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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: June 30, 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
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NATIONAL PENN BANCSHARES, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2215075
------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Philadelphia and Reading Avenues, Boyertown, PA 19512
-----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(610) 367-6001
--------------
(Registrant's telephone number, including area code)
N/A
---
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act.) Yes X No .
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at July 30, 2004
----- ----------------------------
Common Stock (no stated par value) (No.) Shares 27,553,649
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 .......................................31
Item 4. Controls and Procedures.................................31
Part II - Other Information.
- ----------------------------
Item 1. Legal Proceedings ......................................32
Item 2. Changes in Securities, Use of Proceeds
And Issuer Repurchases of Equity Securities.............32
Item 3. Defaults Upon Senior Securities.........................33
Item 4. Submission of Matters to a Vote of
Security Holders .......................................33
Item 5. Other Information33
Item 6. Exhibits and Reports on Form 8-K........................34
Signatures...................................................................36
Exhibits ....................................................................37
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET June 30,
(Dollars in thousands, except per share data) 2004 Dec. 31,
(Unaudited) 2003
----------------- -----------------
ASSETS
Cash and due from banks $107,844 $96,164
Interest bearing deposits in banks 4,720 2,233
Federal funds sold 34042 -
----------------- -----------------
Total cash and cash equivalents $146,606 $98,397
Investment securities available for sale , at fair value 1,010,776 934,375
Loans held for sale 56,871 29,344
Loans and leases, less allowance for loan and lease losses of $57,410 and
$49,265 in 2004 and 2003 respectively 2,658,179 2,192,090
Premises and equipment, net 52,814 43,653
Accrued interest receivable 16,623 14,309
Bank owned life insurance 78,031 69,937
Goodwill and other intangibles 197,536 111210
Unconsolidated investments under the equity method 6,910 2,968
Other assets 29,999 16,291
----------------- -----------------
Total Assets $4,254,345 $3,512,574
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Non-interest bearing deposits $499,067 $386,620
Interest bearing deposits 2,355,197 2,048,676
----------------- -----------------
Total Deposits 2,854,264 2,435,296
Securities sold under repurchase agreements
and federal funds purchased 607,458 500,038
Short-term borrowings 9,998 10,000
Long-term borrowings 231,382 164,037
Subordinated debt 127063 -
Guaranteed preferred beneficial interests in
Company's subordinated debentures - 63,250
Accrued interest payable and other liabilities 26,308 22,140
----------------- -----------------
Total Liabilities 3,856,473 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 - 27,492,395; 2003 - 24,285,506; net of shares
in Treasury: 2004 - 8,214; 2003 -2,626 356182 272534
Retained earnings 37,669 25,770
Accumulated other comprehensive income 4,315 19,595
Treasury stock at cost -294 -86
----------------- -----------------
Total Shareholders' Equity 397,872 317,813
----------------- -----------------
Total Liabilities and Shareholders' Equity $4,254,345 $3,512,574
================= =================
The accompanying notes are an integral part of these financial statements.
3
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
(Dollars in thousands, except per share data) June 30, June 30,
------------------------------------------------------------------------------
2004 2003 2004 2003
------------- ----------- ------------ -------------
INTEREST INCOME
Loans and leases, including fees $35,823 $32,985 $70,009 $64,148
Investment securities
Taxable $7,208 $5,383 13926 10851
Tax-exempt $3,185 $3,301 6426 6555
Federal funds sold 3 86 24 286
Deposits in banks 6 15 14 31
------------- ----------- ------------ -------------
Total interest income 46,225 41,770 90,399 81,871
------------- ----------- ------------ -------------
INTEREST EXPENSE
Deposits 8,269 8,805 16,368 17,385
Securities sold under repurchase agreements and
federal funds purchased 1,552 955 3,139 1,887
Short-term borrowings 9 9 19 17
Long-term borrowings 3,991 3,460 7044 6858
------------- ----------- ------------ -------------
Total interest expense 13,821 13,229 26,570 26,147
------------- ----------- ------------ -------------
Net interest income 32,404 28,541 63,829 55,724
Provision for loan and lease losses 1,200 2,355 2,963 4,610
------------- ----------- ------------ -------------
Net interest income after provision
for loan and lease losses 31,204 26,186 60,866 51,114
------------- ----------- ------------ -------------
OTHER INCOME
Trust income 1,414 1,354 2,775 2,653
Service charges on deposit accounts 3,588 2,922 7,003 5,709
Bank owned life insurance income 1,031 1,080 1762 1732
Other service charges and fees 2,984 2,181 5559 4146
Net (losses) on sales of investment securities - - (196) -
Mortgage banking income 660 1,552 1,963 2,993
Insurance commissions and fees 937 727 1769 1189
Service charges cash management 671 543 1311 1041
Equity in undistributed net earnings of affiliates 28 68 129 115
------------- ----------- ------------ -------------
Total other income 11,313 10,427 22,075 19,578
------------- ----------- ------------ -------------
OTHER EXPENSES
Salaries, wages and employee benefits 15,477 13,590 30,255 26,156
Net premises and equipment 3,680 3,677 7,634 6,946
Advertising and marketing expenses 1,154 1,038 2286 1677
Other operating 5,933 5,509 11,590 10,359
------------- ----------- ------------ -------------
Total other expenses 26,244 23,814 51,765 45,138
------------- ----------- ------------ -------------
Income before income taxes 16,273 12,799 31,176 25,554
Income tax expense 4,093 2,742 7,628 5,739
------------- ----------- ------------ -------------
Net income from continuing operations 12,180 10,057 23,548 19,815
Net income from discontinued operations - 706 - 1,338
------------- ----------- ------------ -------------
Net income $12,180 $10,763 $23,548 $21,153
============= =========== ============ =============
PER SHARE OF COMMON STOCK
Net income per share - basic
Continuing operations $0.49 $0.42 $0.96 $0.83
Discontinued operations 0.00 0.03 0.00 0.06
Net income per share - basic $0.49 $0.45 $0.96 $0.89
Net income per share - diluted
Continuing operations $0.48 $0.41 $0.94 $0.81
Discontinued operations 0.00 0.03 0.00 0.05
Net income per share - diluted $0.48 $0.44 $0.94 $0.87
Dividends paid in cash 0.24 0.22 0.48 0.43
The accompanying notes are an integral part of these condensed financial statements.
