UNITED STATES
SECURlTIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2002
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________to__________
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1504091
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(State or other jurisdiction of I.R.S. Employer
Incorporation or organization) Identification No.)
12 E. BROAD STREET, HAZLETON, PENNSYLVANIA 18201-6591
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570) 459-3700
Securities registered under Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share
(Title of class)
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 a check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. _______
The market value of the voting and non-voting common equity held by non-affiliates (i.e. persons other than directors and executive officers of the registrant) computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter was $63 million.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ___ No _X___
The number of shares of common stock outstanding as of December 30, 2002 was 4,171,525.
(1) Portions of the Annual Report to Shareholders for the year ended September 30, 2002 are incorporated by reference into Part
I, Part II and Part IV of this Form 10-K.
(2) Portions of the definitive proxy statement for the 2002 Annual Meeting of Shareholders are incorporated by reference into
Part III of this Form 10-K.
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
FORM 10-K
TABLE OF CONTENTS
Part I Page
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Item 1 Business 1
Item 2 Properties 12
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote of Security Holders 15
Part II
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Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 16
Item 6 Selected Financial Data 16
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 16
Operation
Item 7A Quantitative and Qualitative Disclosures About Market Risk 16
Item 8 Financial Statements and Supplementary Data 16
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 16
Part III
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Item 10 Directors and Executive Officers of the Registrant 17
Item 11 Executive Compensation 17
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 17
Item 13 Certain Relationships and Related Transactions 17
Item 14 Controls and Procedures 17
Part IV
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Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 18
SIGNATURES 20
CERTIFICATES
21
Part I
Forward Looking Statements
In addition to historical information, our 10-K may include certain "forward-looking statements" within the meaning of the federal securities laws. Such forward-looking statements may be identified by the use of such words as "intend", "believe", "expect", "anticipate", "should", "planned", "estimated" and "potential". These forward-looking statements include, but are not limited to, estimates and expectations of future performance based on current management expectations. Northeast Pennsylvania Financial Corp.'s (the "Company") actual results could differ materially from those management expectations. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulation of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company's loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf. Subject to applicable law and regulation, the Company assumes no obligation to update any forward-looking statements.
Item 1. Business
General
The Company is a Delaware corporation and is the holding company for First Federal Bank (the "Bank"), a federally chartered capital stock savings bank regulated by the Office of Thrift Supervision ("OTS"). The Company's executive offices are located at 12 East Broad Street, Hazleton, Pennsylvania 18201.
The Company's operations are primarily conducted through the Bank. These operations have been and continue to be attracting retail deposits from the general public in the areas surrounding its 19 full service community offices and investing those deposits, together with funds generated from operations and borrowings, primarily in one- to four-family mortgage loans, consumer loans, and multi-family and commercial loans. The Company has attempted to diversify and expand its loan products to better serve its customer base by placing a greater emphasis on its consumer lending and commercial lending, primarily to small businesses and municipalities.
The Company's revenues are derived from its four principal lines of business; Banking, Insurance, Investments and Trust. First Federal Bank's revenues are derived principally from interest on its loans, and to a lesser extent, interest and dividends on its investment and mortgage-related securities and through other non-interest income. Insurance income is generated through Higgins Insurance Agency and Abstractors Inc., principally through their premiums earned on insurance policies written. Investment income is generated through Higgin's Insurance and Salomon Smith Barney through annuity sales and commissions on investment sales. Trust income is generated through Northeast Pennsylvania Trust Co., through its fees on trust assets managed. The Company's primary sources of funds are deposits, principal and interest payments on loans and mortgage related securities, FHLB advances and proceeds from the sale of loans.
In addition other business of the Company is conducted through its other subsidiaries, Abstractors, Inc., which is a title insurance agency, Northeast Pennsylvania Trust Co. (the "Trust Co."), which offers trust, estate and asset management services and products and Higgins Insurance Agency ("Higgins"), which provides insurance and investment products to individuals and businesses. Insurance premium income has increased significantly over the past year due to the addition of Higgins and the continued growth of Abstractors, Inc. The Trust Co. continues to expand its customer base with assets under management of $140.3 million at September 30, 2002.
Market Area and Competition
The Company is a community-oriented banking institution offering a variety of financial products and services to meet the needs of the communities it serves. The Company's lending and deposit gathering is concentrated in its market area consisting of Luzerne, Carbon, Columbia, Monroe, Montour, Northumberland and Schuylkill counties in Northeastern and Central Pennsylvania. The Company invests primarily in loans secured by first or second mortgages on properties located in areas surrounding its offices.
The Company maintains its headquarters in Hazleton. The Company's seven banking offices in Luzerne County, including Hazleton, accounted for $353.5 million or 58.4% of the Company's total deposits at September 30, 2002. Hazleton is situated approximately 100 miles from Philadelphia and New York City and approximately 50 miles from Allentown and the Wilkes-Barre/Scranton area. The Company also maintains two banking offices in Bloomsburg (Columbia County), one each in Lehighton and Weatherly (both in Carbon County), one in Brodheadsville (Monroe County), one in Danville (Montour County), one in Mount Carmel (Northumberland County) and one each in Frackville, Pottsville, Shenandoah, Ashland and Schuylkill Haven (all in Schuylkill County). The Company also operates a banking and a loan production office in Monroe County.
The economy of the greater Hazleton area is characterized by diversified light manufacturing and is the site of production facilities for several major manufacturers including Union Camp, Hershey-Cadbury Chocolates, Quebecor and Hazleton Pumps, Inc. As a consequence, the manufacturing sector employs more than one third of the area's work force. The Hazleton area has excellent access to major highway transportation routes including Interstates 80 and 81 as well as rail transportation. The population of Luzerne County has remained relatively static and has one of the oldest average ages for all counties in the United States. The southern end of Schuylkill County is proving to be a growth area as individuals and companies which were previously based in the Allentown-Berks county area are relocating to the southern end of Schuylkill County. The overall population in the Company's market area is relatively small and, in recent years, has grown slowly, and the unemployment rate in the area is greater than the national average.
Monroe County, the location of the Pocono Pines loan production office and the Brodheadsville banking branch, is dominated by the Pocono Mountains, making the area one of the Mid-Atlantic's most popular resort areas. The Company established its loan production office to take advantage of the market for vacation properties existing in Monroe County as well as to be involved in the growth in the number of permanent residents relocating into the county.
The Company faces significant competition both in generating loans and in attracting deposits. The Company's primary market area is highly competitive and the Bank faces direct competition from a significant number of financial institutions, many with a state wide or regional presence and, in some cases, a national presence. Many of these financial institutions are significantly larger and have greater financial resources than the Company. The Company's competition for loans comes principally from commercial banks, savings banks, credit unions, mortgage brokers, mortgage banking companies and insurance companies. Its most direct competition for deposits has historically come from savings banks and associations, commercial banks and credit unions. In addition, the Bank faces increasing competition for deposits from non-bank institutions such as brokerage firms and insurance companies in such instruments as short-term money market funds, corporate and government securities funds, mutual funds and annuities. Competition has also increased as a result of the lifting of restrictions on the interstate operations of financial institutions, as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to market entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. The Gramm-Leach-Bliley Act, which permits affiliation among banks, securities firms and insurance companies also changed the competitive environment in which the Bank conducts business.
In addition, the Company recognizes that its customer base increasingly focuses on convenience and access to services. The Company has addressed these customer desires through the implementation of PC banking and voice response capabilities, a computerized loan origination and document system and the issuance of debit cards. The Bank has entered into a relationship with Smith Barney, whereby Smith Barney will be placing licensed representatives in the Banking offices to facilitate investment sales. The Company intends to continue to evaluate and enhance its service delivery system.
LENDING ACTIVITIES
General. The information relating to the composition and maturity of the Bank's loan portfolio appears in "Loans" in the Company's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Origination and Sale of Loans. The Bank's lending activities are conducted primarily by its loan personnel operating at its branch and loan origination offices. All loans originated by the Bank are underwritten pursuant to the Bank's policies and procedures. For fiscal 2002 and 2001, the Bank originated or purchased $217.2 million and $185.2 million in total loans, respectively. The Bank originates both adjustable-rate and longer-term and shorter-term fixed-rate loans. The Bank's ability to originate fixed- or adjustable-rate loans is dependent upon the relative customer demand for such loans, which is affected by the current and expected future level of interest rates.
It currently is the policy of the Bank to retain for investment longer-term ( 15 years or greater to maturity at date of origination) fixed-rate one- to four- family loans originated during a fiscal year only up to 25% of its total loan originations during that year. In addition, the Bank generally retains the adjustable rate and shorter-term (maturities of less than 15 years) fixed-rate loans originated. The Company sells in the secondary market longer-term, fixed-rate one- to four-family loans which it originates in excess of its retention policy for such loans. In fiscal year 2002, the Company sold basically all loans originated with a maturity of 15 years or greater at date of origination.
During fiscal years 2002 and 2001, the Bank originated or purchased $34.2 million and $24.0 million, respectively, of one- to four-family mortgage loans. In addition, during fiscal years 2002 and 2001, the Bank originated $13.6 million and $13.1 million, respectively, of construction loans. All of such construction loans were for owner financing of single family properties, which, upon completion of the construction phase, generally would convert to permanent financing. Also, the Bank originated $15.8 million and $27.4 million, respectively, of multi-family and commercial real estate loans during fiscal 2002 and 2001.
Also, during fiscal 2002 and 2001, the Bank originated or purchased $132.1 million and $87.3 million of consumer loans, respectively. Such activity, during fiscal 2002 and 2001, consisted of $20.2 million and $17.5 million, respectively, of home equity loans,
$13.3 million and $6.2 million, respectively, of home equity lines of credit, $94.3 million and $57.6 million, respectively, of direct and indirect automobile loans, $10,000 and $1.9 million, respectively, of education loans, and $4.3 million and $4.2 million, respectively, of other consumer loans. The increase in automobile loans is a direct result of more participating auto dealers.
In addition, during fiscal 2002 and 2001 respectively, the Bank originated $21.6 million and $33.4 million of commercial loans. These originations consisted primarily of commercial business and municipal loans.
The following table sets forth the Bank's loan originations, purchases, sales and principal repayments for the periods indicated:
For the Fiscal Years Ended September 30, ---------------------------------------- (In Thousands) 2002 2001 2000 ---- ---- ---- Loans at beginning of period $511,320 $426,754 $372,799 Originations and Purchases: Real estate: One- to four-family 34,176 23,961 34,316 Multi-family and commercial 24,740 27,418 25,452 Construction 13,550 13,125 10,274 ------ ------ ------ Total real estate loans 72,466 64,504 70,042 ------ ------ ------ Consumer: Home equity loans and lines of credit 33,518 23,730 20,547 Automobile 94,254 57,596 39,300 Education 10 1,855 2,011 Unsecured lines of credit 1,490 586 484 Other 2,778 3,568 4,758 ----- ----- ----- Total consumer loans 132,050 87,335 67,100 Commercial 35,176 33,351 22,859 ------ ------ ------ Total loans originated and purchased 239,692 185,190 160,001 ------- ------- Deduct: Principal loan repayments and prepayments 156,611 96,470 109,346 Loan sales 65,938 9,859 1,806 Transfers to REO 2,174 1,281 614 ----- ----- --- Sub-total 224,723 107,610 111,766 ------- ------- ------- Net loan activity 14,969 77,580 48,235 ------ ------ ------ Loans at end of period (1) $496,351 $504,334 $421,034 ======= ======== ========
(1) Loans at end of period include loans in process of $6,448, $6,986 and $5,951 for fiscal years 2002, 2001 and 2000, respectively.
One- to Four-Family Mortgage Lending. The Bank currently offers both fixed-rate and adjustable-rate mortgage ("ARM") loans with maturities of up to 30 years secured by one- to four-family residences. One- to four-family mortgage loan originations are generally obtained from the Bank's in-house loan representatives, from existing or past customers, and through referrals from members of the Bank's local communities.
The origination of ARM loans, as opposed to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the credit risks associated with adjustable-rate loans but also limit the interest rate sensitivity of such loans.
Most one- to four-family mortgage loans are underwritten according to Fannie Mae and Freddie Mac guidelines. In recent years, the Bank began offering to borrowers one- to four-family mortgage loans which, when underwritten, did not fully meet established Fannie Mae or Freddie Mac standards, for example, the standard regarding income to debt ratios for the borrower . Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank's consent. Due-on-sale clauses are an important means of adjusting the yields on the Bank's fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses. The Bank requires fire, casualty, title and, in certain cases, flood insurance on all properties securing real estate loans made by the Bank.
Multi-Family and Commercial Real Estate Lending. The Bank originates fixed-rate and adjustable- rate multi-family and commercial real estate loans that generally are secured by properties used for business purposes or a combination of residential and retail purposes.
Pursuant to the Bank's underwriting policies a multi-family mortgage and commercial real estate loan may be made in an amount up to 80% of the lower of the appraised value or sales price of the underlying property with terms generally ranging from 15 to 25 years.
The factors considered by the Bank in granting these loans include: the net operating income of the mortgaged premises before debt service and depreciation; the debt coverage ratio (the ratio of net earnings to debt service); and the ratio of loan amount to appraised value. The Bank has generally required that the properties securing commercial real estate loans have debt service coverage ratios of at least 125%.
Construction Lending. The Bank also offers residential construction loans. Such loans have been for presold one- to four-family residences for the construction phase and convert into permanent financing. The Bank generates residential construction loans primarily through direct contact with the borrower or home builders, and these loans involve properties located in the Bank's market area. Such loans require that the Bank review plans, specifications and cost estimates and that the contractor be known to the Bank to be reputable. The amount of construction advances to be made, together with the sum of previous disbursements, may not exceed the percentage of completion of the construction. The maximum loan-to-value limit applicable to such loans is 80%.
Consumer Lending. The Bank offers consumer loans which include home equity loans, home equity lines of credit, direct and indirect automobile loans, education loans and other consumer loans. The Bank's home equity loans are generated primarily through the Bank's retail offices. The Bank generally offers home equity loans with a term of 180 months or less. The Bank also offers home equity lines of credit with terms up to 20 years, the last 10 years of which require full amortization of the principal balance. The maximum loan amount for both home equity loans and home equity lines of credit, is subject to a combined loans-to-value ratio of 80%.
The Bank also offers automobile loans, both on a direct and an indirect basis (through new and used car dealers). The indirect automobile loans are originated by dealers in accordance with underwriting standards pre-established by the Bank and are serviced by the Bank. During fiscal 2002, the Bank had a $50.0 million automobile loan securitization accounted for as a sale. The Bank also offers loans on recreational vehicles and boats and other consumer loans, including education loans which are federally guaranteed and originated under regulations of the Pennsylvania Higher Education Assistance Agency, deposit-secured loans, and other personal and unsecured loans. The Bank's policy is to sell its education loans upon origination to Sallie Mae with servicing released.
Consumer loans tend to bear higher rates of interest and have shorter terms to maturity than first lien residential mortgage loans. Nationally, consumer loans have historically tended to have a higher rate of default. Additionally, consumer loans entail greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Commercial Lending. The Bank makes commercial business loans primarily in its market area to a variety of professionals, sole proprietorships and small businesses. The Bank offers a variety of commercial lending products, including term loans for fixed assets and working capital, revolving lines of credit, letters of credit, and Small Business Administration guaranteed loans. Interest rates charged generally are based on the prime rate as published in the Wall Street Journal. Prior to making commercial business loans, the borrower is required to provide the Bank with sufficient information to allow a prudent loan decision to be made. Such information generally includes financial statements and projected cash flows, and is reviewed to evaluate debt service capability. Commercial business loans are generally secured by a variety of collateral, primarily real estate, and frequently are supported by personal guarantees. In addition, the Bank actively participates in industrial loans arranged through and with the Greater Wilkes-Barre Industrial Fund and CanDo, Inc. a Hazleton area industrial fund.
Commercial business loans generally involve higher credit risks than loans secured by real estate. Unlike mortgage loans, which generally are made on the basis of the borrowers ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Loan Approval Procedures and Authority. The Board of Directors establishes the lending policies and the levels of loan approval authority for employees of the Bank and oversees the Bank's lending activity. The Board of Directors has established a Loan
Committee comprised of the Bank's Chairman of the Board of Directors, President, Senior Vice President Lending, Senior Vice President/ Chief Financial Officer and three outside directors to assist them with these activities.
Non-Performing Assets, Impaired Loans, Real Estate Owned and Allowance for Loan Losses. The information relating to the Bank's non-performing assets, impaired loans, real estate owned and allowance for loan losses appears in "Non-Performing Assets and Impaired Loans" and "Allowance for Loan Losses" in the Registrant's 2002 Annual Report to Shareholders.
Investment Activities
The above captioned information appears in "Investment Activities" in the Registrant's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Source of Funds
Information relating generally to the Bank's source of funds and a description of the Bank's deposits appears under "Sources of Funds" in the Registrant's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Borrowings. The Bank utilizes advances from the FHLB of Pittsburgh as a supplement to retail deposits to fund its operations as part of its operating strategy. These FHLB advances are collateralized primarily by certain of the Bank's mortgage loans and mortgage-related securities and secondarily by the Bank's investment in capital stock of the FHLB of Pittsburgh. FHLB advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB of Pittsburgh will advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the FHLB of Pittsburgh. See "Regulation-Federal Home Loan Bank System." At September 30, 2002, the Bank had $208.4 million in outstanding FHLB advances, compared to $204.4 million at September 30, 2001. Other borrowings consist of overnight retail repurchase agreements and for the periods presented were immaterial.
The following table sets forth certain information regarding the Bank's borrowed funds at or for the periods ended on the dates indicated:
At or For the Fiscal Years Ended September 30,
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2002 2001 2000
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(Dollars in Thousands)
FHLB advances and other borrowings:
Average balance outstanding $211,552 192,981 $191,797
Maximum amount outstanding at any month-end
during the period 217,044 216,227 226,717
Balance outstanding at end of period 213,051 210,431 139,115
Weighted average interest rate during the period 5.70% 5.84% 5.85%
Weighted average interest rate at end of period 5.66% 5.63% 6.13%
Subsidiary Activities
The Company has six wholly-owned subsidiaries: the Bank, incorporated under the laws of the United States; Abstractors, Inc., Northeast Pennsylvania Trust Co., and Higgins Insurance Agency, each of which incorporated under Pennsylvania law; and NEP Capital Trust I and NEP Capital Trust II, each of which is incorporated under Delaware law. FIDACO, Inc. is an inactive subsidiary of First Federal Bank with the only major asset being an investment by FIDACO, Inc. in Hazleton Community Development Corporation. Abstractors, Inc. is a title insurance agency with total assets of $505,000 at September 30, 2002. Northeast Pennsylvania Trust Co., offers trust estate and asset management services and products and had total assets of $652,000 and $140.3 million of trust assets under management at September 30, 2002. At September 30, 2002, total assets of FIDACO, Inc. were $33,000. Higgins provides insurance and investment products to individuals and businesses and had total assets of $1.6 million at September 30, 2002.
Personnel
As of September 30, 2002, the Company had 249 full-time and 43 part-time employees, none of whom were covered by a collective bargaining agreement. Management believes that the Company has good relations with its employees and there are no pending or threatened labor disputes with its employees.
Regulation and Supervision
As a savings and loan holding company, the Company is required by federal law to file reports with and otherwise comply with, the rules and regulations of the OTS. The Bank is subject to extensive regulation, examination and supervision by the OTS, as its chartering agency, and the Federal Deposit Insurance Corporation (the "FDIC"), as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System. The Bank's deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings associations and their holding companies set forth in this Form 10-K does not purport to be complete descriptions of such statutes and regulations and their effects on the Bank and the Company are qualified in its entirety by reference to such statutes and regulations.
Federal Savings Institution and Regulations
Business Activities. The activities of federal savings institutions are governed by the federal laws and regulations. These laws and regulations delineate the nature and extent of the activities in which federal associations may engage. In particular, many types of lending authority for federal associations, e.g., commercial, non-residential real property loans and consumer loans, are limited to a specified percentage of the institution's capital or assets.
Loans-to-One-Borrower. Federal law provides that, savings institutions are generally subject to the national bank limit on loans-to-one borrower. Generally, this limit is 15% of the Bank's unimpaired capital and surplus, plus an additional 10% of unimpaired capital and surplus, if such loan is secured by specified readily marketable collateral. At September 30, 2002, the largest aggregate amount of loans-to-one borrower was $7.3 million, which was less than the Bank's general limit on loans-to-one borrower which was $10.0 million.
QTL Test. Federal law requires savings institutions to meet a qualified thrift lending ("QTL") test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least 9 months out of each 12-month period. A savings association that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of September 30, 2002, the Bank maintained 79.0% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered as "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the OTS is required before any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under OTS regulations (generally, examination ratings in one of two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OTS. If an application is not required, the institution must still give advance notice to the OTS of the capital distribution, if, like the Bank, it is a subsidiary of a holding company. If the Bank's capital fell below its regulatory requirements or if the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution, which would otherwise be permitted by regulation, if the OTS determines that the distribution would be unsafe or unsound practice.
Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are based upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly Thrift Financial Report. The assessments paid by the Bank for the year ended September 30, 2002 totaled $165,000.
Branching. OTS regulations permit federally-chartered savings associations to branch nationwide under certain conditions.
Generally, federal savings associations may establish interstate networks and geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by the federal savings associations.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as implemented by OTS regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received a "Satisfactory" CRA rating in its most recent examination.
Transactions with Related Parties. The Bank's authority to engage in transactions with related parties or "affiliates" (i.e., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The recently enacted Sarbanes-Oxley Act generally prohibits loans by the Company to its executive officers and directors. However, the Act contains a specific exception from such prohibitions for loans by the Bank to its executive officers and directors in compliance with federal banking regulations restrictions on such loans. The Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. An exception exists for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain board approval procedures to be followed.
Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring action against the institution and all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that a savings institution fails to meet any standard prescribed by the guidelines, the OTS may require the institution to submit an acceptable plan to achieve compliance with the standard.
Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3% leverage (core capital) ratio for institutions receiving the highest examination rating on the CAMELS examination rating system (4% for others) and an 8% risk based capital ratio. Core capital is defined as common stockholder's equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus, minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights ("MSRs") and credit card relationships. The OTS regulations require that, in meeting the leverage ratio, tangible and risk-based capital standards institutions generally must deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank. In addition, the OTS prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 3% leverage ratio for institutions receiving the highest examination rating on the CAMELS examination rating system (4% for others), and, together with the risk-based capital standards itself, a 4% Tier I risk-based capital standard.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount
of risk-weighted assets, all assets, including certain off balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of core capital are equivalent to those discussed earlier. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses, limited to a maximum of 1.25% of risk-weighted assets and equity up to 45% of unrealized gains on available-for-sale securities with readily determinable fair market value. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The OTS has adopted an interest rate risk component into its regulatory capital requirements. Savings associations with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. The OTS has deferred implementation of the interest rate risk capital charge and repealed the interest rate risk component in May 2002, concluding it was unnecessary in light of the other tools available to measure and control interest rate risk. At September 30, 2002, the Bank met each of its capital requirements. The following table presents the Bank's capital position at September 30, 2002. (Dollars in thousands)
Capital
---------------------------------------------
Excess
Actual Required (Deficiency)
Capital Capital Amount Actual % Required %
------- ------- ------------ -------- ----------
Tangible $51,628 $13,286 $38,342 5.8% >1.5%
Core (Leverage) 51,628 26,572 25,056 5.8 >3.0
Risk-based 56,828 43,569 13,259 10.4 >8.0
Prompt Corrective Regulatory Action. The OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of under capitalization. Generally, a savings institution that has a total risk-based capital of less than 8% or a leverage ratio or a Tier 1 capital ratio that is less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the higher examination rating) is considered to be undercapitalized. A savings institution that has a total risk-based capital less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for an institution that is critically undercapitalized. The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date an association receives notice that it is “undercapitalized,” significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions may become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators, restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The FDIC maintains a risk-based assessment system by which institutions are assigned to one of three categories based on the institution’s capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution’s assessment rate depends on the categories to which it is assigned. Assessment rates for SAIF member institutions are determined semi-annually and range from 0 basis points, for the healthiest institutions to 27 basis points, for the riskiest institutions. The Bank’s assessment rate for the fiscal year 2002 was 1.75 basis points and the premium paid for this period was $95,000. The FDIC has authority to increase insurance assessments. A significant increase in SAIF insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 2002, FICO payments for SAIF members approximated 1.7 basis points.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Federal Home Loan Bank System. The Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. The Bank was in compliance with this requirement with an investment in FHLB stock at September 30, 2002, of $11.0 million.
FHLB advances must be secured by specified types of collateral and all long-term advances may only be obtained for the purpose of providing funds for residential housing finance. At September 30, 2002, the Bank had $208.4 million in FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. For the years ended September 30, 2002, 2001 and 2000 dividends from the FHLB to the Bank amounted to approximately $439,000, $673,000 and $687,000, respectively. If dividends were reduced, the Bank's net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks' funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $42.1 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts greater than $42.1 million, the reserve requirement is 10%. The first $6.0 million of otherwise reservable balances (subject to adjustment by the Federal Reserve Board) are exempted from the reserve requirements. The Bank is in compliance with these requirements.
Holding Company Regulation
The Company is a non-diversified unitary savings and loan holding company within the meaning of the federal law. The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that, subject to a grandfather provision, existing savings and loan holding companies may only engage in such activities. The Company does qualify for the grandfathering. Permissible holding company activities include banking services such as lending, trust services, insurance activities and underwriting, investment banking and real estate investment.
A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution, or holding company thereof, without prior written approval of the OTS and from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, except: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not currently subject to specific capital requirements or specific restriction on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
Acquisition of the Company. Under the Federal Change in Bank Control Act ("CIBCA"), a notice must be submitted to the OTS if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company's outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of the Company. Under the CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a September 30 fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. Neither the Company nor the Bank has been audited by the IRS in the past five years.
Bad Debt Reserve. Historically, savings institutions such as the Bank which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrifts") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Bank's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted addition to the non-qualifying reserve. Due to the Bank's loss experience, the Bank generally recognized a bad debt deduction equal to 8% of taxable income.
In August 1996, the provisions repealing the above thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also required that all thrift institutions recapture all or a portion of their bad debt reserves added since the base year (the last taxable year beginning before January 1, 1988). The Bank had previously recorded a deferred tax liability equal to the bad debt recapture and as such, the new rules had no effect on net income or federal income tax expense. For taxable years that began after December 31, 1995, the Bank's bad debt deduction was equal to net charge-offs. The new rules allowed an institution to suspend the bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years was equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996. For this purpose, only home purchase and home improvement loans were included and the institution could have elected to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution was permitted to postpone the reserve recapture, it had to begin its six year recapture no later than the 1998 tax year. The unrecaptured base year reserves were not subject to recapture as long as the institution continued to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continued to be subject to a provision of present law referred to below that required recapture in the case of certain excess distributions to shareholders.
Distributions. To the extent that the Bank makes "non-dividend distributions" to the Company that are considered as made: (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method, or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the Bank's taxable income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus if the Bank makes a "non-dividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state and local taxes). The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating loss carryovers of which the Company currently has none. AMTI is increased by an amount equal to 75% of the amount by which the Company's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). In addition, for taxable years beginning after June 30, 1986 and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modifications) over $2.0 million is imposed on corporations, including the Company, whether or not an Alternative Minimum Tax ("AMT") is paid. The Company does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend then 80% of any dividends received may be deducted.
State and Local Taxation
The Company and its non-thrift Pennsylvania subsidiaries are subject to the Pennsylvania Corporation Net Income Tax and Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for fiscal 2001 was 9.99% and was imposed on the Company's and its non-thrift subsidiaries' unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed at the rate of .724% of a corporation's capital stock value, which is determined in accordance with a fixed formula. The Company is also required to file an annual report with and pay an annual Franchise tax to the State of Delaware.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act (the "MTIT"), as amended, to include thrift institutions having capital stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state income tax purposes and from all local taxation imposed by political subdivisions, except taxes on real estate and real estate transfers. The MTIT is a tax upon net earnings, determined in accordance with generally accepted accounting principals ("GAAP") with certain adjustments. The MTIT, in computing GAAP income, allows for the exclusion of interest earned on Pennsylvania and federal securities, while disallowing a percentage of a thrift's interest expense deduction in the proportion of interest income on those securities to the overall interest income of the Bank. Net operating losses, if any, thereafter can be carried forward three years for MTIT purposes. Neither the Company nor the Bank has not been audited by the Commonwealth of Pennsylvania in the last five years.
Additional Item. Executive Officers of the Registrant
- ----------------- ------------------------------------
The following table sets forth information regarding the executive officers of the Company and its subsidiaries of
September 30, 2002 who are not directors.
Name Age as of 9/30/02 Position
- ---- ----------------- --------
Patrick J. Owens, Jr. 59 Senior Vice President, Chief Financial
Officer of the Bank since 1993 and
Treasurer and Chief Financial Officer
of the Company since 1998. Resigned
effective December 31, 2002.
Thomas Burns 52 Trust business line manager. President
and Trust Officer of the Trust Company
since May 2000. Trust Officer for
financial institution in Hazleton, PA
prior to current position.
Allan Farias 55 Banking business line manager. Senior
Vice President, Corporate Retail
Division of the Bank since September
2000. President and Chief Executive
Officer of a financial institution and
consultant in California prior to
current position.
James McCann 43 Investment business line manager.
Senior Vice President, Investments,
Higgins Insurance Agency since 1987.
Item 2. Properties
The Company currently conducts its business through 19 full service community offices located in Luzerne, Carbon, Columbia, Montour and Schuylkill counties, three financial centers and one loan origination office in Monroe County in Northeast Pennsylvania. Abstractors, Inc. and Northeast Pennsylvania Trust Co. conduct their business in downtown Hazleton area. The following table sets forth the Company’s offices as of September 30, 2002.
Net Book Value
of Property or
Leasehold
Original Year Improvements Total Deposits
Leased or Leased or Date of Lease at September at September
Location Owned Acquired Expiration 30, 2002 30, 2002
- -------------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Administrative/Home
Office:
12 E. Broad Street
Hazleton, PA 18201 Owned 1947 - $3,614 $203,767
Branch Offices:
Bloomsburg Office:
17 E. Main Street
Bloomsburg, PA 17815 Owned 1963 - 427 25,609
Shenandoah Office:
5-7 E. Main Street
Shenandoah, PA 17976 Owned 1968 - 405 46,407
Pottsville Office:
111 E. Norweigan Street
Pottsville, PA 17901 Owned 1968 - 561 39,606
Lehighton Office:
111 N. First Street
Lehighton, PA 18235 Owned 1977 - 80 33,875
Laurel Mall Office:
240 Laurel Mall
Hazleton, PA 18201 Leased 1994 2003 194 76,213
Mountaintop Office:
360 S. Mountain Boulevard
Mountaintop, PA 18707 Owned 1997 - 767 20,453
Scott Township Office:
PO Box 518
2691 New Berwick Highway
Bloomsburg, PA 17815 Owned 1998 - 954 31,843
Schuylkill Mall Office:
611 Schuylkill Mall
Frackville, PA 17976 Leased 1978 month-to-month 33 23,106
Gould's IGA Office: Route 93 Sugarloaf, PA 18249 Leased 1995 2005 54 18,228 Danville Office: 1519 Bloom Road Danville, PA 17821 Owned 1999 - 618 13,063 Back Mountain Office: 196 N. Main Street Shavertown, PA 18708 Owned 2001 1,174 20,425 Freeland Office: 402 Front Street Freeland, PA 18224 Leased 1999 2004 - 5,617 Brodheadsville Office: 760 Route 209 & Weirlake Road Brodheadsville, PA 18322 Leased 2000 2005 129 7,525 Weatherly Office: 140 Carbon Street Weatherly, PA 18255 Owned 2001 86 11,656 Drums Office: Route 309 Drums, PA 18222 Owned 2001 222 8,838 Ashland Office: 614 Centre Street Ashland, PA 17921 Owned 2002 64 1,888 Schuylkill Haven Office: 333 Center Avenue Schuylkill Haven, PA 17972 Owned 2002 377 15,317 Mount Carmel Office: 43 S. Oak Street Mt. Carmel, PA 17851 Owned 2002 196 1,530 Laurel Mall Drive-Thru: 345 Laurel Mall Hazleton, PA 18201 Leased 2001 2005 291 N/A Loan Production Origination Office: Pocono L.P.O. Office P.O. Box 1092 Pocono Pines, PA 18350 Leased 1997 month-to-month N/A Title Insurance Agency: Abstractors, Inc. 25 W. Broad Street Hazleton, PA 18201 Owned 2001 24 N/A Trust Company: Northeast Pennsylvania Trust Co. 31 W. Broad Street Hazleton, PA 18201 Owned 2001 28 N/A
Insurance Agency: Higgins Insurance Company 115 S. Centre Street Pottsville, PA 17901 Leased 2001 2010 - N/A
Item 3. Legal Proceedings
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition or results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
Information relating to the market for Registrant's common equity and related shareholder matters appears under "Market for Registrant's Common Equity and Related Stockholder Matters" in the Registrant's 2002 Annual Report to Shareholders on Part I - page 16 and is incorporated herein by reference. Information relating to dividend restrictions for Registrant's common stock appears under "Regulation and Supervision."
Item 6. Selected Financial Data
The above-captioned information appears under "Selected Consolidated Financial and Other Data of the Company" in the Registrant's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The above-captioned information appears under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Registrant's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
The above-captioned information appears under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the section "Management of Interest Rate Risk and Market Risk Analysis" in the Registrant's 2002 Annual Report to Shareholders and is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The Consolidated Financial Statements of Northeast Pennsylvania Financial Corp. and its subsidiaries, together with the report thereon by KPMG LLP appears in the Registrant's 2002 Annual Report to Shareholders and are incorporated herein by reference.
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable.
Item 10. Directors and Executive Officers of the Registrant
The information relating to Directors of the Registrant is incorporated herein by reference to the Section captioned "Proposal 1-Election of Directors" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2003. Reference is made to the section captioned "Additional Item. Executive Officers of the Registrant" in this Form 10-K for information relating to Executive Officers of the Registrant. Reference is made to the cover page of this Form 10-K and to the section captioned "Section 16 (a) Beneficial Ownership Reporting Compliance" in the registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2003 for information regarding compliance into Section 16(a) of the Exchange Act.
Item 11. Executive Compensation
The information relating to executive compensation is incorporated herein by reference to the sections captioned "Executive Compensation and Directors' Compensation" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2003.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the section captioned "Stock Ownership" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2003.
Equity Compensation Plan Information
Number of securites Weighted-average Number of securities
to be issued upon exercise price of remaining available for
exercise of outstanding outstanding options, future issuance under
options, warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)
Plan category
Equity compensation plans approved 686,960 $11.88 129,399
by security holders
Equity compensation plans not approved - - -
by security holders
Total 686,960 $11.88 129,399
Item 13. Certain Relationships and Related Transactions
The information relating to certain relationships and related transactions is incorporated herein by reference to the section captioned "Transactions with Management" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on January 29, 2003.
Item 14. Controls and Procedures
Based on their evaluation as of a date within 90 days of the filing date of this Annual report on Form 10-K, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act") are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules an forms.
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore there were no corrective actions taken.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as a part of this report
(1) Consolidated Financial Statements of the Company are incorporated by reference to the following indicated pages of the 2002
Annual Report to Shareholders:
Consolidated Statements of Financial Condition
as of September 30, 2002 and 2001...............................................................................17
Consolidated Statements of Operations
For the Years Ended September 30, 2002, 2001 and 2000...........................................................18
Consolidated Statements of Comprehensive Income
For the Years Ended September 30, 2002, 2001, and 2000..........................................................19
Consolidated Statements of Changes in Equity
For the Years Ended September 30, 2002, 2001 and 2000...........................................................20
Consolidated Statements of Cash Flows
For the Years Ended September 30, 2002, 2001 and 2000...........................................................21
Notes to Consolidated Financial Statements........................................................................23
Independent Auditors' Report......................................................................................43
(2) All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated
financial statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
3.1 Certificate of Incorporation of Northeast Pennsylvania Financial Corp. (1)
3.2 Bylaws of Northeast Pennsylvania Financial Corp.
4.0 Form of Stock Certificate of Northeast Pennsylvania Financial Corp. (1)
10.1 Employment Agreement between Northeast Pennsylvania Financial Corp. and E. Lee Beard (2)
10.2 Employment Agreement between Northeast Pennsylvania Financial Corp. and Thomas L.
Kennedy (2)
10.3 Employment Agreement between First Federal Bank and E. Lee Beard (2)
10.4 Employment Agreement between First Federal Bank and Thomas L. Kennedy (2)
10.5 Change in Control Agreement between Northeast Pennsylvania Financial Corp. and Patrick
J. Owens, Jr. (3)
10.6 Change in Control Agreement between First Federal Bank and Patrick J. Owens, Jr. (3)
10.7 Employment Agreement between Higgins Insurance Associates, Inc. And Joseph P. Schlitzer (4)
10.8 Change in Control Agreement between First Federal Bank and Allan Farias (4)
10.9 Form of First Federal Bank Supplemental Executive Retirement Plan (1)
10.10 Form of First Federal Bank Employee Severance Compensation Plan (1)
10.11 Form of First Federal Bank Management Supplemental Executive Retirement Plan (1)
10.12 Northeast Pennsylvania Financial Corp. 1998 Stock-Based Incentive Plan (5)
10.13 Northeast Pennsylvania Financial Corp. 2000 Stock Option Plan (6)
10.14 Registration Rights agreement, dated as of December 31, 2000, by and among Northeast Pennsylvania Financial Corp., James
Clark, James McCann, Joseph Schlitzer and John W. Sink (7)
11.0 Statement regarding Computation of Per Share Earnings (See Notes to Consolidated Financial Statements)
13.0 2002 Annual Report to Shareholders 21.0 Subsidiary information is incorporated by reference
to “Part I – Subsidiaries”
13.0 2002 Annual Report to Shareholders
21.0 Subsidary information is incorporated by reference to “Part I – Subsidiaries”
23.0 Consent of KPMG LLP
99.1 Chief Executive Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporated herein by reference into this document from the Exhibits to the Form S- 1 Registration Statement,
and any amendments thereto, Registration No. 333-43281
(2) Incorporated herein by reference into this document from the Exhibits to the Company's Form 10-Q for the
quarter ended June 30, 2002.
(3) Incorporated herein by reference into this document from the Exhibits to the Company's Form 10-K for the
year ended September 30, 1998.
(4) Incorporated herein by reference into this document from the Exhibits to the Company's Form 10-K for the
year ended September 30, 2001.
(5) Incorporated herein by reference into this document from the Proxy Statement for the 1998 Special Meeting of
Shareholders dated September 9, 1998
(6) Incorporated herein by reference into this document from the proxy statement for the 2000 Annual Meeting of
Shareholders dated December 20, 1999.
(7) Incorporated herein by reference into this document from the Exhibits to the Company's Form 10-Q for the
quarter ended March 31, 2002.
(b) Reports on Form 8-K
On July 29, 2002, the Company filed a Form 8-K in which it announced under Item 5 that its stock would
begin trading on the Nasdaq National Market on Thursday, August 1, 2002 under the symbol "NEPF". The press release announcing the
appointment was attached by exhibit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
Northeast Pennsylvania Financial Corp.
By /s/ E. Lee Beard December 23, 2002
E. Lee Beard
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ E. Lee Beard
E. Lee Beard
President, Chief Executive Officer and Director
(Principal Executive Officer)
December 23, 2002
/s/ Paul Conard
Paul Conard
Director
December 23, 2002
/s/ William R. Davidson
Dr. William R. Davidson
Director
December 23, 2002
/s/ Barbara Ecker
Barbara Ecker
Director
December 23, 2002
/s/ R. Peter Haentjens, Jr.
R. Peter Haentjens, Jr.
Director
December 23, 2002
/s/ Thomas L. Kennedy
Atty. Thomas L. Kennedy
Chairman of the Board
December 23, 2002
/s/ John P. Lavelle
Honorable John P. Lavelle
Director
December 23, 2002
/s/ Michael J. Leib
Michael J. Leib
Director
December 23, 2002
/s/_William J. Spear
William J. Spear
Director
December 23, 2002
/s/ Joseph Schlitzer
Joseph Schlitzer
Director
December 23, 2002
/s/ Patrick J. Owens, Jr.
Patrick J. Owens, Jr.
Treasurer, CFO
(Principal Accounting and Financial Officer)
December 23, 2002
I, E. Lee Beard, certify that:
I, Patrick J. Owens, Jr., certify that:
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF THE COMPANY
The selected consolidated financial and other data of the Company set forth below is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and Notes thereto presented elsewhere in
this Annual Report.
At September 30,
---------------
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
SELECTED CONSOLIDATED FINANCIAL DATA:
Total Assets $898,042 $808,830 $637,342 $612,225 $522,268
Cash and cash equivalents 25,302 9,060 6,295 4,177 3,053
Loans, net (1) 489,373 498,151 415,336 364,294 282,706
Securities held-to-maturity:
Investment securities, net 3,652 17,842 30,336 30,332 31,770
Securities available-for-sale:
Mortgage-related securities, net 225,287 138,467 53,076 56,333 75,651
Investment securities, net 102,599 105,181 104,398 133,502 113,443
Deposits 604,966 515,735 419,671 375,983 324,005
FHLB Advances 208,421 204,441 137,461 155,980 106,498
Total equity 68,385 75,837 72,975 75,476 87,434
Assets acquired through foreclosure 547 390 173 98 112
Non-performing assets and
troubled debt restructurings 4,747 5,113 3,672 1,469 1,351
For the Fiscal Years Ended September 30,
---------------------------------------
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
SELECTED OPERATING DATA:
Total interest income $54,255 $54,330 $45,090 $37,674 $30,542
Interest expense 28,988 31,314 26,531 19,822 15,566
------ ------ ------ ------ ------
Net interest income 25,267 23,016 18,559 17,852 14,976
Provision for loan losses 2,766 1,681 1,467 747 1,059
----- ----- ----- --- -----
Net interest income after provision
for loan losses 22,501 21,335 17,092 17,105 13,917
Non-interest income:
Net gain on sale of securities 308 333 37 63 62
Other 8,083 4,982 1,859 1,805 894(2)
Non-interest expense 23,791 19,655 14,471 13,395 15,279(3)
------ ------ ------ ------ --------
Income (loss) before income taxes 7,101 6,995 4,517 5,578 (406)
Income tax expense (benefit) 2,603 2,188 581 1,013 (359)
----- ----- --- ----- ----
Net income (loss) $4,498 $4,807 $3,936 $4,565 ($47)
====== ====== ====== ====== ====
At or for the Fiscal Years Ended September 30,
---------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
SELECTED OPERATING DATA (4):
Performance Ratios:
Average yield on interest-earning assets (5) 6.80% 7.65% 7.52% 7.34% 7.45%
Average rate paid on interest-bearing
liabilities 3.91 4.79 4.81 4.36 4.35
Average interest rate spread (6) 2.89 2.86 2.71 2.98 3.10
Net interest margin (7) 3.21 3.33 3.26 3.65 3.74
Ratio of interest-earning assets to
interest-bearing liabilities 109.17 111.05 112.74 118.00 117.35
Net-interest income after provision for loan
losses to non-interest expense 94.58 108.41 118.11 127.70 91.09
Non-interest expense as a percent of
average assets 2.80 2.63 2.24 2.42 3.53
Return on average assets .53 .63 .61 .83 (.01)
Return on average equity 6.39 6.31 5.44 5.78 (.08)
Ratio of average equity to average assets 8.34 10.02 11.22 14.72 13.40
Common stock dividend payout ratio (diluted) 44.23 37.62 37.97 25.81 N/A
Management's Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION AND BUSINESS
The following discussion
and analysis is presented on a consolidated basis and focuses on the major
components of Northeast Pennsylvania Financial Corp.‘s (the
“Company”) operations and significant changes in the results of
operations for the periods presented. The discussion should be read in
conjunction with the Company’s consolidated financial statements and
accompanying notes thereto presented elsewhere in this Annual Report.
The Company serves
Northeastern and Central Pennsylvania through 19 full service community office
locations, three financial centers and a loan production office. The Company,
through its subsidiaries, provides a wide range of financial services to
individual and corporate customers. The Company is subject to competition from
other financial institutions and other companies that provide financial
services.
The Company is a business
corporation formed at the direction of the Bank under the laws of Delaware on
December 16, 1997. On March 31, 1998: (i) the Bank converted from a
Federally-chartered mutual savings and loan association to a Federally-chartered
stock savings bank; (ii) the Bank issued all of its outstanding capital stock to
the Company; and (iii) the Company consummated its initial public offering of
common stock, par value $.01 per share (the “common stock”), by
selling at a price of $10.00 per share, 5,437,062 shares of common stock to
certain eligible account holders of the Bank who had subscribed for such shares
(collectively, the “Conversion”), by selling 514,188 shares to the
Bank’s Employee Stock Ownership Plan and related trust (“ESOP”)
and by contributing 476,100 shares of common stock to The First Federal
Charitable Foundation (the “Foundation”), a charitable foundation
dedicated to the communities served by the Bank. The common stock contributed by
the Company to the Foundation at a value of $4.8 million was charged to expense.
The Conversion resulted in net proceeds of $52.1 million, after expenses of $2.2
million. Net proceeds of $25.0 million were invested in the Bank to increase the
Bank’s tangible capital to 13.3% of the Bank’s total adjusted assets.
