UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO 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
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
12 E. BROAD STREET, HAZLETON, PENNSYLVANIA 18201
(Address of principal executive offices) (Zip Code)
(570) 459-3700
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--------- -------
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes - No X
--------- -------
The Registrant had 4,176,594 shares of Common Stock outstanding as of May 15, 2003.
Item
No.
- ---
Page
Number
PART I - CONSOLIDATED FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition at
March 31, 2003 and September 30, 2002 (unaudited)............................... 1
Consolidated Statements of Operations for the Three and Six Months
Ended March 31, 2003 and 2002 (unaudited)....................................... 2
Consolidated Statements of Comprehensive Income for the Three and Six
Months Ended March 31, 2003 and 2002 (unaudited)................................ 3
Consolidated Statements of Changes in Equity for the Year Ended
September 30, 2002 and the Six Months Ended
March 31, 2003 (unaudited)...................................................... 4
Consolidated Statements of Cash Flows for the Six Months Ended
March 31, 2003 and 2002 (unaudited)............................................. 5
Notes to Consolidated Financial Statements (unaudited).......................... 7
Item 2 Management Discussion and Analysis of Financial Condition
and Results of Operations.......................................................21
Item 3 Quantitative and Qualitative Disclosures about Market Risk......................26
Item 4 Controls and Procedures.........................................................26
Part II - OTHER INFORMATION
1 Legal Proceedings...............................................................27
2 Changes in Securities and Use of Proceeds.......................................27
3 Defaults Upon Senior Securities.................................................27
4 Submission of Matters to a Vote of Security Holders.............................27
5 Other Information...............................................................27
6 Exhibits and Reports on Form 8 - K..............................................28
Signatures
Certifications
March 31, September 30,
2003 2002
-------------------------------
(in thousands)
ASSETS
Cash and cash equivalents $ 42,024 $ 25,302
Investment securities available for sale 309,749 327,886
Investment securities held to maturity (estimated
market value of $3,610 and $3,707) 3,554 3,652
Loans 498,016 494,822
Less allowance for loan losses 5,270 5,449
---------------- -----------------
Net loans 492,746 489,373
Accrued interest receivable 8,262 7,632
Assets acquired through foreclosure 609 547
Property and equipment 12,752 12,840
Goodwill 3,755 3,655
Intangible assets 9,051 9,093
Bank-owned life insurance 10,616 10,303
Other assets 13,063 15,226
---------------- -----------------
TOTAL ASSETS $ 906,181 $ 905,509
================ =================
LIABILITIES
Deposits $ 597,823 $ 606,412
Federal Home Loan Bank advances 208,411 208,421
Other borrowings 1,062 3,184
Trust-preferred debt 22,000 7,000
Advances from borrowers for taxes and insurance 1,534 852
Accrued interest payable 1,600 1,458
Other liabilities 6,425 9,797
---------------- -----------------
TOTAL LIABILITIES 838,855 837,124
---------------- -----------------
STOCKHOLDERS' EQUITY
Preferred stock ($.01 par value; 2,000,000 authorized shares;
None issued) - -
Common stock, $.01 par value; 16,000,000 shares authorized,
6,427,350 shares issued 64 64
Additional paid-in capital 61,963 62,047
Retained earnings - substantially restricted 39,922 38,672
Accumulated other comprehensive income, net 1,545 3,443
Common stock acquired by stock benefit plans (5,256) (4,847)
Treasury stock, at cost (2,250,756 shares at March 31, 2003
And 2,301,566 shares at September 30, 2002) (30,912) (30,994)
---------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 67,326 68,385
---------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 906,181 $ 905,509
================ =================
See accompanying notes to the unaudited consolidated financial statements.
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
---------------- ---------------- --------------- ----------------
(in thousands, except per share date)
INTEREST INCOME
Interest and fees on loans $ 8,798 $ 9,912 $ 18,022 $ 19,950
Mortgage-related securities 1,646 2,172 3,681 4,029
Investment securities:
Taxable 1,272 1,491 2,455 3,058
Tax-exempt 234 233 467 475
---------------- ---------------- --------------- ----------------
Total interest income 11,950 13,808 24,625 27,512
---------------- ---------------- --------------- ----------------
INTEREST EXPENSE
Deposits 3,209 4,250 6,920 8,654
Federal Home Loan Bank advances 2,939 2,924 5,944 5,811
Other borrowings 10 14 12 34
Trust-preferred debt 281 - 517 -
---------------- ---------------- --------------- ----------------
Total interest expense 6,439 7,188 13,393 14,499
---------------- ---------------- --------------- ----------------
NET INTEREST INCOME 5,511 6,620 11,232 13,013
Provision for loan losses 610 605 980 1,242
---------------- ---------------- --------------- ----------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,901 6,015 10,252 11,771
---------------- ---------------- --------------- ----------------
NONINTEREST INCOME
Service charges and other fees 618 494 1,273 1,003
Insurance commissions 902 724 1,826 1,443
Trust fees 214 195 446 348
Gain (loss) on sale of:
Assets acquired through foreclosure 50 (11) 60 (21)
Loans 359 87 603 239
Available for sale securities 1,131 23 1,142 (11)
Other 388 105 831 186
---------------- ---------------- --------------- ----------------
Total noninterest income 3,662 1,617 6,181 3,187
---------------- ---------------- --------------- ----------------
NONINTEREST EXPENSE
Salaries and employee benefits 3,252 2,966 6,476 5,821
Occupancy costs 852 752 1,656 1,417
Amortization of intangibles 257 234 517 513
Data processing costs 197 167 378 332
Advertising 264 144 528 272
Professional fees 412 371 976 695
Federal Home Loan Bank and other charges 233 245 462 483
Other 1,105 765 2,124 1,565
---------------- ---------------- --------------- ----------------
Total noninterest expense 6,572 5,644 13,117 11,098
---------------- ---------------- --------------- ----------------
Income before income taxes 1,991 1,988 3,316 3,860
Income taxes 702 758 1,084 1,352
---------------- ---------------- --------------- ----------------
NET INCOME $ 1,289 $ 1,230 $ 2,232 $ 2,508
================ ================ =============== ================
EARNINGS PER SHARE:
Basic $ 0.34 $ 0.31 $ 0.59 $ 0.59
Diluted 0.33 0.29 0.56 0.56
See accompanying notes to the unaudited consolidated financial statements.
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
--------------- ------------- ------------ -----------
(in thousands)
Net income
$ 1,289 $ 1,230 $ 2,232 $ 2,508
--------------- ------------- ------------ -----------
Other comprehensive income, net of tax
Unrealized losses on securities and on retained
interest on asset securitization:
Unrealized holding gains (losses) arising during the period (890) (1,552) (1,197) (2,333)
Less: Reclassification adjustment for gains (losses)
included in net income 694 15 701 (7)
--------------- ------------- ------------ -----------
Other comprehensive income (loss) (1,584) (1,567) (1,898) (2,326)
Comprehensive income (loss) $ (295) $ (337) $ 334 $ 182
=============== ============= ============ ===========
See accompanying notes to the unaudited consolidated financial statements.
