31/04 12/31/03 3/31/03
------- -------- -------
Beginning Balance $ 4,559 $ 4,546 $ 4,546
Provisions: -- -- --
Loans charged off:
Real estate -- (10) (1)
Commercial (75) (302) (204)
Consumer (30) (14) (45)
------- ------- -------
Total charged off (105) (326) (250)
Recoveries:
Real estate 15 111 92
Commercial 4 220 78
Consumer 17 8 6
------- ------- -------
Total recoveries 36 339 176
------- ------- -------
Net (charge-offs) recoveries (69) 13 (74)
------- ------- -------
Ending Balance $ 4,490 $ 4,559 $ 4,472
======= ======= =======
NON-INTEREST INCOME
Total non-interest income includes service charges on deposit products;
fees received in connection with the sale of nondepository products and
services, including fiduciary and investment advisory services offered through
DNB Advisors; securities brokerage products and services and insurance brokerage
products and services offered through DNB Financial Services; and other sources
of income such as increases in the cash surrender value of bank owned life
insurance ("BOLI"), net gains on sales of investment securities and other real
estate owned ("OREO") properties. In addition, DNB receives fees for cash
management, merchant services, debit cards, safe deposit box rentals, check
cashing, lockbox services and similar activities.
For the three month period ended March 31, 2004, non-interest income was
$788,000 compared to $674,000 for the same period in 2003. Service charges
increased $13,000 to $312,000 for the three month period ended March 31, 2004,
compared with the same period in 2003. Much of the increase in this category
came from non-sufficient funds ("NSF") fees, which rose $12,000, due to an
increase in the volume of accounts as well as a concerted effort by management
to reduce the waived fee percentage on deposit account overdrafts.
21
As a part of DNB's Strategic Plan to grow and diversify non-interest
income, management has placed a greater focus on its Wealth Management Group.
DNB's Wealth Management Group is comprised of its trust department, which
operates under the name "DNB Advisors", and its retail investment division,
which operates under the name "DNB Financial Services." Combined revenues from
DNB's Wealth Management Group's two units increased $71,000 or 49%
year-over-year, to $212,000, evidencing a greater focus on this line of
business.
During the first quarter of 2004, $52,000 was recorded from increases in
the cash surrender of BOLI policies. In addition there were $46,000 of gains
from the sales of securities during the first quarter of 2004, compared to no
gains during the first quarter of 2003.
NON-INTEREST EXPENSE
Non-interest expense includes salaries & employee benefits, furniture &
equipment, occupancy, professional & consulting fees as well as printing and
supplies, marketing and other less significant expense items.
Non-interest expenses increased $404,000 to $3.2 million for the three
month period ended March 31, 2004, compared to the same period in 2003. The
increase during the three month period was due to increases in a majority of the
expense categories, as discussed below.
Salaries & employee benefits increased $192,000 or 12.6% to $1.7 million
for the three months ended March 31, 2004, compared to $1.5 million for the same
period in 2003. The increase in this category reflects higher levels of salaries
and contributions to DNB's new Profit Sharing Plan. Officer and employee
salaries rose $81,000 year-over-year due to the increase in full-time equivalent
employees, as well as normal merit increases. A portion of the increase came
about as a result of DNB's continuing assessment of strategic goals and
operating objectives when two key additions were made to DNB's management team
in 2003. William J. Hieb joined DNB as Executive Vice President and Chief
Operating Officer in April. Richard M. Wright joined DNB in September to head up
the Bank's retail network. In addition to these two important changes,
management is in the process of expanding its lending and support staff to
facilitate loan growth as part of its balance sheet restructuring plan. DNB
believes that these changes will be integral to achieving its long-term
strategic goals. During the fourth quarter of 2003, DNB froze its existing
pension plan and took steps to make its retirement benefits more cost-efficient
and predictable going forward. As such, DNB instituted a Profit Sharing Plan in
2004. The first quarter expense for this plan was $42,000 and it is anticipated
that the annual cost in 2004 will be approximately $168,000. The cost of DNB's
Pension Plan was $440,000 in 2003.