The Company’s results
of operations are dependent primarily on the results of operation of the Bank
and thus are dependent to a significant extent as on net interest income, which
is the difference between the income earned on its loan and investment
portfolios and its cost of funds, consisting of the interest paid on deposits
and borrowings. However, non-interest income has become a significant segment of
the Company’s operations mainly due to fees earned by non-bank
subsidiaries. In addition to First Federal Bank, a federal savings bank, the
Company’s other subsidiaries are Abstractors, Inc., which is a title
insurance agency, Northeast Pennsylvania Trust Co. (the “Trust Co.”),
which offers trust, estate, and asset management services and products, and
Higgins Insurance Associates, Inc. (“Higgins”), which provides
insurance and investment products to individuals and businesses. FIDACO, Inc. is
an inactive subsidiary of the Bank. Also, the Company has a trust subsidiary
established in connection with trust preferred offerings. Results of operations
are also affected by the Company’s provision for loan losses, loan and
security sales activities, service charges and other fee income, and
non-interest expense. The Company’s non-interest expense principally
consists of compensation and employee benefits, office occupancy and equipment
expense, data processing, professional fees, and advertising and business
promotion expenses. Results of operations are also significantly affected by
general economic and competitive conditions, particularly changes in interest
rates, government policies and actions of regulatory authorities.
Forward Looking Statements
In addition to historical
information, our Annual Report may include certain forward-looking statements
based on current management expectations. The Company intends such
forward-looking statements to be covered by the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, and is including this
statement for purposes of these safe harbor provisions. The Company’s
actual results could differ materially from management expectations. Because of
general economic conditions, legislative and regulatory changes, monetary and
fiscal policies of the Federal government, changes in tax policies, rates and
regulation of Federal, State and local tax authorities, changes in interest
rates, deposit flows, the cost of funds, demand for loan products, demand for
financial services, competition,
changes in the quality or composition of the
Company’s loan and investment portfolios, changes in accounting principles,
policies or guidelines, and other economic, competitive, governmental and
technological factors affecting the Company’s operations, markets, products, services and prices. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements.
Except as required by
applicable law and regulation, the Company does not undertake and specifically
disclaims any obligation to publicly release the result of any revisions which
may be made to any forward-looking statements to reflect events or circumstances
after the date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
Management Strategy
The Company’s
operating strategy is that of a community-based financial services company,
offering a wide variety of financial products to its retail customers, while
concentrating on residential and consumer lending and, to a lesser extent,
construction lending and small business and municipal commercial lending. The
Company is also meeting the needs of its customers through offering financial
services, including insurance products and asset management services. In order
to promote long-term financial strength and profitability, the Company’s
operating strategy has focused on: (i) maintaining strong asset quality by
originating one- to four-family loans located in its market area; (ii)
increasing profitability by emphasizing higher yielding consumer and commercial
loans; (iii) managing its interest rate risk by emphasizing shorter-term,
fixed-rate, one- to four-family loans, in addition to consumer and commercial
loans; limiting its retention of newly originated longer-term fixed-rate one- to
four-family loans; soliciting longer-term deposits; utilizing longer-term
advances from the Federal Home Loan Bank of Pittsburgh (the “FHLB”);
and investing in investment and mortgage-related securities having shorter
estimated durations; (iv) meeting the financial needs of its customers through
expanded products, such as personal and business insurance from Higgins, trust
and investment management services from the Trust Co., title insurance from
Abstractors, Inc., all with improved delivery systems through technological
advances and integration of products; and (v) maintaining a strong regulatory
capital position.
The Company has attempted
to diversify and expand its loan products to better serve its customer base by
placing a greater emphasis on its consumer lending and commercial lending,
primarily to small businesses and municipalities. As a result of its policy to
limit its retention of newly originated longer-term, fixed-rate one- to
four-family loans to 25% of total loan originations during a fiscal year,
periodically the Company has had to limit its originations of such loans.
Additionally, the Company has implemented a program to sell in the secondary
market longer-term, fixed-rate one- to four-family loans which it could
originate in excess of its retention policy for such loans. The Company began
offering loan products which it has historically not offered, such as
nonconforming one- to four-family loans. These loan products are currently being
held in the Company’s portfolio, however they have been originated to be
saleable in the secondary market.
Management of Interest Rate Risk and Market Risk Analysis
The principal objective of
the Bank’s interest rate risk management is to evaluate the interest rate
risk included in certain balance sheet
accounts, determine the
level of risk appropriate given the Bank’s business strategy, operating
environment, capital and liquidity requirements and performance objectives, and
manage the risk consistent with the Board of Directors’ approved
guidelines. Through such management, the Bank seeks to reduce the vulnerability
of its operations to changes in interest rates. The Board of Directors has
established an Asset Liability Committee (the “ALCO”), which is
responsible for reviewing the Bank’s asset/liability policies and interest
rate risk position. The ALCO meets on a quarterly basis and reports trends and
interest rate risk position to the Finance Committee of the Board of Directors.
The ALCO then reviews with the Finance Committee its activities and strategies,
the effect of those strategies on the Bank’s net interest margin, the
market value of the portfolio, and the effect changes in interest rates will
have on the Bank’s portfolio and exposure limits. The extent of the
movement of interest rates is an uncertainty that could have a negative impact
on the earnings of the Bank.
In recent years, the Bank
has utilized the following strategies to manage interest rate risk: (i)
emphasizing the origination and retention of fixed-rate mortgages having terms
to maturity of not more than 15 years, adjustable-rate and shorter-term loans,
commercial loans and consumer loans; (ii) limiting the retention for portfolio
of all fixed-rate mortgage loans greater than 15-years to no more than 25% of
the total originations in a given year; and (iii) selling, in the secondary
market, the excess of origination of fixed-rate mortgage loans with terms
greater than 15 years, which exceed the Bank’s retention policy, while
retaining the servicing rights, and; (iv) investing in shorter-term and, to a
lesser extent, adjustable-rate securities which generally bear lower yields,
compared to longer-term investments, but which better position the Bank for
increases in market interest rates. During fiscal 2002, the Bank continued to
originate in excess of the 25% limitation, however it has continued selling in
the secondary market long-term fixed-rate mortgages that exceed that limit.
Management believes that
reducing its exposure to interest rate fluctuations will enhance long-term
profitability. However, the Bank’s strategies may adversely impact net
interest income due to lower initial yields on some of these investments in
comparison to longer-term fixed-rate investments and whole loans. To promote a
higher yield on its investment securities, while at the same time addressing the
Bank’s interest rate risk management policies, the Bank has invested a
portion of its portfolio of investment securities in longer-term (more than five
years) Federal agency obligations, which have call features. Given the rates of
such securities in comparison to current market interest rates, the Bank
anticipates the majority of such securities may be called prior to their
contractual maturity.
Net Portfolio Value. The Company’s interest rate sensitivity is primarily monitored by
management through the use of a model, which generates estimates of the change
in the Company’s net portfolio value (“NPV”) over a range of
interest rate scenarios. Such analysis was prepared by a third party for the
Company. NPV is the present value of expected cash flows from assets,
liabilities, and off-balance sheet contracts. The NPV ratio, under any interest
rate scenario, is defined as the NPV in that scenario divided by the market
value of assets in the same scenario. The model estimates loan prepayment rates,
reinvestment rates, and deposit decay rates. The OTS also produces a similar
analysis using its own model, based upon data submitted on the Bank’s
quarterly Thrift Financial Reports, the results of which vary from the
Company’s internal model primarily due to differences in assumptions
utilized.
The following table sets forth the Company's NPV as of September 30, 2002.
NPV as % of Portfolio
Net Portfolio Value Value of Assets
-------------------------------------------- ----------------------
Change in
Interest Rates
In Basis Points NPV
(Rate Shock) Amount $ Change % Change Ratio Change(1)
- --------------- ------ -------- -------- ------- ----------
(In Thousands)
300 $90,915 $16,807 22.68% 9.94% 201
200 88,430 14,322 19.33 9.59 165
100 83,247 9,139 12.33 8.95 102
Static 74,108 0 0.00 7.93 0
(100) 54,732 (19,376) (26.15) 5.89 (204)
(1) Expressed in basis points.
The following table sets forth the Company's NPV as of September 30, 2001.
NPV as % of Portfolio
Net Portfolio Value Value of Assets
-------------------------------------------- ----------------------
Change in
Interest Rates
In Basis Points NPV
(Rate Shock) Amount $ Change % Change Ratio Change(1)
- --------------- ------ -------- -------- ------- ----------
(In Thousands)
300 $78,236 $(13,360) (14.59)% 9.70% (120)
200 84,847 (6,748) (7.37) 10.36 (54)
100 90,209 (1,387) (1.51) 10.85 (5)
Static 91,596 0 0 10.90 0
(100) 83,560 (8,036) (8.77) 9.93 (97)
(200) 71,655 (19,941) (21.77) 8.53 (237)
(300) 59,119 (32,477) (35.46) 7.06 (384)
(1) Expressed in basis points.
Certain shortcomings are inherent in the methodology used in the NPV interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV model presented assumes that the composition of the Company's interest sensitive assets and liabilities existing at the beginning of a period remain constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, NPV measurements provide an indication of the Company's interest rate risk exposure at a particular point in time. Such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and will differ from actual results.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities. Net interest income also depends upon the
relative amounts of interest-earning assets and interest-bearing liabilities and
the interest rate earned or paid on them.
Average Balance Sheet. The following table sets forth certain information relating to the Company for the fiscal years
ended September 30, 2002, 2001 and 2000. The average yields and costs are derived by dividing income or expense by the
average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. Average
balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to
yields.
For the Fiscal Years Ended September 30,
---------------------------------------
(in thousands)
2002 2001 2000
---- ---- ----
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
INTEREST-EARNING ASSETS:
Loans (1):
Real estate:
Taxable $283,832 $21,163 7.46% $299,711 $23,202 7.74% $252,129 $18,812 7.46%
Non-taxable(2) 4,018 332 8.26 3,716 323 8.69 286 29 10.08
Commercial:
Taxable 26,978 1,885 6.99 18,591 1,529 8.23 14,119 1,161 8.21
Non-taxable(2) 6,623 456 6.88 8,005 608 7.60 8,820 637 7.22
Consumer
177,907 15,357 8.63 157,084 14,097 8.97 125,697 10,742 8.55
-------- ------- ---- -------- ------- ---- -------- ------ ----
Total loans 499,358 39,193 7.85 487,107 39,759 8.16 401,051 31,381 7.82
Mortgage-related securities (3) 177,373 8,701 4.91 93,581 5,852 6.25 54,749 3,683 6.73
Investment securities (4):
Taxable 95,787 5,507 5.75 103,032 7,174 6.96 104,590 7,274 6.95
Non-taxable (2) 19,708 1,411 7.16 35,699 2,624 7.35 59,173 4,515 7.62
Interest-earning deposits 16,636 172 1.03 6,180 75 1.21 2,107 (80) (3.80)
-------- ------- ---- -------- ------- ---- -------- ------ ----
Total interest-earning assets 808,862 54,984 6.80 725,599 55,484 7.65 621,670 46,773 7.52
Noninterest-earning assets 41,039 34,590 23,414
Total assets $849,901 $760,189 $645,084
======== ======== ========
INTEREST-BEARING LIABILITIES:
Deposits:
Money market and NOW accounts $132,896 $2,457 1.85% $81,118 $1,919 2.37% $59,475 $1,280 2.15%
Savings accounts 93,114 1,141 1.22 88,018 1,796 2.04 68,095 1,463 2.15
Certificates of deposit 303,365 13,324 4.39 291,274 16,323 5.60 232,069 12,568 5.42
-------- ------- ---- -------- ------- ---- -------- ------ ----
Total deposits 529,375 16,922 3.20 460,410 20,038 4.35 359,639 15,311 4.26
FHLB advances and other
borrowings 211,552 12,066 5.70 192,981 11,276 5.84 191,797 11,220 5.85
-------- ------- ---- -------- ------- ---- -------- ------ ----
Total interest-bearing liabilities 740,927 28,988 3.91 653,391 31,314 4.79 551,436 26,531 4.81
Non-interest-bearing liabilities 38,054 30,629 21,288
-------- -------- --------
Total liabilities 778,981 684,020 572,724
Equity 70,920 76,169 72,360
-------- -------- --------
Total liabilities and equity $849,901 $760,189 $645,084
======== ======== ========
Net interest-earning assets $67,935 $72,208 $70,234
Net interest income/interest rate
spread (5) $25,996 2.89% $24,170 2.86% $20,242 2.71%
------- ---- ------- ---- ------ ----
Net interest margin as a percentage
of interest-earning assets (6) 3.21% 3.33% 3.26%
---- ---- ----
Ratio of interest-earning assets to
interest-bearing liabilities 109.17% 111.05% 112.74%
-------- -------- --------
Rate/Volume Analysis.
The
following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company’s interest income and interest
expense during the periods indicated. Information is provided in each category
with respect to: (i) changes attributable to changes in volume (changes in
volume multiplied by prior rate); (ii) changes attributable to changes in rate
(changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated on a proportional basis between changes in rate and volume.
Year Ended September 30,
------------------------
(in thousands)
2002 vs 2001 2001 vs 2000
------------ ------------
Increase Total Increase Increase Total Increase
(Decrease) due to (Decrease) (Decrease) due to (Decrease)
----------------- ---------- ---------------- ---------
Rate Volume Rate Volume
---- ------ ---- ------
INTEREST-EARNING ASSETS:
Loans (1):
Real Estate:
Taxable $(836) $(1,203) $(2,039) $729 $3,661 $4,390
Non Taxable (2) (14) 23 9 (4) 298 294
Commercial:
Taxable (178) 534 356 0 368 368
Non Taxable (2) (53) (99) (152) 37 (66) (29)
Consumer (509) 1,769 1,260 561 2,794 3,355
----- -------- -------- ----- -------- -------
Total loans (1,590) 1,024 (566) 1,323 7,055 8,378
Mortgage-related securities (3) (903) 3,752 2,849 (239) 2,408 2,169
Investment securities (4):
Taxable (1,188) (479) (1,667) 8 (108) (100)
Non Taxable (2) (66) (1,147) (1,213) (160) (1,731) (1,891)
Interest-earning deposits (9) 106 97 (333) 488 155
----- -------- -------- ----- -------- -------
Total interest-earning assets (3,756) 3,256 (500) 599 8,112 8,711
----- -------- -------- ----- -------- -------
INTEREST-BEARING LIABILITIES:
Deposits:
Money Market and NOW accounts (280) 818 538 137 502 639
Savings accounts (766) 111 (655) (69) 402 333
Certificates of deposit (3,711) 712 (2,999) 451 3,304 3,755
FHLB advances and other borrowings (261) 1,051 790 (13) 69 56
----- -------- -------- ----- -------- -------
Total interest-bearing liabilities (5,018) 2,692 (2,326) 506 4,277 4,783
----- -------- -------- ----- -------- -------
Increase (decrease) in net interest income $1,262 $564 $1,826 $93 $3,835 $3,928
===== ======== ======== ===== ======== =======
RESULTS OF OPERATIONS
General. Net income for fiscal 2002 decreased $309,000 from $4.8 million for fiscal 2001, to $4.5 million for fiscal 2002.
This decrease primarily was attributable to a $4.1 million increase in non-interest expense and a $1.1 million increase in provision
for loan loss, offset by a $3.1 million increase in non-interest income, a $2.3 million decrease in interest expense and a $400,000
increase in income tax expense.
The Company experienced a
$871,000 increase in net income for fiscal 2001 compared to 2000. This increase
was primarily due to a $9.2 million increase in interest income and a $3.4
million increase in non-interest income, offset by a $5.2 million increase in
non-interest expense, a $4.8 million increase in interest expense and a $1.6
million increase in income tax expense.
Interest Income. Interest income decreased $75,000 for fiscal 2002. This decrease was partially due to the $2.4 million
decrease in interest income on investment securities from a $23.2 million decrease in the average balance of these securities, as
well as, a decrease of 140 basis points in the average yield. Interest income on loans decreased $525,000 due to a 31 basis point
reduction in the average yield on total loans, while the average balance of total loans increased $12.3 million. Interest income on
mortgage-related securities increased $2.8 million due to a $84.0 million increase in the average balance, offset by a 134 basis
point decrease in the average yield.
Interest income on loans
increased $8.3 million, or 26.6%, to $39.5 million for fiscal 2001 from $31.2
million for fiscal 2000. Taxable real estate interest income increased $4.4
million, or 23.3%, due to a $47.6 million increase in the average balance as a
result of loans acquired from the acquisition of Security Savings Association of
Hazleton. The increase in the average yield of taxable real estate loans is the
result of the Bank originating and holding loans which were not saleable in the
secondary market. Consumer loan interest income increased $3.4 million, due to a
$31.4 million increase in the average balance of these loans, as a result of a
larger automobile dealer base which increased indirect auto originations. The
increase in the average yield of consumer loans is the result of originating
more used auto loans, as compared to new auto loans.
Interest Expense. Interest expense decreased $2.3 million for fiscal 2002. This change in interest expense was
primarily the result of a $3.1 million decrease in interest expense on deposits, due to a 115 basis point
decrease in the average rate, while the average balance on deposits increased $69.0 million.
Interest expense increased $4.8 million, or 18.0%, to $31.3 million in fiscal 2001 compared to $26.5
million for 2000. The increase in interest expense was primarily the result of a
$59.2 million increase in the average balance of certificates of deposit
combined with an 18 basis point increase in the average rate of such accounts.
Also contributing to this increase was a $21.6 million increase in the average
balance of money market and NOW accounts and a $19.9 million increase in the
average balance of savings accounts.
Provision for Loan Losses. The Company's provision for loan losses for fiscal 2002 was $2.8 million, compared to $1.7
million for fiscal 2001. The 2002 provision reflects the Company's increased concentration in commercial and consumer lending, which
carries an increased degree of risk. The increase in the provision from 2000 to 2001 was the result of an
increase in non-performing
loans and charge-offs. Provision for loan losses are charges to earnings to bring the total allowance for loan losses to a level
reflecting management's best estimate of known and inherent loan losses in the loan portfolio based on management's evaluation of
the portfolio's collectibility. Management's judgment as to the appropriate amount for the provision is based upon, among other
things, delinquency trends, the volume of non-performing loans, prior loss experience of the portfolio, current economic conditions
and other relevant factors. Although management believes it has used the best information available to it in making such
determinations, and that the allowance for loan losses is adequate, future adjustments to the allowance may be necessary, and net
income may be adversely affected if circumstances differ substantially from the assumptions used in determining the level of the
allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the
Company's allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance based on
their judgments about information available to them at the time of their examination.
Non-interest Income. Non-interest income increased $3.1 million for fiscal 2002, primarily due to a $1.1 million increase
in insurance premium income. Gain on sale of loans increased $757,000 primarily as a result of the $50.0 million automobile loan
securitization accounted for as a sale during the year. The $744,000 increase in other income is primarily attributable to income
from Bank-owned life insurance and income on the retained interest associated with the sale of automobile loans, as well as, losses
in fiscal 2001 from the Company's investment in BuildersFirst Holdings, Inc. that did not occur in fiscal 2002.
The Company experienced a
$3.4 million increase in non-interest income for fiscal 2001. This increase was
due to a $1.8 million increase in insurance premium income primarily due to the
acquisition of Higgins in December of 2000. Gain of the sale of loans increased
$562,000 due to the sale of certain fixed-rate mortgage loans obtained in the
acquisition of Security Savings. Such loans were sold for interest rate risk
purposes. Service charges and other fees increased $432,000 as a result of
higher outstanding balances on deposits and a larger customer base. The increase
in gain of sale of securities was a result of portfolio restructuring
transactions which resulted in gains.
Non-interest Expense. Total non-interest expense increased $4.1 million, or 21.0%, from $19.7 million for the year ended
September 30, 2001 to $23.8 million for the year ended September 30, 2002. The largest increase was in salary and benefit expense,
which increased $2.2 million, or 21.6% as a result of additional employees required to staff growing lines of business and expanded
delivery channels. Other non-interest expense increased $649,000 mainly due to costs associated with foreclosed properties in the
current year, compared to reimbursements received in fiscal 2001 for such costs. General operating expenses such as telephone,
supplies and postage increased due to additional branch and company growth. Professional fees increased $496,000 due to the
one-time costs associated with the research and design of a campaign to promote the Company's lines of business and increase customer
use of the Company's products and services. Occupancy costs increased $454,000 due to branch, company and technological expansion.
Total non-interest expense
increased $5.5 million, or 38.1%, from $14.5 million for the year ended
September 30, 2000 to $20.0 million for the year ended September 30, 2001, due
primarily to an increase in salary and benefit expense of $2.5 million, or
32.4%, primarily due to additional staff due to the acquisitions of Security
Savings and Higgins, coupled with new community office locations. Other
non-interest expense was also affected by increases in general operating
expenses such as supplies and postage due to additional community office
locations. Amortization of intangibles increased $788,000 as a direct result of
the acquisitions of Security Savings and Higgins. Occupancy expense increased
$649,000 mainly due to renovations and rent costs on properties acquired from
Security Savings. Professional fees increased $383,000 as a result of increased
consulting fees for a unifying brand identification project to maximize market
benefits of all the Company’s subsidiaries.
Income Taxes. The Company had income tax expense of $2.6 million and $2.2
million for the years ended September 30, 2002 and 2001, respectively, resulting
in an effective tax rate of 36.7% for fiscal 2002 as compared to 31.3% for
fiscal 2001. The increase in the effective tax rate was the result of a
combination of a decrease in nontaxable income and a $409,000 increase in the
valuation allowance relating to the deferred tax asset associated with the
carryforward of the 1998 contribution to the First Federal Charitable
Foundation.
For fiscal 2001, the Company had income tax expense of $2.2
million, compared to $581,000 for fiscal 2000. The effective tax rate for the
year ended September 30, 2001 was 31.3% compared to 12.9% at September 30, 2000.
The increases in income tax expense and the effective tax rate were attributable
to the increase in income before taxes, the sale of certain tax-exempt
securities, and the providing of a valuation allowance for the deferred tax
asset associated with the charitable contribution to the First Federal
Charitable Foundation in the amount of $335,000.
FINANCIAL CONDITION
Total assets increased
$89.2 million from $808.8 million at September 30, 2001 to $898.0 million at
September 30, 2002. The growth in assets was primarily due to increases in
securities available for sale, cash, and bank-owned life insurance, offset by a
decrease in securities held to maturity and loans receivable.
Available-for-sale
securities increased $84.3 million, from $243.6 million at September 30, 2001 to
$327.9 million at September 30, 2002. The increase was primarily attributable to
the purchase of mortgage-backed securities, combined with a change in unrealized
gain.
Held-to-maturity securities
decreased $14.2 million from $17.8 million at September 30, 2001 to $3.7 million
at September 30, 2002. This decrease was the result of maturities and calls of
obligations of U.S. government agencies.
Loans, net, decreased $8.8
million to $489.4 million at September 30, 2002. This was primarily due to a
$50.0 million automobile loan securitization accounted for as a sale, offset by
increased automobile originations. Total real estate loans decreased $18.2
million due to the sale of mortgage loans with initial rate adjustments of
fifteen years or more. Commercial loans increased $11.4 million as a result of
increased originations from business development efforts.