Common
Accumulated Stock
Additional Other Acquired by Total
Common Paid-in Retained Comprehensive Stock Treasury Stockholders'
Stock Capital Earnings Income (Loss) Benefit Plans Stock Equity
------------- --------------- -------------- ---------------- ----------------- ------------ --------------
Balance, September 30, 2001 $ 64 $ 62,142 $ 36,136 $ 894 $ (5,213) $ (18,186) $ 75,837
Net income 4,498 4,498
ESOP shares committed to be released 243 515 758
Stock awards (46) 542 496
Stock employee compensation trust
(45,041 shares) (701) (701)
Stock compensation tax benefit 110 110
Stock options exercised (38,714 shares) (402) 10 816 424
Purchase of stock (13,720) (13,720)
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
Cash dividends ($.70 per share) (1,962) (1,962)
------------- --------------- -------------- -------------- -------------- ------------- --------------
Balance, September 30, 2002 64 62,047 38,672 3,443 (4,847) (30,994) 68,385
Net income 2,232 2,232
ESOP shares committed to be released (79) 514 435
Stock awards (11) 125 114
Stock employee compensation trust (1,096) (1,096)
(69,133 shares)
Stock options exercised (3,000 shares) (12) 48 36
Treasury stock reissuance (6,369 shares) 18 82 100
Net changes in gains on (1,986) (1,986)
securities available for sale, net of tax
Net change in gains on retained interest 88 88
on asset securitization, net of tax
Cash dividends ($.24 per share) (982) (982)
------------- --------------- -------------- -------------- -------------- ------------- --------------
Balance, March 31, 2003 $ 64 $ 61,963 $ 39,922 $ 1,545 $ (5,256) $ (30,912) $ 67,326
============= =============== ============== ============== ============== ============= ==============
See accompanying notes to the unaudited consolidated financial statements.
Six Months Ended
March 31,
2003 2002
------------------- -----------------
OPERATING ACTIVITIES
Net income $ 2,232 $ 2,508
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 980 1,242
Provision for assets acquired
through foreclosure 243 581
Depreciation 711 718
Amortization of intangibles 517 513
Deferred income taxes (3,727) 3,105
ESOP expense 435 456
Stock award expense 114 255
Amortization and accretion on:
Held to maturity securities (1) (9)
Available for sale securities 3,136 281
Amortization of deferred loan fees (723) (301)
(Gain) loss on sale of:
Assets acquired through foreclosure (60) 21
Loans (603) (239)
Available for sale securities (1,142) 11
Proceeds from sales of loans 22,026 11,024
Originations of loans held for sale (21,423) (10,705)
Changes in assets and liabilities:
Increase in accrued interest receivable (630) (319)
Increase in other assets (1,377) (1,208)
Increase (decrease) in accrued interest payable 142 (276)
Increase (decrease) in accrued taxes payable 3,084 (2,089)
Increase in other liabilities 1,706 26
------------------- -----------------
Net cash provided by operating activities 5,640 5,595
------------------- -----------------
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities 100,088 36,759
Purchases (148,285) (101,153)
Proceeds from sales 62,132 16,787
Investment securities held to maturity:
Proceeds from repayments and maturities 99 14,199
Increase in loans, net (4,496) (3,039)
Purchase of regulatory stock (1,041) (250)
Purchase of premises and equipment (642) (1,308)
Proceeds from assets acquired through foreclosure 620 522
Net proceeds from acquisition of Schuylkill
Savings and Loan Association - 161
Increase in Bank-owned life insurance (312) -
------------------- -----------------
Net cash provided for (used for) investing activities $ 8,163 $ (37,322)
------------------- -----------------
Six Months Ended
March 31,
2003 2002
-------------- --------------
FINANCING ACTIVITIES
Net increase (decrease )in deposits $ (8,589) $ 49,017
Decrease in Federal Home Loan Bank
short-term advances (10) (6,000)
Borrowings of Federal Home Loan Bank
long-term advances - 10,000
Repayments of Federal Home Loan Bank
long-term advances - (10)
Net increase in advances from borrowers for
taxes and insurance 682 369
Proceeds from other borrowings - 650
Repayment of other borrowings (2,122) -
Proceeds from issuance of trust-preferred securities 15,000 -
Purchase of treasury stock - (8,932)
Purchase of stock for stock employee
compensation trust (1,096) -
Exercise of stock options 36 350
Cash dividends (982) (975)
-------------- --------------
Net cash provided by financing activities 2,919 44,469
-------------- --------------
Increase in cash
and cash equivalents 16,722 12,742
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 25,302 9,060
-------------- --------------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 42,024 $ 21,802
============== ==============
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings $ 13,251 $ 14,775
Income taxes 1,043 324
Supplemental disclosures - non-cash and financing information:
Transfer from loans to assets acquired
through foreclosure 866 1,181
Net change in unrealized losses on securities
available for sale, net of tax 2,876 2,326
See accompanying notes to the unaudited consolidated financial statements.
Northeast Pennsylvania Financial Corp. (the “Company”), through its subsidiaries, provides a wide range of financial products and services to individual, corporate, and municipal customers through its offices in Northeastern and Central Pennsylvania. These products and services from our Banking, Insurance, Investment and Trust lines of business. Banking products, which are offered through the Company’s subsidiary, First Federal Bank (the “Bank”), 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. Insurance products, which are offered through the Company’s subsidiary, Higgins Insurance Associates, Inc. (“Higgins”), include property and casualty, life, long-term care and employee benefit programs. Investment products are offered through licensed Bank employees, Higgins agents and Smith Barney financial consultants who rent space from the Bank. Trust services, which are offered by the Company’s subsidiary Northeast Pennsylvania Trust Co. (the “Trust Co.”), include estate management and trustee services. The Company provides title insurance through Abstractors, Inc., its wholly-owned title agency. 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 regulatory agencies and undergoes periodic examinations by those regulatory authorities. The Trust Co. is subject to state regulation.
Basis of Financial Statements PresentationThe accompanying consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the financial statements, have been included. These financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report for the period ended September 30, 2002. The results for the six months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended September 30, 2003.
Principles of Consolidation and PresentationThe accompanying financial statements of the Company include the accounts of the Bank, Higgins, Abstractors, Inc., Trust Co., FIDACO, Inc., NEP Capital Trust I and NEP Capital Trust II. The Bank, Higgins, Abstractors, Inc. and the Trust Co. are wholly-owned subsidiaries of the Company. NEP Capital Trust I and NEP Capital Trust II are statutory trusts all of the voting securities of which are owned by the Company, which were created under the laws of the state of Delaware in connection with two issuances of trust-preferred securities on April 10 and October 29, 2002, respectively. FIDACO, Inc. is an inactive subsidiary of the Bank with the only major asset being an investment in Hazleton Community Development Corporation. 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 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 the determination of the allowance for loan losses, the evaluation of deferred taxes and the evaluation of other than temporary impairment for certain investments.
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 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. The adoption of this statement did not 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 adoption of this Statement did not 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.” SFAS No. 142 was adopted on October 1, 2001. 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, as of October 1, 2001, the carrying amount of the previously recognized unidentifiable intangible asset related to the Schuylkill Savings branch acquisitions that was reclassified to goodwill was $200,000, 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.”