4
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 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 - - 23,548 - - 23,548 $ 23,548
Cash dividends declared - - (11,649) - - (11,649)
Shares issued under stock-based
plans 378,932 (3,205) - - 9,247 6,042
Shares issued for acquisition
of Peoples Bank of Oxford 3,114,140 86,853
Other comprehensive loss, net
of reclassification adjustment
and taxes - - - (15,280) - (15,280) (15,280)
------------------------------------------------------------------------------------------------
Total comprehensive income - - - - - - $ 8,268
------------------------------------------------------------------------------------------------
Treasury shares purchased (285,183) - - - (9,455) (9,455)
------------------------------------------------------------------------------------------------
Balance at June 30, 2004 27,492,395 $ 356,182 $ 37,669 $ 4,315 $ (294) $ 397,872
June 30, 2004
----------------------------------------
Before Tax Net of
Components of Other Comprehensive Income tax (expense) tax
amount benefit amount
----------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period (24,047) 8,297 (15,750)
Less: Reclassification adjustment for losses
realized in net income (196) 69 (127)
Change in the fair value of cash flow hedges (343) - (343)
----------------------------------------
Other comprehensive income, net (23,508) 8,228 (15,280)
========================================
SIX MONTHS ENDED JUNE 30, 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 - - 21,153 - - 21,153 $ 21,153
Cash dividends declared - - (10,617) - - (10,617)
Shares issued under stock-based
plans 152,330 (5,744) - - 15,212 9,468
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 - - - 8,226 - 8,226 8,226
------------------------------------------------------------------------------------------------
Total comprehensive income - - - - - - $ 29,379
------------------------------------------------------------------------------------------------
Treasury shares purchased (357,272) - - - (18,514) (18,514)
------------------------------------------------------------------------------------------------
Balance at June 30, 2003 23,058,392 $ 227,989 $ 41,129 $ 27,522 $ (1,378) 295,262
June 30, 2003
----------------------------------------
Before Tax Net of
Components of Other Comprehensive Income tax (expense) tax
amount benefit amount
----------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during period 11,518 (4,429) 7,089
Less: Reclassification adjustment for losses
realized in net income - - -
Change in the fair value of cash flow hedges (1,137) - (1,137)
----------------------------------------
Other comprehensive income, net 12,655 (4,429) 8,226
========================================
The accompanying notes are an integral part of these statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Six Months Ended June 30,
2004 2003
- ----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
- ----------------------------------------------------------------------------------------------------------
Net income 23,548 21,153
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan and lease losses 2,963 4,610
Depreciation and amortization 3,416 2,637
Amortization of premiums and discounts on investment
securities, net (453) 331
Investment securities (gains) losses, net 196 -
Mortgage loans originated for resale (68,163) (60,372)
Sale of mortgage loans originated for resale 69,746 62,905
Gain on sale of mortgage loans originated for resale (1,583) (2,533)
Changes in assets and liabilities
(Increase) decrease in accrued interest receivable (767) 771
(Decrease) increase in accrued interest payable (860) (1,893)
Decrease in other assets (3,395) (3,792)
Increase (decrease) in other liabilities 2,994 7,665
Decrease (increase) in assets from discontinued operations - (9,161)
Increase (decrease) in liabilities from discontinued operations - 1,414
- ----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 27,642 23,735
- ----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
- ----------------------------------------------------------------------------------------------------------
Cash paid in excess of cash equivalents for business acquired (32,408) (81)
Proceeds from sales of investment securities available for sale 40,700 -
Proceeds from maturities of investment securities available for sale 113,955 113,474
Purchase of investment securities available for sale (199,990) (189,933)
Net (increase) decrease in loans (140,748) (17,746)
Purchases of premises and equipment (3,193) (3,445)
Purchase of bank-owned life insurance - -
- ----------------------------------------------------------------------------------------------------------
Net cash used in investing activities (221,684) (97,731)
- ----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- ----------------------------------------------------------------------------------------------------------
Net increase in interest and non-interest
bearing demand deposits and savings accounts 7,109 34,523
Net increase in certificates of deposit 30,694 19,967
Net increase in securities sold under
agreements to repurchase and federal funds purchased 120,831 44,971
Net (decrease) in short-term borrowings (2) (3,333)
Proceeds from new long-term borrowings 50,000 -
Repayments of long-term borrowings (13,176) (2,554)
Issuance of subordinated debentures 61,857 -
Issuance of common stock under dividend
reinvestment and stock option plans 6,042 9,468
Purchase of Treasury stock (9,455) (18,514)
Cash dividends (11,649) (10,617)
- ----------------------------------------------------------------------------------------------------------
Net cash provided by (used in ) financing activities 242,251 73,911
- ----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 48,209 (85)
Cash and cash equivalents at beginning of year 98,397 124,124
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at June 30 146,606 124,039
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 on February 25, 2003, are
included in the income statement for the six months ended June 30, 2003 from
February 25, 2003 through June 30, 2003. The results of FirstService Bank and
HomeTowne Heritage Bank, which was acquired on December 12, 2003, are included
in the income statement for the entire first six months in 2004. The results of
Peoples First, Inc., which was acquired on June 10, 2004, are included in the
income statement from acquisition date through June 30, 2004.
The results of operations for the six-month period ended June 30, 2004 are not
necessarily indicative of the results to be expected for the full year.
2. ACQUISITIONS AND DISPOSITIONS
Acquisition of Peoples First, Inc.
----------------------------------
On June 10, 2004, National Penn Bancshares, Inc. completed the acquisition
of Peoples First, Inc. ("Peoples"), parent company of The Peoples Bank of
Oxford. The Peoples Bank of Oxford, headquartered in Oxford, Pennsylvania,
operated eight community offices in Chester and Lancaster Counties,
Pennsylvania, and one community office in Cecil County, Maryland, at the time of
acquisition.
Under the terms of the merger agreement, 2,956,288 shares of Peoples
stock were each converted into 1.505 shares of National Penn common stock,
$49.54 in cash, or a combination of both, resulting in the issuance of 3,114,449
shares of National Penn common stock and payment of approximately $43,936,352
million in cash. The total purchase price (cash and stock) was valued at $130.8
million. In addition, outstanding stock options to purchase shares of Peoples
common stock were converted into options to purchase 107,270 shares of National
Penn common stock, with an exercise price of $14.00 per share. This transaction
was accounted for under the purchase method of accounting. Accordingly, the
results of operations of the Company include Peoples' results from and after
June 10, 2004. The acquisition resulted in the recording of approximately $87.1
million of goodwill and other intangible assets. Management is currently
evaluating the fair value of assets and liabilities from this transaction to
finalize goodwill and other intangible asset balances. The Company acquired
assets, loans and deposits of $455.9 million, $361.6 million, and $381.1
million, respectively.
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 $641,000, for the six months ended June
30, 2003 was $1.3 million.
7
The following represents the per share amounts for continuing and
discontinued operations for the three months and six months ended June 30, 2003:
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 2003 June 30, 2003
------------- -------------
Net income per share - basic
Continuing operations $0.42 $0.83
Discontinued operations 0.03 0.06
Net income per share - basic $0.45 $0.89
Net income per share - diluted
Continuing operations $0.41 $0.81
Discontinued operations 0.03 0.06
Net income per share - diluted $0.44 $0.87
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 $8.6 million at June 30, 2004, all
of which are non-accrual loans. The allowance for loan and lease loss associated
with these impaired loans was $2.6 million at June 30, 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 July 28, 2004, the Company's Board of Directors declared a cash dividend of
$.24 per share payable on August 17, 2004, to shareholders of record on August
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 June 30, 2004, 442,595 shares have been
repurchased at an average price of $32.40 per share.