During the year, the Bank
purchased bank owned life insurance in the amount of $10.0 million. The
bank-owned life insurance had an annualized tax equivalent yield for fiscal 2002
of 9.12%.
Total liabilities increased
$96.7 million from $733.0 million at September 30, 2001 to $829.7 million at
September 30, 2002. The rise in liabilities was mainly attributable to a $89.2
million growth in deposits, the issuance of $7.0 million trust–preferred
securities and a $4.0 million increase in FHLB advances.
Total deposits increased
$89.2 million, or 17.3%, to $605.0 million at September 30, 2002. The increase
in deposits was primarily due to a $86.6 million increase in checking accounts
from $123.3 million at September 30, 2001 to $209.9 million at September 30,
2002, as a result of increased marketing efforts to attract lower costing core
deposits.
During the year, the
Company issued $7.0 million of trust-preferred securities. The interest rate on
the trust-preferred securities is variable and adjusts semi-annually at 3.70%
over six-month LIBOR, with an initial rate of 6.02%. A rate cap of 11.00% is
effective through April 22, 2007. The
Company used the proceeds of the offering for general corporate purposes, specifically, the repurchase its common stock.
FHLB advances increased $4.0 million from $204.4 million at September 30, 2001 to
$208.4 million at September 30, 2002. This was a result of management’s
utilization of FHLB borrowings to fund the purchase of investment securities.
Total equity decreased $7.5
million to $68.4 million at September 30, 2002 primarily due to the repurchase
of 812,903 shares of its common stock during the year at a cost of $14.4
million, and $2.0 million in cash dividends. This decrease in equity was offset
by net income of $4.5 million for the year and a $2.4 million increase in
unrealized gain on securities.
Investment Activities
The investment policy of
the Company, as approved by the Board of Directors, requires management to
maintain adequate liquidity, to generate a favorable return on investments
without incurring undue interest rate and credit risk and to complement the
Company’s lending activities. The Company primarily utilizes investments in
securities for liquidity management and as a method of deploying excess funds
not utilized for loan originations or purchases. Generally, the Company’s
investment policy is more restrictive than the OTS regulations allow and,
accordingly, the Company has invested primarily in U.S. Government and agency
securities, which qualify as liquid assets under the OTS regulations, Federal
funds and U.S. Government-sponsored agency-issued mortgage-backed securities. As
required by SFAS No. 115, the Company has established an investment portfolio of
securities that are categorized as held to maturity or available for sale. The
Company does not currently maintain a portfolio of securities categorized as
held for trading. At September 30, 2002, the available-for-sale securities
portfolio totaled $327.9 million, or 36.5% of assets, and the held-to-maturity
portfolio totaled $3.7 million, or 0.4% of assets.
The following table sets
forth certain information regarding the amortized cost and fair value of the
Company’s securities at the dates indicated.
At September 30,
----------------
(in thousands)
2002 2001 2000
---- ---- ----
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- ----- --------- ----- --------- ------
Investment securities:
Debt securities held to maturity:
Obligations of U.S. government
agencies $- $- $13,992 $14,096 $26,785 $24,906
Other securities 3,553 3,608 3,552 3,425 3,551 3,223
Certificates of Deposit 99 99 298 298 - -
--------- ------- --------- -------- -------- ------
Total $3,652 $3,707 $17,842 $17,819 $30,336 $28,129
--------- ------- --------- -------- -------- ------
Debt securities available for sale:
Obligations of U.S. Treasury and U.S.
government agencies $24,032 $24,446 $14,471 $14,605 $39,477 $38,073
Other securities 61,396 62,842 77,419 76,512 60,639 55,881
--------- ------- --------- -------- -------- ------
Total $85,428 $87,288 $91,890 $91,117 $100,116 $93,954
--------- ------- --------- -------- -------- ------
Equity securities available for sale:
FHLB Stock $10,971 $10,971 $10,222 $10,222 $6,873 $6,873
Freddie Mac Stock 2,241 2,068 1,613 1,592 910 1,260
Fannie Mae Stock 2,000 1,992 2,000 1,999 1,000 1,003
Other equity securities 284 280 206 251 813 1,308
--------- ------- --------- -------- -------- ------
Total equity securities available for
sale 15,496 15,311 14,041 14,064 9,596 10,444
--------- ------- --------- -------- -------- ------
Total debt and equity securities $104,576 $106,306 $123,773 $123,000 $140,048 $132,527
========= ======= ========= ======== ======== ======
Mortgage-related securities available for
sale:
Freddie Mac $17,577 $18,041 $13,253 $13,692 $9,049 $8,918
Fannie Mae 52,615 54,021 29,542 30,146 16,301 16,089
Ginnie Mae 5,930 6,065 12,025 12,224 4,990 5,000
Collateralized mortgage obligations 116,596 118,455 69,426 70,367 23,470 23,069
Other securities 28,665 28,705 12,011 12,038 - -
--------- ------- --------- -------- -------- ------
Total mortgage-related securities
available for sale 221,383 225,287 136,257 138,467 53,810 53,076
--------- ------- --------- -------- -------- ------
Total mortgage-related securities 221,383 225,287 136,257 138,467 53,810 53,076
========= ======= ========= ======== ======== ======
Total securities $325,959 $331,593 $260,030 $261,467 $193,858 $185,603
========= ======= ========= ======== ======== ======
The table below sets forth certain information regarding the carrying value, weighted-average yields and contractual maturities of the Company’s debt securities.
As of September 30, 2002
Maturing Maturing after Maturing after Maturing
within one one year but 5 years but after 10
year within 5 years within 10 years years Total
---------- -------------- --------------- -------- --------
(in thousands)
Available-for-sale debt securities:
Municipal securities $- $- $- $16,247 $16,247
Obligations of U.S. Government agencies 1,000 14,411 5,999 2,622 24,032
Mortgage-related securities 28,665 2,252 14,211 176,255 221,383
Trust Preferred securities - - - 12,604 12,604
Corporate Bonds 6,980 21,616 3,949 - 32,545
------- ------- ------- -------- --------
Total debt securities at amortized cost $36,645 $38,279 $24,159 $207,728 $306,811
======= ======= ======= ======== ========
Total debt securities at fair value $36,821 $39,705 $24,901 $211,148 $312,575
======= ======= ======= ======== ========
Weighted-Average Yield 3.89% 5.22% 5.33% 4.91% 4.86%
Held-to-maturity debt securities:
Municipal securities $- $- $- $3,553 $3,553
Obligations of U.S. Government agencies - - - - -
Certificates of Deposit 99 - - - 99
------- ------- ------- -------- --------
Total debt securities at amortized cost $99 $- $- $3,553 $3,652
======= ======= ======= ======== ========
Total debt securities at fair value $99 $- $- $3,608 $3,707
======= ======= ======= ======== ========
Weighted Average Yield 7.08% - - 4.64% 4.71%
Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Weighted-average yields are based on amortized cost including municipal
securities which are not reported on a tax-equivalent basis.
Loans
Net loans show a slight
decrease during 2002 which reflects the $50.0 million auto loan securitization
accounted for as a sale during the year, offset by originations.
The following table sets forth the composition of the Company’s loan portfolio in dollar amounts and
as a percentage of the portfolio at the dates indicated.
At September 30,
---------------
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of total Amount of Total
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Real Estate Loans:
One- to four-family $198,307 39.95% $220,796 43.78% $205,834 48.89% $196,885 53.43% $176,924 61.74%
Multi-family and
commercial 75,912 15.29 65,095 12.91 43,784 10.40 31,497 8.55 11,938 4.17
Construction 7,157 1.44 13,690 2.71 11,993 2.85 3,983 1.08 3,759 1.31
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate
loans $281,376 56.68% $299,581 59.40% $261,611 62.14% $232,365 63.06% $192,621 67.22%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Consumer loans:
Home equity loans
and lines of credit $79,253 15.97% $79,840 15.84% $72,474 17.21% $70,118 19.03% $52,244 18.23%
Automobile 80,035 16.12 78,307 15.53 51,114 12.14 34,619 9.40 24,589 8.58
Education - - 2,846 0.56 3,516 0.84 2,796 0.76 2,351 0.82
Unsecured lines of 1,884
credit 2,297 0.46 1,884 0.37 1,817 0.43 1,744 0.47 1,589 0.55
Other 10,376 2.09 10,288 2.04 8,021 1.90 5,571 1.51 3,423 1.20
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer
loans $171,961 34.64% $173,165 34.34% $136,942 32.52% $114,848 31.17% $84,196 29.38%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Commercial loans $43,014 8.68% $31,588 6.26% $22,481 5.34% $21,262 5.77% $9,742 3.40%
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans $496,351 100.00% $504,334 100.00% $421,034 100.00% $368,475 100.00% $286,559 100.00%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
Less:
Deferred loan
origination fees $1,529 $1,686 $1,536 $1,361 $1,580
Allowance for
loan losses 5,449 4,497 4,162 2,924 2,273
-------- -------- -------- -------- --------
Total loans, net $489,373 $498,151 $415,336 $364,190 $282,706
======== ======== ======== ======== ========
Loan Maturity. The following table shows the remaining contractual maturity of the Company’s total loans at September 30, 2002. The table does not include the effect of future principal prepayments.
At September 30, 2002
---------------------
(in thousands)
Multi-
One-to Family and
Four- Commercial Total
Family Real Estate Construction(1) Consumer Commercial Loans
------ ------------ ------------ -------- ---------- ------
Amount due in:
One year or less $13,024 $1,835 $679 $25,296 $2,118 $42,952
More than one year to five years 50,001 10,446 19 89,969 9,669 160,104
More than five years 135,282 63,631 6,459 56,696 31,227 293,295
-------- ------- ------ -------- ------- --------
Total amount due $198,307 $75,912 $7,157 $171,961 $43,014 $496,351
======== ======= ====== ======== ======= ========
The following table sets forth, at September 30, 2002, the dollar amount of loans contractually due after September 30, 2003, and whether such loans have fixed interest rates or adjustable interest rates.
Due After September 30, 2003
----------------------------
(in thousands)
Fixed Adjustable Total
------- ---------- -----
Real estate loans:
One- to four-family $107,220 $78,063 $185,283
Multi-family and commercial
real estate 27,853 46,224 74,077
Construction 731 5,747 6,478
-------- -------- ---------
Total real estate loans 135,804 130,034 265,838
-------- -------- ---------
Consumer loans 126,137 20,528 146,665
Commercial loans 15,540 25,356 40,896
-------- -------- ---------
Total loans $277,481 $175,918 $453,399
======== ======== =========
Non-Performing Assets and Impaired Loans. The following table sets forth information regarding non-performing assets, real estate owned (“REO”) and other repossessed assets. At September 30, 2002, non-performing loans totaled $4.2 million consisting of 84 non-accrual loans, and REO totaled $419,000 consisting of nine one- to four-family loans and one commercial loan. The decrease in non-performing loans, REO and repossessed assets was primarily due to the aggressive collection efforts in the consumer loan area. It is the policy of the Company to cease accruing interest on loans 90 days or more past due (unless the loan principal and interest are determined by management to be fully secured and in the process of collection) and to reverse all accrued interest. For the years ended September 30, 2002, 2001 and 2000, the amount of additional interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $464,000, $303,000 and $136,000, respectively. The amount of interest income on such loans included in net income in fiscal year 2002, 2001 and 2000 was $131,000, $152,000 and $66,000, respectively. At September 30, 2002, the Company had a $7.8 million recorded investment in impaired loans, each of which had specific loan loss allowances totaling $1.6 million. At September 30, 2001, there was $9.6 million of impaired loans, each of which had specific loan loss allowances totaling $1.4 million. The average net recorded investment in impaired loans for the fiscal year ended September 30, 2002, 2001, and 2000, was $5.6 million, $1.9 million and $1.1 million, respectively.
At September 30,
----------------
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Non-performing assets:
One- to four-family real estate $2,171 $1,902 $869 $848 $ 509
Consumer 290 771 240 261 254
Commercial 1,739 2,050 2,390 262 476
------ ------ ------ ------ ------
Total(1) $4,200 $4,723 $3,499 $1,371 $1,239
Real estate owned (REO)(1) 419 249 51 19 63
Other repossessed assets(1) 128 141 122 79 49
------ ------ ------ ------ ------
Total non-performing assets $4,747 $5,113 $3,672 $1,469 $1,351
====== ====== ====== ====== ======
Troubled debt restructurings $55 $60 $- $- $-
Troubled debt restructurings and
total non-performing assets $4,802 $5,173 $3,672 $1,469 $1,351
====== ====== ====== ====== ======
Total non-performing loans and
troubled debt restructurings as
a percentage of total loans 0.86% 0.95% 0.83% 0.38% 0.43%
Total non-performing assets and
troubled debt restructurings as a
percentage of total assets 0.53% 0.64% 0.58% 0.24% 0.26%
(1) Real estate owned balances and other repossessed assets are shown net of related loss allowances.
Allowance for Loan Losses.
The allowance for loan
losses is maintained at a level representing management’s best estimate of
known and inherent losses in the portfolio, based upon management’s
evaluation of the portfolio’s collectibility. Management’s evaluation
is based upon an analysis of the portfolio, past loss experience, current
economic conditions and other relevant factors. While management uses the best
information available to make evaluations, such evaluations are highly
subjective, and future adjustments to the allowance may be necessary if
conditions differ substantially from the assumptions used in making the
evaluations. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank’s allowance for
losses on loans. Such agencies may require the Bank to recognize additions to
the allowance, based on their judgments about information available to them at
the time of their examination. The allowance is increased by the provision for
loan losses, which is charged to operations. The allowance for loan losses is
also increased by balances acquired through acquisitions and recoveries and
decreased by charge-offs. Loan losses are charged directly against the
allowance, and recoveries on previously charged-off loans are added to the
allowance.
In determining the
provision, management considers both specifically identified problem loans as
well as credit risks not specifically identified in the loan portfolio.
Management determines the allowance through a formula allowance, which gives
consideration to historical losses and the current composition of the
portfolios, specific allowances for identified problem loans and an unallocated
allowance.
The formula allowance
element gives consideration to historical losses and the current composition of
the portfolios. Losses are recognized when (a) information indicates that it is
probable that a loss has been incurred and (b) the amount of the loss can be
reasonably estimated. Borrowers are impacted by events that result in loan
default such as job loss, divorce, medical crisis or the loss of a major tenant.
The average time-frame between the occurrence of such events and the resulting
default and loss realization is between 1.0 and 2.5 years, depending upon the
loan type. Therefore, for example, if the general credit characteristics of a
portion of a loan portfolio have not changed significantly over time, losses can
be estimated by calculating historical loss experience over such periods.
The formula allowance is
determined by applying loss factors against all non-impaired loans. Loss factors
may be adjusted for significant factors that, in management’s judgment,
affect the collectibility of the portfolio as of the evaluation date. Loss
factors are calculated based on models that estimate the probability of default
and the period of loss realization, depending on the loan type and the rates of
loss that have been experienced on such loans. Historical foreclosure and loss
rates are then reviewed in order to attempt to estimate current losses. The
Company’s analysis includes consideration of risk associated with
imprecision in estimating inherent loan losses.
Specific allowances are
established against individual residential 1-4 mortgage, consumer, commercial,
and commercial and multi-family real estate loans for which management has
performed analyses and concluded that, based on current information and events,
it is probable that the Bank will be unable to collect all amounts due according
to the contractual terms of the loan agreement. Generally, management believes
that full collectibility in the normal manner is improbable if a loan is
severely delinquent or if it has been determined that a borrower’s cash
flow is inadequate for debt repayment. The amount of specific allowance is
determined by an estimation of any underlying fair value of collateral, net of
the cost of disposition of the collateral and the fair value is compared to the
net book value of the loan. If the net book value exceeds the fair value, a
specific allowance is established in an amount equal to the excess. Loans
evaluated for specific allowance are excluded from the formula allowance
analysis so as not to double-count loss exposure.
An unallocated allowance is
established for losses which may not have been identified through the formula
and specific portions of the allowance. The unallocated portion is more
subjective and requires a high degree of management judgment and experience.
Management has identified several factors that impact credit losses that are not
considered in either the formula or the specific allowance segments. These
factors consist of industry and geographic loan concentrations, changes in the
composition of loan portfolios through acquisitions and new business strategies,
changes in underwriting processes and trends in problem loan and loss recovery
rates. Each factor is analyzed and assigned a range of values. At this time,
management has chosen an unallocated allowance amount at the mid-point of the
range for each factor.
As of September 30, 2002,
the Company’s allowance for loan losses was $5.4 million, or 1.10% of total
loans compared to $4.5 million, or 0.89% as of September 30, 2001. The increase
in the allowance ratio was the result of the increased loss rate associated with
a higher concentration in commercial and consumer lending. The Company will
continue to monitor and modify its allowance for loan losses as conditions
dictate. In light of the increased lending focus of the Company on loans
involving greater risk than one- to four-family mortgage loans, and the
anticipated future growth in such loans as a percentage of the Company’s
total loan portfolio, the Company recognizes that its allowance for loan losses
as a percentage of total loans may need to increase further in future periods.
The following table sets forth activity in the Company's allowance for loan losses for the periods indicated.
At or for the Fiscal Years Ended September 30,
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Allowance for loan losses,
beginning of year $4,497 $4,162 $2,924 $2,273 $1,272
Charged-off loans:
One- to four-family real estate 56 - 3 10 19
Consumer 205 566 244 91 57
Commercial 1,732 1,621 - - -
------ ------ ------ ------ ------
Total charged-off loans 1,993 2,187 247 101 76
------ ------ ------ ------ ------
Recoveries on loans previously
charged off:
One- to four-family real estate - - - - -
Consumer 179 24 18 5 18
------ ------ ------ ------ ------
Total recoveries 179 24 18 5 18
------ ------ ------ ------ ------
Net loans charged off 1,814 2,163 229 96 58
Provision for loan losses 2,766 1,681 1,467 747 1,059
Additional allowance from acquisition
of Security Savings - 817 - - -
------ ------ ------ ------ ------
Allowance for loan losses,
end of period $5,449 $4,497 $4,162 $2,924 $2,273
====== ====== ====== ====== ======
Net loans charged off to average
loans 0.36% 0.38% 0.06% 0.03% 0.02%
------ ------ ------ ------ ------
Allowance for loan losses
to total loans 1.10% 0.89% 0.99% 0.80% 0.80%
------ ------ ------ ------ ------
Allowance for loan losses to
non-performing loans and troubled
debt restructuring 128.06% 94.02% 118.95% 213.27% 183.45%
------ ------ ------ ------ ------
Net loans charged off to allowance
for loan losses 33.29% 40.76% 5.50% 3.28% 2.55%
------ ------ ------ ------ ------
Recoveries to charge offs 8.98% 1.29% 7.29% 4.95% 23.68%
------ ------ ------ ------ ------
The following table sets forth the Company’s allowance for loan losses in each of the categories listed at the dates indicated and the percentage of such amounts to the total allowance and to total loans. These allocations are no more than estimates and are subject to revision as conditions change. The change in the allowance from 2001 to 2002 reflects increased activity in commercial and consumer lending and increased levels of non-performing loans.
At September 30,
(in thousands)
2002 2001 2000
---- ---- ----
Percent of Percent of Percent of
% of Allowance Loans in % of Allowance Loans in % of Allowance Loans in
in each each in each each in each each
Category to Category to Category to Category to Category to Category to
Total Total Total Total Total Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
---------------------------------------------------------------------------------------------------------
Real Estate $1,641 30.12% 56.69% $1,391 30.93% 59.40% $979 23.52% 62.14%
Consumer 1,015 18.63 34.65 739 16.43 34.34 489 11.75 32.52
Commercial 2,297 42.15 8.66 1,951 43.38 6.26 2,108 50.65 5.34
Unallocated 496 9.10 - 416 9.26 - 586 14.08 -
------ ------ ------ ------ ------ ------ ------ ------ ------
Total Allowance
for loan losses $5,449 100.00% 100.00% $4,497 100.00% 100.00% $4,162 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
1999 1998
---- ----
Percent of Percent of
% of Allowance Loans in % of Allowance Loans in
in each each in each each
Category to Category to Category to Category to
Total Total Total Total
Amount Allowance Loans Amount Allowance Loans
---------------------------------------------------------------------
Real Estate $1,037 35.47% 63.06% $748 32.91% 67.22%
Consumer 424 14.50 31.17 300 13.20 29.38
Commercial 1,072 36.67 5.77 546 24.02 3.40
Unallocated 391 13.36 - 679 29.87 -
------ ------ ------ ------ ------ ------
Total Allowance
for loan losses $2,924 100.00% 100.00% $2,273 100.00% 100.00%
====== ====== ====== ====== ====== ======
Sources of Funds
General. Deposits, loan repayments and prepayments, proceeds from sales of loans, cash flows generated from operations
and FHLB advances are the primary sources of the Company's funds for use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit products with a range of interest rates and terms. The Company's
deposits consist of checking, money market, savings, NOW, certificate accounts and Individual Retirement Accounts. More than
49.5% of the Company's deposits at September 30, 2002 are in certificate of deposit accounts. At September 30, 2002, core
deposits (savings, NOW and money market accounts) represented 45.2% of total deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The
Company's deposits are obtained predominantly from the areas in which its community offices are located. The Company has
historically relied primarily on customer service and long-standing relationships with customers to attract and retain these
deposits; however, market interest rates and rates offered by competing
financial institutions significantly affect the Company’s ability to
attract and retain deposits. The Company uses traditional means of advertising
its deposit products, including radio and print media, and generally does not
solicit deposits from outside its market area.
At September 30, 2002, the Company had $71.4 million in certificate accounts in amounts of $100,000 or more maturing as follows:
Maturity Period Amount
------------------------------------------------------------------------------------
(in thousands)
Three months or less $18,745
Over 3 through 6 months 11,965
Over 6 through 12 months 13,384
Over 12 months 27,285
------
Total $71,379
=======
The following table sets forth the distribution of the Company’s average deposit accounts for the periods indicated and the weighted average interest rates on each category of deposits presented and such information during the last three fiscal years. Averages for the periods presented utilize daily balances.
At September 30,
2002 2001 2000
---------------------------------------------------------------------------
(in thousands)
Percent Percent Percent
Total Total Total
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Paid Balance Deposits Rate Paid Balance Deposits Rate Paid
----------------------------------------------------------------------------------------------------------
Savings accounts $93,114 16.75% 1.22% $88,018 18.28% 2.04% $68,095 18.15% 2.15%
Money Market
accounts 60,063 10.80 2.39 33,556 6.97 4.26 22,772 6.07 4.18
NOW accounts 72,833 13.10 1.40 47,562 9.88 1.02 36,703 9.78 0.89
Certificates of Deposit 303,365 54.57 4.39 291,274 60.49 5.60 232,069 61.84 5.42
Non-interest-bearing
deposits:
Demand deposits 26,546 4.78 - 21,113 4.38 - 15,600 4.16 -
-------- ------ ---- -------- ------ ---- -------- ----- ----
-
-
Total averagets $555,921 100.00% 3.04% $481,523 100.00% 4.16% $375,239 100.00% 4.08%
======== ====== ==== ======== ====== ==== ======== ====== ====
Borrowings. The Bank utilizes advances from the FHLB of Pittsburgh as an alternative to retail deposits to fund its
operations as part of its operating strategy. These FHLB advances are collateralized primarily by certain mortgage loans and
mortgage-related securities of the Bank and secondarily by the Bank's investment in capital stock of the FHLB of Pittsburgh.