Stock OptionsIn December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.” This statement amends FASB Statement No.123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002, except for financial reports containing condensed financial statements for interim periods for which disclosure is effective for periods beginning after December 15, 2002. This Statement announces, “in the near future, the Board plans to consider whether it should propose changes to the U.S. standards on accounting for stock-based compensation”.
The following table represents the effect on net income and earnings per share had the Company applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:
Three Months Ended March 31, Six Months Ended March 31,
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
(Dollars in thousands, except per share data)
Net income, as reported: $ 1,289 $ 1,230 $ 2,232 $ 2,508
Less: proforma expense related
To stock options 99 98 195 218
----------------- ----------------- ----------------- -----------------
Proforma net income 1,190 1,132 2,037 2,290
================= ================= ================= =================
Basic net income per common share:
As reported $ 0.34 $ 0.31 $ 0.59 $ 0.59
Pro forma 0.32 0.28 0.54 0.54
Diluted net income per common share:
As reported $ 0.33 $ 0.29 $ 0.56 $ 0.56
Pro forma 0.30 0.27 0.52 0.51
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The amendments set forth in SFAS No. 149 require that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The guidance should be applied prospectively. The provisions of this statement that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003. The adoption of this statement is not expected to have a material effect on the Company’s financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This interpretation clarifies that a guarantor is required to disclose (a) the nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability, if any, for the guarantor’s obligations under the guarantee; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. This interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The initial recognition and initial measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material effect on the Company’s financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, in an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities
and activities of another entity. The objective of this interpretation is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. This interpretation changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of this interpretation apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of this interpretation has not and is not expected to have a material effect on the Company’s financial position or results of operations.
1. EARNINGS PER SHAREEarnings per share (“EPS”), basic and diluted, were $0.34 and $0.33, respectively, for the three months ended March 31, 2003 compared to $0.31 and $0.29, respectively, for the three months ended March 31, 2002. EPS, basic and diluted, were $0.59 and $0.56, respectively, for both the six months ended March 31, 2003 and March 31, 2002.
The following table presents the reconciliation of the numerators and denominators of the basic and diluted EPS computations.
Three Months Ended Six Months Ended
March 31, March 31,
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
(Dollars in thousands, except per share data)
Net income $ 1,289 $ 1,230 $ 2,232 $ 2,508
================ ================ ================ ================
Weighted-average common shares
Outstanding 6,427,350 6,427,350 6,427,350 6,427,350
Average treasury stock shares (2,253,162) (1,984,049) (2,255,165) (1,778,464)
Average common stock acquired by stock benefit plans:
Stock employee compensation trust (87,098) - (76,864) -
Stock awards unallocated, net (75,636) (117,814) (75,636) (117,814)
ESOP shares unallocated, net (250,663) (302,083) (257,090) (308,510)
---------------- ---------------- ---------------- ----------------
Weighted-average common shares used
To calculate basic earnings per share 3,760,791 4,023,404 3,762,595 4,222,562
Dilutive effect of stock awards 10,203 26,114 12,128 26,430
Dilutive effect of outstanding
stock options 178,824 211,577 177,757 199,043
---------------- ---------------- ---------------- ----------------
Weighted-average common shares used
To calculate diluted earnings per share 3,949,818 4,261,095 3,952,480 4,448,035
================ ================ ================ ================
Earnings per share-basic $ 0.34 $ 0.31 $ 0.59 $ 0.59
Earnings per share-diluted $ 0.33 $ 0.29 $ 0.56 $ 0.56
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 10,485 and 9,535 anti-dilutive common stock options outstanding as of March 31, 2003 and 2002, respectively. These options are not included in the calculation of diluted earnings per share for the periods presented.
2. INVESTMENT SECURITIESThe amortized cost and estimated market values of investment securities are summarized as follows:
March 31, 2003
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Available-for-sale securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
U.S. Government agency
securities $ 33,115 $ 370 $ (14) $ 33,471
Municipal securities 16,650 130 (8) 16,772
Corporate securities 41,031 1,311 (60) 42,282
Trust Preferred securities 12,769 87 (657) 12,199
Mortgage-backed securities 183,317 1,744 (379) 184,682
----------------- ----------------- ----------------- -----------------
Total debt securities 286,882 3,642 (1,118) 289,406
FHLB Stock 12,012 - - 12,012
Freddie Mac stock 2,241 - (309) 1,932
Fannie Mae stock 6,000 85 (40) 6,045
Other equity securities 284 106 (36) 354
----------------- ----------------- ----------------- -----------------
Total equity securities 20,537 191 (385) 20,343
Total $ 307,419 $ 3,833 $ (1,503) $ 309,749
================= ================= ================= =================
March 31, 2003
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Held-to-maturity securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
Municipal securities $ 3,554 $ 56 $ - $ 3,610
----------------- ----------------- ----------------- -----------------
Total $ 3,554 $ 56 $ - $ 3,610
================= ================= ================= =================
September 30, 2002
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Available-for-sale securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
U.S. Government agency
securities $ 24,032 $ 414 $ - $ 24,446
Municipal securities 16,247 197 - 16,444
Corporate securities 32,545 1,442 (18) 33,969
Trust Preferred securities 12,604 336 (511) 12,429
Mortgage-backed securities 221,383 4,047 (143) 225,287
----------------- ----------------- ----------------- -----------------
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
================= ================= ================= =================
September 30, 2002
---------------------------------------------------------------------------
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Held-to-maturity securities: Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
Municipal securities $ 3,553 $ 55 $ - $ 3,608
Certificates of deposit 99 - - 99
----------------- ----------------- ----------------- -----------------
Total $ 3,652 $ 55 $ - $ 3,707
================= ================= ================= =================
Loans consists of the following:
March 31, September 30,
2003 2002
----------------- -----------------
(in thousands)
Real Estate Loans:
One-to four-family $ 174,861 $ 198,307
Multi-family and commercial 79,207 75,912
Construction 6,234 7,157
----------------- -----------------
Total real estate loans 260,302 281,376
----------------- -----------------
Consumer Loans:
Home equity loans and lines of credit 75,128 79,253
Automobile 105,490 80,035
Unsecured lines of credit 2,668 2,297
Other 9,999 10,376
----------------- -----------------
Total consumer loans 193,285 171,961
----------------- -----------------
Commercial Loans
46,011 43,014
----------------- -----------------
Total loans 499,598 496,351
Less:
Deferred loan fees, net 1,582 1,529
Allowance for loan losses 5,270 5,449
----------------- -----------------
Net loans $ 492,746 $ 489,373
================= =================
The activity in the allowance for loan losses is as follows (in thousands):
Six Months Six Months
Ended Year Ended Ended
March 31, September 30, March 31,
2003 2002 2002
----------------- ----------------- -----------------
(in thousands)
Balance, Beginning of Period $ 5,449 $ 4,497 $ 4,497
Add:
Provisions charged to
operation 980 2,766 1,242
Recoveries 226 179 22
Less loans charged off 1,385 1,993 724
----------------- ----------------- -----------------
Balance, End of Period $ 5,270 $ 5,449 $ 5,037
================= ================= =================
In June 2002, the Bank sold $50.0 million in 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 automobile loans of $854,000, which was 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 March 31, 2003. The retained interest includes 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-only strip and cash collateral account for the transaction is shown in the following table:
March 31, June 30,
2003 2002
----------------- -----------------
Retained interest
Average annual repayment rate 1.5 % 1.5 %
Average annual expected default rate 1.5 1.5
Discount rate 15.0 18.0
Weighted average life of underlying automobile loans (in months) 41 48
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:
March 31, 2003
(dollars in thousands)
Fair value of retained
interest $ 3,207
Weighted-average repayment rate assumption:
Pre-tax decrease to earnings due to a 10% adverse change $ 51
Pre-tax decrease to earnings due to a 20% adverse change $ 100
Weighted-average expected default rate:
Pre-tax decrease to earnings due to a 10% adverse change $ 58
Pre-tax decrease to earnings due to a 20% adverse change $ 116
Weighted-average discount rate:
Pre-tax decrease to earnings due to a 10% adverse change $ 56
Pre-tax decrease to earnings due to a 20% adverse change $ 110
As of March 31, 2003, the weighted-average life of the underlying automobile loans in the Trust was 41 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.