Furniture & equipment expense declined $30,000 or 8.5% to $323,000 for the
three months ended March 31, 2004. This compares to $353,000 for the same period
in 2003. The decline during the most recent three month period was due to lower
levels of equipment depreciation, as several pieces of computer hardware became
fully depreciated in the fourth quarter of 2003.
22
Occupancy expense increased approximately $28,000 or 14.2% to $223,000 for
the three months ended March 31, 2004, compared to $195,000 for the same period
in 2003. The increase was due to higher levels of utility costs.
Professional & consulting expense increased $41,000 or 35.2% to $157,000
for the three month period ended March 31, 2004, compared to $116,000 for the
same period in 2003. In addition to a $22,000 reimbursement of legal fees from a
loan workout in the first quarter of 2003 (which did not reoccur in 2004), the
increase was due to higher costs incurred in the first quarter for services
relating to strategic planning, legal and accounting services to ensure
Sarbanes-Oxley compliance as well as other professional services. Part of the
professional services included sales training for our retail staff as the Bank
shifts the focus of its retail network.
Printing & supplies expense increased $33,000 or 48.0% to $101,000 for the
three month period ended March 31, 2004, compared to $68,000 for the three
months ended March 31, 2003. Marketing expense increased $27,000 or 43.9% to
$89,000 for the three months ended March 31, 2004, compared to $62,000 for the
same period in 2003. Printing & supplies as well as marketing expenditures
increased as a result of the recently announced name change.
INCOME TAXES
Income tax expense was $154,000 for the three months ending March 31, 2004
compared with $94,000 for the three months ending March 31, 2003. The effective
tax rates were 19% and 16%, respectively. The effective tax rates in 2004 and
2003 were less than the statutory rate due to the effect of tax-exempt income,
tax credits recognized on a low-income housing limited partnership and income
from bank-owned life insurance policies.
ASSET QUALITY
Non-performing assets are comprised of nonaccrual loans, loans delinquent
over ninety days and still accruing and Other Real Estate Owned ("OREO").
Nonaccrual loans are loans for which the accrual of interest ceases when the
collection of principal or interest payments is determined to be doubtful by
management. It is the policy of DNB to discontinue the accrual of interest when
principal or interest payments are delinquent 90 days or more (unless the loan
principal and interest are determined by management to be fully secured and in
the process of collection), or earlier, if considered prudent. Interest received
on such loans is applied to the principal balance, or may in some instances, be
recognized as income on a cash basis. A nonaccrual loan may be restored to
accrual status when management expects to collect all contractual principal and
interest due and the borrower has demonstrated a sustained period of repayment
performance in accordance with the contractual terms. OREO consists of real
estate acquired by foreclosure or deed in lieu of foreclosure. OREO is typically
carried at the lower of cost or estimated fair value, less estimated disposition
costs. Any significant change in the level of nonperforming assets is dependent,
to a large extent, on the economic climate within DNB's market area.
23
The following table sets forth those assets that are on nonaccrual status
or contractually delinquent by 90 days or more and still accruing for the
periods presented. DNB had no OREO at the end of all reported periods.