FHLB advances are made pursuant to several different credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB of Pittsburgh will advance to member institutions, including the Bank,
fluctuates from time to time in accordance with the policies of the FHLB of Pittsburgh. At September 30, 2002, the Bank had
$208.4 million in outstanding FHLB advances, compared to $204.4 million at September 30, 2001. Other borrowings consist of
overnight retail repurchase agreements and for the periods presented were immaterial.
Liquidity and Capital Resources
The Company’s primary
sources of funds on a long-term and short-term basis are deposits, principal and
interest payments on loans, mortgage-backed and investment securities and FHLB
advances. The Company uses the funds generated to support its lending and
investment activities as well as any other demands for liquidity such as deposit
outflows. While maturities and scheduled amortization of loans are predictable
sources of funds; deposit flows, mortgage prepayments and the exercise of call
features are greatly influenced by general interest rates, economic conditions
and competition.
At September 30, 2002, the
Bank exceeded all of its regulatory capital requirements with a tangible capital
level of $51.6 million, or 5.8% of total assets, which is above the required
level of $13.3 million, or 1.5%; core capital of $51.6 million, or 5.8% of total
assets, which is above the required level of $26.6 million, or 3.0%; and
risk-based capital of $56.8 million, or 10.4% of risk-weighted assets, which is
above the required level of $43.6 million, or 8.0%.
The initial impact of the
Conversion on the liquidity and capital resources of the Company was significant
as it substantially increased the liquid assets of the Company and the capital
base on which the Company operates. Additionally, the Company invested the
substantial majority of Conversion proceeds in readily-marketable investment-
grade securities which, if liquidity needs developed, could be sold by the
Company to provide additional liquidity. Further, the additional capital
resulting from the offerings increased the capital base of the Bank. At
September 30, 2002, the Bank had total equity, determined in accordance with
GAAP, of $68.4 million, or 7.6% of total assets, which exceeded the Bank’s
regulatory tangible capital at that date of 6.5% of total assets. An institution
with a ratio of risk-based capital to risk-weighted assets of greater than or
equal to 10.0%, a ratio of tier 1 capital to risk-weighted assets of greater
than or equal to 6.0% and a ratio of core capital to total assets of greater
than or equal to 5.0% is considered to be “well-capitalized” pursuant
to OTS regulations.
The Bank’s most liquid
assets are cash and cash equivalents and its investment and mortgage-related
securities available for sale. The levels of these assets are dependent on the
Bank’s operating, financing, lending and investing activities during any
given period. At September 30, 2002, cash and cash equivalents and investment
and mortgage-related securities available for sale totaled $353.2 million, or
39.3% of total assets.
The Bank has other sources
of liquidity if a need for additional funds arises, including FHLB advances. At
September 30, 2002, the Bank had $208.4 million in advances outstanding from the
FHLB, and had an additional overall borrowing capacity from the FHLB of $416.1
million. Depending on market conditions, the pricing of deposit products and
FHLB advances, the Bank may continue to rely on FHLB borrowings to fund asset
growth.
At September 30, 2002, the Company had commitments to originate and purchase loans and unused outstanding lines of credit undisbursed proceeds of construction mortgages totaling $80.7 million. The Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificate accounts, including Individual Retirement Accounts (“IRA”) and KEOGH accounts, which are scheduled to mature in less than one year from September 30, 2002, totaled $143.1 million. Based on past experience, the Company expects that substantially all of the maturing certificate accounts will be retained by the Company at maturity.
Impact of Inflation and Changing Prices
The Consolidated Financial
Statements and Notes thereto presented herein have been prepared in accordance
with generally accepted accounting principles (“GAAP”), which requires
the measurement of financial position and operating results generally in terms
of historical dollar amounts without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of the Company’s operations. Unlike
industrial companies, nearly all of the assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a greater impact on the
Company’s performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services.
Impact of Recent Accounting Standards
In June 2001, the Financial
Accounting Standards Board (FASB) issued Statement No. 143, “Accounting for
Asset Retirement Obligations.” This Statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. It applies
to legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and (or) the normal
operation of a long-lived asset, except for certain obligations of lessees. As
used in this Statement, a legal obligation is an obligation that a party is
required to settle as a result of an existing or enacted law, statute, ordinance
or written or oral contract or by legal construction of a contract under the
doctrine of promissory estoppel. This Statement requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This Statement amends FASB Statement No. 19,
“Financial Accounting and Reporting by Oil and Gas Producing
Companies”, and it applies to all entities. It is effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Earlier application is encouraged. The adoption of this Statement on October 1,
2002 did not have an impact on the Company’s earnings, financial condition
or equity.
In August 2001, the FASB
issued Statement No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.” This Statement addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of”. However, the Statement
retains the fundamental provisions of Statement 121 for (a) recognition and
measurement of the impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of by sale. This Statement
supersedes the accounting and reporting provisions of APB Opinion No. 30,
“Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions”, for the disposal of a segment of a
business. However, this Statement retains the requirement of Opinion No. 30 to
report discontinued operations separately from continuing operations and extends
that reporting to a component of an entity that either has been disposed of (by
sale, by abandonment or in distribution to owners) or is classified as held for
sale. This Statement also amends ARB No. 51, “Consolidated Financial
Statements”, to eliminate the exception to consolidation for a
temporarily-controlled subsidiary. The provisions of this Statement are
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years, with earlier
application encouraged. The provisions of this Statement generally are to be
applied prospectively. The Adoption of this Statement on October 1, 2002 did not
have an impact on the Company’s earnings, financial condition or equity.
In April 2002, the FASB
issued SFAS No. 145 “Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections.” This
Statement rescinds FASB Statement No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements, along with rescinding FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers and amending FASB Statement No.
13, Accounting for Leases. This Statement (1) eliminates an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions, (2) eliminates the extraordinary item
treatment of reporting gains and losses from extinguishments of debt, and (3)
makes certain other technical corrections.
The provisions of this
Statement related to the rescission of Statement 4 shall be applied in fiscal
years beginning after May 15, 2002. Any gain or loss on extinguishments of debt
that was classified as an extraordinary item in prior periods presented that
does not meet the criteria in Opinion 30 for classification as an extraordinary
item shall be reclassified. Early application of the provisions of this
Statement related to the rescission of Statement 4 is encouraged.
The provisions of this
Statement related to Statement 13 shall be effective for transactions occurring
after May 15, 2002. All other provisions of this Statement shall be effective
for financial statements issued on or after May 15, 2002.
Early application of this
Statement is encouraged. The Corporation does not expect the adoption of this
Statement to have an impact on its earnings, financial condition or equity.
In June 2002, the FASB
issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal
Activities.” This Statement addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring).”
The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Corporation does not
expect the adoption of this Statement to have an impact on its earnings,
financial condition or equity.
On October 1, 2002, the
FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions,
effective for all business combinations initiated after October 1, 2002. This
Statement addresses the financial accounting and reporting for the acquisition
of all or part of a financial institution, except for a transaction between two
or more mutual enterprises. This Statement removes acquisitions of financial
institutions, other than transactions between two or more mutual enterprises,
from the scope of SFAS No. 72, Accounting for Certain Acquisitions of Banking
or Thrift Institutions, and FASB Interpretation No. 9, Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method. The acquisition of all or part of a financial institution that meets
the definition of a business combination shall be accounted for by the purchase
method in accordance with SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. This Statement also
provides guidance on the accounting for the impairment or disposal of acquired
long-term customer-relationship intangible assets (such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible
assets), including those acquired in transactions between two or more mutual
enterprises. Upon early adoption of this statement, the carrying amount of the
previously recognized unidentifiable intangible asset related to the Schuylkill
Savings branch acquisitions that was reclassified to goodwill was $202,000,
while the related 2002 amortization expense that was reversed was $81,000,
pre-tax. The Company will continue to review the remaining goodwill on an annual
basis for impairment. However, $10.9 million in core deposit intangible will
continue to be amortized and reviewed for impairment in accordance with SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Market for Registrant's Common Equity And Related Stockholder Matters
The Company’s common
stock is traded on the Nasdaq National Market under the symbol NEPF. At
September 30, 2002, the Company had 1,533 registered common stockholders of
record. The following table sets forth the range of high and low sales prices
for the common stock for the periods presented.
The closing market price of the common stock at September 30, 2002 was 14.75.
Stock Price Range
Low High Dividends
----- ------ -----------
2002 1st quarter 14.12 17.50 .11
2nd quarter 16.22 17.40 .11
3rd quarter 16.10 17.85 .12
4th quarter 14.55 16.19 .12
2001 1st quarter 10.63 12.25 .09
2nd quarter 11.68 12.70 .09
3rd quarter 12.03 12.75 .10
4th quarter 12.65 15.25 .10
Quarterly Financial Data (unaudited)
(In Thousands, Except Per Share Amount)
First Second(1) Third(1) Fourth
2002 Quarter Quarter Quarter Quarter
- ---- -------------------------------------------------------------------------------
Net Interest Income $6,392 $6,620 $6,428 $5,827
Provision for Loan Losses 388 290 1,292 796
Non-Interest Income 1,571 1,617 2,682 2,521
Non-Interest Expense 5,703 5,932 5,410 6,746
Net Income $1,278 $1,257 $1,578 $385
- ----------------------------------------------------------------------------------------------------------------------
Earnings Per Share
Basic $.29 $.31 $.39 $.12
Diluted $.28 $.29 $.37 $.11
- ----------------------------------------------------------------------------------------------------------------------
2001
- ----
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income $5,219 $5,504 $6,016 $6,277
Provision for Loan Losses - 391 623 667
Non-Interest Income 706 1,176 1,697 1,736
Non-Interest Expense 4,112 4,892 5,183 5,468
Net Income $1,291 $1,023 $1,256 $1,237
- ----------------------------------------------------------------------------------------------------------------------
Earnings Per Share
Basic $.28 $.21 $.27 $.28
Diluted $.27 $.21 $.26 $.27
Consolidated Statements of Financial Condition
September 30, 2002 and 2001
(in thousands, except share and per share data)
September 30, September 30,
2002 2001
---- ----
Assets
- ------
Cash and cash equivalents $25,302 $9,060
Securities available for sale 327,886 243,648
Securities held to maturity (estimated fair value of $3,707
in 2002 and $17,819 in 2001) 3,652 17,842
Loans (less allowance for loan losses of $5,449 for 2002 and $4,497 for 2001) 489,373 498,151
Accrued interest receivable 7,632 6,892
Assets acquired through foreclosure 547 390
Property and equipment, net 12,840 12,165
Goodwill 3,655 2,957
Intangible assets 9,093 9,355
Bank-owned life insurance 10,303 -
Other assets 7,759 8,370
----- -----
Total assets $898,042 $808,830
======== ========
Liabilities and Equity
- ----------------------
Deposits $604,966 $515,735
Federal Home Loan Bank advances 208,421 204,441
Other borrowings 4,630 5,990
Trust preferred debt 7,000 -
Advances from borrowers for taxes and insurance 852 646
Accrued interest payable 1,458 2,130
Other liabilities 2,330 4,051
----- -----
Total liabilities 829,657 732,993
Preferred stock ($.01 par value; 2,000,000 authorized shares; 0 shares issued) - -
Common stock ($.01 par value; 16,000,000 authorized shares;
6,427,350 shares issued) 64 64
Additional paid-in capital 62,047 62,142
Common stock acquired by stock benefit plans (4,156) (5,213)
Retained earnings - substantially restricted 38,672 36,136
Accumulated other comprehensive income, net 3,443 894
Treasury stock, at cost (2,301,566 shares for 2002 and 1,533,945
shares for 2001) (31,685) (18,186)
------ ------
Total equity 68,385 75,837
------ ------
Total liabilities and equity $898,042 $808,830
======== ========
See accompanying notes to consolidated financial statements
Consolidated Statements of Operations
For the Years Ended September 30, 2002, 2001 and 2000
(in thousands, except per share data)
2002 2001 2000
---- ---- ----
Interest Income:
Loans $38,931 $39,456 $31,165
Mortgage-related securities 8,701 5,852 3,693
Investment securities:
Taxable 5,679 7,249 7,184
Non-taxable 944 1,773 3,048
--- ----- -----
Total interest income 54,255 54,330 45,090
------ ------ ------
Interest expense:
Deposits 16,922 20,038 15,311
Federal Home Loan Bank advances and other borrowings 12,066 11,276 11,220
------ ------ ------
Total interest expense 28,988 31,314 26,531
------ ------ ------
Net interest income 25,267 23,016 18,559
Provision for loan losses 2,766 1,681 1,467
----- ----- -----
Net interest income after provision for loan losses 22,501 21,335 17,092
------ ------ ------
Non-interest income:
Service charges and other fees 2,177 1,678 1,246
Other income 787 43 328
Trust fee income 719 601 35
Insurance premium income 3,136 2,064 275
Gain (loss) on sale of:
Assets acquired through foreclosure (58) 42 (48)
Loans 1,343 586 24
Available-for-sale securities 308 333 37
Other (21) (32) (1)
---- ---- ---
Total non-interest income 8,391 5,315 1,896
Non-interest expense:
Salaries and net employee benefits 12,623 10,384 7,845
Occupancy costs 3,059 2,605 1,956
Amortization of goodwill and intangibles 1,008 1,151 363
Federal deposit insurance premiums 253 231 227
Data processing 697 718 610
Advertising 911 626 621
Professional fees 1,359 863 480
Federal Home Loan Bank and other service charges 990 835 670
Other 2,891 2,242 1,699
----- ----- -----
Total non-interest expense 23,791 19,655 14,471
Income before income taxes 7,101 6,995 4,517
Income tax expense 2,603 2,188 581
----- ----- ---
Net income $4,498 $4,807 $3,936
====== ====== ======
Earnings per share -basic $1.11 $1.03 $0.84
Earnings per share - diluted 1.05 1.02 0.81
See accompanying notes to consolidated financial statements
Consolidated Statements of Comprehensive Income
For the Years Ended September 30, 2002, 2001 and 2000
(in thousands)
2002 2001 2000
---- ---- ----
Net income $4,498 $4,807 $3,936
Other comprehensive income, net of tax
Unrealized gains (losses) on securities and on
retained interest on asset securitization:
Unrealized holding gains (losses) arising
during the period 2,752 4,825 (813)
Less: Reclassification adjustment for gains
included in net income 203 220 24
--- --- --
Other comprehensive income (loss) $2,549 $4,605 $(837)
------ ------ ------
Comprehensive income $7,047 $9,412 $3,099
====== ====== ======
See accompanying notes to consolidated financial statements
Consolidated Statements of Changes in Equity
For the Years Ended September 30, 2002, 2001, and 2000
(in thousands)
Common Stock Accumulated
Additional Acquired by Other
Common Paid In Stock Benefit Retained Comprehensive Treasury Total
Stock Capital Plans Earnings Income (Loss) Stock Equity
------ ---------- ------------- -------- ------------- --------- -------
Balance, September 30, 1999 $ 64 $ 62,119 $ (7,066) $ 30,818 $ (2,874) $ (7,585) $ 75,476
ESOP shares committed to be released 89 328 417
Stock awards (44) 517 473
Net changes in (losses) on
securities available for sale, net of tax (837) (837)
Treasury stock at cost, (507,534 shares) (4,943) (4,943)
Cash dividend paid (1,547) (1,547)
Net income 3,936 3,936
------ -------- -------- -------- -------- -------- --------
Balance, September 30, 2000 $ 64 $ 62,164 $ (6,221) $ 33,207 $ (3,711) $(12,528) $ 72,975
ESOP shares committed to be released 105 443 548
Stock awards (49) 565 516
Stock options exercised (32,808 shares) (204) 391 187
Net changes in gains on
securities available for sale, net of tax 4,605 4,605
Treasury stock at cost (647,604 shares) (8,423) (8,423)
Acquisition of Higgins Insurance
Agency (215,052 shares) 126 2,374 2,500
Cash dividend paid (1,878) (1,878)
Net income 4,807 4,807
------ -------- -------- -------- -------- -------- --------
Balance, September 30, 2001 $ 64 $ 62,142 $ (5,213) $ 36,136 $ 894 $(18,186) $ 75,837
ESOP shares committed to be released 243 515 758
Stock awards (46) 542 496
Stock compensation tax benefit 110 110
Stock options exercised (38,714 shares) (402) 826 424
Treasury stock reissuance (6,568 shares) 96 96
Net changes in gains on
securities available for sale, net of tax 2,439 2,439
Net change in gains on retained interest
on asset securitization, net of tax 110 110
Treasury stock at cost (812,903 shares) (14,421) (14,421)
Cash dividend paid (1,962) (1,962)
Net income 4,498 4,498
------ -------- -------- -------- -------- -------- --------
Balance, September 30, 2002 $ 64 $ 62,047 $ (4,156) $ 38,672 $ 3,443 $(31,685) $ 68,385
See accompanying notes to consolidated financial statements
Consolidated Statements of Cash Flows
For the Years Ended September 30, 2002, 2001 and 2000
(in thousands)
2002 2001 2000
---- ---- ----
Operating Activities:
Net Income $4,498 $4,807 $3,936
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Provision for foreclosed assets 132 124 100
Provision for loan losses 2,766 1,681 1,467
Depreciation 1,437 1,425 1,153
Amortization of goodwill and intangibles 1,008 1,151 363
Deferred income tax provision (benefit) 681 1,191 (362)
ESOP shares committed to be released 758 548 417
Stock award expense 496 516 473
Origination of loans held for sale (64,595) (9,273) (1,782)
Proceeds from loans sold 65,938 9,859 1,806
Amortization and accretion on:
Held-to-maturity securities (9) (4) (4)
Available-for-sale securities 1,419 (226) (2,337)
Amortization of deferred loan fees and mortgage servicing rights (653) (402) (159)
(Gain) loss on sale of:
Assets acquired through foreclosure 58 (42) 48
Loans (1,343) (586) (24)
Available-for-sale securities (308) (333) (37)
Loss on disposal of property and equipment 21 32 1
Changes in assets and liabilities:
Increase in accrued interest receivable (740) (1,491) (632)
Increase in other assets (3,556) (17,438) (3,189)
Increase (decrease) in accrued interest payable (672) (342) 1,155
Increase (decrease) in accrued income taxes payable (2,716) 511 (271)
Increase in other liabilities 1,061 1,810 832
----- ----- ---
Net cash provided by operating activities $5,681 $(6,482) $2,954
------ -------- ------
Investing Activities:
Net (increase) decrease in loans $5,327 $(85,045) $(52,837)
Proceeds from sale of:
Available-for-sale securities 31,243 80,719 56,412
Assets acquired through foreclosure 991 652 391
Proceeds from repayments of held-to-maturity securities 14,199 18,952 -
Proceeds from repayments of available-for-sale securities 85,738 34,792 9,404
Net cash proceeds from business acquisitions 104 3,218 -
Proceeds from disposal of fixed assets 1 37 18
Purchase of:
Held-to-maturity securities - (6,454) -
Available-for-sale securities (197,413) (182,091) (26,177)
Office properties and equipment (2,133) (3,781) (1,181)
Federal Home Loan Bank stock (800) (11,525) (6,274)
Bank-Owned Life Insurance (10,000) - -
------- --------- --------
Net cash used in investing activities $(72,743) $(150,526) $(20,244)
--------- ---------- ---------
See accompanying notes to consolidated financial statements
Consolidated Statements of Cash Flows
For the Years Ended September 30, 2002, 2001 and 2000
(in thousands)
2002 2001 2000
---- ---- ----
Financing Activities:
Net increase in deposit accounts $89,231 $96,064 $43,570
Net decrease in Federal Home Loan Bank (6,000) - (18,500)
short-term advances
Borrowings of Federal Home Loan Bank
long-term advances 10,000 124,100 30,000
Repayments of Federal Home Loan Bank long-term advances (20) (57,120) (30,019)
Net increase (decrease) in other borrowings (1,360) 4,336 1,248
Net increase (decrease) in advances from
borrowers for taxes and insurance 206 7 (401)
Proceeds from issuance trust-preferred securities 7,000 - -
Stock options exercised 424 187 -
Stock compensation tax benefit 110 - -
Stock issued for the purchase
of Higgins Insurance Agency - 2,500 -
Purchase of treasury stock (14,421) (8,423) (4,943)
Treasury stock reissuance 96 - -
Cash dividend on common stock (1,962) (1,878) (1,547)
------- ------- -------
Net cash provided by financing activities $83,304 $159,773 $19,408
------- -------- -------
Increase in cash and cash equivalents 16,242 2,765 2,118
Cash and cash equivalents, beginning of year 9,060 6,295 4,177
----- ----- -----
Cash and cash equivalents, end of year $25,302 $9,060 $6,295
======= ====== ======
Supplemental disclosures of cash flow information: Cash paid during the year for:
Interest $29,660 $31,656 $25,642
======= ======= =======
Income taxes $1,179 $1,288 $1,185
====== ====== ======
Supplemental disclosure - non-cash information:
Transfer from loans to asset acquired through foreclosure $1,206 $1,281 $614
====== ====== ====
Purchase of business acquisitions:
Loans 11,396 78,061 -
Securities - 16,674 -
Other assets 872 2,836 -
Deposits (13,017) (87,251) -
Advances - (11,500) -
Other liabilities 19 (692) -
Net change in unrealized gains (losses) on securities
available-for-sale, net of tax $2,549 $4,605 $(837)
====== ====== ======
See accompanying notes to consolidated financial statements
1. Summary of Significant Accounting Policies.
Business. Northeast Pennsylvania Financial Corp. (the "Company"), through its principal subsidiary, First Federal Bank (the "Bank")
provides a wide range of financial products and services to individual and corporate customers through its community offices in
Northeastern and Central Pennsylvania. All of the offices are full-service and offer commercial and retail products. These products
include checking accounts (interest and non-interest bearing), savings accounts, certificates of deposit, commercial and consumer
loans, real estate loans and home equity loans. The Bank also serves its loan customers through a loan production office located in
Monroe County, Pennsylvania. The Company is subject to competition from other financial institutions and other companies that
provide financial services. The Company is subject to the regulations of certain federal bank regulatory agencies and undergoes
periodic examinations by those regulatory authorities.
Principles of Consolidation and Presentation. The accompanying financial statements of the Company include the accounts of the Bank,
Abstractors, Inc., FIDACO, Inc., Northeast Pennsylvania Trust Co. (the "Trust Co." ) and Higgins Insurance Associates, Inc.