5. DEPOSITSDeposits consist of the following major classifications:
March 31, 2003 September 30, 2002
------------------------------------- ------------------------------------
Percent Percent
Amount of Total Amount of Total
----------------- ------------------ ----------------- -----------------
(in thousands)
Noninterest-bearing $ 35,703 5.97 % $ 32,428 5.35 %
----------------- ------------------ ----------------- -----------------
Interest-bearing:
Savings 99,448 16.64 95,779 15.78
NOW checking 95,493 15.97 78,684 12.98
Money market 108,107 18.08 100,274 16.54
----------------- ------------------ ----------------- -----------------
303,048 50.69 274,737 45.30
----------------- ------------------ ----------------- -----------------
Certificates of deposit greater
than $100,000: 51,083 8.55 71,379 11.77
Certificates of deposit less
than $100,000: 207,989 34.79 227,868 37.58
----------------- ------------------ ----------------- -----------------
259,072 43.34 299,247 49.35
----------------- ------------------ ----------------- -----------------
Total $ 597,823 100.00 % $ 606,412 100.00 %
================= ================== ================= =================
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 March 31, 2003 and September 30, 2002, such advances mature as follows:
March 31,
Weighted 2003
Due by March 31, Average Rate (in thousands)
----------------------------- ----------------- -----------------
2004 5.63% $ 56,000
2005 5.72 25,000
2006 5.91 72,000
2007 5.05 5,087
2008 - -
Thereafter 5.29 50,324
----------------- -----------------
Total FHLB advances 5.64% $ 208,411
=================
September 30,
Weighted 2002
Due by September 30, Average Rate (in thousands)
----------------------------- ----------------- -----------------
2003 - % $ -
2004 5.60 59,000
2005 6.34 52,000
2006 5.33 42,000
2007 5.05 5,089
Thereafter 5.29 50,332
----------------- -----------------
Total FHLB advances 5.64% $ 208,421
=================
7. TRUST PREFERRED SECURITIES
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 a pooled trust preferred securities offering. 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.
The stated maturity of the debentures is April 22, 2002. 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.
The Company has the right, at one or more times, to defer interest payments on the Debentures for up to ten consecutive semi-annual periods. All deferrals will end on an interest payments date and will not extend beyond April 22, 2032, the stated maturity ate of the Debentures. If the Company defers interest payments on the Debentures, the Trust will also defer distributions on the capital securities. During any deferral period, each installment of interest that would otherwise have been due and payable will bear additional interest (to the extent payment of such interest would be legally enforceable) at the applicable distribution rate, compounded quarterly. Furthermore in 2002, the Company recognized an amortizable intangible asset with a value of $220,000 relating to the issuance of these trust preferred securities.
On October 15, 2002, the Company sponsored the creation of NEP Capital Trust II, a Delaware statutory business trust. The Company is the owner of all of the common securities of the Trust. On October 29, 2002, the Trust issued $15.0 million in the form of floating rate capital securities through a pooled trust preferred securities offering. The proceeds from this issuance, along with the company's $464,000 capital contribution for the Trust's common securities, were used to acquire $15.5 million aggregate principal amount of the Company's floating rate junior subordinated deferrable interest debentures due November 7, 2032 (the "Debentures"), which constitute the sole asset of the Trust. The interest rate on the Debentures and the distribution rate on the capital securities is variable and adjustable quarterly at 3.45% over the three-month LIBOR, with an initial rate of 5.27%. A rate cap of 12.5% is effective through 2007. 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.
The stated maturity of the Debentures is November 7, 2032. 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 August 7, 2007. The Debentures are also subject to redemption after the occurrence of certain events that would either have a negative tax effect on the Trust or the Company 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.
The Company has the right, at one or more times, to defer interest payments on the Debentures for up to twenty consecutive quarterly periods. All deferrals will end on an interest payment date and will not extend beyond November 7, 2032, the stated maturity date of the Debentures. If the Company defers interest payments on the Debentures, the Trust will also defer distributions on the capital securities. During any deferral period, each installment of interest that would otherwise have been due and payable will bear additional interest (to the extent payment of such interest would be legally enforceable) at the applicable distribution rate, compounded quarterly. The Company recognized an amortizable intangible asset with a value of $450,000 relating to the issuance of these trust preferred securities.
A summary of the trust securities issued and outstanding is as follows:
Amount
Outstanding at Prepayment Distribution
March 31, Option Payment
Name 2003 Rate Date Maturity Frequency
- ------------------------- ----------------- --------- ----------------- ----------------- -----------------
NEP Capital Trust I $ 7,000,000 5.32% 4/22/2007 4/22/2032 Semi-annually
NEP Capital Trust II $ 15,000,000 4.79% 8/7/2007 11/7/2032 Quarterly
A summary of goodwill and intangible assets is as follows:
At March 31, 2003
-----------------------------------------------------------
Gross Net
Carrying Accumulated Carrying
Goodwill Amount Amortization Amount
---------------------------------- -----------------------------------------------------------
(in thousands)
Acquisition of:
Abstractors $ 248 $ (160) $ 88
Security Savings Association of Hazleton 571 (28) 543
Higgins Insurance Associates, Inc. 2,619 (95) 2,524
Schuylkill Savings and Loan Association 200 - 200
DeAndrea Association 400 - 400
------------------- ----------------- ------------------
Total goodwill $ 4,038 $ (283) $3,755
=================== ================= ==================
Gross Net
Carrying Accumulated Carrying
Other Intangible Assets Amount Amortization Amount
----------------------------------------------------- ------------------- ----------------- ------------------
(in thousands)
Amortizing:
Omega core deposit intangible $ 1,537 $ (881) $ 656
Security Savings Association of Hazleton
core deposit intangible 9,086 (1,772) 7,314
Schuylkill Savings and Loan Association
core deposit intangible 255 (37) 218
Other intangibles 929 (141) 788
Nonamortizing intangible assets
Other intangible assets 75 - 75
----------------- ----------------- ------------------
Total intangible assets $ 11,882 $ (2,831) $ 9,051
================= ================= ==================
Nonamortizing intangible assets consist of title plant of $75,000 at March 31, 2003 and 2002.