(Dollars in Thousands) 3/31/04 12/31/03 3/31/03
------- -------- -------
Nonaccrual Loans:
Residential mortgage $ 164 $ 165 $ 328
Commercial mortgage 2,138 2,142 1,049
Commercial 206 233 468
Consumer 13 16 248
------ ------ ------
Total nonaccrual loans 2,521 2,556 2,093
Loans 90 days past due and still accruing 145 472 502
Troubled debt restructurings -- -- --
------ ------ ------
Total non-performing loans 2,666 3,028 2,595
Other real estate owned -- -- --
------ ------ ------
Total non-performing assets $2,666 $3,028 $2,595
====== ====== ======
The following table sets forth DNB's asset quality and allowance coverage
ratios at the dates indicated:
3/31/04 12/31/03 3/31/03
------- -------- -------
Non-performing Loans/Total Loans 1.3% 1.5% 1.4%
Non-performing Assets/Total Assets 0.6 0.7 0.6
Allowance for Loan Losses/Total Loans 2.2 2.2 2.5
Allowance for Loan Losses/Total Loans and OREO 2.2 2.2 2.5
Allowance for Loan Losses/Non-performing Assets 168.4 150.5 172.3
Allowance for Loan Losses/Non-performing Loans 168.4 150.5 172.3
If interest income had been recorded on nonaccrual loans, interest would
have increased as shown in the following table:
3 Months Year 3 Months
Ended Ended Ended
(Dollars in thousands) 3/31/04 12/31/03 3/31/03
------- -------- -------
Interest income which would have been recorded
under original terms $ 47 $ 191 $ 34
Interest income recorded during the period (37) (169) (14)
----- ----- -----
Net impact on interest income $ 10 $ 22 $ 20
===== ===== =====
Information regarding impaired loans is as follows:
3 Months Year 3 Months
Ended Ended Ended
(Dollars in thousands) 3/31/04 12/31/03 3/31/03
------- -------- -------
Total recorded investment $2,159 $2,147 $1,353
Average recorded investment 2,153 2,074 1,897
Specific ALLL allocation -- -- --
Total cash collected 43 42 7
Interest income recorded 37 37 --
====== ====== ======
24
LIQUIDITY AND CAPITAL RESOURCES
For a financial institution, liquidity is a measure of the ability to fund
customers' needs for loans and deposit withdrawals. Management regularly
evaluates economic conditions in order to maintain a strong liquidity position.
One of the most significant factors considered by management when evaluating
liquidity requirements is the stability of DNB's core deposit base. In addition
to cash, DNB maintains a portfolio of short-term investments to meet its
liquidity requirements. DNB has historically relied on cash flow from operations
and other financing activities. Liquidity is provided by investing activities,
including the repayment and maturing of loans and investment securities.
At March 31, 2004 DNB has $14.4 million in unused commitments to fund
commercial real estate, construction and land development. In addition, DNB had
unfunded commitments totaling $11.2 million in home equity lines of credit and
$17.4 million in other unused commitments. Management anticipates the majority
of these commitments will be funded by means of normal cash flows. In addition,
$44.7 million of time deposits at DNB are scheduled to mature during the nine
months ending December 31, 2004. Management believes that the majority of such
deposits will be reinvested with DNB and that certificates that are not renewed
will be funded by a reduction in Federal funds sold or by paydowns and
maturities of loans and investments.
On July 25, 2001, DNB authorized the buyback of up to 175,000 shares of its
Common Stock over an indefinite period. The buyback, if fully completed, would
reduce the number of outstanding shares by approximately 10%. The repurchases
are conducted through open market or privately negotiated transactions. Shares
purchased in the program are held as treasury stock. Through March 31, 2004, DNB
had repurchased 153,831 shares of its Common Stock pursuant to the program at a
total cost of $3.5 million.
Stockholders' equity was $26.3 million or $13.91 per share, compared to
$25.4 million or $13.35 per share at December 31, 2003. The increase in
stockholders' equity was the result of a $799,000 increase in the fair market
value of available-for-sale securities, net of taxes, as well as net income of
$669,000 for the three months ended March 31, 2004. These increases were
partially offset by the purchase of 13,400 shares of treasury stock ($375,000)
and dividends paid of approximately $248,000 or $.13 per share. The
Corporation's common equity position at March 31, 2004 exceeds all regulatory
required minimums.
Effective March 31, 2004, DNB deconsolidated DNB Capital Trust I, resulting
in a change in the characterization of the underlying consolidated debt
obligations from the previous trust preferred securities to junior subordinated
debentures. While the junior subordinated debentures do not quality as Tier I
capital for risk-based, they continue to quality as a component of capital for
purposes of calculating total risk-based capital.
25
On May 6, 2004, the Federal Reserve Board proposed formally to allow the
continued inclusion of outstanding and prospective issuances of trust preferred
securities in the tier 1 capital of bank holding companies, subject to stricter
quantitative limits and qualitative standards. The Board also proposed to revise
the quantitative limits applied to the aggregate amount of cumulative perpetual
preferred stock, trust preferred securities, and minority interests in the
equity accounts of certain consolidated subsidiaries (collectively, restricted
core capital elements) included in the tier 1 capital of bank holding companies.
The quantitative limits would become effective after a three-year transition
period. In addition, the Board proposed to revise the qualitative standards for
capital instruments included in regulatory capital consistent with longstanding
Board policies. These proposals were intended to address supervisory concerns,
competitive equity considerations, and changes in generally accepted accounting
principles. Management does not anticipate that the Federal Reserve Board's
proposal will have a material adverse impact on DNB, the Bank or their
regulatory capital ratio compliance.
The following table summarizes data and ratios pertaining to the
Corporation and the Bank's capital structure.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- -------------------- --------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
DNB Financial Corporation
As of March 31, 2004:
Total risk-based capital $32,204 12.55% $20,530 8.00% $25,663 10.00%
Tier 1 risk-based capital 28,980 11.29 10,265 4.00 15,398 6.00
Tier 1 (leverage) capital 28,980 7.17 16,162 4.00 20,202 5.00
Downingtown National Bank
As of March 31, 2004:
Total risk-based capital $31,777 12.36% $20,574 8.00% $25,717 10.00%
Tier 1 risk-based capital 28,547 11.10 10,287 4.00 15,430 6.00
Tier 1 (leverage) capital 28,547 7.09 16,106 4.00 20,132 5.00
In addition, the Federal Reserve Bank (the "FRB") leverage ratio rules
require bank holding companies to maintain a minimum level of "primary capital"
to total assets of 5.5% and a minimum level of "total capital" to total assets
of 6%. For this purpose, (i) "primary capital" includes, among other items,
common stock, certain perpetual debt instruments such as eligible Trust
preferred securities, contingency and other capital reserves, and the allowance
for loan losses, (ii) "total capital" includes, among other things, certain
subordinated debt, and "total assets" is increased by the allowance for loan
losses. DNB's primary capital ratio and its total capital ratio are both well in
excess of FRB requirements.
REGULATORY MATTERS
Dividends payable to the Corporation by the Bank are subject to certain
regulatory limitations. Under normal circumstances, the payment of dividends in
any year without regulatory permission is limited to the net profits (as defined
for regulatory purposes) for that year, plus the retained net profits for the
preceding two calendar years.
FORWARD-LOOKING STATEMENTS
This report contains statements, that are not of historical facts and may
pertain to future operating results or events or management's expectations
regarding those results or events. These are "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
26
Securities and Exchange Act of 1934. These forward-looking statements may
include, but are not limited to, statements about our plans, objectives,
expectations and intentions and other statements contained in this report that
are not historical facts. When used in this report, the words "expects",
"anticipates", "intends", "plans", "believes", "seeks", "estimates", or words of
similar meaning, or future or conditional verbs, such as "will", "would",
"should", "could", or "may" are generally intended to identify forward-looking
statements. Forward-looking statements involve certain risks and uncertainties,
and actual results may differ materially from those contemplated by such
statements. For example, actual results may be adversely affected by the
following possibilities: (1) competitive pressures among financial institutions
may increase; (2) changes in interest rates may reduce banking interest margins;
(3) general economic conditions and real estate values may be less favorable
than contemplated; (4) adverse legislation or regulatory requirements may be
adopted; (5) other unexpected contingencies may arise; (6) DNB may change one or
more strategies described in this document; or (7) management's evaluation of
certain facts, circumstances or trends and the appropriate responses to them may
change. These forward-looking statements are inherently subject to significant
business, economic and competitive uncertainties and contingencies, many of
which are either beyond our control or not reasonably capable of predicting at
this time. In addition, these forward-looking statements are subject to
assumptions with respect to future business strategies and decisions that are
subject to change. Actual results may differ materially from the results
discussed in these forward-looking statements. Readers of this report are
accordingly cautioned not to place undue reliance on forward-looking statements.
DNB disclaims any intent or obligation to update publicly any of the
forward-looking statements herein, whether in response to new information,
future events or otherwise. With regard to DNB's balance sheet repositioning,
the degree to which these steps can be accomplished will depend on a number of
factors, including changes in the interest rate environment for loans,
investments and deposits, loan prepayments, market opportunities for new loan
and participation originations, and the availability of loan and lease
receivables for purchase at attractive prices and yields, as well as
management's assessment of the timing of each of these opportunities and steps
in light of future, unknown developments affecting DNB's business generally.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
To measure the impacts of longer-term asset and liability mismatches beyond
two years, DNB utilizes Modified Duration of Equity and Economic Value of
Portfolio Equity ("EVPE") models. The modified duration of equity measures the
potential price risk of equity to changes in interest rates. A longer modified
duration of equity indicates a greater degree of risk to rising interest rates.
Because of balance sheet optionality, an EVPE analysis is also used to
dynamically model the present value of asset and liability cash flows, with
rates ranging up or down 200 basis points. The economic value of equity is
likely to be different if rates change. Results falling outside prescribed
27
ranges require action by management. At March 31, 2004 and December 31, 2003,
DNB's variance in the economic value of equity as a percentage of assets with an
instantaneous and sustained parallel shift of 200 basis points was within its
negative 3% guideline, as shown in the table below. The change as a percentage
of the present value of equity with a 200 basis point increase or decrease at
December 31, 2003, was within DNB's negative 25% guideline.
March 31, 2004 December 31, 2003
------------------------------------ -----------------------------------
Change in rates Flat -200bp +200bp Flat -200bp +200 bp
---- ------ ------ ---- ------ -------
EVPE $ 33,260 $ 26,972 $ 28,994 $ 33,915 $ 29,953 $ 27,357
Change (6,288) (4,266) (3,691) (6,557)
Change as a % of assets (1.5%) (1.0%) (1.0%) (1.6%)
Change as a % of PV equity (18.9%) (12.8%) (11.7%) (19.3%)
ITEM 4 - CONTROLS AND PROCEDURES
DNB's Chief Executive Officer and Chief Financial Officer have reviewed and
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Exchange Act Rule 15d-14(c) as of March 31, 2004 in accordance with
the requirements of Exchange Act Rule 240.15d-15(b). Based on that evaluation,
the Chief Executive Officer and the Chief Financial Officer have concluded that
DNB's current disclosure controls and procedures are effective and timely,
providing them with material information relating to DNB and its subsidiaries
required to be disclosed in the report DNB files under the Exchange Act.
DNB's conducted an evaluation of internal control over financial reporting
to determine whether any changes occurred during the quarter ended March 31,
2004, that have materially affected, or are reasonably likely to materially
affect, DNB's internal control over financial reporting. Based on this
evaluation, there has been no such change during the quarter ended March 31,
2004.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
28
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6.
(a) EXHIBITS:
3 (i) Amended and Restated Articles of Incorporation, as amended
effective June 15, 2001, filed on August 14, 2001, as Item
6(a) to Form 10-Q (No. 0-16667 and incorporated herein by
reference.
(ii) By-laws of the Registrant as amended December 19, 2001,
filed on March 24, 2002 at Item 3b to Form 10-Q (No. 0-16667
and incorporated herein by reference.
10 (a) Employment Agreement between Downingtown National Bank and
Henry F. Thorne dated December 31, 1996 filed on March 26,
1999 at Item 10.l to Form K for the fiscal year ended
December 31, 1998 (No. 0-16667) and incorporated herein by
reference.
(b) Form of Change of Control Agreements (i) dated May 5, 1998
between DNB Financial Corporation and Downingtown National
Bank and the following executive officers: Ronald K.