("Higgins"). The Bank, Abstractors, Inc., Northeast Pennsylvania Trust Co. and Higgins Insurance Agency are wholly-owned subsidiaries
of Northeast Pennsylvania Financial Corp. Abstractors, Inc. is a title insurance agency. Northeast Pennsylvania Trust Co. offers
trust, estate and asset management services and products. Higgins Insurance Agency provides insurance and investment products to
individuals and businesses. FIDACO, Inc. is an inactive subsidiary of the Bank with the only major asset being an investment in
Hazleton Community Development Corporation. Also, the Company has two trust subsidiaries established in connection with trust
preferred offerings. All material inter-company balances and transactions have been eliminated in consolidation. Prior period
amounts are reclassified, when necessary, to conform with the current year's presentation.
The Company follows accounting principles and reporting practices which are in accordance with
generally accepted accounting principles (“GAAP”). The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ significantly from
those estimates. Material estimates that are particularly susceptible to
significant change in the near-term relate to determination of the allowance for
loan losses, the evaluation of deferred taxes and the evaluation of other than
temporary impairment for certain investments.
Risks and Uncertainties. In the normal course of its business, the Company
encounters two significant types of risk: economic and regulatory. There are
three main components of economic risk: interest rate risk, credit risk and
market risk. The Company is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different speeds, or on
different bases from its interest-earning assets. The Company’s primary
credit risk is the risk of default on the Company’s loan portfolio that
results from the borrowers’ inability or unwillingness to make
contractually required payments. The Company’s lending activities are
concentrated in Pennsylvania. The largest concentration of the Company’s
loan portfolio is located in Northeastern Pennsylvania. The ability of the
Company’s borrowers to repay amounts owed is dependent on several factors,
including the economic conditions in the borrowers’ geographic regions and
the borrowers’ financial conditions. Market risk reflects changes in the
value of the collateral underlying loans, the valuation of real estate held by
the Company, and the valuation of loans held for sale, securities, mortgage
servicing assets and other investments.
The Bank is subject to the
regulations of various government agencies. These regulations can and do change
significantly from period to period. The Bank also undergoes periodic
examinations by the regulatory agencies which may subject it to further changes
with respect to asset valuations, amounts of required loss allowances and
operating restrictions resulting from the regulators’ judgments based on
information available to them at the time of their examination.
Cash and Cash Equivalents. For the purpose of the consolidated statement of
cash flows, cash and cash equivalents include cash and interest-bearing deposits
with an original maturity of three months or less.
Securities. The Company divides its securities portfolio into two segments: (a) held to maturity
and (b) available for sale. Securities in the held-to -maturity category are
accounted for at cost, adjusted for amortization of premiums and accretion of
discounts, using the level yield method, based on the Company’s intent and
ability to hold the securities until maturity. All other securities are included
in the available-for-sale category and are accounted for at fair value, with
unrealized gains or losses, net of taxes, being reflected as adjustments to
equity.
At the time of purchase,
the Company makes a determination as to whether or not it will hold the
securities to maturity, based upon an evaluation of the probability of future
events. Securities which the Company believes may be involved in interest rate
risk, liquidity or other asset/liability management decisions, which might
reasonably result in such securities not being held to maturity, are classified
as available for sale. If securities are sold, a gain or loss is determined by
specific identification and reflected in the operating results in the period the
trade occurs.
Other Investment. The Company has a $1.5 million investment in the preferred
stock of Buildersfirst Holdings, Inc. Since the investment does not have a
readily determinable market value, the Company is not accounting for the
investment under SFAS No. 115. The accounting for this security was initially
guided by EITF Topic No. D-68, EITF Topic No. 98-13 and EITF Topic No. 99-10,
which, in essence, provide that investee losses should be absorbed by
investments in other securities once an investee’s common equity has been
exceeded by net losses. However, during the Company’s 2001 third fiscal
quarter the investee issued additional equity and entered into certain other
business relationships which reduced the Company’s influence over the
investee and resulted in the Company prospectively utilizing the cost method of
accounting for its remaining investment in Buildersfirst Holdings, Inc.
Allowance for Loan Losses. The allowance for loan
losses is maintained at a level representing management’s best estimate of
known and inherent losses in the portfolio, based upon management’s
evaluation of the portfolio’s collectibility. Management’s evaluation
is based upon an analysis of the portfolio, past loss experience, current
economic conditions and other relevant factors. While management uses the best
information available to make evaluations, such evaluations are highly
subjective, and future adjustments to the allowance may be necessary if
conditions differ substantially from the assumptions used in making the
evaluations. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company’s allowance for
losses on loans. Such agencies may require the Company to recognize additions to
the allowance, based on their judgments about information available to them at
the time of their examination. The allowance is increased by the provision for
loan losses, which is charged to operations. Loan losses are charged directly
against the allowance, and recoveries on previously charged-off loans are added
to the allowance.
Loans are deemed to be “impaired” if upon
management’s assessment of the relevant facts and circumstances, it is
probable that the Company will be unable to collect all proceeds due according
to the
contractual terms of the loan agreement. For purposes of applying the measurement criteria
for impaired loans, the Company excludes large groups of smaller balance
homogeneous loans, primarily consisting of residential real estate and consumer
loans, as well as commercial loans with balances of less than $100,000.
The Company's policy for the recognition of interest income on impaired loans is the same as for non-accrual loans discussed below.
Impaired loans are charged off when the Company determines that foreclosure is probable, and the fair value
of the collateral is less than the recorded investment of the impaired loan or
in the case of unsecured loans, management determines the loan to be
uncollectable.
Loans, Loan Origination Fees, and Uncollected Interest.
Loans are recorded at cost, net of unearned discounts, deferred fees and
allowances. Discounts or premiums on purchased loans are amortized using the
interest method over the remaining contractual life of the portfolio, adjusted
for actual prepayments. Loan origination fees and certain direct origination
costs are deferred and amortized using the level yield method over the
contractual life of the related loans as an adjustment of the yield on the
loans. Uncollected interest receivable on loans is accrued to income as earned.
Non-accrual loans are loans on which the accrual of interest has ceased because
the collection of principal or interest payments is determined to be doubtful by
management. It is the policy of the Bank to discontinue the accrual of interest
when principal or interest payments are delinquent 90 days or more (unless the
loan principal and interest are determined by management to be fully secured and
in the process of collection), or earlier if the financial condition of the
borrower raises significant concern with regard to the ability of the borrower
to service the debt in accordance with the terms of the loan. Interest income on
such loans is not accrued until the financial condition and payment record of
the borrower demonstrates the ability to service the debt.
Loan Securitization. In June 2002 the Bank sold auto loan receivables through
a securitization transaction. A transfer of financial assets in which the
transferor surrenders control over those assets is accounted for as a sale to
the extent that consideration, other than beneficial interests in the
transferred assets, is received in exchange. Liabilities and derivatives
incurred or obtained by transferors as part of a transfer of financial assets
are initially measured at fair value, if practicable. Servicing assets and other
retained interests in the transferred assets are measured by allocating the
previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfer.
The Company allocates the previous carrying amount of the securitized auto loan receivables plus any other
transferred assets between the assets sold and the retained interests
(principally an interest-only strip net of a recourse obligation (the
“Interest–Only Strip”) and a cash reserve), based on their
relative estimated fair values at the date of sale. A gain is recognized at the
time of sale equal to the excess of the fair value of the assets obtained
(principally cash) over the allocated fair value of the assets sold.
Over the term of the
securitized assets, securitization income includes the yield of the retained
interests, which includes certain fees from the underlying assets as well as
contractual servicing fees resulting from the Company’s right to service
the underlying assets.
Due to prepayment risk, the
retained interest-only strips are measured like available-for-sale securities.
Accordingly, the retained interest-only strips are reported at their fair value,
which at September 30, 2002, approximates the net carrying amount of such assets
Unrealized holding gains or losses on the retained interest-only strips, if any,
are excluded from earnings and reported, net of taxes, as a separate component
of shareholders’ equity, except that, if a decline in fair value is judged
to be other than temporary, such a decline is accounted for as a realized loss
and is presented as a reduction of securitization income in the accompanying
consolidated statement of operations.
The Company estimates the
fair value of the retained interest-only strip at the date of the transfer based
on a discounted cash flow analysis. The cash flows of the retained interest-only
strip are estimated as the excess of the cash inflows of the loans sold over the
sum of the pass-through interest rate (weighted average of 3.6% as of September
30, 2002) plus the servicing fee, a trustee fee, credit enhancement costs and an
estimate of future credit losses over the life of the loans. These cash flows
are estimated over the life of the loans using prepayment, default and interest
rate assumptions that market participants would use for financial instruments
subject to similar levels of prepayment, credit and interest rate risk.
The cash reserve account is
not subject to prepayment risk and is initially recorded at the allocated
carrying amount based on its fair value as estimated by management at the date
of transfer using the “cash-out” method.
Management discounts the
net cash flows of the retained interest-only strips and cash reserve accounts at
the date of the securitization transaction at interest rates that management
believes a purchaser unrelated to the seller of such a financial instrument
would demand. The discount on the cash reserve account is accreted and recorded
in the results of operations.
Loans Held for Sale. Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated fair value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income. Loans held for sale in the amounts of $2.8 million and $0 as of
September 30, 2002 and 2001, respectively, were included in total loans.
Mortgage Servicing Rights. Upon the sale of a mortgage loan where the
Company retains servicing rights, a mortgage servicing right is recorded which
is included in other assets on the statement of financial condition. Mortgage
servicing rights are amortized into income over the average life of the loans
sold using the level yield method of amortization. Such assets are subject of
disaggregated impairment tests.
Assets Acquired Through Foreclosure. Real estate acquired through
foreclosure and other repossessed collateral or by deed in lieu of foreclosure
is classified as assets acquired through foreclosure. Assets acquired through
foreclosure are carried at the lower of cost or fair value less selling
expenses. Costs relating to the development or improvement of the property are
capitalized; holding costs are charged to expense.
Property and Equipment. Property and equipment are stated at cost less accumulated
depreciation. Depreciation for each class of depreciable asset is computed using
the straight-line method over the estimated useful lives of the assets
(generally 39 years for buildings and 3 to 7 years for furniture and equipment).
When assets are retired, or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts. The cost of maintenance
and repairs is charged to expense as incurred and renewals and betterments are
capitalized . Leasehold improvements are depreciated using the straight line
method over the shorter of the useful life of the improvement or the remaining
life of the lease.
Intangible Assets. Intangible assets include core deposit intangibles and certain
other deferrable acquisition costs. The core deposit intangibles are being
amortized to expense over a 10- to 31-year life on an accelerated basis and
other intangible assets are being amortized to expense on an accelerated basis
over a period of 3.7- to 5 years. The recoverability of the carrying value of
intangible assets is evaluated on an ongoing basis, and permanent declines in
value, if any, are charged to expense.
Goodwill. Goodwill is the excess of cost over the fair value of assets acquired in connection with business acquisitions and was
being amortized on the straight-line method over 5, 6 and 20 years, prior to October 1, 2001. On October 1, 2001, the Company adopted
SFAS No. 142, Goodwill and Other Intangible Assets, which changed the accounting for goodwill from an amortization method to an
impairment-only approach. This statement eliminates the regularly scheduled amortization of goodwill
and replaces this method
with a two-step process for testing the impairment of goodwill on at least an
annual basis. This approach could cause more volatility in the Company’s
reported net income because impairment losses, if any, could occur irregularly
and in varying amounts. The Company, upon adoption of this Statement, stopped
amortizing existing goodwill of $3.0 million. In addition, the Company performed
its initial impairment analysis of goodwill and other intangible assets and
determined that the estimated fair value exceeded the carrying amount.
Income Taxes. The Company accounts for income taxes under the asset/liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, as well as
operating loss and tax credit carryforwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is established against deferred tax assets when in the
judgment of management, it is more likely than not that such deferred tax assets
will not become available. Because the judgment about the level of future
taxable income is dependent to a great extent on matters that may, at least in
part be beyond the Bank’s control, it is at least reasonably possible that
management’s judgment about the need for a valuation allowance for deferred
taxes could change in the near term.
Retained earnings at
September 30, 2002 and 2001 include approximately $10.3 million and $10.2
million, respectively, for which no provision for Federal income tax has been
made. These amounts represent allocations of earnings to bad debt reserves for
tax purposes and are a restriction upon retained earnings. If, in the future,
this portion of retained earnings is reduced for any purpose other than tax bad
debt losses, Federal income taxes may be imposed at the then-applicable rates.
Earnings per Share. Earnings per share, basic and diluted,
were $1.11 and $1.05, respectively for the year ended September 30, 2002, $1.03
and $1.02, respectively, for the year ended September 30, 2001, and $.84 and
$.81, respectively, for the year ended September 30, 2000.
The Company provides dual
presentation of basic and diluted earnings per share. Basic earnings per share
is calculated utilizing net income as reported in the numerator and average
shares outstanding in the denominator. The computation of diluted earnings per
share differs in that the dilutive effects of any stock options, warrants, and
convertible securities are adjusted in the denominator.
The following table presents the reconciliation of the numerators and denominators of the basic and diluted EPS computations:
For the Year Ended For the Year Ended For the Year Ended
September 30, September 30, September 30,
Basic: 2002 2001 2000
---- ---- ----
Net Income $4,497,678 $4,806,942 $3,935,652
========== ========== ==========
Weighted average shares outstanding 3,834,673 4,498,966 4,551,672
Plus: ESOP shares released or committed
to be released 214,426 167,113 115,694
------- ------- ---------
Basic weighted-average shares outstanding 4,049,099 4,666,079 4,667,366
========= ========= =========
Earnings per share - basic $1.11 $1.03 $.84
===== ===== ====
Diluted(1):
Net Income $4,497,678 $4,806,942 $3,935,652
========== ========== ==========
Basic weighted-average shares outstanding 4,049,099 4,666,079 4,667,366
Dilutive Instruments:
Dilutive effect of outstanding stock options 193,699 45,160 11
Dilutive effect of stock awards 24,808 8,931 193,869
------ ----- ---------
Diluted weighted-average shares outstanding 4,267,606 4,720,170 4,861,246
========= ========= =========
Earnings per share - diluted(1) $1.05 $1.02 $.81
===== ===== ====
(1) Diluted earnings per share include the dilutive effect of the Company's weighted-average stock options/awards outstanding
using the Treasury Stock method.
The company had 8,735;
9,600; and 4,100 anti-dilutive common stock options outstanding as of September
30, 2002, 2001 and 2000, respectively. These options are not included in the
calculation of diluted earnings per share for the periods presented.
Comprehensive Income. The Company is required to present comprehensive income in a full
set of general purpose financial statements for all periods presented. Other
comprehensive income is comprised of unrealized holding gains (losses) on the
available for sale securities portfolio and on retained interest on asset
securitization. The Company has elected to report the effects of other
comprehensive income as part of the Consolidated Statement of Changes in Equity.
Stock Options. The Company maintains stock option plans for officers,
employees, and directors. When the exercise price of the Company’s stock
options is greater than or equal to the market price of the underlying stock on
the date of the grant, no compensation expense is recognized in the
Company’s financial statements. Pro forma net income and earnings per share
are presented to reflect the impact of the stock option plan assuming
compensation expense had been recognized based on the fair value of the stock
options granted under the plan.
Reclassification of Comparative Amounts. Certain comparative amounts for the
prior year have been reclassified to conform to current year classifications.
Such reclassifications had no effect on net income or stockholders’ equity.
2. Securities.
Securities are summarized as follows:
SEPTEMBER 30, 2002
------------------
(in thousands)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
Available-for-sale securities:
Municipal securities $16,247 $197 $- $16,444
Obligations of U.S. Government agencies 24,032 414 - 24,446
Mortgage-related securities 221,383 4,047 (143) 225,287
Trust Preferred securities 12,604 336 (511) 12,429
Corporate Bonds 32,545 1,442 (18) 33,969
------ ----- --- ------
Total debt securities 306,811 6,436 (672) 312,575
FHLB Stock 10,971 - - 10,971
Freddie Mac Stock 2,241 151 (324) 2,068
Fannie Mae Stock 2,000 100 (108) 1,992
Other equity securities 284 24 (28) 280
--- -- --- ---
Total equity securities 15,496 275 (460) 15,311
Total $322,307 $6,711 $(1,132) $327,886
======== ====== ======= ========
Held-to-maturity securities:
Certificates of Deposit $99 $ - $ - $99
Municipal securities 3,553 55 - 3,608
----- -----
Total $3,652 $55 $ - $3,707
====== ===== ==== ======
SEPTEMBER 30, 2001
------------------
(in thousands)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
Available-for-sale securities:
Municipal securities $23,030 $42 $(532) $22,540
Obligations of U.S. Government agencies 14,471 134 - 14,605
Mortgage-related securities 136,257 2,294 (84) 138,467
Trust Preferred securities 13,701 - (1,723) 11,978
Corporate Bonds 40,688 1,337 (31) 41,994
------ ----- --- ------
Total debt securities 228,147 3,807 (2,370) 229,584
FHLB Stock 10,222 - - 10,222
Freddie Mac Stock 1,613 37 (58) 1,592
Fannie Mae Stock 2,000 4 (5) 1,999
Other equity securities 206 50 (5) 251
--- -- -- ---
Total equity securities 14,041 91 (68) 14,064
Total $242,188 $3,898 $(2,438) $243,648
======== ====== ======== ========
Held-to-maturity securities:
Municipal securities $3,552 $- $(127) $3,425
Obligations of U.S. government agencies 13,992 106 (2) 14,096
Certificates of Deposit 298 - - 298
--- - - ---
Total $17,842 $106 $(129) $17,819
======= ==== ====== =======
The amortized cost and estimated fair value of debt securities by contractual maturity:
September 30, 2002
------------------
(in thousands)
Maturing Maturing after Maturing after Maturing
within one one year but 5 years but after 10
year within 5 years within 10 years years Total
---------- -------------- --------------- -------- -----
Available-for-sale debt securities:
Municipal securities $- $- $- $16,247 $16,247
Obligations of U.S. Government agencies 1,000 14,411 5,999 2,622 24,032
Mortgage-related securities 28,665 2,252 14,211 176,255 221,383
Trust Preferred securities - - - 12,604 12,604
Corporate Bonds 6,980 21,616 3,949 - 32,545
------- ------- ------- -------- --------
Total debt securities at amortized cost $36,645 $38,279 $24,159 $207,728 $306,811
======= ======= ======= ======== ========
Total debt securities at fair value $36,821 $39,705 $24,901 $211,148 $312,575
======= ======= ======= ======== ========
Weighted-Average Yield 3.89% 5.22% 5.33% 4.91% 4.86%
Held-to-maturity debt securities:
Municipal securities $- $- $- $3,553 $3,553
Certificates of Deposit 99 - - - 99
Total debt securities at amortized cost $99 $- $- $3,553 $3,652
=== == == ====== ======
Total debt securities at fair value $99 $- $- $3,608 $3,707
=== == == ====== ======
Weighted Average Yield 7.08% - - 4.64% 4.71%
Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties. Weighted
average yields are based on amortized cost including municipal securities which
are not reported on a tax-equivalent basis.
Proceeds from sales of securities available for sale during the year ended September 30, 2002 were
$31.2 million resulting in gross realized gains of $513,000 and gross realized
losses of $205,000. Proceeds from sales of securities available for sale during
the year ended September 30, 2001 were $80.7 million resulting in gross realized
gains of $978,000 and gross realized losses of $646,000. Proceeds from sales of
securities available for sale during the year ended September 30, 2000 were
$56.4 million resulting in gross realized gains of $2.3 million and gross
realized losses of $2.2 million.
Securities classified as
agencies and mortgage-related securities, with an amortized cost of $114.2
million and a fair value of approximately $117.1 million at September 30, 2002,
were pledged to secure public deposits as required by law.
3. Loans
Loans are summarized as follows:
At September 30,
----------------
(in thousands)
2002 2001
---- ----
Real Estate loans:
One- to four-family $198,307 $220,796
Multi-family and commercial 75,912 65,095
Construction 7,157 13,690
----- ------
Total real estate loans 281,376 299,581
------- -------
Consumer Loans:
Home equity loans and lines of credit 79,253 79,840
Automobile 80,035 78,307
Education - 2,846
Unsecured lines of credit 2,297 1,884
Other 10,376 10,288
------ ------
Total consumer loans 171,961 173,165
------- -------
Commercial loans 43,014 31,588
------ ------
Total loans 496,351 504,334
Less:
Allowance for loan losses (5,449) (4,497)
Deferred loan origination fees (1,529) (1,686)
------- -------
Total loans, net $489,373 $498,151
======== ========
At September 30, 2002, the
Company had a $7.8 million recorded investment in impaired loans, each of which
had specific loan loss allowances totaling $1.6 million. At September 30, 2001,
there was $9.6 million of impaired loans, each of which had specific loan loss
allowances totaling $1.4 million. The average net recorded investment in
impaired loans for the years ended September 30, 2002, 2001 and 2000 was $5.6
million, $1.9 million and $1.1 million, respectively. The related amount of
interest income recognized on impaired loans was $375,000, $201,000 and $257,000
for the years ended September 30, 2002, 2001 and 2000, respectively.
Non-accrual
loans totaled $4.2 million, $ 5.1 million and $1.6 million at September 30,
2002, 2001 and 2000, respectively. There were $55,000, $60,000 and $0 in
troubled debt restructuring loans at September 30, 2002, 2001and 2000,
respectively. The Bank has no commitments to lend additional funds to borrowers
whose loans were classified as non-performing or troubled debt restructuring.
The activity in the allowance for loan losses is as follows:
September 30,
--------------
(in thousands)
2002 2001 2000
---- ---- ----
Balance, beginning $4,497 $4,162 $2,924
Additional allowance from
acquisition of Security - 817 -
Provision charged to income 2,766 1,681 1,467
Charge-offs (1,993) (2,187) (247)
Recoveries 179 24 18
--- -- --
Balance, ending $5,449 $4,497 $4,162
====== ====== ======
An analysis of the activity of loans to directors and executive officers is as follows:
September 30,
(in thousands)
2002 2001
---- ----
Balance, beginning of year $2,277 $1,903
New loans and line of credit advances 803 572
Repayments (928) (198)
----- -----
Balance end of year $2,152 $2,277
====== ======
4. Mortgage Servicing Activity
A summary of mortgage servicing rights activity follows:
Years Ended September 30,
--------------------------
(in thousands)
2002 2001 2000
---- ---- ----
Balance, beginning of year $493 $251 $303
Originated servicing rights 143 352 7
Amortization (171) (110) (59)
----- ----- ----
Balance, end of year $465 $493 $251
==== ==== ====
At September 30, 2002, 2001 and 2000, the Bank serviced loans for others of $67.2 million, $65.7 million and $37.4 million, respectively. Loans serviced by others for the Bank as of September 30, 2002, 2001 and 2000 were $31.5 million, $55.5 million and $64.2 million, respectively.