Amortization expense of other amortizing intangible assets for the six and three months ended March 31, 2003 and March 31, 2002 is as follows:
For the Three Months Ended For the Six Months Ended
March 31, March 31,
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
(Dollars in thousands)
Core deposit intangibles $ 205 $ 234 $ 415 $ 477
Other amortizing intangibles 52 102 36
----------------- ----------------- ----------------- -----------------
Total amortizing intangibles $ 257 $ 234 $ 517 $ 513
================= ================= ================= =================
The estimated amortization expense of amortizing intangible assets for each of the five succeeding fiscal years is as follows:
Core Other Total
Deposit Amortizing Amortizing
Intangibles Intangibles Intangibles
----------------- ----------------- -----------------
(in thousands)
Estimated Annual Amortization Expense
-------------------------------------------------------
For the year ended September 30, 2003 $ 849 $ 176 $ 1,025
For the year ended September 30, 2004 750 176 926
For the year ended September 30, 2005 644 176 820
For the year ended September 30, 2006 586 145 731
For the year ended September 30, 2007 558 90 648
Intangible assets acquired during the six months ended March 31, 2003 are as follows:
Weighted
Average
Amortization
Amount Residual Period
Assigned Value in Years
----------------- ----------------- -----------------
(dollars in thousands)
Other intangibles $ 450 - 5
The adoption of SFAS No. 142 and SFAS No. 147 as of October 1, 2001 had no impact on March 31, 2003 or 2002 results.
| Item 2. | MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
In addition to historical information, this Form 10-Q includes certain forward-looking statements based on current management expectations. These forward-looking statements are generally identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project” or similar expressions. The Company intends such forward-looking statements to be covered by the safe harbor provisions of the Private Securities Reform Act of 1995 and is including this statement for purposes of such safe harbor provisions. The Company’s 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 regulations 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 Bank’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 factors should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company does not undertake – and specifically disclaims any obligation – to publicly revise any forward – looking statements to reflect events or circumstances after the date of the statements to reflect the occurrence of anticipated or unanticipated events. Further description of the risks and uncertainties to the business are included in detail in Section B, Management Strategy, Section C, Critical Accounting Policies, and Section E, Liquidity and Capital Resources.
| A. | General |
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 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 meaningful component of the Company’s operations mainly due to fees earned by non-bank subsidiaries. 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.
On January 2, 2002, the Company purchased three banking offices from Schuylkill Savings and Loan Association of Schuylkill Haven, Pa. The Company purchased $11.4 million of loans and assumed $12.8 million of deposits from these offices.
On January 8, 2002, Higgins acquired the DeAndrea Agency, which specializes in personal and commercial insurance.
On September 4, 2002, the Bank formed a relationship with Smith Barney under which Smith Barney Investment Centers will provide retail brokerage products and services at all of the First Federal offices. This is Smith Barney’s first relationship with a bank in the Commonwealth of Pennsylvania. Smith Barney, an independent, registered broker-dealer, is not affiliated with the Bank.
| B. | 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, multi-family and commercial real estate lending, construction lending and small business and municipal commercial lending. In order to promote long-term financial strength and profitability, the Company has focused on: (i) maintaining strong asset quality by originating one- to four-family loans located in its market area; (ii) emphasizing higher yielding consumer loans, specifically indirect automobile loans, and commercial loans, primarily to small businesses and municipalities; (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.
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, and in light of the low interest rate environment, the Company is selling conforming mortgage loan originations with interest rate adjustments of fifteen years or greater. These loan products are sold at origination in the secondary market. The Company also offers nonconforming one- to four-family loans.
| C. | Critical Accounting Policies |
Other Investment. The Company has a $1.5 million net investment in the preferred stock of BuildersFirst Holdings, Inc., which makes loans to and provides services to builders in the Eastern United States. The Company is utilizing the cost method of accounting for this investment. BuildersFirst continues to experience losses. At this time, BuildersFirst is seeking additional capital to allow it to expand its funding of builders and thereby achieve greater efficiency of scale. If BulidersFirst cannot obtain such additional capital and achieve greater efficiency in its operations, the Company may be required to write off its investment. The Company periodically evaluates the current value of the investment.
Allowances 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. 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 uncollected portion of 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.
Intangible Assets. Intangible assets include core deposit intangibles and certain other miscellaneous intangibles. 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 eliminated the regularly scheduled amortization of goodwill and replaced 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 go beyond the Company’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.
| D. | Non-Performing Assets and Impaired Loans |
The following table presents information regarding the Bank’s non-performing loans, real estate owned and other repossessed assets at the dates indicated (unaudited):
March 31, September 30,
2003 2002
----------------- -----------------
(dollars in thousands)
Nonperforming loans:
Non-accrual loans plus other impaired loans $ 4,346 $ 4,200
Real estate owned and other repossessed assets
609 547
----------------- -----------------
Total non-performing assets 4,955 4,747
Troubled debt restructurings - 55
----------------- -----------------
Troubled debt restructurings and total non-performing assets $ 4,955 $ 4,802
================= =================
Total non-performing loans as a percentage of total loans 0.87% 0.85%
Total non-performing assets as a percentage of total assets 0.55 0.53
The increase in non-performing assets was primarily the result of additional delinquencies associated with commercial loans.
| E. | Liquidity and Capital Resources |
Liquidity is the ability to meet current and future financial obligations. The Bank further defines liquidity as the ability to respond to depositors as well as maintaining flexibility to take advantage of lending and investment opportunities. The Bank’s primary sources of funds on a long-term and short-term basis are deposits, principal and interest payments on loans, sales and maturities of mortgage-backed and investment securities, and FHLB advances. The Bank 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 and securities 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.
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 March 31, 2003, cash and cash equivalents and investment and mortgage-related securities available-for-sale totaled $351.8 million, or 38.8% of total assets.
The Bank has other sources of liquidity if a need for additional funds arises, including FHLB advances. At March 31, 2003, the Bank had $208.4 million in advances outstanding from the FHLB under its overall borrowing capacity from the FHLB of $288.5 million. The Bank plans to use the proceeds from the sale of current investments to pay the $56.0 million fixed rate FHLB borrowings that will mature within the next twelve months. 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. In addition to these traditional funding sources, the Bank began utilizing alternative funding sources such as the sale and securitization of automobile loans.
At March 31, 2003, the Bank had commitments to originate and purchase loans and unused outstanding lines of credit and undisbursed proceeds of construction mortgages totaling $110.2 million. The Bank anticipates that it will have sufficient funds available to meet these commitments. Certificate accounts, including Individual Retirement Account (“IRA”) and KEOGH accounts, which are scheduled to mature in less than one year from March 31, 2003 totaled $100.7 million. Based on past experience, the Bank expects that substantially all of these maturing certificate accounts, with the exception of jumbo certificates of deposit, will be retained by the Bank at maturity. At March 31, 2003, the Bank had $22.7 million in jumbo certificates, the majority of which are deposits from local school districts and municipalities.