Dankanich, Eileen M. Knott and Bruce E. Moroney and (ii)
dated July 18, 2000, April 28, 2003 and September 22, 2003
between DNB Financial Corporation and Downingtown National
Bank and Kristen J. LaDow, William J. Hieb and Richard M.
Wright, respectively, each in the form filed on March 26,
1999 at Item 10.2 to Form 10-K for the fiscal year ended
December 31, 1998 (No. 0-16667), and incorporated herein by
reference.
(c) 1995 Stock Option Plan of DNB Financial Corporation (as
amended and restated, effective as of April 27, 1999), filed
on May 20, 1999 as Exhibit 4 to Registration Statement No.
33-93272, and incorporated herein by reference.
(d) Death Benefit Agreement between Downingtown National Bank
and Henry F. Thorne dated November 24, 1999, filed March 20,
2002 as Item 10(d) to Form 10-K for the fiscal year ended
December 31, 2001 (No. 0-16667) and incorporated herein by
reference.
(e) Form of Change of Control Agreements, as amended November
10, 2003, between DNB Financial Corporation and Downingtown
National Bank and each of the following Directors: William
S. Latoff, James H. Thornton, Louis N. Teti,. Joseph G.
Riper, James J. Koegel, Eli Silberman and Henry F. Thorne,
filed on November 14, 2003 as Item 10(e) to Form 8-K (No.
0-16667) and incorporated herein by reference.
29
(f) Retirement and Change of Control Agreement dated as of
February 27, 2002, between DNB Financial Corporation and
Downingtown National Bank and Thomas R. Greenleaf, a
Director, filed on November 14, 2003 as Item 10(f) to Form
8-K (No. 0-16667) and incorporated herein by reference.
(g) First Amendment to Employment Agreement of Henry F. Thorne
dated December 23, 2003, filed on March 29, 2004 at Item
10(g) to Form 10-K for the fiscal year ended December 31,
2003 (No. 0-16667) and incorporated herein by reference.
(h) Retirement and Death Benefit Agreement between Downingtown
National Bank and Henry F. Thorne dated December 23, 2003,
filed on March 29, 2004 at Item 10(h) to Form 10-K for the
fiscal year ended December 31, 2003 (No. 0-16667) and
incorporated herein by reference.
11 Computation of Earnings per Common Share. The information
for this Exhibit is incorporated by reference to pages 6 and
7 of this Form 10-Q.
23 Consent of KPMG LLP, filed on March 29, 2004 at Item 23 to
Form 10-K for the fiscal year ended December 31, 2003 (No.
0-16667) and incorporated herein by reference.
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for the Chief Executive Officer.
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for the Chief Financial Officer.
32.1 Certification of Chief Executive Officer pursuant to Section
906.
32.2 Certification of Chief Financial Officer pursuant to Section
906.
30
(b) Reports on Form 8-K
The Registrant filed the following Current Reports on Form 8-K during the
quarter ended March 31, 2004:
Date Item Reported
---- -------------
January 6, 2004 Items 7 and 9 - Press Release announcing promotion
of Kenneth R. Kramer as SVP of Retail Lending and
Leasing.
February 5, 2004 Items 7, 9 and 12 - Fourth quarter earnings
release with summary financial information.
February 27, 2004 Items 7 and 9 - Announcement of cash dividend.
March 29, 2004 Items 7 and 9 - Announcement of name change of
Downingtown National Bank subsidiary to DNB First.
(c) Exhibits required by Item 601 of Regulation S-K. The exhibits required
to be filed pursuant to this item are listed above under part (a) of
this Item.
31
SIGNATURES
Pursuant to the requirements of The Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DNB FINANCIAL CORPORATION
(Registrant)
DATE: May 17, 2004 /S/ Henry F. Thorne
------------------------------
Henry F. Thorne, President
and Chief Executive Officer
DATE: May 17, 2004 /S/ Bruce E. Moroney
-----------------------------
Bruce E. Moroney
Chief Financial Officer
32