5. Office Properties and Equipment
Properties and equipment by major classification are summarized as follows:
September 30,
-------------
(in thousands)
2002 2001
---- ----
Land $2,083 $1,992
Buildings and improvements 11,215 10,440
Furniture, fixtures and equipment 8,511 7,370
Leasehold improvements 934 900
--- ---
Total $22,743 $20,702
Less accumulated depreciation 9,903 8,537
----- -----
Net $12,840 $12,165
======= =======
The Company has entered into operating leases for several of its branch facilities and operating departments. The minimum annual rental payments under these leases at September 30, 2002 are as follows:
Years Ending September 30,
--------------------------
2002 $255,961
2003 159,024
2004 65,794
2005 25,010
2006 20,820
2007 and after 55,520
------
Total $582,129
========
Rent expense was $312,000, $290,000 and $235,000 for the years ended September 30, 2002, 2001 and 2000, respectively.
6. Asset Securitization. In June 2002, the Bank sold automobile loan receivables through a securitization transaction. In the
transaction, automobile loan receivables were transferred to an independent trust (the "Trust") that issued certificates representing
ownership interests in the Trust, primarily to institutional investors. Although the Bank continues to service the underlying
accounts and maintain the customer relationships, this transaction is treated as a sale for financial reporting purposes to the
extent of the investors' interest in the Trust. Accordingly, the receivables associated with the investors' interests are not
reflected on the balance sheet. In connection with this transaction, the Bank enhanced the credit protection of the
certificateholders by funding a cash reserve account.
In connection with this
June 2002 transaction, the Bank recorded a pre-tax gain on the sale of auto
loans of $854,000, which is included in gain on sale of loans in the
consolidated statement of operations. The Bank has recognized a retained
interest related to the loan sale, which, in aggregate, totaled $3.2 million at
September 30, 2002. The retained interests include an Interest-Only Strip and
cash reserve account. The cash reserve account is subject to liens by the
providers of the credit enhancement facilities for the securitizations.
The key assumptions used in measuring the fair value of the retained interest and cash collateral account for the transaction is shown in the following table:
Retained interest
Average annual repayment rate 5.0%
Average annual expected default rate 5.0%
Discount rate 8.0%
Weighted average life of underlying automobile
loans 45 months
The key economic assumptions and the sensitivity of the fair value of the retained interest asset to an immediate adverse change of 10% and 20% to those assumptions are as follows for the period indicated:
September 30, 2002
------------------
(dollars in thousands)
Fair value of retained interest $ 3,170
Weighted-average repayment rate assumption:
Pre-tax decrease to earnings due to a 10% adverse change $ 59
Pre-tax decrease to earnings due to a 20% adverse change $ 108
Weighted-average expected default rate:
Pre-tax decrease to earnings due to a 10% adverse change $ 77
Pre-tax decrease to earnings due to a 20% adverse change $ 153
Weighted-average discount rate:
Pre-tax decrease to earnings due to a 10% adverse change $ 7
Pre-tax decrease to earnings due to a 20% adverse change $ 154
As of September 30, 2002,
the weighted-average life (in years) of the underlying auto loans in the Trust
was 45 months. The terms of the transaction included provisions related to the
performance of the underlying receivables and other specific conditions that
could result in an early payout of invested amounts to the certificateholders.
Changes in fair value based
on a 10% adverse variation in assumptions generally cannot be extrapolated
because the relationship of the change in assumption to the change in fair value
may not be linear. Also, the effect of an adverse variation on a particular
assumption on the fair value of the retained interest is calculated without
changing any other assumption. However, changes in one factor may result in
changes in another (for example, increases in market interest rates may result
in lower prepayments and increased credit losses), which might magnify or
counteract the sensitivities.
7. Deposits
Deposits consist of the following major classifications:
At September 30,
---------------------------
(in thousands)
2002 2001
---- ----
Weighted- Weighted-
Average Percent of Average Percent of
Rate Amount Total Rate Amount Total
--------- ------ ---------- --------- ------ ----------
Savings accounts
(passbook, statement, clubs) 1.01% $95,779 15.83% 1.31% $89,936 17.44%
Money market accounts 2.77 100,274 16.58 2.88 40,185 7.79
Certificates of deposit
less than $100,000 4.20 227,868 37.66 5.40 218,811 42.42
Certificates of deposit
greater than $100,000 (A) 4.20 71,379 11.80 5.40 83,682 16.23
NOW Accounts 1.49 77,238 12.77 2.03 58,829 11.41
Non-interest-bearing deposits - 32,428 5.36 - 24,292 4.71
- ------ ---- - ------ ----
Total deposits at end of period 2.96% $604,966 100.00% 4.08% $515,735 100.00%
==== ======== ======= ===== ======== =======
(A) Deposit balances in excess of $100,000 are not Federally insured.
The certificates of deposit frequently are renewed at maturity rather than paid out; a summary of certificates by contractual maturity at September 30, 2002 is as follows:
Years Ending September 30,
--------------------------
(in thousands)
--------------
Amount
2003 $143,075
2004 45,152
2005 12,560
2006 94,789
2007 3,398
2008 and after 273
---
Total $299,247
========
Interest expense on deposits is comprised of the following:
Years Ended September 30,
-------------------------
(in thousands)
2002 2001 2000
---- ---- ----
Savings accounts $1,141 $1,796 $1,463
Money market accounts 1,436 1,430 954
Certificates less than $100,000 11,261 12,515 10,299
Certificates greater than $100,000 2,063 3,808 2,269
NOW Accounts 1,021 489 326
----- --- ---
Total $16,922 $20,038 $15,311
======= ======= =======
8. Federal Home Loan Bank Advances
Under terms of its
collateral agreement with the Federal Home Loan Bank of Pittsburgh
(“FHLB”), the Bank maintains otherwise unencumbered qualifying assets
(principally one-to-four family residential mortgage loans and U.S. Government
and Agency notes and bonds) in the amount of at least as much as its advances
from the FHLB. The Bank’s FHLB stock is also pledged to secure these
advances. At September 30, 2002 and 2001, such advances mature as follows:
Due by September 30, Weighted-Average Rate September 30, 2002
-----------------------------------------------------------------------------------------
(in thousands)
2003 5.66% $59,089
2004 6.43 50,000
2005 5.28 44,000
2006 4.87 5,332
2007 4.89 10,000
Thereafter 5.42 40,000
---- --------
Total FHLB advances 5.66% $208,421
===== ========
Due by September 30, Weighted-Average Rate September 30, 2001
--------------------- --------------------- ------------------
(in thousands)
2002 3.56% $6,000
2003 - -
2004 5.64 58,094
2005 6.43 50,000
2006 5.36 40,000
Thereafter 5.29 50,347
---- ------
Total FHLB advances 5.63% $204,441
===== =======
The Bank has included in
the preceding tables annually renewable lines of credit totaling $75.0 million.
The Bank, from time to time, has used the lines of credit to meet liquidity
needs. At September 30, 2001, the balance outstanding on the line of credit was
$6.0 million with an interest rate at the overnight FHLB borrowing rate of
3.56%. There were no such borrowings outstanding at September 30, 2002.
At September 30, 2002, the
Bank had outstanding advances from the FHLB of $140.0 million which have
callable features. The advances have a fixed rate for a specified period of time
after which the FHLB can, at its option, convert the advance to a variable rate.
The Bank, at the same time, can repay the advance penalty free.
9. Trust Preferred Debt.On March 25, 2002, the Company sponsored the creation of NEP Capital Trust I, a Delaware statutory
business trust. The Company is the owner of all of the common securities of the Trust. On April 10, 2002, the Trust issued $7.0
million of floating rate capital securities through to a pooled investment vehicle. The proceeds from this issuance, along with the
Company's $217,000 capital contribution for the Trust's common securities, were used to acquire $7.2 million aggregate principal
amount of the Company's floating rate junior subordinated deferrable interest debentures due April 22, 2032 (the "Debentures"), which
constitute the sole asset of the Trust. The interest rate on the Debentures and the capital securities is variable and adjustable
semi-annually at 3.70% over the six-month LIBOR, with an initial rate of 6.02%. The Company has, through the Trust agreement
establishing the Trust, the guarantee agreement, the notes and the related Indenture, taken together, fully irrevocably and
unconditionally guaranteed all of the trust's obligations under the capital securities.
In addition, the Debentures
are subject to redemption at par at the option of the Company, subject to prior
regulatory approval, in whole or in part on any interest payment date after
April 22, 2007. The Debentures are also subject to redemption prior to April 22,
2007 after the occurrence of certain events that would either have a negative
tax effect on the Trust or the Company or would result in the trust being
treated as an investment company that is required to be registered under the
Investment Company Act of 1940. Upon repayment of the Debentures at their stated
maturity or following their redemption, the Trust will use the proceeds of such
repayment to redeem an equivalent amount of outstanding trust preferred
securities and trust common securities. Furthermore in 2002, the Company
recognized an amortizable intangible asset with a value of $220,000 relating to
the issuance of trust preferred securities.
10. Income Taxes
The Small Business Job
Protection Act of 1996, enacted August 20, 1996, repealed the tax bad debt
deduction computed under the percentage of taxable income method. Upon repeal,
the Bank was required to recapture into income, over a six-year period, the
portion of its tax bad debt reserves that exceeded its base year reserves (i.e.,
tax reserves for tax years beginning before 1988). The base year tax reserves,
which may be subject to recapture if the Bank ceases to qualify as a savings
bank for Federal income tax purposes, are restricted with respect to certain
distributions. The Bank’s total tax bad debt reserves at September 30, 2002
were approximately $10.4 million, of which $10.3 million represented the base
year amount and $172,000 was subject to recapture. The Bank had previously
recorded a deferred tax liability for the amount to be recaptured; therefore,
this recapture did not impact the statement of operations.
The provision for income taxes is summarized as follows:
Year Ended September 30,
-----------------------
(in thousands)
2002 2001 2000
---- ---- ----
Current:
Federal $1,504 $739 $769
State 418 258 174
Deferred - Federal 681 1,191 (362)
--- ----- -----
Total $2,603 $2,188 $581
====== ===== ===
The provision for income taxes differs from the statutory rate due to the following:
Year Ended September 30,
------------------------
(in thousands)
2002 2001 2000
---- ---- ----
Federal income tax at
statutory rate $2,414 $2,378 $1,536
Tax exempt interest, net (420) (689) (1,003)
State taxes, net of Federal benefit 276 170 115
Excess ESOP compensation expense 35 - (69)
Bank-owned life insurance (99)
Other, net (12) (6) (148)
Increase in valuation allowance for
deferred tax assets 409 335 150
--- --- ---
Total $2,603 $2,188 $581
====== ===== ===
The components of the net deferred tax liability (asset) are as follows:
September 30,
-------------
(in thousands)
2002 2001
---- ----
Deferred tax assets:
ESOP funding difference $(132) $(132)
Recognition and retention plan (154) (146)
Deferred compensation (375) (282)
Accrued hospitalization (20) (50)
Charitable contributions (1,177) (1,289)
Book bad debt reserves - loans (1,922) (1,623)
Intangibles amortization (186) (148)
Investment writedown (174) (174)
AMT credit carryforward (30) (227)
Net operating loss carryover (55) (486)
Purchase accounting adjustment-loans (270) (481)
Consulting agreements - (16)
Capital loss carryover (78) -
---- -
Gross deferred tax assets $(4,573) $(5,054)
-------- --------
Valuation allowance $894 $485
---- ----
Net deferred tax asset $(3,679) $(4,569)
-------- --------
Deferred tax liabilities:
Depreciation $121 $134
Accretion 183 95
Tax bad debt reserves in excess of base year 58 117
Title plant 26 26
Loan fees and costs 34 13
Unrealized gain on available-for-sale 2,170 566
securities
Purchase accounting adjustment-deposits 2,597 2,843
----- -----
5,189 3,794
Net deferred tax liability (asset) $1,510 $(775)
====== ======
Deferred income taxes
reflect the net tax-effect of temporary differences between the carrying amount
of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Based on the Company’s history of prior operating
earnings and its expectation of the future, management believes that taxable
income will more likely than not be to realize all of the Company’s gross
deferred tax assets at September 30, 2002 and 2001. Valuation allowance of
$409,000 and $335,000 were established during the years ended September 30, 2002
and September 30, 2001, respectively, to offset a portion of the charitable
contribution carryforward that management believes may not be realizable. Such
charitable contribution carryover will expire on September 30, 2003, if not
utilized.
On November 10, 2000, the
Company acquired Security of Pennsylvania Financial Corporation and its
wholly-owned subsidiary, Security Savings Association of Hazleton
(“Security Savings”), in a tax-free acquisition. As a result of this
acquisition, the Company recorded various net deferred tax liabilities
associated with various purchase accounting adjustments. In addition, for
Federal income tax purposes, the Company has approximately $163,000 of net
operating loss carryforwards resulting in a deferred tax asset of $55,000 as of
September 30, 2002. The net operating loss will begin to expire after the year
ended September 30, 2020 if not utilized.
11. Stock Option Plan
The Company maintains a
stock-based incentive plan (“the 1998 Plan”) for officers, directors
and certain employees of the Company and its subsidiaries. Pursuant to the terms
of the 1998 Plan, the number of common shares reserved for the issuance of
options was 642,735. All options were issued at not less than fair market value
at the date of grant and expire in 10 years from date of grant. The majority of stock options granted vest over a five year period from the date of
grant. In January 2000, the Company adopted the 2000 Stock Option Plan
(“the 2000 Plan”). The 2000 Plan reserved an additional 173,624 shares
for issuance under terms similar to the 1998 Plan. At September 30, 2002, 89,517
shares subject to option remain available for grant under the 2000 Plan.
A summary of the status of
the Company’s outstanding stock option plans as of September 30, 2002, 2001
and 2000 and changes during the years then ended is presented below:
2002 2001 2000
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------ -------------- ------ -------------- ------ --------------
Stock Options:
Outstanding at beginning of year 718,189 $11.42 632,382 $9.98 618,355 $11.68
Options exchanged in conjunction
with Security Savings acquisition - - 39,240 5.71 - -
Granted 15,085 16.44 117,095 12.97 18,510 10.52
Forfeited (7,600) 11.75 (37,720) 10.66 (4,483) 9.78
Exercised (38,714) $10.73 (32,808) 5.71 - -
-------- ------ -------- ---- ------- ------
Outstanding at end of year 686,960 $11.88 718,189 $11.42 632,382 $9.98
Exercisable at end of year 404,667 303,470 125,398
Weighted-average fair value
of options granted $4.21 $4.47 $3.72
The Black-Scholes option
pricing model was used to determine the grant-date fair-value of the options.
Significant assumptions used in the model included a weighted-average risk-free
rate of return of 3.6% in 2002, 4.6% in 2001 and 5.8% in 2000; expected option
life of 10 years; expected stock price volatility of 21.0% for 2002 awards,
22.6% for 2001 awards and 29.1% for 2000 awards; and expected dividend yield of
2.78% for 2002 and 3.0% for 2001 and 2000.
In October 1995, the FASB
Issued SFAS No. 123, “Accounting for Stock-Based Compensation.” This
Statement encourages, but does not require, the adoption of fair-value
accounting for stock-based compensation to employees. The Company, as permitted,
has elected not to adopt the fair-value accounting provisions of SFAS No. 123,
and has instead continued to apply APB Opinion No. 25 and related
interpretations in accounting for the plans and to provide the required proforma
disclosures of SFAS No. 123. Had the grant-date fair-value provisions of SFAS
No. 123 been adopted, the Company would have recognized $1.3 million, $801,000
and $621,000 of compensation expense in 2002, 2001 and 2000, respectively,
related to options granted under its stock option plans. As a result, proforma
net income of the Company would have been $3.7 million, $4.3 million and $3.5
million in 2002, 2001, and 2000, respectively and proforma diluted earnings per
share would have been $0.86, $0.91 and $0.73 in 2002, 2001, and 2000,
respectively.
The effects on pro forma net income and diluted earnings per share of applying the disclosure requirement of SFAS No. 123 in past years may not be representative of the future proforma effects on net income and EPS due to the vesting provisions of the options and future awards that are available to be granted.
The following table summarizes all stock options outstanding for the plans as of September 30, 2002, segmented by range of exercise prices:
Outstanding
-------------------------------------------------------
Weighted- Weighted-
Average Average
Exercise Remaining
Number Price Contractual Life
------ ---------- ----------------
Stock Options:
- --------------
$10.00-$10.12 1,045 $10.00 7.0 years
$10.13-$10.24 1,600 10.13 6.6
$10.25-$10.37 1,910 10.25 7.1
$10.38-$10.62 14,500 10.38 7.2
$10.63-$11.37 3,045 10.63 6.7
$11.38-$11.62 4,955 11.38 6.8
$11.63-$11.74 2,000 11.63 6.8
$11.75-$11.99 521,925 11.75 6.1
$11.75-$11.99 52,955 11.75 8.1
$12.00-$12.24 1,800 12.00 7.4
$12.25-$12.74 54,140 12.25 8.3
$12.25-$12.74 2,400 12.25 8.4
$12.75-$14.19 2,000 12.75 6.4
$14.20-$14.99 2,645 14.20 9.0
$15.00-$15.44 4,955 15.00 8.9
$15.45-$16.39 5,000 15.45 9.1
$16.40-$16.74 435 16.41 9.5
$16.75-$16.89 1,550 16.75 9.2
$16.90-$16.94 800 16.90 9.3
$16.95-$17.69 6,750 16.95 9.2
$17.70-$17.75 550 17.70 9.7
--- ----- ---
686,960 $11.88 6.6 years
12. Commitments, Contingencies, and Financial Instruments
The Company is party to
financial instruments with off-balance-sheet risk in the normal course of
business to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. Commitments to originate loans
amounted to $19.9 million as of September 30, 2002, of which $729,000 was for
variable-rate loans. The balance of the commitments represent fixed-rate loans
with interest rates ranging from 5.1% to 7.5%. In addition, at September 30,
2002, the Company had undisbursed loans in process for construction loans of
$6.6 million and $52.9 million in undisbursed lines of credit. These instruments
involve, to varying degrees, elements of credit, interest rate or liquidity risk
in excess of the amount recognized in the balance sheet. The contract or
notional amounts of these commitments reflect the extent of involvement the
Company has in particular classes of financial instruments.
The Company’s exposure
to credit loss from nonperformance by the other party to the financial
instruments for commitments to extend credit is represented by the contractual
amount of those instruments. The Company uses the same credit policies in making
commitments as it does for balance-sheet instruments.
Commitments to extend
credit are legally-binding agreements to lend to customers. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of fees. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future liquidity requirements. The Company evaluates each
customer’s credit-worthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company on extensions of credit,
is based on management’s credit assessment of the counterparty. At
September 30, 2002, the Company expects all commitments to be funded within 60
days.
The Company is required to
disclose estimated fair values for its financial instruments. The following
describes various limitations and assumptions related to such fair value
disclosures.
Limitations. Estimates of fair value are made at a specific point in time based upon, where available, relevant market prices and
information about the financial instrument. Such estimates do not include any premium or discount that could result from offering for
sale at one time the Company's entire holdings of a particular financial instrument. For a substantial portion of the Company's
financial instruments, no quoted market exists. Therefore, estimates of fair value are necessarily based on a number of significant
assumptions (many of which involve events outside the control of management). Such assumptions include assessments of current
economic conditions, perceived risks associated with these financial instruments and their counterparties, future expected loss
experience and other factors. Given the uncertainties surrounding these assumptions, the reported fair values represent estimates
only, and therefore cannot be compared to the historical accounting model. Use of different assumptions or methodologies is likely to
result in significantly different fair value estimates.
The estimated fair values
presented neither include nor give effect to the values associated with the
Company’s banking, or other businesses, existing customer relationships,
extensive branch banking network, property, equipment, goodwill or certain tax
implications related to the realization of unrealized gains or losses. Also, the
fair value of non-interest-bearing demand deposits, savings, NOW accounts and
money market deposit accounts is equal to the carrying amount because these
deposits have no stated maturity. Obviously, this approach to estimating fair
value excludes the significant benefit that results from the low-cost funding
provided by such deposit liabilities, as compared to alternative sources of
funding. As a consequence, the fair value of individual assets and liabilities
may not be reflective of the fair value of a banking organization that is a
going concern.
The following methods and
assumptions were used to estimate the fair value of each major classification of
financial instruments at September 30, 2002 and 2001.
Cash and cash equivalents. Current carrying amounts approximate estimated fair value.
Securities. Current quoted market prices were used to determine fair value.
Loans. Fair values were estimated for portfolios of loans with similar financial characteristics. Loans were segregated by type, and
each loan category was further segmented by fixed-and adjustable-rate interest terms. The estimated fair value of the segregated
portfolios was calculated by discounting cash flows through the estimated maturity using estimated prepayment speeds while using
estimated market discount rates that reflect credit and interest rate risk inherent in the loans. The estimate of the maturities and
prepayment speeds was based on the Company's historical experience. Cash flows were discounted using market rates adjusted for
portfolio differences.
Accrued interest receivable. Current carrying amounts approximate estimated fair value.
Bank-owned life insurance. The fair value is equal to the cash surrender value of the life insurance policies.
Deposits with no stated maturity. Current carrying amounts approximate estimated fair value.
Certificates of deposit. Fair values were estimated by discounting the
contractual cash flows using current market rates offered in the Company’s
market area for deposits with comparable terms and maturities.
Federal Home Loan Bank Advances. The fair value of borrowings was
estimated using rates currently available to the Company for debt with similar
terms and remaining maturities.
Other borrowings. Current carrying amounts approximate estimated fair value.
Accrued interest payable. Current carrying amounts approximate estimated fair value.
Trust preferred debt. The fair value of trust preferred debt is equal to the available quoted market price.
Commitments to extend credit. The majority of the Company’s
commitments to extend credit carry current market interest rates if converted to
loans. Because commitments to extend credit are generally unassignable by either
the Company or the borrower, they only have value to the Company and the
borrower. The fair value of commitments to extend credit is estimated using the
fees currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present credit worthiness of the
counter parties.
The carrying amounts and estimated fair values of the Company's financial instruments were as follows:
At September 30,
----------------
(in thousands)
2002 2001
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Financial Assets:
Cash and cash equivalents $25,302 $25,302 $9,060 $9,060
Securities available for sale 327,886 327,886 243,648 243,648
Securities held to maturity 3,653 3,707 17,842 17,819
Loans 489,373 500,925 498,151 520,412
Accrued interest receivable 7,632 7,632 6,892 6,892
Bank owned life insurance 10,303 10,303 - -
Financial Liabilities:
Deposits with no stated maturity which
consist of savings, money market, NOW
and non-interest bearing deposits $305,719 $305,719 $213,242 $213,242
Certificates of deposit 299,247 306,108 302,493 306,438
Federal Home Loan Bank advances 208,421 231,271 204,441 216,536
Other borrowings 4,630 4,630 5,990 5,990
Accrued interest payable 1,458 1,458 2,130 2,130
Trust preferred debt 7,000 7,583 - -
Contractual Estimated Contractual Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Off balance sheet assets:
Loan commitments $26,484 $397 $12,592 $189
Consumer lines of credit 22,330 - 18,908 -
Commercial lines of credit 30,609 2 22,149 2
13. Capital and Regulatory Matters
The Bank is subject to
various regulatory capital requirements administered by Federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory - and possible additional discretionary - actions by regulators that,
if undertaken, could have a direct material effect on the Company’s
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank’s assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank’s capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures
established by regulation to ensure capital adequacy require the Bank to
maintain minimum amounts and ratios (set forth in the table below) of total and
Tier I capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital and tangible capital (as defined) to total
assets (as defined). Management believes, as of September 30, 2002 that the Bank
meets all capital adequacy requirements to which it is subject.As of September
30, 2002, the most recent notification from the Office of Thrift Supervision
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum ratios as set forth in the table below. There are no conditions
or events since that notification that management believes have changed the
institution’s category.