The primary sources of funding for the Company are dividend payments from the Bank, sales and maturities of investment securities, the issuance of trust-preferred securities and, to a lesser extent, earnings on investments and deposits of the Company. Dividend
payments by the Bank have primarily been used to fund the Company’s repurchase of its stock, to pay cash dividends, and to pay interest on the trust-preferred securities. The Bank’s ability to pay dividends and other capital distributions to the Company is generally limited by the regulations of the Office of Thrift Supervision. During April 2002, the Company obtained $7.0 million through a trust-preferred offering, and in October 2002, the Company obtained an additional $15.0 million through a trust-preferred offering. Of the total trust-preferred proceeds, $10.0 million was used to purchase bank-owned life insurance, $5.0 million was used to further capitalize the Bank, and the remaining amount at the Company level was used for general corporate purposes, as well as to fund the trust established to purchase the Company’s stock. To date, the Company has contributed $1.8 million to the trust, which has used such funds to purchase 114,174 shares of common stock.
At March 31, 2003, the Bank exceeded all of its regulatory capital requirements with a tangible capital level of $59.7 million, or 6.8% of total adjusted assets, which is above the required level of $13.2 million, or 1.5%; a core capital level of $59.7 million, or 6.8% of total adjusted assets, which is above the required level of $26.5 million, or 3.0%; and a risk-based capital of $65.0 million, or 11.5% of risk-weighted assets, which is above the required level of $45.1 million, or 8.0%.
At March 31, 2003, the Bank had total equity, determined in accordance with generally accepted accounting principles, of $70.3 million, or 7.9%, of total assets, which approximated the Bank’s regulatory tangible capital at that date of 6.5% of assets. An institution with a ratio of tangible capital to total assets of greater than or equal to 5% is considered to be “well-capitalized” pursuant to OTS regulations.
| F. | Comparison of Financial Condition at March 31, 2003 and September 30, 2002 |
Total assets increased $672,000 from $905.5 million at September 30, 2002 to $906.2 million at March 31, 2003. The growth was generated by a $16.7 million increase in cash and cash equivalents that was primarily funded by a $60.3 million sale of mortgage-backed securities and a $15.0 million trust-preferred offering, offset by security purchases and loan originations. As discussed previously, the Company anticipates continuing to utilize these additional funds for general corporate purposes and to purchase stock for the stock option trust. Securities classified as available-for-sale decreased $18.2 million, from $327.9 million at September 30, 2002 to $309.7 million at March 31, 2003. The decrease was attributable to the sale of $60.3 million of mortgage-backed securities with an average yield of 2.89% and an average life of 1.18 years, with a portion of the proceeds reinvested in securities with average lives of 4.5 years and an average yield of 3.48%. The reinvestment had not been completed as of March 31, 2003. This restructuring was done to minimize the effect of prepayments of mortgage-backed securities in the lower market interest rate environment.
Net loans increased $3.3 million from September 30, 2002. Consumer loans increased $21.3 million due to a $25.5 million increase in indirect automobile loan originations within the Company’s market area offset by a decrease in other consumer loan balances. Commercial loans increased during the six month period by $3.0 million. Total real estate loans decreased $21.1 million due to the $23.4 million decrease in one- to four- family loans as a result of prepayments of mortgages due to the lower market interest rate environment.
Total liabilities increased $1.7 million from $837.1 million at September 30, 2002 to $838.9 million at March 31, 2003, due primarily to the issuance of $15.0 million in trust-preferred securities, offset by an $8.6 million decrease in deposits, a $3.4 million decrease in other liabilities and a $2.1 million decrease in other borrowings. Other liabilities decreased due to a $3.7 million decrease in deferred taxes as a result of a decrease in unrealized gain on securities. Other borrowings decreased as a result of a decrease in overnight sweep accounts.
Deposits decreased $8.6 million from $606.4 million as of September 30, 2002 to $597.8 million at March 31, 2003. The largest decrease was in certificates of deposit, which decreased $40.2 million as a result of matured certificates being rolled into checking and other interest-bearing accounts as well as municipalities and local school districts withdrawing funds for use in operations.
In October 2002, the Company issued an additional $15.0 million of trust-preferred securities. The interest rate on the trust-preferred securities is variable based on three month LIBOR and adjusts quarterly with a rate as of March 31, 2003 of 4.79%, with a rate cap of 12.5% through November 7, 2007.
Total equity decreased slightly primarily due to a $1.9 million decrease in accumulated other comprehensive income as a result of a decrease in unrealized gains on securities. Because of interest rate volatility, accumulated other comprehensive income could materially fluctuate from period to period depending on economic and interest rate conditions. Equity also decreased due to the purchase of 69,133 shares for the stock employee compensation trust at a cost of $1.1 million and dividend payments of $982,000. These decreases were offset by net income for the six months of $2.2 million, the release of shares under the employee stock ownership plan and the vesting of previously granted shares of restricted stock.
| G. | Comparison of Operating Results for the Three Months ended March 31, 2003 and March 31, 2002 |
General. The Company had net income of approximately $1.3 million and $1.2 million for the three months ended March 31, 2003 and March 31, 2002, respectively. Basic and diluted earnings per share increased to $0.34 and $0.33 per share, respectively, for the three months ended March 31, 2003 as compared to $0.31 and $0.29 per share, respectively, for the same period in 2002.
Interest Income. Total interest income decreased $1.8 million, or 13.5%, from $13.8 million for the three months ended March 31, 2002 to $12.0 million for the three months ended March 31, 2003. This decrease was primarily due to a 125 basis point decline on the tax-equivalent yield on earning assets to 5.72% for the three months ended March 31, 2003 as compared to 6.97% for the same period ended 2002. Interest income on loans decreased $1.1 million primarily due to a 77 basis point decrease in the yield, combined with a $6.9 million decrease in the average balance of loans. Interest income on mortgage related securities decreased $526,000 as the yield on such securities declined 165 basis points, while the average balance increased $34.4 million. Interest income on taxable investment securities decreased $219,000 as a result of a 175 basis point decline. Rapid repayment of mortgage-backed securities has resulted in reinvestment options at substantially lower rates than the previous year.
Interest Expense. Interest expense decreased $749,000, or 10.4%, from $7.2 million for the three months ended March 31, 2002 to $6.4 million for the three months ended March 31, 2003. The decrease in interest expense was primarily attributable to a declining interest rate environment that resulted in the cost of deposits decreasing to 2.31% for the three months ended March 31, 2003 as compared to 3.28% for the same period ended 2002. Offsetting the declining rates was an increase in the average balance of interest-bearing liabilities of $56.2 million to $794.9 million for the three months ended March 31, 2003. The decrease in interest expense on deposits of $1.0 million was primarily due to a $1.2 million decrease in interest expense on certificates of deposit, which was the result of a 104 basis point decrease in interest rates and a $44.6 million decrease in the average balance, offset by a $77.4 million increase in the average balance on checking accounts. Interest expense on trust-preferred debt increased $281,000 due to the $22.0 million trust-preferred securities which the Company did not have during the second quarter of 2002.