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.
5. EARNINGS PER SHARE
Three Months ended June 30, 2004
- --------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- ------
Basic earnings per share
Net income available to common stockholders $12,180 24,607 $0.49
Effect of dilutive securities
Options -- 475 (0.01)
Diluted earnings per share
Net income available to common stockholders ----------- ------------- ------
Plus assumed conversions $ 12,180 25,082 $0.48
========== ============= ======
8
Year to Date June 30, 2004
- --------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- -------
Basic earnings per share
Net income available to common stockholders $23,548 24,607 $0.96
Effect of dilutive securities
Options -- 558 (0.02)
Diluted earnings per share
Net income available to common stockholders ---------- ------------ --------
Plus assumed conversions $ 23,548 25,165 $0.94
========== ============ ========
Options to purchase 338,427 shares of common stock at $32.35 to $33.13 per
share, that were outstanding for the three and six months ended June 30, 2004,
were not included in the computation of diluted earnings per share because the
option exercise price was greater than the average market price.
Three Months ended June 30, 2003
- --------------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- -------
Basic earnings per share
Net income available to common stockholders $10,763 23,789 $0.45
Effect of dilutive securities
Options -- 606 (0.01)
Diluted earnings per share
Net income available to common stockholders --------- ------------ -------
Plus assumed conversions $ 10,763 24,395 $ 0.44
========= ============ =======
Year to Date June 30, 2003
- --------------------------
Income Shares Per Share
(numerator) (denominator) Amount
----------- ------------- -------
Basic earnings per share
Net income available to common stockholders $21,153 23,789 $0.89
Effect of dilutive securities
Options -- 586 (0.02)
Diluted earnings per share
Net income available to common stockholders ----------- ------------- -------
Plus assumed conversions $ 21,153 24,375 $0.87
=========== ============= =======
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 June 30, 2004, to
create a reportable operating segment, "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 Community Banking operating 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
9
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
six months ended June 30, 2003.
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 Six Months Ended, June 30, 2004
- --------------------------------------------------
Total assets $3,695,370 $558,975 $4,254,345
Total deposits 2,854,264 -- 2,854,264
Net interest income (loss) 66,100 (2,271) 63,829
Total noninterest income 15,949 6,126 22,075
Total noninterest expense 45,892 5,873 51,765
Net income (loss) $24,918 $(1,370) $23,548
As of, and for the Six Months Ended, June 30, 2003
- --------------------------------------------------
Total assets $3,695,370 $374,141 $3,371,134
Total deposits 2,269,327 -- 2,269,327
Net interest income (loss) 57,988 (2,264) 55,724
Total noninterest income 14,403 5,175 19,578
Total noninterest expense 40,398 4,740 45,138
Net income from continuing
operations 21,089 (1,274) 19,815
Discontinued operations 1,338 -- 1,338
Net income (loss) $22,427 $(1,274) $21,153
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 June 30, 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
10
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.
Three Months Ended June 30,
---------------------------
2004 2003
---- ----
Net income, as reported $12,180 $10,763
Less: stock-based compensation costs determined under fair value-
based method for all awards (269) (208)
--------- --------
Net income, pro forma $ 11,911 $ 10,555
======== ========
Earnings per share of common stock - basic As reported $0.49 $0.45
Pro forma 0.48 0.44
Earnings per share of common stock - diluted As reported 0.48 0.44
Pro forma $0.47 $0.43
Year to Date Ended June 30,
---------------------------
2004 2003
---- ----
Net income, as reported $23,548 $21,153
Less: stock-based compensation costs determined under fair value-
based method for all awards (538) (415)
---- ----
Net income, pro forma $ 23,010 $ 20,738
======== ========
Earnings per share of common stock - basic As reported $0.96 $0.89
Pro forma 0.94 0.87
Earnings per share of common stock - diluted As reported 0.94 0.87
Pro forma $0.91 $0.86
The Company granted options for 12,639 and 10,341 shares in the first six 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
11
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 June 30, 2004, the Company has established four statutory
business trusts, NPB Capital Trust II, NPB Capital Trust III, NPB Capital Trust
IV and NPB Capital Trust V. 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
on 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 on 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
on March 25, 2004 mature on April 7, 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 V
on 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.
In first quarter 2004, management determined that NPB Capital Trust II
qualified as a variable interest entity under FIN 46, as revised. NPB Capital
Trust II had previously issued mandatorily redeemable preferred capital
securities to investors and loaned the proceeds to the Company through the
purchase of debentures as discussed above. 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 had to 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 de-consolidated 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 resulted 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 Federal Reserve has issued proposed guidance on the regulatory capital
treatment for the trust-preferred securities issued by the various business
trusts identified above as result of the adoption of FIN 46(R). The proposed
rule would retain the current maximum percentage of total capital permitted for
trust preferred securities at 25%, but would enact other changes to the rules
governing trust preferred securities that affect their use as part of the
collection of entities known as "restricted core capital elements". The rule
would take effect March 31, 2007; however, a three year transition period
leading up to that date would allow bank
12
holding companies to continue to count trust preferred securities as Tier 1
Capital after applying FIN-46(R). Management has evaluated the effects of the
proposed rule and does not anticipate a material impact on its capital ratios
when the proposed rule is finalized.
9. EMPLOYEE BENEFIT PLANS
Net periodic defined benefit pension expense for the six months ended June
30, 2004 and 2003 included the following components:
June 30, 2004 June 30, 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 six months ended June 30, 2004.
10. NEW ACCOUNTING PRONOUNCEMENTS
Staff Accounting Bulletin 105
-----------------------------
The Securities and Exchange Commission staff 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 internally developed intangible
assets, such as customer-related intangible assets, in determining the fair
value of loan commitments accounted for as derivatives.
The Company adopted SAB 105 at the beginning of second quarter 2004. It is
effective for commitments entered into after March 31, 2004. The requirements of
SAB 105 apply to the Company's mortgage loan interest rate lock commitments
related to loans held for sale. At June 30, 2004, such commitments with a
notional amount of approximately $11.1 million were outstanding. The Company's
prior accounting policy was to not record the fair value of these commitments
because they were immaterial. The Company anticipates that application of SAB
105 will not have a material impact on the Company's results of operations.
EITF Issue No. 03-1
- -------------------
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
issued EITF Abstract 03-1, The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments (EITF 03-1). The quantitative and
qualitative disclosure provisions of EITF 03-1 were effective for years ending
after December 15, 2003 and were included in the Company's 2003 Form 10-K . In
March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. The Company is in the process of determining
the impact that this EITF will have on its financial statements.
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 13.2% increase in second quarter 2004 net income
and an 11.3% increase in net income for the first six months of 2004, compared
to the same periods in 2003. Diluted earnings per share for the three and six
month periods of $0.48 and $0.94 increased 9.1% and 8.0%, respectively, compared
to the same periods in 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 various acquisitions since January 2003. Per share results for
2003 have been restated for the 5% stock dividend paid September 30, 2003.
For the six months ended June 30, 2004, the annualized return on
average shareholders' equity and annualized return on average assets were 15.2%
and 1.30%, compared to 15.9% and 1.34% for the same period in 2003. This
decrease is due primarily to the higher levels of average equity and average
assets outstanding resulting from various acquisitions since January 2003. The
return on average tangible equity for the first six months of 2004 was 24.7%,
compared to 20.5% for the same period in 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 States 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.
14
Reconciliation Table for Non-GAAP Financial Measure
June 30, 2004 June 30, 2003
------------- -------------
Return on average shareholders' 15.2% 15.9%
equity
Effect of goodwill and intangibles 9.5% 4.6%
Return on average tangible equity 24.7% 20.5%
Average tangible equity excludes acquisition related average goodwill and
intangibles:
Average shareholders' equity $311,489 $266,697
Average goodwill and intangibles (120,419) (60,254)
-------- -------
Average tangible equity $191,070 $206,443
======== ========
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 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.
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
("GAAP") and general practices within the financial services industry. The
preparation of financial statements in conformity with GAAP 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 the determination of the allowance for loan and
lease losses to involve 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's 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. In this
testing, 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 a reporting unit is less than its book value, an expense may be required on
the Company's books to write down the related goodwill to the proper carrying
value. The Company usually tests for impairment goodwill as of June 30 each
year. Through its annual analysis as of June 30, 2004, the Company has not
identified any impairment of its goodwill. No assurance can be given that future
goodwill impairment tests will not result in a charge to earnings.
15
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 June 30, 2004 was $12.2 million, 13.2%
more than for the second quarter of 2003. For the first six months of 2004, net
income was $23.6 million or 11.3% more than the $21.2 million reported in the
first six months of 2003.
The Company's performance has been and will continue to be influenced
in part by the strength of the economy and conditions in the real estate market.
The results of second quarter 2004 include Peoples First, Inc. from its
acquisition date, June 10, 2004, through June 30, 2004. The results of second
quarter 2003 include FirstService Bank, acquired on February 25, 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
second quarter of 2004 was $32.4 million, which increased $3.9 million or 13.5%
over the $28.5 million for the second quarter of 2003. Net interest income for
the six months ended June 30, 2004 was $63.8 million, a 14.5% increase over net
interest income in the comparable period in 2003.
Interest income for the second quarter of 2004 increased $4.5 million
due to an increase in loan interest income of $2.8 million and an increase in
investment securities income of $1.7 million, offset by a decrease in interest
on federal funds sold and deposits in bank of $92,000. Interest expense for
second quarter 2004 increased $592,000 due to an increase in expense for
securities sold under repurchase agreements and federal funds sold of $597,000
and an increase in interest on long-term borrowings of $531,000, offset by a
decrease in interest on deposits of $536,000. The increase in interest expense
on these categories of borrowings is a result of increased balances due in part
to the issuance of $60 million of trust preferred securities. Interest on
deposits decreased, as non-interest bearing deposits make up a proportionately
larger percentage of total deposits as of June 30, 2003.
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:
o changes in volume (i.e., changes in volume multiplied by old
rate); and
o changes in rate (i.e., changes in rate multiplied by old
volume).
For purposes of this table, changes attributable to both rate and
volume, which cannot be segregated, have been allocated proportionately to the
change due to volume and the change due to rate. The information is presented on
a taxable equivalent basis, using an effective rate of 35% (in thousands). Net
interest income, on a taxable equivalent basis, increased $8.1 million in the
first six months of 2004, as compared to the same period in 2003. This increase
is due to a $13.8 million increase due to volume,
16
attributable mainly to the FirstService Bank, HomeTowne Heritage Bank and
Peoples First, Inc. acquisitions, offset by a $5.7 million net interest margin
compression.
Six Months Ended June 30, 2004 over 2003
----------------------------------------
Volume Rate Total
------ ---- -----
Increase (decrease) in:
Interest income:
Interest bearing deposits in banks $ 5 $ (22) $ (17)
Federal funds sold (238) (24) (262)
Investment securities 5,168 (2,221) 2,947
Total loans 14,206 (8,345) 5,861
------ ------ -----
Total interest income $19,141 $ (10,612) $8,529
------- --------- ------
Interest expense:
Interest bearing deposits $ 2,568 $ (3,585) $ (1,017)
Short-term borrowings 1,634 (381) 1,253
Long-term borrowings 1,152 (966) 186
----- ---- ---
Total interest expense $ 5,354 $ (4,932) $422
------- -------- ----
Increase (decrease) in net interest income $ 13,787 $ (5,680) $ 8,107
======== ========= =========
Net interest margin is net interest income divided by total interest
earning assets. During second quarter 2004, net interest margin decreased to
4.01%, compared to 4.37% during the second quarter of 2003 and 4.20% during the
first quarter of 2004. Nine basis points of the decline in the net interest
margin was attributable to the issuance of $60.0 million of trust preferred
securities bearing an interest rate of 2.75% over the three-month London
InterBank Offered Rate ("LIBOR") -- or 4.34% June 30, 2004 -- for capital and
liquidity purposes in conjunction with the acquisition of Peoples First, Inc.,
as well as the exchange of $50.0 million of overnight borrowings with the
Federal Home Loan Bank of Pittsburgh for long-term advances for purposes of
managing interest rate risk. Both of these actions resulted in significantly
higher funding costs. The remainder of the margin decline is due to continued
competitive pressures and general overall margin compression.
Despite the current interest 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.
Management conducts a quarterly analysis of the loan portfolio and
adjusts the 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 portfolio concentration of any type, either
customer, industry loan type, collateral or risk grade.
Based on the analysis for second quarter 2004, the Company provided
$1.2 million to its allowance for loan and lease losses, a decrease of $1.2
million compared to the three months ended June 30, 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 $109,000 for
the three months ended June 30, 2004 decreased by $1.4 million, compared to the
$1.5 million in net charge-offs for the same period in 2003. The Company
provided $3.0 million to its allowance for loan and leases losses for the six
months ended June 30, 2004, a $1.6 million decrease compared to the $4.6 million
provided in the
17
same period ended June 30, 2003. Net charge-offs decreased $2.6 million in the
six months ended June 30, 2004 from $3.6 million in the first six months of
2003, to $982,000 as of June 30, 2004.
The Company's Allowance for Loan and Lease losses increased $8.1
million, from $49.3 million as of December 31, 2003 to $57.4 million as of June
30, 2004. The following table details the components of the change in balance of
the allowance for loan and lease losses as of June 30, 2004:
Balance at 12/31/2003 $49,265
Acquisition of Peoples First, Inc. 6,164
Charge-Offs (2,246)
Recoveries 1,264
Provision for loan and lease losses 2,963
-----
Balance at 6/30/2004 $57,410
Non-interest income increased $886,000 or 8.5% during the second
quarter of 2004 compared to the same period in 2003, principally as a result of
increased service charges on deposit accounts and other service charges and fees
of $1.5 million, increased cash management service charges of $128,000, and
increased insurance commissions and fees of $210,000. These increases totaling
$1.8 million were partially offset by a decrease in mortgage banking income of
$892,000, as compared to second quarter 2003. The mortgage income decrease is a
result of much slower refinancing volume in the second quarter, reflecting the
rise in interest rates that began in mid-June 2003. Mortgage banking income is
vulnerable as interest rates rise and mortgage refinance volume contracts.
Management continues working to identify alternative strategies to replace the
refinance volume. Increased service charge income and other service charges and
fees is due primarily to an increase in the collection of fees on a larger
deposit base and price increases. Increased cash management service charge
revenue and insurance commissions are due to the growth in the customer base.
Non-interest income increased $2.5 million, or 12.8%, in the six months
ended June 30, 2004. The inclusion of a full six months of income in 2004 from
FirstService and HomeTowne Heritage contributed to the increase, as compared to
125 days of FirstService income and no Hometown Heritage income for the same
period in 2003. Increases in service charges on deposit accounts of $1.3
million, other service charges and fees of $1.4 million and service charges cash
management of $270,000 are attributable to an increase in the collection of fees
on a larger base and price increases. The increase in insurance commissions and
fees of $580,000 is due to the growth in the customer base of First Service
Insurance. Trust income increased $122,000 primarily as a result of the
improving performance in the equity markets. Mortgage banking income decreased
$1.0 million in the six months ended June 30, 2004 compared to the same period
in 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.
Non-interest expenses increased $2.4 million, or 10.2% to $26.2 million
during the second quarter of 2004, compared to second quarter 2003, principally
as the result of increased salaries, wages and benefits, increased advertising
and marketing expenses, and increased other operating expenses. Salaries, wages
and benefits increased due to normal salary increases and an increase in staff
resulting from various acquisitions beginning January 2003. The FirstService
acquisition resulted in the addition of 137 employees; the acquisition of
HomeTowne Heritage Bank added 30 employees; and the acquisition of Peoples
First, Inc. on June 10, 2004 added 160 employees. The increase in advertising
and marketing expense is attributable to additional mass media advertising
campaigns conducted in the second quarter of 2004. Other operating expenses
increased $424,000 through June 30, 2004, compared to the same period last year.
The inclusion of a full quarter of expenses from HomeTowne Heritage Bank and 20
days of expenses from Peoples First, Inc. contributed to the second quarter 2004
increase.
Non-interest expenses increased $6.6 million or 14.7% for the six
months ended June 30, 2004 compared to the same period in 2003. Salaries, wages
and employee benefits increased $4.1 million, due to the inclusion of a full six
months of expense from FirstService and HomeTowne (compared to 125 days of
FirstService expenses and no HomeTowne expenses in the first six months of
2003), as well normal salary
18
increases. The increase in net premises and equipment expense of $688,000 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 of $609,000 is
attributable to additional advertising campaigns conducted in the first six
months of 2004. Other operating expenses increased $1.2 million June 30, 2004,
compared to the same period last year. The inclusion of a full six months of
expenses from FirstService and HomeTowne Heritage Bank and 20 days of expenses
from Peoples First, Inc. contributed to the increase.
Income taxes increased $1.4 million or 49.3% for the quarter ended June
30, 2004 due to a higher proportion of taxable assets to total assets compared
to the same period in 2003. The Company's effective tax rate increased for the
three months ended June 30, 2004 compared to the same period in 2003, to 25.2%
from 21.4%. Net income after tax from continuing operations increased $2.1
million, or 9.0% in second quarter 2004 compared to second quarter 2003.
Income taxes increased $1.9 million or 32.9% for the six months ended
June 30, 2004 due to a higher proportion of taxable assets to total assets
compared to the same period in 2003. The Company's effective tax rate increased
for the six months ended June 30, 2004 compared to the same period in 2003, to
24.5% from 22.5%. The increase in the effective tax rate both for the quarter
and year to date in 2004 is due to the decrease in tax-free income relative to
total income. Our average tax-free assets for six months ended 6/30/2004
totaling $311.6 million were 9.5% of average earning assets, which totaled
$3.267 billion. average tax-free assets in 2004 were comprised of $257.4 million
in marketable securities and $54.2 million in loans. For six months ended June
30, 2003, average tax-free assets were $299.9 million, or 11.24% of average
earning assets of $2.67 billion. Average tax-free assets for 2003 were comprised
of $261.0 million in marketable securities and $38.9 million in loans.
FINANCIAL CONDITION
-------------------
At June 30, 2004, total assets were $4.25 billion, an increase of
$741.8 million or 21.1% from the $3.51 billion at December 31, 2003. Of this
increase, $455.9 million was attributable to the acquisition of Peoples First,
Inc. on June 10, 2004.
Total cash and cash equivalents increased $48.2 million or 49.0% at
June 30, 2004 when compared to December 31, 2003. This increase resulted from an
increase in federal funds sold of $34.0 million, an increase in cash and due
from banks of $11.7 million, of which $10.3 million resulted from the
acquisition of Peoples First, Inc., and an increase in interest bearing deposits
in banks of $2.5 million.
Net loans and leases, including loans held for sale, which totaled
$2.72 billion at June 30, 2004, increased $493.6 million, or 22.2% compared to
the $2.221 billion in loans at December 31, 2003. Of this increase, $355.4
million is attributable to the Peoples First, Inc. acquisition. Loans also
continued to increase as a result of the improving economy and an increase in
capital goods spending by the Company's business customers. Loans originated for
immediate resale during the six month period ended June 30, 2004 amounted to
$68.2 million.
For the three months ended June 30, 2004, approximately sixty-two
percent of the Company's gross revenue (total interest income plus total other
income or $57.5 million through June 30, 2004) was derived from interest income
on loans it makes to individuals and business owners throughout its marketplace,
which totaled $35.8 million. The Company's total loan portfolio, including loans
held for sale, as of June 30, 2004, was $2.77 billion and consisted of three
broad categories of loans:
o Loans to individuals to finance the purchase of personal assets
or activities was $306.1 million or 11.0% of total loans.
o Residential mortgage loans for the purchase or financing of an
individual's private residence was $318.1 million or 11.5% of
total loans.
19
o Commercial loans were $2.15 billion or 77.5% of the total loan
portfolio. This includes commercial real estate, commercial
construction, commercial and industrial loans, and agricultural
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 and developers
with loans outstanding to this group of $431.0 million. These loans outstanding
are 20.1% of the commercial loan portfolio and 15.5% 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 detail in the
Liquidity and Interest Rate Sensitivity subsection of this Management's
Discussion and Analysis section.
The following table shows detailed information and ratios pertaining to
the Company's loans and asset quality (dollars in thousands):
20
June 30, 2004 December 31, 2003
------------- -----------------
Nonaccrual loans $10,690 $13,673
Loans past due 90 or more days
As to interest or principal 195 318
--- ---
Total nonperforming loans 10,885 13,991
Other real estate owned 747 318
--- ---
Total nonperforming assets $11,632 $14,309
======= =======
Total loans and leases, including loans
held for sale 2,772,460 2,270,700
Average total loans and leases 2,374,929 2,036,847
Allowance for loan and lease losses 57,410 49,265
Allowance for loan and lease losses to:
Nonperforming assets 493.6% 344.3%
Total loans and leases (1) 2.07% 2.17%
Average total loans and leases 2.42% 2.42%
Six months ended Six months ended
---------------- ----------------
June 30, 2004 June 30, 2003
------------- -------------
Net charge-offs to: (annualized) $982 $3,579
Total loans and leases .07% .35%
Average total loans and leases .08% .37%
Allowance for loan and lease losses 3.42% 15.72%
_______________________________
(1) Ratio includes Loans Held for Sale of $56.9 million as of June 30, 2004 and
$29.3 million as of December 31, 2003. This ratio is 2.11% as of June 30, 2004
and 2.20% as of December 31, 2003, excluding Loans Held for Sale.
The $2.7 million decrease in nonperforming assets is due primarily to a
$3.0 million decrease in nonaccrual loans, from $13.7 million at December 31,
2003 to $10.7 million at June 30, 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 collectable. Management expects nonaccrual loans to remain
stable for the balance of 2004. Management reviews the loan portfolio quarterly
to identify nonperforming credits. As of June 30, 2004, loans secured by
non-farm, non-residential real estate and commercial and industrial loans
account for 71.0% of total nonaccrual loans; residential real estate-secured
loans account for 16.2% of total nonaccrual loans.
The investment portfolio is primarily a secondary source of liquidity,
but it also serves as a source of income. As such, the investment portfolio
consists of shorter-term investments that provide current liquidity and
longer-term investments that provide higher income. Over the past three 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 $76.4 million or 8.2% to $1.01 billion at June
30, 2004 compared to December 31, 2003. Of this increase, $54.8 million was
attributable to the June 10, 2004 acquisition of Peoples First, Inc. Investment
purchases during the six months ended June 30, 2004 were $187.0 million,
21
primarily U.S. Government Agency securities. This increase was partially offset
by investment calls and maturities and the amortization of mortgage-backed
securities totaling $142.9 million. Also, during the first quarter of 2004, the
Company sold approximately $40.9 million in investment securities available for
sale resulting in a $196,000 loss. The sale proceeds were re-deployed into
higher yielding investments.
Other assets on the balance sheet increased to $381.9 million, an
increase of $123.5 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 increased
goodwill and other intangibles of $86.3 million resulting from the Peoples
First, Inc. acquisition. The increases in premises and equipment, accrued
interest receivable and Bank owned life insurance are also due primarily to the
acquisition of Peoples First, Inc. Also, there was an increase in unconsolidated
investments of $3.9 million, attributable to the $60.0 million in additional
trust preferred securities issued in the first half of 2004 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 its financial
statements. Other assets increased $13.7 million, primarily due to an increase
in the deferred tax asset, related to the decrease of the in market valuation of
investment securities.
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 $2.854 billion at
June 30, 2004 increased $419.0 million or 17.2%, as compared to December 31,
2003. The increase is comprised of a $112.4 million increase in non interest
bearing deposits, and a $306.5 million increase in interest bearing deposits.
The acquisition of Peoples First, Inc. was the primary source of the total
deposit increase from December 31, 2003. Peoples' $387.7 million in deposits
consisted of non-interest bearing deposits of $100.0 million, interest-bearing
non-time deposits of $198.4 million, and time deposits of $89.3 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
$975.9 million at June 30, 2004, and $737.3 million at December 31, 2003. The
increase of $238.6 million in purchased funds and borrowing is comprised of a
$107.4 million increase in securities sold under repurchase agreements and
federal funds purchased, of which $5.9 million resulted from the Peoples First,
Inc. acquisition. Securities sold under repurchase agreements, which is a
short-term investment vehicle for our commercial clients, increased $68.3
million, while federal funds purchased and short term borrowings increased $39.5
million since December 31, 2003. Subordinated debt increased $61.9 million, as
the result of issuance of trust preferred securities, and an increase in
long-term borrowings of $67.3 million, of which $30.5 million resulted from the
Peoples First, Inc. acquisition. Long-term borrowings also increased as a result
of the Company's decision to term out short term adjustable rate borrowings to
longer-term fixed rate borrowings. 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 three new trust preferred securities issues of $20.0 million each.
Shareholders' equity increased $80.1 million from December 31, 2003
through June 30, 2004. This was primarily due to the issuance of 3,114,449
shares of National Penn common stock in the June 10, 2004 acquisition of Peoples
First, Inc. Retained earnings increased $11.9 million due to the retention of
first and second quarter 2004 net income, partially offset by cash dividends
declared. Accumulated other comprehensive income decreased $15.3 million due to
a decrease in market values of available for sale
22
investment securities and adjustments to the fair value of interest rate swaps.
Cash dividends paid during the first six months of 2004 increased $1.0 million
or 9.7 % to $11.6 million compared to the cash dividends paid during the first
six months of 2003. Earnings retained during the first six months of 2004 were
50.5% compared to 49.8% during the first six months of 2003.
REGULATORY/COMPLIANCE AND INTERNAL CONTROL
------------------------------------------
Management 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 the future as well as other new
regulations. Management has an effective means of monitoring existing and new
regulatory developments. The increased reporting and documentation requirements
will likely result in increased operating costs.
LIQUIDITY AND INTEREST RATE SENSITIVITY
---------------------------------------
The primary functions of asset/liability management are to assure
adequate liquidity and maintain an appropriate balance between interest-earning
assets and interest-bearing liabilities.
Liquidity management involves the ability to meet the cash flow
requirements of customers who may be either depositors wanting to withdraw funds
or borrowers needing assurance that sufficient funds will be available to meet
their credit needs. During the past year, liquidity has tightened as loan demand
has improved and competition for deposits has intensified. These factors have
combined to cause an increased use of wholesale funding. Wholesale funding is
defined here as funding sources outside our core deposit base, such as the
national jumbo CD market, or correspondent bank borrowings. At the present time,
we have ample availability of wholesale funding because our use of these sources
of funds had been reduced from prior periods, plus we increased our availability
of wholesale funding over the past year. Regardless of our comfort with our
liquidity position at present time, we actively monitor our position and any
increased use of wholesale funding increases our attention in this area.
The Company's main liquidity concern is that as the economy and
consequently the equity markets strengthen, the Company may suffer
disintermediation back to the equity market. The Company has sought to prepare
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 three 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.
The Company's acquisition on June 10, 2004 of Peoples First, Inc.,
parent company of The Peoples Bank of Oxford, did not have an immediate material
impact on the Company's current liquidity position. As a division of National
Penn Bank, The Peoples Bank of Oxford has retained its name and management.
Accordingly, the Company expects no material run-off in deposits over the long
term, and as a result, does not anticipate a negative material impact on the
Company's overall long-term liquidity position.
The 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.
23
The following table shows separately the interest rate sensitivity of
each category of interest-earning assets and interest-bearing liabilities at
June 30, 2004.
Repricing Periods(1)
----------------------------------------------------------------------------------
Within Three Months One Year Over
Three Months Through One Year Through Five Years Five Years
------------ ---------------- ------------------ ----------
Assets
Interest bearing deposits $4,720 $0 $0 $0
at banks
Federal funds sold 34,042 0 0 0
Investment securities 51,980 78,595 571,294 308,907
Loans(1) 1,263,823 258,776 897,077 295,374
Other assets 0 0 0 489,757
Liabilities and equity
Non-interest bearing deposits 5,240 10,929 134,748 348,150
Interest bearing deposits(2) 978,767 379,777 230,270 766,383
Borrowed funds 433,412 17,500 124,800 273,126
Subordinated debt 61,857 0 0 65,206
Other liabilities 0 0 0 26,308
Shareholders' equity 0 0 0 397,872
------- ------- ------- -------
Interest sensitivity gap (124,711) (70,835) 978,553 (783,007)
Cumulative interest rate $(124,711) $(195,546) $783,007 $0
========= ========= ======== ==
Sensitivity gap
- ---------------------------------------------
(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 second 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,
24
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 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 June 30, 2004 are as follows:
MVPE
Change in Interest Rate Amount % Change
- ----------------------- ------ --------
(In Thousands)
+300 Basis Points 485,192 (2.59%)
+200 Basis Points 496,318 (0.36%)
+100 Basis Points 498,430 0.07%
Flat Rate 498,098 0.00%
- -100 Basis Points 481,871 (3.26%)
- -200 Basis Points 460,780 (7.49%)
- -300 Basis Points 435,275 (12.61%)
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.
June 30, 2004 June 30, 2003
----------------------------------------- --------------------------------------------
Change in $ Change in % Change in $ Change in % Change in
Interest Rates Net Income Net Income Net Income Net Income
- ----------------------- --------------------- ------------------- --- ---------------------- ---------------------
(In basis points) (Dollars in Thousands)
+300 $(2,268) (4.0%) 397 0.9%
+200 ( 1,419) (2.5%) 1,279 2.9%
+100 (609) (1.1%) 1,380 3.1%
-100 (484) (0.8%) (3,157) (7.2%)
-200 (2,338) (4.1%) (4,829) (11.0%)
-300 (6,207) (10.8%) (4,872) (11.1%)
25
The Company uses financial derivative instruments for management of
interest rate sensitivity. The Company's Asset/Liability Management 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, ALCO'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 are 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 at Part I, Item 1 of this Report.
The following table sets forth the contractual obligations and other
commitments representing required and potential cash outflows as of June 30,
2004:
Less than One to Four to After
(Dollars in thousands) Total One Year Three Years Five Years Five Years
--------- -------- ----------- ---------- ----------
Minimum annual rentals or
noncancellable operating leases 20,952 2,635 4,499 3,283 10,535
Remaining contractual maturities of
time deposits 777,979 544,057 179,727 50,543 3,652
Loan commitments 814,504 526,534 54,734 25,406 207,830
Long-term borrowed funds 231,382 13,812 59,854 64,946 92,770
Subordinated debt 127,063 61,857 --- --- 65,206
Standby letters of credit 74,571 51,233 12,302 10,903 133
------ ------ ------ ------ ---
Total 2,046,451 1,200,128 311,116 155,081 380,126
--------- --------- ------- ------- -------
The Company currently does not have any off-balance sheet special
purpose entities. The Company had no capital leases at June 30, 2004.
26
CAPITAL LEVELS
--------------
The following table sets forth the Company's capital ratios:
Tier 1 Capital to Tier 1 Capital to Total Capital to
Average Assets Ratio Risk-Weighted Assets Ratio Risk-Weighted Assets Ratio
---------------------------- --------------------------- ------------------------------
June 30, Dec. 31, June 30, Dec. 31, June 30, Dec. 31,
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
The Company 8.96% 7.84% 10.21% 9.74% 11.47% 11.00%
National Penn Bank 8.07% 7.06% 9.22% 8.88% 10.48% 10.14%
"Well Capitalized" 5.00% 5.00% 6.00% 6.00% 10.00% 10.00%
institution (under
banking regulation)
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 June 30,
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.
The issuance of trust preferred securities in the six months ended June
30, 2004 improved the Company's capital ratios. The Company has various trust
preferred securities outstanding. See Footnote #8 to the financial statements at
Part I, Item 1 of this Report. During second quarter 2004, the Board of
Governors of the Federal Reserve System issued a proposed rule that would retain
trust preferred securities in the Tier 1 capital of bank holding companies, but
with stricter quantitative and clearer qualitative standards. Under the
proposal, after a three-year transition period, the aggregate amount of trust
preferred securities and certain other capital elements would be limited to 25
percent of Tier 1 capital elements, net of goodwill. The amount of trust
preferred securities and certain other elements in excess of the limit could be
included in Tier 2 capital, subject to certain restrictions. As of the date of
this report, the Board of Governors has not taken any action on this proposed
rule change. Management has evaluated the effects of the proposed rule and does
not anticipate a material impact on its capital ratios when the proposed rule is
finalized.
Historically, the Company's dividend payout ratio has been in the range
of 45% to 50%. We do not anticipate a material change to this ratio due to the
Peoples First acquisition. The level of dividend payout remains at the
discretion of the Company's Board of Directors.
The acquisition of Peoples First, Inc. also contributed to the
increased capital ratios, as Peoples First, Inc. had proportionately higher
capitalization than National Penn. At present, the Company's commitments for
significant capital expenditures are within its historical norms.
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.
27
RELATED PARTY TRANSACTIONS
--------------------------
The Company has no material transactions with related parties as
defined in SFAS No. 57, Related Party Disclosures, or with any other persons
who, because of a prior relationship with the Company, i.e. former members of
senior management or individuals with former management relationships with the
Company, had the ability to negotiate transactions with the Company on more
favorable terms to themselves than had they not had such prior relationships
with the Company.
ACQUISITION OF PEOPLES FIRST, INC.
----------------------------------
On June 10, 2004, National Penn Bancshares, Inc. acquired Peoples
First, Inc., parent company of The Peoples Bank of Oxford in a stock and cash
transaction. The Peoples Bank of Oxford, headquartered in Oxford, Pennsylvania,
operated eight community offices in Chester and Lancaster Counties,
Pennsylvania, and one community office in Cecil County, Maryland, at the time of
acquisition.
Under the terms of the merger agreement, Peoples shareholders were
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. As a result of applicable allocation procedures, 30 percent of the
Peoples shares were exchanged for cash, and 70 percent of the Peoples share were
exchanged for shares of National Penn common stock. Options to purchase shares
of Peoples common stock were converted into options to purchase shares of
National Penn common stock.
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, and in the Company's Report on Form 8-K
dated June 10, 2004, filed with the SEC.
Additional information is also included in Footnote #2 to the financial
statements included in Part I, Item 1 of this Report.
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 The principal challenge faced by the Company today is to grow our
earnings in light of the 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, especially revenues from insurance and wealth
management activities. We anticipate continued pressure on net interest
margin through the end of 2004.
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.
28
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.
* 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.
29
* 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.
* 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.
30
* Recent and proposed legislative or regulatory changes,
including changes in accounting rules and practices, new
internal controls documentation and testing requirements of
the Sarbanes-Oxley Act, 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
subsection of Part I, Item 2 of this Report, Management's Discussion and
Analysis of Financial Condition and Results of Operations, is incorporated by
reference into this Item 3.
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 June 30,
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 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 June 30, 2004 that
materially affected, or are reasonably likely to materially affect, National
Penn's internal control over financial reporting.
31
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings.
- ------- ------------------
None.
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity
- ------------------------------------------------------------------------------
Securities.
- -----------
Issuance of Unregistered Securities
-----------------------------------
As previously reported by National Penn on a Form 8-K dated April 7,
2004, NPB Capital Trust V, a Delaware statutory trust subsidiary of National
Penn, issued on April 7, 2004 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 Capital Securities were offered and sold to an initial
purchaser in a private transaction that was not registered under the Securities
Act of 1933, the initial purchaser intending to sell the Capital Securities to
"qualified institutional buyers" (as defined in Rule 144A under the Securities
Act of 1933). The Capital Securities will not be registered under the Securities
Act of 1933 and may not be offered or otherwise sold in the United States absent
registration or an applicable exemption from such registration requirements. For
additional information, see Footnote #8 to the financial statements at Part I,
Item 1 of this Report, which information is incorporated by reference into this
Item 2.
Quarterly Stock Repurchases
---------------------------
The following table provides information on repurchases by National
Penn of its common stock in each month of the quarter ended June 30, 2004:
Total Number of Maximum Number
Shares Purchased as Of Shares that may
Part of Publicly yet be Purchased
Total Number of Average Price Paid Announced Plan Under the Plans
Period Shares Purchased Per Share or Programs or Programs
- ------ ---------------- --------- ----------- -----------
April 1, 2004
through
April 30, 2004 109,691 $32.17 106,961 558,449
May 1, 2004
through
May 31, 2004 1,044 30.00 1,044 557,405
June 1, 2004
through
June 30. 2004 -0- --- 0 557,405
32
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.
- ------- ----------------------------------------------------
The 2004 annual meeting of the shareholders of National Penn
Bancshares, Inc. was held on April 26, 2004. Notice of the meeting was mailed to
shareholders of record on or about March 25, 2004 together with proxy
solicitation materials prepared in accordance with Section 14(a) of the
Securities Exchange Act of 1934, as amended, and the regulations promulgated
thereunder.
The annual meeting was held to elect four Class II directors to hold
office for three years from the date of election and until their successors are
elected and qualified.
There was no solicitation in opposition to the nominees of the Board of
Directors for election to the Board of Directors and all such nominees were
elected. The number of votes cast for or withheld, as well as the number of
abstentions and broker non-votes, for each of the nominees for election to the
Board of Directors were as follows:
Abstentions and
Nominee For Withheld Broker Nonvotes
------- --- -------- ---------------
Fred D. Hafer 18,582,791 330,615 -0-
C. Robert Roth 18,681,540 231,866 -0-
Wayne R. Weidner 18,744,012 169,394 -0-
Donald P. Worthington 18,763,589 149,817 -0-
Item 5. Other Information.
- ------- ------------------
Cash Dividend
-------------
On July 28, 2004, the Board of Directors of National Penn declared a
cash dividend of $.24 per share payable on August 17, 2004 to shareholders of
record as of August 7, 2004.
33
National Penn Mortgage Operations
---------------------------------
Beginning in June 2004, National Penn's mortgage company, Penn 1st
Financial Services, Inc., began marketing itself as "National Penn Mortgage
Company" in order to more closely align the organization with its parent
company. In addition, Jorge A. Leon was promoted from Chief Operating Officer to
President of the Company.
Item 6. Exhibits and Reports on Form 8-K.
- ------- ---------------------------------
(a) Exhibits.
3.1 Articles of Incorporation, as amended, of National Penn
Bancshares, Inc.
4.1 Form of Declaration of Trust between National Penn Bancshares,
Inc., as sponsor, and Wells Fargo Delaware Trust Company.
(Incorporated by reference to Exhibit 4.1 to National Penn's
Report on Form 8-K dated April 7, 2004, as filed on April 13,
2004.)
4.2 Form of Amended and Restated Declaration of Trust among
National Penn Bancshares, Inc., as sponsor, Wells Fargo
Delaware Trust Company, as Delaware Trustee, Wells Fargo Bank,
National Association, 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 April 7, 2004, as filed on April 13, 2004.)
4.3 Form of Indenture between National Penn Bancshares, Inc. and
Wells Fargo Bank, as Institutional Trustee. (Incorporated by
reference to Exhibit 4.3 to National Penn's Report on Form 8-K
dated April 7, 2004, as filed on April 13, 2004.)
4.4 Form of Guarantee Agreement between National Penn Bancshares,
Inc., as Guarantor, and Wells Fargo Bank, National
Association, as Guarantee Trustee. (Incorporated by reference
to Exhibit 4.4 to National Penn's Report on Form 8-K dated
April 7, 2004, as filed on April 13, 2004.)
10.1 National Penn Bancshares, Inc. Peoples First, Inc. Substitute
2001 Stock Option Plan. (Incorporated by reference to Exhibit
4.1 to National Penn's Registration Statement No. 333-116767
on Form S-8, as filed on June 23, 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.)
34
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 June 30, 2004,
National Penn filed the following Reports on Form 8-K:
* Report dated April 7, 2004. The Report provided information
under Item 5 on National Penn's issuance on April 7, 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.
* Report dated April 15, 2004. The Report provided information
under Item 12 on National Penn's earnings for first quarter
2004. The Report did not contain any financial statements.
* Report dated April 28, 2004. The Report provided information
under Item 5 on National Penn's amended and restated bylaws,
including a copy thereof, and information on National Penn's
then pending acquisition of Peoples First, Inc. The Report did
not contain any financial statements.
* Report dated June 10, 2004. The Report provided information
under Item 5 on National Penn's completion of the acquisition
of Peoples First, Inc. The Report did not contain any
financial statements.
35
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.
Dated: August 5, 2004 By /s/ Wayne R. Weidner
-----------------------------------------------
Name: Wayne R. Weidner
Title: Chairman and Chief Executive Officer
Dated: August 5, 2004 By /s/ Gary L. Rhoads
-----------------------------------------------
Name: Gary L. Rhoads
Title: Treasurer and Chief Financial Officer
36