The capital position of the Company does not differ significantly from the Bank’s. The Bank’s actual capital amounts and ratios at September 30, 2002 and 2001 are also presented in the following table (in thousands):
As of September 30, 2002
------------------------
(in thousands)
To be Well Capitalized
For Capital under prompt corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- ------------------------
Amount Ratio(1) Amount Ratio(1) Amount Ratio(1)
------ -------- ------ -------- ------ --------
Risk-based Capital
(Total Capital to risk-weighted assets)$56,828 10.4% $43,569 >8.0% $54,462 >10.0%
Tier I Capital
(to risk-weighted assets) 51,628 9.5% 21,785 >4.0% 32,677 >6.0%
Core Capital
(Tier I Capital to total assets) 51,628 5.8% 26,572 >3.0% 44,286 >5.0%
Tangible Capital
(Tier I Capital to total assets) 51,628 5.8% 13,286 >1.5% N/A N/A
As of September 30, 2001
------------------------
(in thousands)
To be Well Capitalized
For Capital under prompt corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- ------------------------
Amount Ratio(1) Amount Ratio(1) Amount Ratio(1)
------ -------- ------ -------- ------ --------
Risk-based Capital
(Total Capital to risk-weighted assets)$55,947 11.7% $38,417 >8.0% $48,021 >10.0%
Tier I Capital
(to risk-weighted assets) 51,433 10.7% 19,208 >4.0% 28,812 >6.0%
Core Capital
(Tier I Capital to total assets) 51,433 6.5% 23,725 >3.0% 39,541 >5.0%
Tangible Capital
(Tier I Capital to total assets) 51,433 6.5% 11,862 >1.5% N/A N/A
(1) Tangible and core capital are completed as a percentage of total assets of $886 million and $791 million at September 30, 2002
and 2001, respectively. Risk-based capital and Tier I capital is computed as a percentage of total risk-weighted assets of $545
million and $480 million at September 30, 2002 and 2001, respectively.
The Bank established a
liquidation account at the time of its conversion from a Federally-chartered
mutual savings and loan association to a Federally-chartered stock savings bank
(“the Conversion”). This liquidation account was initially established
in an amount equal to the equity of the Bank as of the date of its latest
balance sheet date, September 30, 1997, contained in the final Prospectus used
in connection with the Conversion. In the unlikely event of a complete
liquidation of the Bank, (and only in such an event), eligible depositors who
continue to maintain accounts at the Bank shall be entitled to receive a
distribution from the liquidation account. The total amount of the liquidation
account, which decreases if the balances of eligible deposits decrease at the
annual determination dates, approximated $6.3 million at September 30, 2002.
The Company may not declare
nor pay dividends on its stock if such declaration and payment would violate
statutory or regulatory requirements.
In addition to the
16,000,000 authorized shares of common stock, the Company authorized 2,000,000
shares of preferred stock with a par value of $.01 per share (the
“preferred stock”). The Board of Directors is authorized, subject to
any limitations by law, to provide for the issuance of the shares of preferred
stock in series, to establish from time to time the number of shares to be
included in each such series, and to fix the designation, powers, preferences
and rights of the shares of each such series and any qualifications, limitations
or restrictions thereof. As of September 30, 2002, there were no shares of
preferred stock issued.
14. Employee Benefit Plans
Defined Benefit Plan
The Company participates in
a multi-employer defined benefit pension plan covering all employees meeting
eligibility requirements of being at least age 21 with one year of service with
the Company. Because of the multi-employer nature of the plan, information
regarding the Company’s portion of present values of vested and nonvested
benefits is not available. The plan is fully funded and no contributions were
required during the years ended September 30, 2002, 2001 and 2000.
401K Plan
The Bank maintains a
Section 401(k) defined contribution plan which covers substantially all of its
employees. The Company made contributions to this plan of approximately
$205,000, $159,000 and $113,000 for the years ended September 30, 2002, 2001 and
2000, respectively.
Employee Stock Ownership Plan
The Bank maintains an
Employee Stock Ownership Plan (“ESOP”). The Plan is designed to
provide retirement benefits for eligible employees. Because the ESOP invests in
the stock of the Company, it gives eligible employees an opportunity to acquire
an ownership interest in the Company. Employees are eligible to participate in
the Plan after reaching age 21 and completing six months of service. Benefits
become 100% vested after four years, with a 25% vesting occurring each year.
The ESOP purchased 8.0% or
514,188 shares of the common stock issued in the Conversion. The ESOP borrowed
100% of the aggregate purchase price of the common stock, or $5.1 million, from
the Company. The loan has a 10 year term, with an annual interest rate of prime
(6.0% at September 30, 2002) and will be repaid principally from the Bank’s
contributions to the ESOP. The Company recognized $758,000, $548,000 and
$417,000 in compensation and benefit expense related to the ESOP for the years
ended September 30, 2002, 2001 and 2000, respectively, offset by dividends in the amount of $214,000, $182,000 and $143,000, respectively.
Shares purchased by the
ESOP were pledged as collateral for the loan and are held in a suspense account
until released for allocation among participants
as the loan is repaid. The
pledged shares are released annually from the suspense account in an amount
proportional to the repayment of the ESOP loan for each plan year. The released
shares are allocated among the accounts of participants on the basis of the
participant’s compensation for the year of allocation.
At September 30, 2002, the
ESOP held 514,188 shares of the Company’s stock of which 244,242 shares
were allocated to participant accounts. The unallocated ESOP shares are
presented as a reduction of stockholders’ equity in the consolidated
financial statements. At September 30, 2002, the unallocated ESOP shares had a
fair market value of $4.0 million.
Stock Awards
The Company maintains a
Stock-Based Incentive Plan for officers, directors and certain employees of the
Company and its subsidiaries, under which 257,094 shares of common stock were
available for grant. All awards granted vest over a five-year period from the
date of grant and result in compensation expense during the vesting period. The
Company recognized $496,000, $516,000 and $473,000 in compensation and benefit
expense related to the stock awards for the fiscal years ended September 30,
2002, 2001 and 2000, respectively. A total of 42,178 shares have been vested in
fiscal 2002. A total of 43,164 shares and 48,256 shares were vested in fiscal
2001 and fiscal 2000, respectively. At September 30, 2002, 28,296 shares of the
stock award plan remain unawarded.
Option Plan
The Stock Option Plan is described in footnote 11, page 33.
15. Goodwill and Intangible Assets
A summary of goodwill and intangible assets is as follows:
Gross Net
carrying Accumulated carrying
amount amortization amount
--------------------------------------------------
Goodwill
- --------
Balance at October 1, 2000 $248 $(110) $138
Acquisition of:
Security Savings Association of Hazleton 473 - 473
Higgins Insurance Associates, Inc. 2,519 - 2,519
Amortization expense - (173) (173)
------ ----- ------
Balance at September 30, 2001 $3,240 $(283) $2,957
Acquisition of:
Schuylkill Savings and Loan Association 200 - 200
DeAndrea Agency 400 - 400
Additional goodwill associated with Security Savings
Association of Hazleton acquisition 98 - 98
------ ----- ------
Balance at September 30, 2002 $3,938 $(283) $3,655
====== ====== ======
Gross Net
carrying Accumulated carrying
amount amortization amount
--------------------------------------------------
Amortizing Intangible Assets
- ---------- ---------- ------
Balance at October 1, 2000 $1,537 $(389) $1,148
Security Savings Association of Hazleton
core deposit intangible 9,086 - 9,086
Amortization expense - (954) (954)
------ ----- ------
Balance at September 30, 2001 $10,623 $(1,343) $9,280
Schuylkill Savings and Loan Association
core deposit intangible 255 - 255
Other intangibles 435 - 435
Amortization expense - (952) (952)
------ ----- ------
Amortizing intangible assets $11,313 $(2,295) $9,018
------ ----- ------
Nonamortizing intangible assets - - 75
------ ----- ------
Balance at September 30, 2002 $9,093
====== ====== ======
Nonamortizing intangible assets consist of title plant of $75,000 at September 30, 2002 and 2001.
Amortization expense of amortizing intangible assets for the years ended September 30, 2002, 2001 and 2000 is as follows:
Other Total
Core deposit amortizing amortizing
intangibles intangibles intangibles
----------- ----------- -----------
Aggregate Amortization Expense:
- --------- ------------ -------
(in thousands)
For the year ended September 30, 2000 $309 $- $309
For the year ended September 30, 2001 1,007 - 1,007
For the year ended September 30, 2002 954 54 1,008
The estimated amortization expense of amortizing intangible assets for each of the five succeeding fiscal years is as follows:
Other Total
Core deposit amortizing amortizing
intangibles intangibles intangibles
----------- ----------- -----------
Estimated annual amortization expense:
- --------- ------ ------------ -------
(in thousands)
For the year ended September 30, 2003 $849 $86 $935
For the year ended September 30, 2004 750 86 836
For the year ended September 30, 2005 644 86 730
For the year ended September 30, 2006 586 55 641
For the year ended September 30, 2007 558 22 580
Intangible assets acquired in the year ended September 30, 2002 are as follows:
(in thousands)
Weighted average
Amount Residual amortization
assigned value period in years
-------- -------- ----------------
Core deposit intangible $255 - 13
Other intangibles 435 - 4
---- --- ---
Total $690 - -
==== = =
The following table sets forth a comparison of net income and basic and diluted earnings per share
adjusted for the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets":
For the Year Ended
September 30,
2002 2001 2000
---- ---- ----
(Dollars in thousands, except per share data)
Goodwill amortization $- $144 $54
== ==== ===
Net Income $4,498 $4,807 $3,936
====== ====== ======
Addback: Goodwill amortization (net of tax) - 106 34
- --- --
Adjusted net income $4,498 $4,913 $3,970
====== ====== ======
Basic earnings per share:
Net income $1.11 $1.03 $0.84
----- ----- -----
Goodwill amortization - 0.02 0.01
- ---- ----
Adjusted basic earnings per share $1.11 $1.05 $0.85
===== ===== =====
Diluted earnings per share:
Net income $1.05 $1.02 $0.81
----- ----- =====
Goodwill amortization - 0.02 0.01
- ---- ----
Adjusted diluted earnings per share $1.05 $1.04 $0.82
===== ===== =====
16. Recent Accounting Pronouncements.
In June 2001, the Financial
Accounting Standards Board (FASB) issued Statement No. 143, “Accounting for
Asset Retirement Obligations.” This Statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. It applies
to legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and (or) the normal
operation of a long-lived asset, except for certain obligations of lessees. As
used in this Statement, a legal obligation is an obligation that a party is
required to settle as a result of an existing or enacted law, statute, ordinance
or written or oral contract or by legal construction of a contract under the
doctrine of promissory estoppel. This Statement requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. This Statement amends FASB Statement No. 19,
“Financial Accounting and Reporting by Oil and Gas Producing
Companies”, and it applies to all entities. It is effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Earlier application is encouraged. The adoption of this Statement on October 1,
2002 did not have an impact on the Company’s earnings, financial condition
or equity.
In August 2001, the FASB
issued Statement No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.” This Statement addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of”. However, the Statement
retains the fundamental provisions of Statement 121 for (a) recognition and
measurement of the impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of by sale. This Statement
supersedes the accounting and reporting provisions of APB Opinion No. 30,
“Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions”, for the disposal of a segment of a
business. However, this Statement retains the requirement of Opinion No. 30 to
report discontinued operations separately from continuing operations and extends
that reporting to a component of an entity that either has been disposed of (by
sale, by abandonment or in distribution to owners) or is classified as held for
sale. This Statement also amends ARB No. 51, “Consolidated Financial
Statements”, to eliminate the exception to consolidation for a
temporarily-controlled subsidiary. The provisions of this Statement are
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years, with earlier
application encouraged. The provisions of this statement generally are to be applied prospectively. The Adoption of the Statement on October 1, 2002 did not have an impact on the Company’s earnings, financial condition or equity.
In April 2002, the FASB
issued SFAS No. 145 “Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections.” This
Statement rescinds FASB Statement No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements, along with rescinding FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers and amending FASB Statement No.
13, Accounting for Leases. This Statement (1) eliminates an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions, (2) eliminates the extraordinary item
treatment of reporting gains and losses from extinguishments of debt, and (3)
makes certain other technical corrections.
The provisions of this
Statement related to the rescission of Statement 4 shall be applied in fiscal
years beginning after May 15, 2002. Any gain or loss on extinguishments of debt
that was classified as an extraordinary item in prior periods presented that
does not meet the criteria in Opinion 30 for classification as an extraordinary
item shall be reclassified. Early application of the provisions of this
Statement related to the rescission of Statement 4 is encouraged. The provisions
of this Statement related to Statement 13 shall be effective for transactions
occurring after May 15, 2002. All other provisions of this Statement shall be
effective for financial statements issued on or after May 15, 2002. Early
application of this Statement is encouraged. The adoption of the effective
portions of this Statement did not have an impact on the Company’s
earnings, financial condition or equity. The adoption of the remaining portions
of this Statement is not expected to have an impact on the Company’s
earnings, financial condition or equity.
In June 2002, the FASB
issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal
Activities.” This Statement addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring).”
The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Company does not
expect the adoption of this Statement to have an impact on its earnings,
financial condition or equity.
On October 1, 2002, the
FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions,
effective for all business combinations initiated after October 1, 2002. This
Statement addresses the financial accounting and reporting for the acquisition
of all or part of a financial institution, except for a transaction between two
or more mutual enterprises. This Statement removes acquisitions of financial
institutions, other than transactions between two or more mutual enterprises,
from the scope of SFAS No. 72, Accounting for Certain Acquisitions of Banking
or Thrift Institutions, and FASB Interpretation No. 9, Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method. The acquisition of all or part of a financial institution that meets
the definition of a business combination shall be accounted for by the purchase
method in accordance with SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. This Statement also
provides guidance on the accounting for the impairment or disposal of acquired
long-term customer-relationship intangible assets (such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible
assets), including those acquired in transactions between two or more mutual
enterprises. Upon early adoption of this statement, the carrying amount of the
previously recognized unidentifiable intangible asset related to the Schuylkill
Savings branch acquisitions that was reclassified to goodwill was $202,000,
while the related 2002 amortization expense that was reversed was $81,000,
pre-tax. The Company will continue to review the remaining goodwill on an annual
basis for impairment. However, $10.9 million in core deposit intangible will
continue to be amortized and reviewed for impairment in accordance with SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets.
17. Related Party Transactions
The Company retains a law
firm, in which the Chairman of the Company’s Board of Directors also is a
partner, that provides general legal counsel to the Company. The Company paid
legal fees to this law firm of $74,145, $54,653 and $37,373 for the years ended
September 30, 2002, 2001 and 2000, respectively. The Company paid rent of
$20,820 in fiscal 2002 for its Pottsville office to a partnership in which a
director of the Company has a one-third ownership interest.
18. Acquisitions
On November 10, 2002, the
Company acquired Security of Pennsylvania Financial Corp.
(“Security”), based in Hazleton, Pennsylvania, the holding company of
Security Savings Association of Hazleton, a Pennsylvania-chartered savings and
loan association. Pursuant to an Agreement and Plan of Merger, each share of
Security’s issued and outstanding common stock, par value $0.01 per share,
was acquired for $17.50 in cash. In addition, on November 10, 2000, Security
Savings was merged with and into First Federal Bank, with First Federal being
the surviving institution. The acquisition of Security was accounted for as a
purchase transaction. Accordingly, only the results of Security’s
operations subsequent to the date of acquisition are included in these
consolidated financial statemen6ts. The intangibles acquired are being amortized
using both straight line and accelerated methods of amortization over lives
ranging from 13 to 31 years. The following pro forma results of operations
assume that the acquisition had been consummat3ed at the beginning of each
respective period shown.
Fiscal Year Ended
(in thousands)
September 30, 2001 September 30, 2000
------------------ ------------------
Net interest income $21,916 $22,814
Other income 3,736 2,269
Net income 930 4,182
Earnings per share - basic $0.20 $0.90
Earnings per share - diluted $0.20 $0.86
As of the close of business
on December 31, 2000, the Company issued 215,052 shares of stock to acquire
Higgins Insurance Associates, Inc., a Pottsville- based insurance agency, which
has been serving customers throughout Schuylkill and Luzerne counties since
1946. Higgins offers personal, health and commercial insurance. The transaction
was accounted for using the purchase method of accounting. During 2002, the
Company purchased three banking offices from Schuylkill Savings and Loan
Association while Higgins acquired the DeAndrea Agency which specializes in
personal and commercial insurance. These acquisitions resulted in the Company
recognizing an amortizable core deposit intangible of $255,000 and amortizable
other intangible assets of $435,000.
19. Parent Company Financial Information
Condensed Statement of Financial Condition
September 30,
-------------
(in thousands)
2002 2001
---------------------------
Assets:
Cash $752 $187
Investment in subsidiaries 65,567 63,551
Securities available for sale 4,344 6,410
Accrued interest receivable 84 136
Due from affiliates 761 404
Other assets 6,028 5,576
----- -----
Total Assets $77,536 $76,264
======= =======
Liabilities and stockholders' equity:
Trust preferred debt $7,000 $-
Note payable to subsidiary bank 1,000 -
Other liabilities 1,151 427
----- ---
Total Liabilities 9,151 427
----- ---
Total stockholders' equity 68,385 75,837
------ ------
Total Liabilities and Stockholders' Equity $77,536 $76,264
======= =======
Condensed Statement of Operations
For the years ended September 30,
(in thousands)
2002 2001 2000
---- ---- ----
Income:
Interest income $445 $878 $1,059
Other income (expense) (37) (581) (59)
Equity in undistributed income of
subsidiaries 5,296 5,637 3,902
----- ----- -----
Total Income 5,704 5,934 4,902
----- ----- -----
Expenses:
Interest expense 244 41 153
Other operating expenses 749 952 792
----- ----- -----
Total Expense 993 993 945
----- ----- -----
Income before income taxes 4,711 4,941 3,957
Income tax expense 213 134 21
----- ----- -----
Net income $4,498 $4,807 $3,936
===== ===== =====
Condensed Statements of Cash Flows
For the Years Ended September 30,
(in thousands)
2002 2001 2000
Operating Activities:
Net Income $4,498 $4,807 $3,936
Adjustments to reconcile net income to net cash provided by
Operating activities:
Equity in undistributed income of subsidiaries 5,296 5,637 3,902
Deferred income tax (benefit) provision 2,061 4,590 (655)
Reduction in unallocated ESOP shares 758 548 417
Stock award expense 496 516 473
Amortization and accretion on:
Available-for-sale securities 38 (184) 8
Loss on sale of:
Available-for-sale securities 37 192 14
Changes in assets and liabilities:
Increases in other assets (980) (1,348) (1,799)
Increase (decrease) in other liabilities 790 318 (40)
--- --- ----
Net cash provided by operating activities $12,994 $15,076 $6,256
------- ------- ------
Investing Activities:
Increase in investment in subsidiaries $(7,313) $(13,499) $(4,371)
Proceeds from sale of:
Available-for-sale securities 4,880 11,688 1,048
Proceeds from repayments of available-for-sale securities 1,000 - -
Purchase of Security Savings - (24,246) -
Purchase of available-for-sale securities (3,243) (3,103) (61)
------- ------- ----
Net cash used in investing activities $(4,676) $(29,160) $(3,384)
Financing Activities:
Borrowings of note payable $1,000 $- $3,185
Repayment of long-term debt - (3,185) -
Proceeds issuance trust-preferred securities 7,000 - -
Stock options exercised 424 187 -
Stock compensation tax benefit 110 - -
Stock issued for the purchase of Higgins Insurance Agency - 2,500 -
Purchase of treasury stock (14,421) (8,423) (4,943)
Issuance of treasury stock 96 - -
Cash dividend received from subsidiary - 25,000 -
Cash dividend on common stock (1,962) (1,878) (1,547)
------- ------- ------
Net cash provided by (used in) financing activities $(7,753) $14,201 $(3,305)
-------- ------- --------
Increase (decrease) in cash and cash equivalents 565 117 (43)
Cash and cash equivalents, beginning of year 187 70 503
--- -- ---
Cash and cash equivalents, end of year $752 $187 $70
==== ==== ===
Management's Statement on Financial Reporting
To Our Shareholders:
Management of Northeast Pennsylvania Financial Corp. and subsidiaries (the "Company") is responsible for establishing and
maintaining effective internal control over financial reporting presented in conformity with accounting principles generally accepted
in the United States of America. This internal control contains monitoring mechanisms, and actions are taken to correct deficiencies
identified.
There are inherent limitations in any internal control, including the possibility of human error and the circumvention
or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to
financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Management assessed the Company's internal control over financial reporting presented in conformity with accounting
principles generally accepted in the United States of America as of September 30, 2002. This assessment was based on criteria for
effective internal control over financial reporting established in Internal Control-- Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of September 30, 2002,
the Company maintained effective internal control over financial reporting presented in conformity with accounting principles
generally accepted in the United States of America.
The Company assessed its compliance with the designated laws and regulations relating to safety and soundness. Based on
this assessment, management believes that Northeast Pennsylvania Financial Corp. and subsidiaries complied, in all material respects,
with the designated laws and regulations related to safety and soundness for the year ended September 30, 2002.
E. Lee Beard Patrick J. Owens, Jr. President & Vice President, Treasurer, Chief Executive Officer & Chief Financial Officer
KPMG
1601 Market Street
Philadelphia PA 19103-7212
Independent Auditors' Report
To the Board of Directors
Northeast Pennsylvania Financial Corp.
Hazleton, Pennsylvania:
We have audited the accompanying consolidated statements of financial condition of Northeast Pennsylvania Financial Corp. and
subsidiaries (the "Company") as of September 30, 2002 and 2001 and the related consolidated statements of operations, comprehensive
income, changes in equity, and cash flows for each of the years in the three year period ended September 30, 2002. These consolidated
financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of the Company as of September 30, 2002 and 2001 and the results of its operations and its cash flows for each of the years
in the three year period ended September 30, 2002, in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Notes 1, 15 and 16 to the consolidated financial statements, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets and Statement of Financial Accounting Standards No. 147,
Acquisition of Certain Financial Institutions: an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9, during
fiscal 2002.
KPMG LLP
October 25, 2002