Provision for Loan Losses. The provision for loan losses increases the allowance for loan losses. The Bank’s provision for loan losses for the three months ended March 31, 2003 increased $5,000 compared to the comparable 2002 period. The increase was due to increased mortgage and consumer charge offs, offset by a decrease in non-accrual loans. During the quarter, the Company enhanced its loan servicing function to ensure the speedy resolution of delinquencies and employed a new collections manager and a new recovery manager to address the risk of deterioration in loan quality. As a result, total delinquencies for mortgage and consumer loans were reduced during the quarter to .40% and .05% of total loans, respectively, at March 31, 2003, from .50% and .09% at March 31, 2002. The Bank also completed a full review of its mortgage and consumer loan portfolios and charged-off loans where the fair value of assets fell below the book value. This analysis led to net loan charge-offs of $515,000 for the quarter ended March 31, 2003, compared to net loan charge-offs of $422,000 for the quarter ended March 31, 2002. This increased level of charge-offs is expected to be a one-time event. Net loan charge-offs, as a percentage of total loans for the current quarter, were 10 basis points. During the March 2003 quarter, $208,000 of the addition to provision for loan losses was due to two commercial real estate loans having specific reserves established and one commercial loan borrower who declared bankruptcy affecting a loan that was current at December 31, 2002. At March 31, 2003, delinquent commercial loans were .42% of total loans, a slight increase from the .41% level at March 31, 2002, due to the change in this commercial loan.
The allowance is maintained at a level that represents management’s best estimate of known and inherent estimated losses based upon an evaluation of the loan portfolio. Loan losses, other than those incurred on loans held for sale, are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. Management’s evaluation 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 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.
Non-interest Income. Non-interest income increased $2.1 million, or 126.5% from $1.6 million for the three months ended March 31, 2002 to $3.7 million for the three months ended March 31, 2003. Gain on sale of available securities increased $1.1 million due primarily to the $1.1 million gain on the sale of $60.3 million in mortgage-backed securities as part of the expanding staff in business lines restructuring of the investment portfolio. Gain-on-sale of loans increased $272,000 as originations of fixed-rate mortgages, in excess of the Bank’s retention policy, were sold. Other income, for the three months ended March 31, 2003 increased $283,000 as a result of $156,000 of income from bank-owned life insurance and $148,000 from income on the retained interest associated with the sale and securitization of $50.0 million of automobile loans in June 2002. Insurance commission income increased $178,000, due to continued growth in insurance related services. Service charges and other fees increased $124,000 due to a larger customer base that partially resulted from the acquisition of three additional branches of another community financial institution during 2002. Trust fee income increased $19,000 as a result of growth in assets under management.
Non-interest Expense. Total non-interest expense increased $928,000, or 16.4%, from $5.6 million for the three months ended March 31, 2002 to $6.6 million for the three months ended March 31, 2003. This increase was due primarily to an increase in compensation and employee benefits of $286,000 for new staff associated with the acquisitions of three additional branches as well as additional employees to staff expanding business lines in 2002. Other non-interest expense increased $340,000 due to costs associated with foreclosed properties combined with general increases in operating expenses such as supplies and telephone and other incremental increases that resulted from operating a larger organization. Given the change in the loan servicing function, it is not expected that the level of expenses for OREO will continue. Telephone costs will be reduced beginning in April 2003, due to a change in long distance carriers and installation of a new phone system by June 30, 2003. These changes are expected to result in pre-tax cost savings of $150,000 for the first year following the changes, and $125,000 per year thereafter. Advertising costs increased to $120,000 over the previous year quarter as the Company continued the promotion of a new branding campaign. Occupancy expenses increased $100,000 due to seasonal operating expenses such as utilities and maintenance. In late March 2003, First Federal decided to close three retail offices, sell the buildings occupied by two of these offices and reduce the office hours at a fourth office. These actions are expected to result in savings of $330,000 per year beginning with the fourth fiscal quarter of 2003. Deposit services will be provided by nearby First Federal offices. The Company also determined to build a new Schuylkill County regional office that will replace an existing office inside a nearby mall. When the new office is completed and occupied in late 2003 or early 2004, it is expected to reduce the cost of serving this community.
Income Taxes. The Company had an income tax provision of $702,000 for the three months ended March 31, 2003, compared to a provision of $758,000 for the three months ended March 31, 2002, resulting in effective tax rates of 35.3%, and 38.1%, respectively. This decrease, despite pre-tax income remaining relatively constant, was due to income generated from bank-owned life insurance, which is excludable for income tax purposes. Included in the income tax provision for both the three months ended March 31, 2003 and March 31, 2002 was an approximately $60,000 increase to a deferred tax asset valuation allowance related to the charitable contribution carryforward. The contribution carryforward will expire September 30, 2003, if not utilized.
| H. | Comparison of Operating Results for the Six Months ended March 31, 2003 and March 31, 2002 |
General. The Company had net income of approximately $2.2 million and $2.5 million for the six months ended March 31, 2003 and March 31, 2002, respectively. Basic and diluted earnings per share were $0.59 and $0.56 per share, respectively, for both the six months ended March 31, 2003 and March 31, 2002.
Interest Income. Total interest income decreased $2.9 million, or 10.5%, from $27.5 million for the six months ended March 31, 2002 to $24.6 million for the six months ended March 31, 2003. This decrease was primarily due to a 123 basis point decline on the tax-equivalent yield on earning assets to 5.83% for the six months ended March 31, 2003 as compared to 7.06% for the same period ended 2002. Interest income on loans decreased $1.9 million primarily due to a 69 basis point decrease in the yield. Interest income on taxable investment securities decreased $603,000 as a result of a 173 basis point decline. Interest income on mortgage related securities decreased $348,000 as the yield on such securities declined 155 basis points, offset by an increase in average balance of $63.4 million. Rapid repayment of mortgage-backed securities has resulted in reinvestment options at substantially lower rates than the previous year.
Interest Expense. Interest expense decreased $1.1 million, or 7.6%, from $14.5 million for the six months ended March 31, 2002 to $13.4 million for the six months ended March 31, 2003. The decrease in interest expense was primarily attributable to a declining interest rate environment that resulted in the cost of deposits decreasing to 2.43% for the six months ended March 31, 2003 as compared to 3.40% for the same period ended 2002. Offsetting the declining rates was an increase in the average balance of interest-bearing liabilities of $80.6 million to $800.8 million for the six months ended March 31, 2003. In particular, the average balance of transaction accounts increased $80.4 million to $198.2 million. This increase was the result of the addition of three branch offices in 2002, as well as the competitively priced products being marketed throughout the Company’s market area. Deposit growth also was driven by a general shift in customer preference away from the equity markets and into insured bank deposits. The decrease in interest expense on deposits of $1.7 million, was primarily due to a $2.2 million decrease in interest expense on certificates of deposit, which was the result of a 111 basis point decrease in interest rates, offset by an increase in the average balance on transaction accounts of $80.4 million. Interest expense on trust-preferred debt increased $517,000 as a result of the $22.0 million trust-preferred securities which the Company did not have during the six months ended March 31, 2002.
Provision for Loan Losses. The Company’s provision for loan losses for the six months ended March 31, 2003 decreased $262,000 compared to the comparable 2002 period. The Bank’s success in maintaining asset quality was the basis for reduction of the loan loss provision. Non-performing assets at March 31, 2003 were reduced to $5.0 million, or .55% of total assets, from $5.3 million, or .58% of total assets as of March 31, 2002. The Company enhanced its loan servicing function to ensure the speedy resolution of delinquencies and employed a new collections manager and a new recovery manager to address the risk of deterioration in loan quality. As a result, total delinquencies for mortgage and consumer loans were reduced to .40% and .05% of total loans, respectively, at March 31, 2003, from ..50% and .09% at March 31, 2002. The Bank also completed a full review of its mortgage and consumer loan portfolios and charged-off loans where the fair value of assets fell below the book value. This analysis led to net loan charge-offs of $1.2 million for the six months ended March 31, 2003, compared to net loan charge-offs of $702,000 for the six months ended March 31, 2002. This increased level of charge-offs is expected to be a one-time event. Net loan charge-offs, as a percentage of total loans for the fiscal year-to-date were 18 basis points. For the six months ended March 31, 2003, $286,000 of the addition to provision for loan losses was due to two commercial real estate loans having specific reserves established and one commercial loan borrower who declared bankruptcy affecting a loan that was current at December 31, 2002. At 2003, delinquent commercial loans were .42% of total loans, a slight increase from the .41% level at March 31, 2002.
Non-interest Income. Non-interest income increased $3.0 million, or 93.9% from $3.2 million for the six months ended March 31, 2002 to $6.2 million for the six months ended March 31, 2003. During the six months ended March 31, 2003 there was a $60.3 million sale of mortgage-backed securities, which resulted in gains on sale of securities of $1.1 million. Other income for the six months ended March 31, 2003 increased $645,000 as a result of $312,000 of income from bank-owned life insurance and $294,000 from income on the retained interest associated with the sale and securitization of $50.0 million of automobile loans in June 2002. Insurance commission income increased $383,000 due to continued growth in insurance related services. Gain-on-sale of loans increased $364,000 as $21.9 million of originations of fixed-rate mortgages, in excess of the Bank’s retention policy were sold in the six months ended March 31, 2003 compared to $7.6 million of such loans sold in the same period in 2002. During the current period, gains totaled $603,000, as compared to a gain of only $239,000 in the comparable prior year period. Service charges and other fees increased $270,000 due to a larger customer base that partially resulted from the acquisition of three additional branches of another community financial institution during 2002. Trust fee income increased $98,000 from prior year and the Trust assets under management increased to $147.0 million as of March 31, 2003, with over 350 accounts under management.
Non-interest Expense. Total non-interest expense increased $2.0 million, or 35.8% from $11.1 million for the six months ended March 31, 2002 to $13.1 million for the six months ended March 31, 2003. This increase was due primarily to an increase in compensation and employee benefits of $655,000 for increased hospitalization costs and new employees to staff the growth in the Company’s business lines. Other non-interest expense increased $559,000 due to costs associated with foreclosed properties combined with general increases in operating expenses such as supplies and telephone and other incremental increases that resulted from operating a larger organization. Professional fees increased $281,000 as a result of accounting fees related to fiscal 2002 audit matters coupled with an increase in consulting services during the continued transition between chief financial officers. Advertising costs increased to $256,000 over the previous year quarter as the Company continued the promotion of a new branding campaign. Occupancy expenses increased $239,000 due to Company expansion.
Income Taxes. The Company had an income tax provision of $1.1 million for the six months ended March 31, 2003, compared to a provision of $1.4 million for the six months ended March 31, 2002 resulting in effective tax rates of 32.7%, and 35.0%, respectively. The decline in income tax expense was primarily attributable to a decrease in taxable income, along with an increase in tax-exempt income from bank-owned life insurance. Included in the income tax provision for the six months ended March 31, 2003, was a $99,000 increase to a deferred tax asset valuation allowance related to the charitable contribution carryforward. As of March 31, 2003, the Company had $184,000 of net deferred tax assets resulting from the charitable contribution carryforward related to the creation of the First Federal Foundation in 1998. This carry forward will expire at the end of fiscal year 2003, if not utilized.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
| As of March 31, 2003, there have been no material changes in the quantative and qualitative disclosures about market risks presented in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002. | |
| Item 4. | CONTROLS AND PROCEDURES |
| (a)Evaluation of disclosure controls and procedures. The Company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company files or submits under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. Based upon her evaluation of those controls and procedures performed
within 90 days of the filing date of this report, the chief executive officer and the chief financial officer of the
Company concluded that the Company's disclosure controls and procedures were adequate. (b)Changes in internal controls.The Company made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the chief executive officer. |
Part II - OTHER INFORMATION
| Item 1. | 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 2. | Changes in Securities and Use of Proceeds |
| Not applicable. | |
| Item 3. | Defaults Upon Senior Securities |
| Not applicable. | |
| Item 4. | Submission of Matters to a Vote of Security Holders |
| The Annual Meeting of the Stockholders of the Company was held on January 29, 2003. The results of the vote were as follows: |
1. The following individuals were elected as directors, each for a three-year term:
VOTES FOR VOTES WITHHELD
--------- --------------
Paul L. Conard 3,506,705 104,214
John P. Lavelle 3,506,017 104,902
Michael J. Leib 3,510,298 100,621
2. The appointment of KPMG LLP as independent auditors of Northeast Pennsylvania Financial
Corp. for the fiscal year ended September 30, 2003 was ratified by the stockholders by
the following vote:
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
3,538,940 57,303 14,676 1
| Item 5. | Other information |
| Not applicable. |
| Item 6. | Exhibits and Reports on Form 8-K |
| Not applicable. | |
| (A) | Exhibits |
| 3.1 | Certificate of Incorporation of Northeast Pennsylvania Financial Corp.* |
| 3.2 | Bylaws of Northeast Pennsylvania Financial Corp.* |
| 4.0 | Form of Stock Certificate of Northeast Pennsylvania Financial Corp.* |
| 11.0 | Statement regarding Computation of Per Share Earnings (See Notes to Consolidated Financial Statements) |
| 99.1 | Chief Executive Officer and Chief Financial Officer Certification Pursuant to Section 906, of the Sarbanes-Oxley Act of 2002 |
| * | Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement, and any amendments thereto, Registration No. 333-43281. |
| ** | Incorporated herein by reference into this document from the Exhibits to the Form 10-K/A as filed with the Securities and Exchange Commission on January 8, 2003. |
| (B) | Reports on Form 8-K |
| None. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NORTHEAST PENNSYLVANIA FINANCIAL CORP. |
|
| Date: May 15, 2003 | By: /s/ E. Lee Beard E. Lee Beard President, Chief Executive Officer, and chief financial officer |
I, E. Lee Beard, certify that: