Attached files

file filename
EX-21 - North Penn Bancorp Incv179315_ex21.htm
EX-23.2 - North Penn Bancorp Incv179315_ex23-2.htm
EX-31.1 - North Penn Bancorp Incv179315_ex31-1.htm
EX-23.1 - North Penn Bancorp Incv179315_ex23-1.htm
EX-32.2 - North Penn Bancorp Incv179315_ex32-2.htm
EX-32.1 - North Penn Bancorp Incv179315_ex32-1.htm
EX-31.2 - North Penn Bancorp Incv179315_ex31-2.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended
  December 31, 2009

¨    TRANSITION REPORT PURSUANT TO UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from
 
to
 

 
Commission file number
     000-52839

NORTH PENN BANCORP, INC.

(Exact name of Registrant as specified in its charter)

Pennsylvania
 
26-0261305
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

216 Adams Avenue, Scranton, Pennsylvania
 
18503
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code
  
   (570) 344-6113

Securities registered pursuant to Section 12(b) of the Act:
   None
 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.10 per share

(Title of class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes ¨      Nox
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes ¨      Nox
 
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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes ¨ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K  is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  ¨
 
Accelerated filer ¨
     
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
 
Small reporting company  x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨    No x
 
The aggregate market value of the Company’s common stock held by non-affiliates on December 31, 2009, based on the closing price of such stock on that date totaled $10,810,188
 
The number of shares of common stock outstanding as of March 15, 2010 was 1,327,271.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Corporation’s definitive proxy statement relating to the 2010 Annual Meeting of Stockholders, to be held on May 25, 2010, are incorporated by reference in Part III.
 
 
 

 

North Penn Bancorp, Inc.
Form 10-K
INDEX
 
   
Page
       
FORWARD-LOOKING STATEMENTS
 
1
 
       
PART I
     
       
ITEM 1 – BUSINESS
 
1
 
       
ITEM 1A – RISK FACTORS
 
14
 
       
ITEM 1B – UNRESOLVED STAFF COMMENTS
     
       
ITEM 2 –PROPERTIES
 
19
 
       
ITEM 3 – LEGAL PROCEEDINGS
 
19
 
       
ITEM 4 – (REMOVED AND RESERVED)
 
19
 
       
PART II
     
       
ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
19
 
       
ITEM 6 – SELECTED FINANCIAL DATA
 
20
 
       
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
 
20
 
       
ITEM 7A -  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
29
 
       
ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
30
 
       
ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND  FINANCIAL DISCLOSURE
 
64
 
       
ITEM 9A(T) – CONTROLS AND PROCEDURES
 
64
 
       
ITEM 9B– OTHER INFORMATION
 
65
 
       
PART III
     
       
ITEM 10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
65
 
       
ITEM 11 – EXECUTIVE COMPENSATION
 
65
 
       
ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
66
 
       
ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
66
 
       
ITEM 14 –PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
66
 
       
PART IV
     
       
ITEM 15 – EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
66
 
       
SIGNATURES
  
67
 

 
II

 

FORWARD-LOOKING STATEMENTS

Cautionary Statement for Purposes of the Private Securities Litigation Reform Act of 1995

North Penn Bancorp, Inc. makes forward-looking statements in this report.  These forward-looking statements may include: statements of goals, intentions and expectations; estimates of risks and of future costs and benefits; assessments of probable loan losses; assessments of market risk; and statements of the ability to achieve financial and other goals.  Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. The Company does not assume any duty and does not undertake to update its forward-looking statements.  Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that the Company anticipated in its forward-looking statements and future results could differ materially from historical performance.

The Company’s forward-looking statements are subject to the following principal risks and uncertainties: general economic conditions and trends, either nationally or locally; conditions in the securities markets; changes in interest rates; changes in deposit flows, and in the demand for deposit and loan products and other financial services; changes in real estate values; changes in the quality or composition of the Company’s loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the Company’s ability to retain key members of management; changes in legislation, regulation, and policies; and a variety of other matters which, by their nature, are subject to significant uncertainties.  The Company’s forward-looking statements may also be subject to other risks and uncertainties, including those that it may discuss elsewhere in this report or in its other filings with the SEC.

If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results could differ materially from those expressed in forward-looking information and statements contained in this annual report.  Therefore, we caution you not to place undue reliance on our forward-looking information and statements.

We do not intend to update our forward-looking information and statements to reflect change.  All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

PART I

ITEM 1. BUSINESS

Corporate History

North Penn Bank was organized on February 28, 1877 as The German Building Association of Scranton.  The institution eventually became North Penn Savings and Loan Association.  On October 1, 2003, North Penn converted from a Pennsylvania state-chartered savings association to a Pennsylvania state-chartered savings bank and changed its name to North Penn Bank (the “Bank”).  .  North Penn Bancorp, Inc. (the “Company”) was organized on November 22, 2004 in anticipation of the mutual holding company reorganization and minority stock issuance of North Penn Bank. The mutual holding company reorganization and minority stock issuance was completed on June 1, 2005.  In the stock issuance, the Company sold 44.1% of its outstanding shares of common stock to the public, issued 53.9% of its outstanding shares of common stock to North Penn Mutual Holding Company, the mutual holding company parent of the Company and the Bank, and contributed 2% of its outstanding shares of common stock to North Penn Charitable Foundation.

The “second-step” conversion of the Bank from the mutual holding company structure to the stock holding company structure was consummated on October 1, 2007, at which time the shares held by North Penn Mutual Holding Company were sold in an offering to certain depositors of the Bank and others. The Company exchanged shares of its common stock for the then issued and outstanding shares of prior North Penn Bancorp, Inc., the mid-tier holding company for the Bank, held by persons other than North Penn Mutual Holding Company. As a result of the conversion, the current North Penn Bancorp is the successor to the original North Penn Bancorp.  The Company’s common stock trades on the OTC Bulletin Board under the symbol “NPBP.OB”.

 
1

 

 The principal activities of the Company are ownership and supervision of the Bank.  The Bank is a community-oriented full-service savings bank providing traditional financial services to consumers and businesses in Northeastern Pennsylvania, including the communities in Lackawanna, Luzerne, Wayne and Monroe counties, among others.  The Company and the Bank (sometimes referred to herein as “we”) compete with the many existing and larger financial institutions in our geographic market by emphasizing personalized service, responsive decision making and an overall commitment to excellence.

The Bank offers commercial and consumer loans of all types, including real estate loans, residential mortgage loans, home equity loans and lines of credit, auto loans and other credit products.  The Bank’s deposit services include business and individual demand and time deposit accounts, NOW accounts, money market accounts, Individual Retirement Accounts and holiday accounts.  We provide a number of convenience-oriented services and products to our customers, including direct payroll and social security deposit services, bank-by-mail services, access to a national automated teller machine network, safe deposit boxes, night depository facilities, notary services and travelers checks.  We also offer internet banking and electronic bill payment.

As of December 31, 2009, the Bank employed 36 full-time and 10 part-time employees.   None of these employees are represented by a collective bargaining agent, and the Company believes that it enjoys good relations with its personnel.

Management Strategy

We operate as an independent community bank that offers a broad range of customer-focused financial services as an alternative to large regional, multi-state banks in our market area. Management has invested in the infrastructure and staffing to support our strategy of serving the financial needs of businesses, individuals and municipalities in our market area focusing on core deposit generation and quality loan growth which provides a favorable platform for long-term sustainable growth. Highlights of management’s business strategy are as follows:

Operating as a Community Bank.  We are a community bank that strives to deliver unmatched personal service and value to customers and shareholders. Our employees are united by a proud tradition of delivering excellent customer service.   As an independent community bank, we emphasize the local nature of our decision-making to respond more effectively to the needs of our customers while providing a full range of financial services to the businesses, individuals, and municipalities in our market area. We desire to preserve the integrity and traditional values in the way we conduct business as we achieve consistent, quality financial performance.  As a result, we are able to provide, at the local level, the financial services required to meet the needs of the majority of existing and potential customers in our market.

Enhancing Customer Service. We are committed to providing superior customer service as a way to differentiate us from our competition.  In addition, we offer multiple access channels to our customers, including our branch and ATM network and internet banking.

Growing and maintaining a Diversified Loan Portfolio. We offer a broad range of loan products to commercial businesses, real estate owners, developers and individuals. We have experienced commercial lenders in place to attract commercial loans, which we are pursuing to balance our large portfolio of residential mortgages.  We are actively pursuing business relationships by capitalizing on the experience of our lending team, as well as existing customers, to develop deposit and lending relationships which emphasize service.  We have experienced consistent and significant growth in our commercial loan portfolio while continuing to provide residential mortgage and consumer lending services. As a result, we believe that we have developed a high quality diversified loan portfolio with a favorable mix of loan types, maturities and yields.

 
2

 

Expanding our Banking Franchise. Management intends to continue the expansion of the banking franchise and to increase the number of customers served and products used by businesses and consumers in our market area. Our strategy is to deliver exceptional customer service, which depends on multiple access channels, as well as courteous personal contact from a trained and motivated workforce. This approach has resulted in a relatively high level of core deposits, which drives our overall cost of funds.

Market Area

We are headquartered in Scranton, Pennsylvania, which is located in Northeastern Pennsylvania.  In addition to our main office in center city Scranton, we operate four branch offices, located in Scranton, Clarks Summit, Stroudsburg and Effort, Pennsylvania.  We consider our primary market area to include Lackawanna and Monroe Counties, and to a lesser extent, certain areas of the adjoining counties.

Competition

Banking is a very competitive business, with both large and small banks competing for the same customers.  In addition, non-bank competitors, such as brokerage firms, credit unions, insurance companies and mortgage brokers, are offering customers loan and deposit services.  Legislative, regulatory and technological changes in the financial services industry have created these new competitors, and will continue to do so in the future. Technological advances have lowered the barriers to enter new market areas, allowed banks to expand their geographic reach by providing services over the internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks.  Changes in federal law permit affiliation among banks, securities firms and insurance companies, which increases competition in the financial services industry

Executive Officers of the Registrant

Name
 
Age
 
Principal Occupation for Past Five Years
         
Frederick L. Hickman
 
54
 
President, Chief Executive Officer of North Penn Bancorp and North Penn Bank.
         
Thomas J. Dziak
 
54
 
Executive Vice President – Senior Lending Officer of North Penn Bancorp and North Penn Bank.
         
Thomas A. Byrne
 
49
 
Senior Vice President – Commercial Lending Officer of North Penn Bancorp and North Penn Bank. Prior to joining North Penn Bank in January of 2005, Mr. Byrne served as a vice president and commercial loan officer at Community Bank & Trust.
         
Christe A. Casciano  Sr.
 
53
 
Senior Vice President – Chief Technology and Risk Officer of North Penn Bancorp and North Penn Bank.  Prior to joining North Penn Bank in April of 2007, Mr. Casciano served as Vice President and Director of Marketing at  Penn Security Bank and Trust Co.
         
Joseph F. McDonald
 
55
 
Senior Vice President – Chief Financial Officer of North Penn Bancorp and North Penn Bank.  Prior to joining North Penn Bank, Mr. McDonald was Senior Vice President of National Penn Bancshares in Boyertown, Pennsylvania.  Prior to National Penn Bancshares’s merger with Keystone Nazareth Bank and Trust Company (“KNBT”) in February, 2008, Mr. McDonald served as Senior Vice President, Controller of KNBT.
 
 
3

 

Available Information

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on our website, www.northpennbank.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission.  The information on our website shall not be considered as incorporated by reference into this Annual Report on Form 10-K.

Loan Portfolio

The Bank’s business of making loans is its primary source of income.  Historically, the principal lending activity of the Bank has been the origination of fixed and adjustable rate mortgage (“ARM”) loans collateralized by one- to four-family residential properties located in its market area. The Company also originates multifamily, commercial real estate, commercial, construction and consumer loans which typically have higher yields than traditional one- to four-family loans
 .
In recent years, the Bank has increased its emphasis on commercial lending and has actively pursued small business accounts.

Commercial Loans

Our commercial lending consists primarily of real estate based loans, including commercial and residential real estate collateral, with conservative loan-to-value ratios and the ability to repay based on operating cash flow. The Bank has continued developing the commercial business loan program.  The purpose of this program is to increase the Bank’s interest rate sensitive assets, increase interest income and diversify both the loan portfolio and the Bank’s customer base.  The Bank has two experienced commercial lenders to help in this effort. The terms and conditions of each loan are tailored to the needs of the borrower and based on the financial strength of the project and any guarantors.  In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise and credit history and the value of the underlying property.  Loan to value ratios are a very important consideration.  Generally, however, commercial real estate loans originated by us will not exceed 80% of the appraised value or the purchase price of the property, whichever is less.  We also make commercial vehicle loans.

Residential Mortgages

The Bank makes fixed and adjustable mortgages and home equity loans on owner occupied residential real estate.  The Bank offers fixed-rate mortgage loans with maturities up to 30 years and less than 20% down payment supplemented with private mortgage insurance. These loans are secured by one- to four-family residences that are located in its primary market area.   All of the mortgages are underwritten to be eligible for resale in the secondary market.

Home equity loans are offered as both closed end loans and lines of credit.  Closed end loans can be fixed rate or adjustable.  Home equity lines of credit have adjustable rates. The underwriting standards utilized for home equity loans and equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan.  The combined (first and second mortgage liens) loan-to-value ratio for home equity loans and equity lines of credit is generally limited to 80% These loans offer the consumer access to liquidity and lower interest rates, and interest payments may be tax deductible.

Consumer Loans

The Bank offers secured consumer loans, including deposit secured loans, auto loans, and indirect auto loans made through new and used car dealers.  Our procedures for underwriting consumer loans include an assessment of an applicant’s credit history and the ability to meet existing obligations and payments on the proposed loan. Although an applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral security, if any, to the proposed loan amount. 

 
4

 

The following table summarizes the Bank’s loan portfolio by type of loan on the dates indicated.

   
At December 31,
 
   
2009
   
2008
   
2007
 
   
 
   
Percent
   
 
   
Percent
   
 
   
Percent
 
(Dollars in thousands)
 
Amount 
   
of Total
   
Amount 
   
of Total
   
Amount 
   
of Total
 
Commercial
  $ 3,368       2.91 %   $ 1,796       1.67 %   $ 2,157       2.19 %
Real estate mortgages
    108,943       93.89 %     100,127       93.34 %     88,878       90.31 %
Consumer
    3,719       3.21 %     5,353       4.99 %     7,383       7.50 %
Total gross loans
    116,030       100.00 %     107,276       100.00 %     98,418       100.00 %
Less: allowance for loan losses
    1,484               1,170               1,171          
Loans, net
  $ 114,546             $ 106,106             $ 97,247          

The following table sets forth the estimated maturity of the Bank’s loan portfolio as December 31, 2009.  The table does not include prepayments or scheduled principal repayments.

   
Within One Year
   
One-Five Years
   
Over Five Years
   
Total
 
(Dollars in thousands)
                       
Commercial
  $ 116     $ 797     $ 2,455     $ 3,368  
Real estate mortgages
    6,483       3,307       99,152       108,942  
Consumer
    348       2,996       376       3,720  
Total
  $ 6,947     $ 7,100     $ 101,983     $ 116,030  

The following table presents, as of December 31, 2009, the dollar amount of all loans due after December 31, 2010, and whether such loans have fixed or adjustable interest rates.

   
Due After December 31, 2010
 
   
Fixed
   
Adjustable
   
Total
 
(Dollars in thousands)
                 
Commercial
  $ 3,252     $ -     $ 3,252  
Real estate mortgages
    47,685       54,774       102,459  
Consumer
    3,371       1       3,372  
Total
  $ 54,424     $ 54,775     $ 109,083  

Risk Elements

Risk elements in the loan portfolio include past due, non-accrual loans, other real estate owned and a concentration of loans to one type of borrower.  We monitor the loan portfolio to reduce the risk of delinquent and problem credits.  Underwriting standards, including, but not limited to, loan-to-value and debt-to-income ratios, are followed to limit credit risk in the portfolio.  Loan review is conducted by an outside party that evaluates loan quality, including adherence to underwriting standards.  The loan review report goes directly to the Bank’s Board of Directors for their evaluation.  The Pennsylvania Department of Banking and the Federal Deposit Insurance Corporations (FDIC), as the Bank’s regulators, also review the loan portfolio as part of their review process.

Asset Quality

The Bank manages asset quality and controls credit risk through diversification of the loan portfolio and the application of policies designed to foster sound underwriting and loan monitoring practices.  The Bank’s senior officers are responsible for monitoring asset quality, establishing credit policies and procedures subject to approval by the Board of Directors, ensuring the policies and procedures are followed and adjusting policies as appropriate.

 
5

 

Non-performing assets include non-performing loans and foreclosed real estate held for sale.  Non-performing loans consist of loans where the principal, interest, or both, is 90 or more days past due and loans that have been placed on non-accrual.  Income recognition of interest is discontinued when, in the opinion of management, the payment of such interest becomes doubtful.  A loan is generally classified as non-accrual when principal or interest has been in default for 90 days or more or because of deterioration in the financial condition of the borrower such that payment in full of principal or interest is not expected.  Loans past due 90 days or more and still accruing interest are loans that are generally well secured and in the process of collection.  When loans are placed on non-accrual, accruing interest is no longer posted to earnings.  At December 31, 2009, the Bank had $1.8 million in non-accrual loans as compared with $1.1 million at December 31, 2008.  As of December 31, 2009, for purposes of accounting and reporting in accordance with FASB ASC 310-40 Receivables – Troubled Debt Restructuring by Creditors (SFAS 15), the Bank had no significant troubled debt restructuring.  As of December 31, 2009, for purposes of accounting and reporting in accordance with FASB ASC 310-10.35 Receivables – Subsequent Measurement (SFAS 114), the Bank had $1.8 million in “impaired” loans.

The following table presents information regarding non-accrual mortgage, consumer and other loans, and foreclosed real estate as of the date indicated:

   
At December 31
 
(Dollars in Thousands)
 
2009
   
2008
 
Non-accrual commercial
  $ 42       -  
Non-accrual commercial mortgage
    960       572  
Non-accrual residential mortgage
    768       500  
Non-accrual consumer
    4       35  
Total non-performing loans
    1,774     $ 1,107  
Foreclosed real estate
    88       -  
Total non-performing assets
  $ 1,862     $ 1,107  

For the period ended December 31, 2009, the bank would have received an additional $44,000 in interest income under the original terms of such loans.

Allowance for Loan Losses

The Bank determines the provision for loan losses through a quarterly analysis of the loan portfolio. The allowance for loan losses is established through provisions for losses charged to earnings.  Loan losses are charged against the allowance when management believes that the collection of principal is unlikely.  Recoveries of loans previously charged-off are credited to the allowance when realized.  The allowance for loan losses is the amount that management has determined to be necessary to absorb probable incurred loan losses inherent in the existing portfolio.  Management’s evaluations, which are subject to periodic review by the Bank’s regulators, are made using a consistently applied methodology that takes into consideration such factors as the Company’s past loan loss experience, changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and collateral values, and current economic conditions.  Part of management’s review includes risk ratings of commercial loans, and the engagement of an external loan review of all loans over $400,000, insider loans and delinquent loans.  Modifications to the methodology used in the allowance for loan losses evaluation may be necessary in the future based on further deterioration in economic and real estate market conditions, new information obtained regarding known problem loans, regulatory guidelines and examinations, the identification of additional problem loans, and other factors.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of December 31, 2009. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States and will consider future additions to the allowance that may be necessary based on changes in economic and other conditions. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the recognition of adjustments to the allowances based on their judgments of information available to them at the time of their examinations.

 
6

 

Management realizes that general economic trends greatly affect loan losses. The recent downturn in the real estate market has resulted in increased loan delinquencies, defaults and foreclosures, and we believe that these trends are likely to continue.  Assurances cannot be made either (1) that further charges to the allowance account will not be significant in relation to the normal activity or (2) that further evaluation of the loan portfolio based on prevailing conditions may not require sizable additions to the allowance and charges to provision expense.
 
The following table sets forth the year-end balances of and changes in the allowance for loan losses, as well as certain related ratios, as of December 31 for the year indicated:

(Dollars in thousands)
 
2009
   
2008
   
2007
 
Balance at beginning of period
  $ 1,170     $ 1,171     $ 1,121  
Charge-offs:
                       
  Commercial
    146       -       -  
  Real estate mortgages
            3       -  
  Consumer
    25       47       45  
TOTAL
    171       50       45  
Recoveries:
                       
  Commercial
    -       -       -  
  Real estate mortgages
    -       -       -  
  Consumer
    10       18       9  
TOTAL
    10       18       9  
Net charge-offs
    161       32       36  
Provision charged to operations
    475       31       86  
Balance at end of period
  $ 1,484     $ 1,170     $ 1,171  
                         
Average loans outstanding, December 31
    109,740     $ 101,543     $ 96,567  
Loan reserve ratios:
                       
  Net loan charge-offs to average loans
    0.15 %     0.03 %     0.04 %
  Allowance as a percentage of total loans
    1.28 %     1.09 %     1.19 %

The following table sets forth the breakdown of the allowance for loan losses by loan category as of December 31 for the year indicated:

   
2009
   
2008
   
2007
 
 (Dollars in thousands)
 
Amount
   
% of 
Total
Loans
   
Amount
   
% of
Total
Loans
   
Amount
   
% of
Total
Loans
 
Construction and land development
  $ -       0.3 %   $ -       0.5 %   $ -       0.1 %
Residential, 1-4 family
    476       40.9 %     313       41.9 %     310       46.3 %
Residential, multi-family
    -       0.8 %     -       1.1 %     -       1.5 %
Commercial real estate
    963       51.9 %     765       49.9 %     749       42.4 %
Commercial
    -       2.9 %     -       1.7 %     -       2.2 %
Consumer
    45       3.2 %     92       4.9 %     112       7.5 %
Total
  $ 1,484       100.0 %   $ 1,170       100.0 %   $ 1,171       100.0 %

 
7

 

Securities

Securities, primarily U.S. government agency bonds, mortgage-backed, and municipal bonds, totaled $19.4 million or 12.4% of total assets at December 31, 2009 as compared with $20.3 million or 14.6% of assets at December 31, 2008.  The Bank’s securities portfolio is used to assist the Bank in liquidity, asset/liability management and earnings.  Securities can be classified as securities “held-to-maturity” or “available-for-sale.” Investment securities held-to-maturity are carried at cost adjusted for amortization of premiums and accretion of discounts.  Securities available-for-sale may be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, general liquidity needs and other similar factors. Available-for-sale securities are carried at fair market value with unrealized gains and losses, net of tax, being included in the Bank’s accumulated other comprehensive income account. At December 31, 2009, accumulated other comprehensive income, a component of shareholders’ equity, was a loss of $2,000 versus a loss of $460,000 at December 31, 2008.  The Bank classifies all new bond purchases as available-for-sale.

The following tables summarize the composition of our investment portfolio as of the date indicated,

Securities Portfolio
 
   
December 31, 2009
Available for Sale
 
(Dollars in thousands)
 
Amortized
Cost
   
Estimated
Fair Value
 
U.S. Agency securities
  $ 1,500     $ 1,518  
Mortgage-backed securities
    2,662       2,751  
State & political subdivisions
    8,719       8,855  
Other bonds
    4,969       5,090  
Total debt securities
    17,850       18,214  
Equity securities
    1,591       1,184  
Total securities
  $ 19,441     $ 19,398  

   
December 31, 2008
Available for Sale
 
(Dollars in thousands)
 
Amortized
Cost
   
Estimated
Fair Value
 
U.S. Agency securities
  $ 3,000     $ 3,016  
Mortgage-backed securities
    5,074       5,142  
State & political subdivisions
    8,529       8,211  
Other bonds
    3,017       2,866  
Total debt securities
  $ 19,620     $ 19,235  
Equity securities
    1,371       1,058  
Total securities
  $ 20,991     $ 20,293  
 
   
December 31, 2007
Available for Sale
 
(Dollars in thousands)
 
Amortized
Cost
   
Estimated
Fair Value
 
U.S. Agency securities
  $ 385     $ 385  
Mortgage-backed securities
    4,521       4,480  
State & political subdivisions
    7,026       7,061  
Other bonds
    500       500  
Total debt securities
  $ 12,432     $ 12,426  
Equity securities
    1,071       940  
Total securities
  $ 13,503     $ 13,366  
 
 
8

 

The amortized cost and weighted average yield of the Bank’s investment securities at December 31, 2009, by contractual maturity, are reflected in the following table.  Actual maturities will differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
At December 31, 2009
 
   
Due in 1
year or less
   
Due in
1–5
years
   
Due in
5–10
years
   
Due
after 10
years
   
Total
 
(Dollars in thousands)
     
US Agency securities:
                             
  Amortized cost
  $ 1,000     $ 500     $ -     $ -     $ 1,500  
  Weighted average yield
    3.75 %     0.79 %  
%
   
%
      2.76 %
State & political subdivisions
                                       
  Amortized cost
  $ 1,050     $ 710     $ 3,187     $ 3,772     $ 8,719  
  Weighted average yield (1)
    4.15 %     4.26 %     3.94 %     4.01 %     4.02 %
Mortgage-backed securities
                                       
  Amortized cost
  $ 1,146     $ -     $ 975     $ 541     $ 2,662  
  Weighted average yield
    4.14 %  
%
      4.70 %     4.81 %     4.48 %
Other bonds
                                       
  Amortized cost
  $ 494     $ 3,445     $ 1,030       -     $ 4,969  
  Weighted average yield
    2.97 %     3.87 %     6.88 %             4.40 %
Total amortized cost
  $ 3,690     $ 4,655     $ 5,192     $ 4,313     $ 17,850  
Total fair value
  $ 3,737     $ 4,709     $ 5,382     $ 4,387     $ 18,214  
Weighted average yield
    3.88 %     3.55 %     4.66 %     4.11 %        

(1)  Yields on tax-exempt securities were adjusted to a tax-equivalent basis using a 34% rate.

Deposits

The Bank’s primary source of funds is retail deposit accounts held primarily by individuals and businesses within our market area. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposits consist of interest bearing and non-interest bearing checking accounts, money market, savings and certificate of deposit accounts and also IRA accounts. The Bank’s customer relationship strategy focuses on relationship banking for retail and business customers to enhance their overall experience with us. Deposit activity is influenced by state and local economic activity, changes in interest rates, internal pricing decisions and competition. The Bank uses traditional means of advertising our deposit products and generally do not solicit retail deposits from outside its market area. Deposits are primarily obtained from the areas surrounding our branch locations.

The following table sets forth the distribution of average deposits by major category and the average rate paid in each year as applicable:

Distribution of Average Deposits
 
   
Years Ended December 31,
 
   
2009
   
2008
   
2007
 
(Dollars in thousands)
 
Average
Balance
   
Average
Rate
   
Average
Balance
   
Average
Rate
   
Average
Balance
   
Average
Rate
 
Non-interest bearing demand deposits
  $ 8,653       0.00 %   $ 7,433       0.00 %   $ 8,437       0.00 %
Interest bearing demand deposits
    10,386       1.24 %     10,533       1.76 %     8,266       2.32 %
Savings and money market deposits
    37,149       1.48 %     37,524       2.19 %     18,742       2.88 %
Time deposits
    60,305       3.01 %     42,545       3.90 %     49,201       4.50 %
  Total deposits
  $ 116,493             $ 99,900             $ 84,646          

 
9

 

Maturities of Time Deposits of $100,000 and Over

The following table is a summary of time deposits of $100,000 or more by remaining maturities as of December 31, 2009:
 
(Dollars in thousands)
 
Amount
   
Percent
 
Three months or less
  $ 6,950       41.26 %
Three to six months
    5,284       31.37  
Six to twelve months
    2,444       14.51  
Over twelve months
    2,166       12.86  
  Total
  $ 16,844       100.00 %
 
Total deposits were $124.1 million at December 31, 2009 compared to total deposits of $99.2 million at December 31, 2008 and total deposits of $83.7 million at December 31, 2007.

Short-Term Borrowings

The Bank, as part of its operating strategy, utilizes advances from the FHLBank of Pittsburgh (“FHLB”) as an alternative to retail deposits to fund its operations.  The Bank has a line-of-credit with FHLBank of Pittsburgh for short-term borrowings varying from one day to three years.  Borrowings under this line of credit are secured by qualified assets in the form of a blanket lien.  Interest paid on these short-term borrowings varies based on interest rate fluctuations.  At December 31, 2009, we had not utilized this credit facility.  At December 31, 2008 and December 31, 2007, the line had a balance of $7,648,000 and $5,879,000, respectively.

The following table sets forth information regarding FHLBank of Pittsburgh overnight advances during the years ended.

(Dollars in thousands)
 
2009
   
2008
   
2007
 
Maximum amount outstanding at any month end
  $ 3,985     $ 7,648     $ 11,287  
Average amount outstanding
  $ 909     $ 1,172     $ 7,804  
Weighted average interest rate
    1.08 %     1.69 %     5.11 %
Balance outstanding at end of period
  $ -     $ 7,648     $ 5,879  
Weighted average interest rate at end of period
    - %     0.59 %     5.13 %

REGULATION AND SUPERVISION

Regulation of Pennsylvania Savings Banks

General. As a Pennsylvania state chartered savings bank with deposits insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”), North Penn Bank is subject to extensive regulation and examination by the Pennsylvania Department of Banking and by the FDIC, which insures its deposits to the maximum extent permitted by law. The federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. The laws and regulations governing North Penn Bank generally have been promulgated to protect depositors and not for the purpose of protecting stockholders.  This regulatory structure also gives the federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.  Any change in such regulation, whether by the Pennsylvania Department of Banking, the FDIC or the United States Congress, could have a material impact on us and our operations.

 
10

 

Federal law provides the federal banking regulators, including the FDIC and the Office of Thrift Supervision, with substantial enforcement powers. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders, and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined.  In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices.  Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

Pennsylvania Savings Bank Law. The Pennsylvania Banking Code (the “Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of trustees, officers, and employees, as well as corporate powers, savings and investment operations and other aspects of North Penn Bank and its affairs.  The Code delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking so that the supervision and regulation of state chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.

The Code also provides state-chartered savings banks with all of the powers enjoyed by federal savings and loan associations, subject to regulation by the Pennsylvania Department of Banking.  The Federal Deposit Insurance Act, however, prohibits a state-chartered bank from making new investments or loans or becoming involved in activities as principal and making equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the bank meets all applicable capital requirements.  Accordingly, the additional operating authority provided to us by the Code is significantly restricted by the Federal Deposit Insurance Act.
 
Federal Deposit Insurance. North Penn Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. Under the Federal Deposit Insurance Corporation’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned. Effective April 1, 2009, assessment rates range from seven to 77-1/2 basis points. No institution may pay a dividend if in default of the federal deposit insurance assessment.  The Federal Deposit Insurance Corporation imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital, as of June 30, 2009 (capped at ten basis points of an institution’s deposit assessment base), in order to cover losses to the Deposit Insurance Fund.  That special assessment was collected on September 30, 2009.  The Federal Deposit Insurance Corporation provided for similar assessments during the final two quarters of 2009, if deemed necessary.  However, in lieu of further special assessments, the Federal Deposit Insurance Corporation required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012.  The estimated assessments, which include an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009.  As of December 31, 2009, and each quarter thereafter, a charge to earnings will be recorded for each regular assessment with an offsetting credit to the prepaid asset.  The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of North Penn Bank. Management cannot predict what insurance assessment rates will be in the future.

Regulatory Capital Requirements.  The FDIC has promulgated capital adequacy requirements for state-chartered banks that, like us, are not members of the Federal Reserve System.  At December 31, 2008, we exceeded all regulatory capital requirements and were classified as “well capitalized.”

The FDIC’s capital regulations establish a minimum 3% Tier 1 leverage capital requirement for the most highly rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively increases the minimum Tier 1 leverage ratio for such other banks to 4% to 5% or more. Under the FDIC’s regulation, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue  interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System.  Tier 1 or core capital is defined as the sum of common stockholders’ equity (including retained earnings), non-cumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain purchased mortgage servicing rights and purchased credit card relationships.

 
11

 

The FDIC’s regulations also require that state-chartered, non-member banks meet a risk-based capital standard.  The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item.  The components of Tier 1 capital for the risk-based standards are the same as those for the leverage capital requirement.  The components of supplementary (Tier 2) capital include cumulative perpetual preferred stock, mandatory subordinated debt, perpetual subordinated debt, intermediate-term preferred stock, up to 45% of unrealized gains on equity securities and a bank’s allowance for loan and lease losses.  Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets.  Overall, the amount of supplementary capital that may be included in total capital is limited to 100% of Tier 1 capital.

A bank that has less than the minimum leverage capital requirement is subject to various capital plan and activities restriction requirements.  The FDIC’s regulations also provide that any insured depository institution with a ratio of Tier 1 capital to total assets that is less than 2% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and could be subject to potential termination of deposit insurance.

We are also subject to minimum capital requirements imposed by the Pennsylvania Department of Banking on Pennsylvania-chartered depository institutions.  Under the Pennsylvania Department of Banking’s capital regulations, a Pennsylvania bank or savings bank must maintain a minimum leverage ratio of Tier 1 capital (as defined under the FDIC’s capital regulations) to total assets of 4%.  In addition, the Pennsylvania Department of Banking has the supervisory discretion to require a higher leverage ratio for any institutions based on the institution’s substandard performance in any of a number of areas.  We were in compliance with both the FDIC and the Pennsylvania Department of Banking capital requirements as of December 31, 2009.

Restrictions on Dividends.  The Code states, in part, that dividends may be declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital.  The Bank has not declared or paid any dividends that have caused its retained earnings to be reduced below the amount required.  Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due the FDIC.

Affiliate Transaction Restrictions.  Federal laws strictly limit the ability of banks to make loans to, and to engage in certain other transactions with (collectively, “covered transactions”), their affiliates, including their bank holding companies and the holding companies’ nonbank affiliates.  The aggregate amount of covered transactions with any individual affiliate is limited to 10% of a bank’s capital and surplus, and the aggregate amount of covered transactions with all affiliates is limited to 20% of capital and surplus.  Further, loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts.  Federal law also requires that all transactions between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.
 
The Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to its executive officers and directors. However, that act contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, North Penn Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The law restricts both the individual and aggregate amount of loans North Penn Bank may make to insiders based, in part, on North Penn Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.

 
12

 

Federal Home Loan Bank System.  We are a member of FHLBank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks.  Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank system.  It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank.  As a member, we are required to purchase and maintain stock in FHLBank of Pittsburgh.  At December 31, 2009, we were in compliance with this requirement.

Loans to One Borrower.  Under Pennsylvania law, savings banks have, subject to certain exemptions, lending limits to one borrower in an amount equal to 15% of the institution's capital accounts.  An institution's capital account includes the aggregate of all capital, surplus, undivided profits, capital securities and general reserves for loan losses.  As of December 31, 2009, our loans-to-one borrower limitation was $2,500,500 and we were in compliance with such limitation.

Regulation of Holding Companies

General.  Federal law allows a state savings bank that qualifies as a “qualified thrift lender” to elect to be treated as a savings association for purposes of the savings and loan holding company provisions of federal law.  Such election allows its holding company to be regulated as a savings and loan holding company by the Office of Thrift Supervision rather than as a bank holding company by the Federal Reserve Board.  The Bank has elected to be treated as a savings association so that the Company will be regulated as a savings and loan holding company under federal law.  As such, the Company has registered with the Office of Thrift Supervision and is subject to Office of Thrift Supervision regulations, examinations, supervision, reporting requirements and regulations concerning corporate governance and activities.  In addition, the Office of Thrift Supervision has enforcement authority over the Company and its non-savings institution subsidiaries.  Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the Bank.

As a unitary savings and loan holding company, the Company is able to engage only in activities permitted to a financial holding company and those permitted for a multiple savings and loan holding company, which includes non-banking activities that the Federal Reserve Board has determined to be permissible for bank holding companies.

Limitation on Capital Distributions.  Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger.  Under the regulations, an application to and the prior approval of the Office of Thrift Supervision is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under Office of Thrift Supervision regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the Office of Thrift Supervision.  If an application is not required, the institution must still provide prior notice to the Office of Thrift Supervision of the capital distribution if, like the Bank, it is a subsidiary of a holding company.  If the Bank’s capital were ever to fall below its regulatory requirements or regulators notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted.  In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution that would otherwise be permitted by the regulation if the agency determines that such distribution would constitute an unsafe or unsound practice.

Qualified Thrift Lender Test. In order for the Company to be regulated by the Office of Thrift Supervision as a savings and loan holding company (rather than by the Federal Reserve Board as a bank holding company) the Bank must meet a qualified thrift lender test.  Under the test, the Bank is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less:  (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period.  Education loans, credit card loans and small business loans may be considered “qualified thrift investments.”  As of December 31, 2009, the Bank met the qualified thrift lender test.

 
13

 

Acquisition of Control.  Under the federal Change in Bank Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association.  An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or savings institution or as otherwise defined by the Office of Thrift Supervision.  Under the Change in Bank Control Act, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition.  Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

ITEM 1A.  Risk Factors

Recent Legislation in Response to Market and Economic Conditions May Significantly Affect Our Operations, Financial Condition, and Earnings.

Instability and volatility in the credit markets has led to the adoption of legislation and regulatory actions which have the potential to significantly affect financial institutions and holding companies, including us.

In response to this financial crisis affecting the banking system and financial markets, the United States Congress enacted the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009. Under these and other laws and government actions:

 
·
the U.S. Department of the Treasury, or “Treasury,” has provided capital to financial institutions and adopted programs to facilitate and finance the purchase of problem assets and finance asset-backed securities via the Troubled Assets Relief Program, or “TARP”;
 
·
the FDIC has temporarily increased the limits on federal deposit insurance with the exception of depository institutions who have voluntarily opted out of the program and has also provided availability of temporary liquidity guarantee, or “TLG”, of all FDIC-insured institutions and their affiliates’ debt, as well as deposits in noninterest-bearing transaction deposit accounts; and
 
·
the federal government has undertaken various forms of economic stimulus, including assistance to homeowners in restructuring mortgage payments on qualifying loans.

TARP and the TLG are winding down, and the effects of this wind-down cannot be predicted.

In addition, the federal government is considering various proposals for a comprehensive reform of the financial services industry and markets and coordinating reforms with other countries. There can be no assurance that these various initiatives or any other future legislative or regulatory initiatives will be successful at improving economic conditions globally, nationally or in our markets, or that the measures adopted will not have adverse consequences. These new laws, regulations, and changes will increase our FDIC insurance premiums and may also increase our costs of regulatory compliance and of doing business, and otherwise affect our operations.  At this time, we cannot fully determine the extent of these effects, or any other effects, on us caused by these and future laws and regulations.  However, they may significantly affect the markets in which we do business, the markets for and value of our investments, and our ongoing operations, costs and profitability.

 
14

 

Difficult Market Conditions Have Adversely Affected Our Industry.

We are operating in a challenging and uncertain economic environment, including generally uncertain national and local conditions.  Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets.  Dramatic declines in the housing market over the past two years, with falling home prices and increasing foreclosure, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks.  These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and cash securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions.  This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally.  The resulting economic pressure on consumers and lack of confidence in the financial markets may adversely affect our business, financial condition and results of operations.  A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial services industry.  In particular, we may face the following risks in connection with these events:

·
We expect to face increased regulation of our industry, and compliance with such regulation may increase our costs, limit our ability to pursue business opportunities, and increase compliance challenges.
·
Our ability to assess the creditworthiness of our customers or to estimate the values of our assets may be impaired if the models and approaches we use become less predictive of future behaviors, valuations, assumptions or estimates. The process we use to estimate losses inherent in our credit exposure or estimate the value of certain assets requires difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans or impact the value of assets, which may no longer be capable of accurate estimation which may, in turn, impact the reliability of the process.
·
Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.

A further deterioration in economic conditions or a prolonged delay in economic recovery areas could result in the following consequences, any of which could have a material adverse effect on our business:

 
·
Loan delinquencies may increase further;
 
·
Problem assets and foreclosures may increase further;
 
·
Demand for our products and services may decline;
 
·
Collateral for loans made by us, especially real estate, may decline further in value, in turn reducing a customer’s borrowing power, and reducing the value of assets and collateral associated with our loans; and
 
·
Investments in mortgage-backed securities may decline in value as a result of performance of the underlying loans or the diminution of the value of the underlying real estate collateral.

Our emphasis on commercial lending may expose us to increased lending risks.

These types of loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers.  Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans.  Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time.  In addition, some of our commercial borrowers have more than one loan outstanding with us.  Consequently, an adverse development with respect to one loan or one credit relationship may expose us to a greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.

 
15

 

The unseasoned nature of our commercial loan portfolio may expose us to increased lending risks.

A significant amount of our commercial and multi-family real estate loans and commercial business loans are unseasoned, meaning that they were originated recently.  Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability.  Furthermore, these loans have not been subjected to unfavorable economic conditions.  As a result, it may be difficult to predict the future performance of this part of our loan portfolio.  These loans may have delinquency or charge-off levels above our expectations, which could adversely affect our future performance.

Changes in interest rates could reduce our net interest income and earnings.

Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding.  Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yield catches up.  Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. 

Our efforts to increase core deposits may not be successful, which would limit our ability to grow.

Our goal is to fund growth of interest-earning assets by attracting core deposits, which we define as demand, savings and money market deposits.  Our primary markets for deposits are the communities in which our offices are located.  We face significant competition for core deposits from other financial institutions.  If we are unable to attract core deposits, we will not be able to increase our interest-earning assets unless we use other funding sources, such as certificates of deposit or borrowed funds, which generally require us to pay higher interest rates compared to core deposits.  In addition, competition may require us to pay higher rates on core deposits.  Many institutions currently offer high yielding checking, savings and/or money market accounts.  We may have to offer similar high yielding accounts in order to attract core deposits, which would contribute to the compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability.  We currently do not have any plans to expand our market area for deposits.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.
 
FDIC insurance premiums increased substantially in 2009 and we expect to pay significantly higher FDIC premiums in the future. Market developments have significantly depleted the DIF and reduced the ratio of reserves to insured deposits. The FDIC adopted a revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised deposit insurance premiums. On May 22, 2009, the FDIC also implemented a five basis point special assessment of each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points times the institution’s assessment base for the second quarter of 2009, which was collected on September 30, 2009. In imposing the special assessment, the FDIC noted that additional special assessments may be imposed by the FDIC for future periods.
 
On November 12, 2009, the FDIC adopted a final rule that requires insured depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009. For purposes of calculating the prepaid amount, the base assessment rate in effect at September 30, 2009 would be used for 2010. That rate would be increased by an annualized 3 basis points for 2011 and 2012 assessments. The prepayment calculation would also assume a 5 percent annual growth rate, increased quarterly, through the end of 2012. Under the final rule, an institution will account for the prepayment by recording the entire amount of its prepaid assessment as a prepaid expense (an asset) as of

 
16

 

December 30, 2009. Subsequently, each institution will record an expense (charge to earnings) for its regular quarterly assessment and an offsetting credit to the prepaid assessment until the asset is exhausted. Once the asset is exhausted, the institution would resume paying and accounting for quarterly deposit insurance assessments as they do currently. Under the final rule, the FDIC stated that its requirement for prepaid assessments does not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system during 2009, 2010, 2011, 2012, or thereafter, pursuant to notice-and-comment rulemaking procedures provided by statute, and therefore, continued actions by the FDIC could significantly increase the Bank’s noninterest expense in fiscal 2010 and for the foreseeable future. 
 
Determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires significant estimates, and actual losses may vary from current estimates.
 
        The Bank maintains an allowance for loan losses to provide for loans in its portfolio that may not be repaid in their entirety. The determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us and the Bank to make significant estimates of current credit risks and future trends, all of which may undergo material changes.
 
        In evaluating the adequacy of the Bank's allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and classified loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Finally, we consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding the Bank's borrowers' abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. In considering information about specific borrower situations, our analysis is subject to the risk that we are provided inaccurate or incomplete information. Because of the degree of uncertainty and susceptibility of these factors to change, the Bank's actual losses may vary from our current estimates.
 
Additionally, bank regulators periodically review the Bank's allowance for loan losses and may require an increase in the provision for loan losses or recognize loan charge-offs based upon their judgments, which may be different from ours. Any increase in the Bank's allowance for loan losses or loan charge-offs required by these regulatory authorities may adversely affect our operating results.
 
Because most of our borrowers are located in Northeast Pennsylvania, a downturn in the local economy or a decline in local real estate values could cause increases in nonperforming loans, which could hurt our profits.

Substantially all of our loans are secured by real estate or made to businesses in Northeast Pennsylvania.  As a result of this concentration, a downturn in the local economy could cause significant increases in nonperforming loans, which would hurt our profits.  A decline in real estate values could cause some of our mortgage loans to become inadequately collateralized, which would expose us to a greater risk of loss.  Additionally, a decline in real estate values could adversely impact our portfolio of commercial real estate loans and could result in a decline in the origination of such loans.

 
17

 

Strong competition within our market area could hurt our profits and inhibit growth.

We face intense competition in making loans, attracting deposits and hiring and retaining experienced employees.  This competition has made it more difficult for us to make new loans and attract deposits.  Price competition for loans and deposits sometimes results in us charging lower interest rates on our loans and paying higher interest rates on our deposits, which reduces our net interest income.  Competition also makes it more difficult and costly to attract and retain qualified employees.  Many of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer products and services that we do not provide.  We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.  Our profitability depends upon our continued ability to compete successfully in our market area.

We are dependent upon the services of our management team.

We rely heavily on our President and Chief Executive Officer, Frederick L. Hickman and our senior executives Thomas J. Dziak and Thomas A. Byrne.  The loss of our chief executive officer or other senior executive officers could have a material adverse impact on our operations because, as a small community bank, we have fewer management-level personnel that have the experience and expertise to readily replace these individuals. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.  We have employment agreements with Messrs. Hickman, Dziak and Byrne.  We do not maintain key man life insurance for these executives.

The Company’s articles of incorporation and bylaws and certain laws and regulations may prevent or make more difficult certain transactions, including a sale or merger of the Company.

Provisions of the Company’s articles of incorporation and bylaws, state corporate law and federal banking regulations may make it more difficult for companies or persons to acquire control of the Company.  As a result, our shareholders may not have the opportunity to participate in such a transaction and the trading price of our common stock may not rise to the level of other institutions that are more vulnerable to hostile takeovers.  The factors that may discourage takeover attempts or make them more difficult include:

 
·
Articles of incorporation and bylaws. Provisions of the articles of incorporation and bylaws of the Company may make it more difficult and expensive to pursue a takeover attempt that the board of directors opposes.  These provisions also make more difficult the removal of current directors or management, or the election of new directors. These provisions include:

 
·
supermajority voting requirements for certain business combinations and changes to some provisions of the articles of incorporation and bylaws;

 
·
limitation on the right to vote shares;
 
 
·
the election of directors to staggered terms of three years;

 
·
provisions regarding the timing and content of shareholder proposals and nominations;

 
·
provisions restricting the calling of special meetings of shareholders;

 
·
the absence of cumulative voting by shareholders in the election of directors; and

 
·
the removal of directors only for cause.

 
·
Pennsylvania anti-takeover statutes.  Pennsylvania law contains four anti-takeover sections that apply to public reporting companies relating to control share acquisitions, the disgorgement of profits by certain controlling persons, business combination transactions with interested shareholders and the ability of shareholders to put their stock following a control transaction.

 
·
Office of Thrift Supervision regulations. Office of Thrift Supervision regulations prohibit, for three years following the completion of our second-step conversion, the offer to acquire or the acquisition of more than 10% of any class of equity security of a converted institution without the prior approval of the Office of Thrift Supervision.  

 
18

 

ITEM 2.  PROPERTIES

The Bank currently conducts its business through its five full-service banking offices in Scranton, Stroudsburg, Clarks Summit and Effort, Pennsylvania.  The Bank owns all of its offices, except for Clarks Summit, which is subject to a renewable lease that expires in 2011.  The net book value of the land, buildings, furniture, fixtures and equipment owned by the Company was $4.0 million as of December 31, 2009.

ITEM 3.  LEGAL PROCEEDINGS

We are periodically parties to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to our business.  We do not believe that there is any pending or threatened proceeding against us which, if determined adversely, would have a material effect on our business or financial position.

ITEM 4.  (REMOVED AND RESERVED)

PART II

ITEM 5.
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND REGISTRANT’S ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is quoted on the OTC Bulletin Board under the symbol “NPBP.OB”. An active trading market does not currently exist for our common stock.

The following table sets forth the high and low bid information for the periods indicated. Share price and dividend information has not been adjusted to reflect the exchange of the former North Penn Bancorp common stock for 1.092 shares of the Company’s common stock on October 1, 2007.

2009
 
Dividends
   
High
   
Low
   
Close
 
First Quarter
  $ 0.03     $ 8.00     $ 6.00     $ 6.00  
Second Quarter
  $ 0.03     $ 8.80     $ 6.00     $ 8.55  
Third Quarter
  $ 0.03     $ 9.25     $ 8.55     $ 9.25  
Fourth Quarter
  $ 0.03     $ 9.25     $ 8.75     $ 9.25  
 
2008
 
Dividends
   
High
   
Low
   
Close
 
First Quarter
  $ 0.03     $ 9.20     $ 8.35     $ 8.50  
Second Quarter
  $ 0.03     $ 9.00     $ 7.40     $ 7.40  
Third Quarter
  $ 0.03     $ 8.65     $ 7.30     $ 7.75  
Fourth Quarter
  $ 0.03     $ 8.25     $ 6.95     $ 7.25  

The over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.

As of March 15, 2010, there were approximately 770 holders of record of our common stock.

Registrar and Transfer, Inc. serves as transfer agent and registrar for our common stock.

 
19

 

On October 1, 2008, North Penn Bancorp, Inc. announced that its Board of Directors authorized a stock repurchase plan for up to 158,157 shares of the Company’s outstanding common stock.

 On April 28, 2009, the Company’s Board of Directors authorized the completion of the previous 10% stock repurchase plan (29,657 shares) and the repurchase of up to 142,341 shares of the Company’s outstanding common stock, or approximately 10% of outstanding shares.  The initial program was subsequently completed during the second quarter of 2009.  The Company’s average cost per share of shares under this program was $7.99

The current repurchase authorization will remain in effect until all shares have been repurchased or until the Company terminates the authorization. As of December 31, 2009, 93,343 shares have been purchased under this second plan at an average cost per share of $8.96.

 Purchases under the program will be conducted solely through a Rule 10b5-1 repurchase plan with Stifel, Nicolaus & Company, Incorporated and will be based upon the parameters of the Rule 10b5-1 repurchase plan.   The Rule 10b5-1 repurchase plan allows the Company to repurchase its shares during periods when it would normally not be active in the market due to its internal trading blackout period.
The information under Notes 17 to the Company’s Consolidated Financial Statements the Company’s dividend policy is incorporated herein by reference.
Period
 
(a)
Total number of
Shares Purchased
   
(b)
Average Price Paid
per Share
   
(c)
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs (1)
   
(d)
Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs
 
October  1, 2009
through
October  31, 2009
    15,700     $ 8.95       227,000       73,498  
November 1, 2009
through
November 30, 2009
    14,500     $ 9.11       241,500       58,998  
December 1, 2009
through
December 31, 2009
    10,000     $ 9.20       251,500       48,998  
Total
    37,200     $ 9.09                  

ITEM 6.  SELECTED FINANCIAL DATA

Not applicable as the Company is a smaller reporting company.

ITEM 7.  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Overview

The following presents a review of North Penn Bancorp’s results of operations and financial condition. This information should be read in conjunction with its consolidated financial statements and the accompanying notes to financial statements. The Company’s consolidated earnings are derived primarily from the operations of its wholly owned savings bank subsidiary, North Penn Bank, and to a lesser degree its other subsidiaries

 
20

 

Effective June 1, 2005, the Bank became a wholly owned subsidiary of North Penn Bancorp, Inc., which has no material operations other than ownership of the Bank. The Bank conducts community banking activities by accepting deposits and making loans in our market area.  The Bank’s lending products include commercial loans and mortgages, and lines of credit, consumer and home equity loans, and residential mortgages on single family and multi family dwellings.  The Bank maintains an investment portfolio of municipal, U.S. government and investment grade corporate bonds to manage its liquidity and interest rate risk.  The Bank’s loan and investment portfolios are funded with deposits as well as collateralized borrowings from FHLBank of Pittsburgh, secured by a blanket lien on the Bank’s loans.

Our earnings come primarily from net interest income, which is the difference between what we earn on loans and investments and what we pay for our deposits and borrowings. The net interest income is impacted buy our loan loss provision, other income, and other expenses.

Critical Accounting Matters

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as the date of the financial statements and the reported amounts of income and expenses during the reporting period.  Actual results could differ 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 and the valuation of the deferred tax assets.

We consider the allowance for loan losses to be a critical accounting policy. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, at a minimum, and establishes the provision for loan losses based on the composition of the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectability of the loan portfolio.

Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, our regulatory authorities as an integral part of their examination process periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of examination.

The Bank believes that the judgments used in establishing the allowance for loan losses are based on reliable present information.  In assessing the sufficiency of the allowance for loan losses, management considers, among other things described above, how well prior estimates have related to actual experience.  The Bank has not found it necessary to call into question the reliability of judgments used in its calculation.

There are also no particular risk elements in the local economy that put a group or category of loans at increased risk, however, the Bank is pursuing commercial loans secured primarily by real estate, which may bear a higher risk of loss.  These factors could lead to higher levels of allowance in future periods.

The estimate of the allowance level is always subject to normal inherent risk associated with any loan portfolio and can change based on future events, not known or predictable.

We use the asset and liability method of accounting for deferred income taxes. Under this 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. If current available information raises doubt as to the realization of deferred tax assets, a valuation allowance is established. 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. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed continually as regulatory and business factors change.  Management’s recording of deferred tax assets and liabilities and the need for a valuation allowance is made based on information available to the Bank at the time.  In particular, management evaluates the recoverability of deferred tax assets based on the ability of the Bank to generate future profits to utilize such benefits.  Management employs budgeting and periodic reporting processes to continually monitor progress.  These factors lower the inherent risk in the assumption of future profits.  Historically, the Bank has had sufficient profits for tax recovery.

 
21

 

Statement of Changes in Financial Condition

General. Our assets increased $17.3 million, or 12.5% to $156.3 million at December 31, 2009 compared to $139.0 million at December 31, 2008. An increase in loans outstanding combined with an increase in cash and cash equivalents were the primary reasons for the growth in assets. Liabilities increased $17.4 million or 14.5% to $137.1 million at December 31, 2009 as compared with $119.7 million at December 31, 2008.  The primary reason for the increase was an increase in deposits.  Stockholders’ equity remained essentially unchanged at $19.3 million at both December 31, 2009 and 2008.

Assets.  Cash and cash equivalents increased $9.6 million or 423.8% to $11.9 million at December 31, 2010 as compared to $2.3 million at December 31, 2009. The primary reason for the increase in cash and cash equivalents was due to liquidity caused by the maturities of investments and increased deposits at December 31, 2009.

Gross loans, net of loans held for sale, increased $8.4 million or 8.0% to $114.5 million at December 31, 2009 as compared with $106.1 million at December 31, 2008. Commercial mortgages increased $6.7 million, or 12.6%, from $53.4 million at December 31, 2008, to $60.2 million at December 31, 2009. Commercial loans increased $1.6 million or 87.8% to $3.4 million at December 31, 2009 from $1.8 million at December 31, 2008. We continue to implement our strategy of diversifying the mix within our loan portfolio by increasing commercial real estate and commercial business loans.

Our residential mortgage portfolio increased $2.2 million, or 4.9%, to $48.4 million at December 31, 2009, from $46.1 million at December 31, 2008. Consumer loans decreased $1.6 million from $5.4 million at December 31, 2008 to $3.7 million at December 31, 2009.

The investment portfolio decreased $895,000, or 4.4%, to $19.4 million at December 31, 2009, from $20.3 million at December 31, 2008.  The decrease was primarily the result of declines in mortgage-backed securities portfolio of $2.4 million or 46.5% and in the US Agency securities portfolio of $1.5 million or 49.7%.   We intend to maintain a level of investment securities that is sufficient to maintain pledging and collateralized borrowing requirements while also temporarily deploying excess liquidity

The Company reviews investment debt securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”).  An impairment that is an “other-than-temporary-impairment” is a decline in the fair value of an investment below its amortized cost attributable to factors that indicate the decline will not be recovered over the anticipated holding period of the investment. Other-than-temporary-impairments result in reducing the security’s carrying value by the amount of credit loss. The credit component of the other-than-temporary impairment loss is realized through the statement of income and the remainder of the loss remains in other comprehensive income.  After our review, we concluded that two securities were impaired. OTTI losses of $38,000 on these securities were recognized during the fourth quarter 2009.  In accordance, with FASB ASC 320, the impairment was deemed credit related and run entirely though the income statement.  

Deposits. Total deposits increased $24.9 million, or 25.1%, to $124.1 million at December 31, 2009, from $99.2 million at December 31, 2008. The increase reflects, in part, our continuing efforts to attract and maintain deposits to utilize as a primary source of funds to fuel our growth in loans.  Core deposits which consist of all deposits other than certificates of deposit, increased $2.7 million or 4.8% to $58.1 million at December 31, 2009 as compared with $55.5 million at December 31, 2008.  Time deposit products, which include certificates of deposit, increased $22.2 million, or 50.8%, from $43.7 million at December 31, 2008, to $65.9 million at December 31, 2009.  The Bank has tried to lessen its dependency on more volatile and rate sensitive certificates of deposit and has focused more on growing core deposits, particularly non-interest-bearing deposits.

 
22

 

Borrowings. Borrowings were $12.0 million at December 31, 2009, a $7.6 million or 38.9% decrease over the $19.6 million at December 31, 2008.  As of December 31, 2009, we have two outstanding loans, a line of credit and a letter of credit with FHLBank of Pittsburgh. Our line of credit is available up to $15.0 million at an interest rate equal to the current overnight rate. This line is a source of liquidity which is used to fund our loan demand when deposit volume is inadequate.  We have a long term note of $5.0 million with FHLBank which matures on July 18, 2010. The annual percentage rate on this note is 6.19% and carries a prepayment penalty equal to a percentage of the remaining interest payments. The Bank also has a long term note of $7.0 million from the FHLBank of Pittsburgh at a rate of 4.34%, maturing July 13, 2015.

Equity. Stockholders’ equity remained essentially unchanged at $19.3 million at both December 31, 2009 and 2008. The increase in net income and improvement in accumulated other comprehensive loss were offset by our continuing purchases of Treasury Stock and payment of cash dividends. In 2008, a stock repurchase plan was approved and commenced whereby up to 10% of the company’s common stock will be purchased in the open market.  In addition, on April 28, 2009, the Board of Directors authorized completion of the 2008 Plan (29,657 shares) and the repurchase of up to 142,341 shares of our outstanding common stock, or 10% of outstanding shares. At December 31, 2009, Treasury Stock purchases totaled $2.1 million, a $1.3 million or 160.9% increase as compared with $805,000 at December 31, 2008.

Comparison of Results of Operations for the Years Ended December 31, 2009 and 2008

General. For the year ended December 31, 2009, we recorded net income of $787,000 an increase of $433,000 or 122.3% compared to net income of $354,000 for December 31, 2008.

Net Interest Income. Our principal source of revenue is net interest income. Net interest income is the difference between interest earned on securities and loans, less the interest paid on deposits and borrowed funds. Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources and interest rate fluctuations. Other factors include prepayment risk on mortgage and investment-related assets and the composition and maturity of earning assets and interest-bearing liabilities. Our primary interest earning assets are loans, while deposits make up the majority of our interest bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. In the current market, wholesale funding sources cost less than certain client deposits; however, ordinarily funding from client deposits costs less than wholesale funding sources. Factors, such as general economic activity, Federal Reserve Board monetary policy and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin.

Net interest income increased $169,000 or 3.9%, to $4.5 million for the year ended December 31, 2009, compared to $4.4 million for the year ended December 31, 2008. Interest income remained flat at $7.7 million for both years.  Interest expense decreased $185,000, or 5.6%, to $3.1 million at December 31, 2009 from $3.3 million at December 31, 2008, due to lower interest rates in deposits and reduced utilization of overnight borrowing. Consequently, the interest rate spread on a full tax equivalent basis decreased to 2.95% for the year ended December 31, 2009, compared to 3.09% for 2008. The ratio of average interest-earning assets to average interest-bearing liabilities decreased from 120.32% for the year ended December 31, 2008, to 116.97% for the year ended December 31, 2009.

Interest Income. Total interest income was essentially unchanged at $7.7 million for the years ending December 31, 2009 and 2008.  Increased loan volume partially offset a 74 basis point decrease in full tax equivalent total earning asset yield.  For the year ending December 31, 2009, average interest earning assets increased $16.4 million or 13.1% to $141.2 million as compared with $124.9 million for the comparable period in 2008.    The primary reason for the increase in average interest earning assets was growth in the average balance of loans.  For the twelve months ending December 31, 2009, average mortgages and average commercial loans increased $8.9 million or 9.5% and $1.1 million or 83.8% respectively, over the same period in 2008.

Total loan income for the year ended December 31, 2009 was $6.9 million, a $63,000 or 0.9% increase over the comparable 2008 period.

 
23

 

For the twelve months ended December 31, 2009, total average investment securities decreased $2.0 or 11.6% as compared to the same period in 2008.  The primary reason for the decrease was that maturing investments were used to help fund growth in our lending portfolio.

Interest Expense. Interest expense for the year ended December 31, 2009 totaled $3.1 million. This represents a decrease of $185,000, or 5.6%, for the year compared to $3.3 million in 2008. The primary reason for the increase was a 60 basis point decline in yield on interest bearing liabilities between the twelve months ended December 31, 2009 and 2008.  The decline in yield partially offset growth in total interest bearing liabilities.

For the year ending December 31, 2009, average interest bearing liabilities increased $17.0 million or 16.4% to $120.7 million as compared with $103.8 million for the comparable period in 2008.  The primary reason for the growth in average interest bearing liabilities was the growth in average time deposits of $17.8 million or 41.8% to $60.3 million for the year ended December 31, 2009.  This compares with $42.5 million for the year ended December 31, 2008

The FHLBank of Pittsburgh average advance balance decreased $263,000 million, or 2.0%, to $12.9 million at December 31, 2009 from $13.2 million for the year ended December 31, 2008.  The decrease was the result of reduced need for overnight borrowings due to growth of deposits.

The following table presents information regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income and dividends from average interest-earning assets and interest expense on average interest-bearing liabilities and the resulting average yields and costs.  The yields and costs for the periods indicated are derived by dividing annual income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of the below table, average balances have been calculated using the average of daily balances, and non-accrual loans are included in average balances; however, accrued interest income has been excluded from these loans.

 
24

 

Average Balance, Interest Income and Expense, Average Yield and Rates

   
Years Ended December 31,
 
   
2009
   
2008
   
2007
 
         
Interest
   
Average
         
Interest
   
Average
         
Interest
   
Average
 
   
Average
   
Income/
   
Interest
   
Average
   
Income/
   
Interest
   
Average
   
Income/
   
Interest
 
(Dollars in thousands)
 
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
Interest Earning Assets:
                                                     
Loans:
                                                     
Commercial
  $ 2,302     $ 138       5.99 %   $ 1,188     $ 95       8.00 %   $ 1,749     $ 120       6.86 %
Real estate mortgages
    102,942       6,389       6.21 %     94,058       6,248       6.64 %     85,801       6,086       7.09 %
Consumer
    4,496       351       7.81 %     6,297       479       7.61 %     9,017       591       6.55 %
Total loans
    109,740       6,878       6.27 %     101,543       6,822       6.72 %     96,567       6,797       7.04 %
                                                                         
Investment securities:
                                                                       
U.S. government securities
    5,838       214       3.67 %     6,383       252       3.95 %     5,221       220       4.21 %
Municipal securities (1)
    8,622       475       5.51 %     7,774       440       5.66 %     7,017       435       6.20 %
Other securities
    3,891       197       5.06 %     2,279       141       6.19 %     497       18       3.62 %
Equities
    1,100               1.64 %     999       42       4.10 %     969       37       3.82 %
Total securities
    19,451       886       4.86 %     17,435       875       5.02 %     13,704       710       5.18 %
                                                                         
Equity securities at cost
    1,591       47       2.95 %     827       42       5.08 %     1,183       75       6.34 %
Deposits in banks
    2,887       1       0.03 %     728       7       0.96 %     530       18       3.40 %
Fed funds sold
    7,569       12       0.16 %     4,325       95       2.20 %     -       -       - %
Total interest earning assets
    141,238       7,863       5.54 %     124,858       7,841       6.28 %     111,984       7,600       6.79 %
                                                                         
Non-interest earning assets:
                                                                       
Cash and due from banks
    2,886                       1,430                       1,821                  
Other assets
    6,953                       2,910                       5,875                  
Less:  allowance for loan losses
    (1,232 )                     (1,192 )                     (1,157 )                
Total non-interest earning assets
    8,607                       3,148                       6,539                  
Total assets
    149,845                     $ 128,006                     $ 118,523                  
                                                                         
Liabilities and stockholders’ equity
                                                                       
Interest bearing liabilities
                                                                       
Deposits:
                                                                       
Interest bearing demand
    10,386       129       1.24 %   $ 10,533       185       1.76 %   $ 8,266       135       1.63 %
Savings and money market
    37,149       551       1.48 %     37,524       822       2.19 %     18,742       434       2.32 %
Time deposits
    60,305       1,815       3.01 %     42,545       1,661       3.90 %     49,201       2,248       4.57 %
Total interest bearing deposits
    107,840       2,495       2.31 %     90,602       2,668       2.94 %     76,209       2,817       3.70 %
Other borrowings
    12,909       631       4.89 %     13,172       643       4.88 %     19,761       1,043       5.28 %
Total interest bearing liabilities
    120,749       3,126       2.59 %     103,774       3,311       3.19 %     95,970       3,860       4.02 %
Total  non-interest bearing liabilities
    9,598                       9,099                       10,441                  
Total liabilities
    130,347                       112,873                       106,411                  
Stockholders’ equity
    19,498                       15,133                       12,112                  
Total liabilities and     stockholders’ equity
    149,845                     $ 128,006                     $ 118,523                  
Net interest spread (1)
                    2.95 %           $ 4,530       3.09 %           $ 3,740       2.77 %
Net interest margin (1)
                    3.33 %                     3.63 %                     3.34 %
Taxable equivalent adjustment
          $ 149                     $ 150                     $ 148          
Average earning assets as a percentage of interest bearing liabilities
                    116.97 %                     120.32 %                     116.69 %


(1) The yield on municipal securities is computed on a tax equivalent basis at the U.S. federal income tax rate of 34%.

We believe that it is common practice in the banking industry to present interest income and related yield information on tax exempt securities on a tax-equivalent basis and that such information is useful to investors because it facilitates comparisons among financial institutions.  However, the adjustment of interest income and yields on tax exempt securities to a tax equivalent amount may be considered to include non-GAAP financial information.  A reconciliation to GAAP is provided below.

 
25

 

Tax Equivalent Reconciliation
 
   
Years Ended December 31,
 
   
2009
   
2008
   
2007
 
(Dollars in thousands)
 
Interest
   
Average
Yield
   
Interest
   
Average
Yield
   
Interest
   
Average
Yield
 
Municipal securities – nontaxable
  $ 288       3.80 %   $ 290       3.73 %   $ 287       4.09 %
Tax equivalent adjustment (1)
    149               150               148          
Municipal securities – tax equivalent
  $ 437       5.75 %   $ 440       5.66 %   $ 435       6.20 %
                                                 
Net interest income – nontaxable
  $ 4,549             $ 4,380             $ 3,592          
Tax equivalent adjustment (1)
    149               150               148          
Net interest income – tax equivalent
  $ 4,698             $ 4,530             $ 3,740          
                                                 
Interest rate spread – no tax adjustment
            2.85 %             2.97 %             2.63 %
Net interest margin – no tax adjustment
            3.22 %             3.51 %             3.21 %
 

(1) The tax equivalent adjustment is based on a tax rate of 34% for all periods presented.
 
 
26

 

Rate/Volume Analysis

   
Year Ended December 31, 2009
Compared to 2008
 
         
Increase (Decrease)
Due to
 
(Dollars in thousands)
 
Net
   
Volume
   
Rate
 
Interest Income:
                 
Loans
  $ 56     $ 551     $ (495 )
Investment securities
    10       101       (91 )
Equity securities
    5       39       (34 )
Deposits in other banks
    (5 )     21       (26 )
Fed funds sold
    (83 )     71       (154 )
Total
  $ (17 )   $ 783     $ (800 )
                         
Interest Expense:
                       
Interest bearing demand deposits
  $ (56 )   $ (3 )   $ (53 )
Savings and money market deposits
    (271 )     (8 )     (263 )
Time deposits
    154       693       (539 )
Other borrowings
    (12 )     (13 )     1  
Total
  $ (185 )   $ 669     $ (854 )
Net Interest Income
  $ 168     $ 114     $ 54  

Changes in interest due to volume and rate have been allocated by reference to changes in the average balances and the average interest rates of interest earning assets and interest bearing liabilities.

Interest Sensitivity Analysis

   
At December 31, 2009 Maturing Or Repricing In:
 
   
Within 3 Months
   
4 – 12
Months
   
1 – 5
Years
   
Over
5 Years
   
Total
 
Interest earning assets:
                             
Interest bearing deposits
  $ 560       -       -       -     $ 560  
Investment securities
    -       3,741       4,337       11,320       19,398  
Loans
    16,434       7,365       45,702       46,529       116,030  
Total interest earning assets
  $ 16,994     $ 11,106     $ 50,039     $ 57,849     $ 135,988  
                                         
Interest bearing liabilities:
                                       
Interest bearing demand
  $ 7,916       -       -       -     $ 7,916  
Money market
    7,598       -       -       -       7,598  
Savings
    -       -       -       33,838       33,838  
Time deposits
    24,758       28,830       12,330       -       65,918  
Borrowed funds
    -       5,000       -       7,000       12,000  
Total interest bearing liabilities
  $ 40,272     $ 33,830     $ 12,330     $ 40,838     $ 124,270  
Period Gap
  $ (23,278 )   $ (22,724 )   $ 37,709     $ 17,011          
Cumulative gap
  $ (23,278 )   $ (46,002 )   $ (8,293 )   $ 8,718          
Ratio of cumulative gap to total  assets
    (14.89 %)     (29.43 %)     (5.30 %)     5.58 %        


Assumptions:
*Adjustable rate loans have been distributed among the categories by repricing dates.
*Mortgage backed investments and loans do not take into account principal prepayments.
*All transaction deposit accounts have been placed into the within three months category as they have no stated maturity and rates will adjust as market rates adjust.
*All savings accounts have been placed in the beyond five years category based upon historical experience.
 
 
27

 
 
Earnings are dependent on maintaining adequate net interest yield or spread between rates earned on assets and the cost of interest bearing liabilities. We must manage our interest rate sensitivity to maintain adequate spread during rising and declining interest rate environments. Decisions about which bonds to purchase are based upon factors such as term, yield and asset quality. Short term bonds enhance rate sensitivity but typically have lower yields. Our investment strategy carries the majority of our investments as maturing after the five year period illustrated above. All of our investments are held available for sale which gives us the flexibility to sell in response to market changes. The money can then be used to fund loan growth or reinvested in bonds at the new interest rate.

Having a similar amount of assets repricing, or maturing, at or about the same time as our liabilities reprice or mature, reduces our interest rate risk. However, we recognize certain trends and historical experiences for some products. We know that while all our customers could withdraw their money on any given day, they do not do so, even with interest rate changes. Accounts such as savings, interest checking, and money market accounts are core deposits and do not have the same reaction to interest rate changes as time deposits do. These accounts tend to change according to cash flow and the transaction needs of our customers.

According to the table, we have a negative gap position, which means our liabilities will reprice faster than our assets. When interest rates are rising, this will tend to reduce our interest spread and our net interest income, and when rates are falling; our interest spread and net income should increase.

Provisions for Loan Losses; Allowance for Loan Losses.  For the year ending December 31, 2009, we recorded a provision for loan loss in the amount of $475,000, compared to $31,000 for the year ended December 31, 2008.  The increase in the provision expense reflects an increase in the levels of delinquent loans and management’s analysis of economic conditions in the Bank’s market areas.  In addition, the increased provision reflects our continuing strategy of growing our commercial portfolio.  These loans have a higher risk of default and loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of a business or the underlying property

 The allowance for loan losses as a percent of total loans was 1.28% at December 31, 2009, compared to 1.09% at December 31, 2008.

 The following table illustrates information related to the Bank’s nonperforming assets at the dates indicated.  The Bank had no troubled debt restructurings or accruing loans past due 90 or more days at the dates presented.
 
   
At December 31,
       
   
2009
   
2008
   
%
Change
 
(Dollars in thousands)
                 
Nonaccrual loans
  $ 1,774     $ 1,107       60.3 %
Other real estate owned
    88       -          
                         
Total nonperforming assets
  $ 1,862     $ 1,107       68.2 %
Total nonperforming loans to total loans
    1.53 %     1.03 %     48.4 %
Total nonperforming loans to total assets
    1.13 %     0.80 %     41.8 %
Total nonperforming assets to total assets
    1.19 %     0.80 %     48.88 %

Non-Interest  Income

For the year ended December 31, 2009, non-interest income totaled $404,000, a $66,000 or 19.5% increase over the same period in 2008. The increase was primarily the result a $56,000 or 58.9% increase in income on bank owned life insurance over the comparable period in 2008.  The increase in non-interest income was partially offset by an other-than-temporary impairment charge on several equity securities of $38,000 for the year ending December 31, 2009.

 
28

 
 
Non-Interest Expense

For the year ended December 31, 2009, non-interest expense decreased $566,000 or 13.5% to $3.6 million as compared to $4.2 million for the year ending December 31, 2008.  The primary reason for the decrease was the 2009 receipt of a net insurance settlement of $468,000 stemming from the 2008 loss on accounting errors of $475,000.  Salaries and employee benefits increased $79,000 or 3.9% to $2.1 million for the year ended December 31, 2009 as compared with the same period in 2008. Primary reason for the increase was increased benefit costs and merit increases for staff. For the year ended December 31, 2009, FDIC insurance was $240,000 as compared to $14,000 for the same period in 2008.  The increase in the FDIC assessment for the year ended December 31, 2009 was attributable to the expiration of credits during 2008, an increase in the assessment rate for 2009 and an FDIC-imposed industry-wide 5 basis point special assessment totaling $67,000.

Income taxes. The Bank recorded income tax expense for the year ended December 31, 2009 of $85,000, compared to an income tax expense of $153,000 for the year ended December 31, 2008.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCOVERIES ABOUT MARKET RISK

Not applicable as the Company is a smaller reporting company.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 
29

 
 
 
 
30

 

 
 
31

 

North Penn Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
December 31, 2009 and 2008

(In thousands, except per share amounts)
 
2009
   
2008
 
ASSETS
           
Cash and due from banks
  $ 2,652     $ 1,604  
Interest bearing deposits at other financial institutions
    560       43  
Federal funds sold
    8,700       627  
Total cash and cash equivalents
    11,912       2,274  
Investment securities, available for sale
    19,398       20,293  
Equity securities at cost, substantially restricted
    1,143       1,090  
Loans, net of allowance for loan losses of $1,484 in 2009 and  $1,170 in 2008
    114,546       106,106  
Loans held for sale
    -       684  
Bank premises and equipment, net
    3,965       4,126  
Accrued interest receivable
    665       676  
Cash surrender value of bank-owned life insurance
    3,015       2,864  
Deferred income taxes
    705       657  
Prepaid FDIC insurance
    604       -  
Other real estate owned
    88       -  
Other assets
    286       220  
TOTAL ASSETS
  $ 156,327     $ 138,990  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
LIABILITIES
               
Deposits:
               
Non-interest bearing
  $ 8,785     $ 6,985  
Interest bearing
    115,270       92,168  
Total deposits
    124,055       99,153  
Other borrowed funds
    12,000       19,648  
Accrued interest and other liabilities
    1,002       891  
TOTAL LIABILITIES
    137,057       119,692  
                 
STOCKHOLDERS’ EQUITY
               
Preferred stock, no par value; authorized 20,000,000 shares;  none issued
    -       -  
Common stock, par value $0.10; 80,000,000 shares authorized; 1,581,571 shares issued in 2009 and 2008; outstanding: 1,330,071 in 2009 and 1,478,571 in 2008
    158       158  
Additional paid-in capital
    13,580       13,480  
Retained earnings
    8,541       7,905  
Unearned ESOP shares
    (907 )     (980 )
Accumulated other comprehensive loss
    (2 )     (460 )
Treasury stock – at cost: 251,500 and 103,000 shares at December 31, 2009 and  2008, respectively
    (2,100 )     (805 )
TOTAL STOCKHOLDERS’ EQUITY
    19,270       19,298  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 156,327     $ 138,990  
 
See notes to consolidated financial statements.

 
32

 

North Penn Bancorp, Inc. and Subsidiary
Consolidated Statements of Income
For the Years ended December 31, 2009 and 2008

(In thousands, except per share amounts)
           
   
2009
   
2008
 
INTEREST INCOME
           
Interest on loans
  $ 6,878     $ 6,822  
Interest and dividends on investments
    797       869  
Total interest income
    7,675       7,691  
INTEREST EXPENSE
               
Interest on deposits
    2,495       2,668  
Interest on borrowed funds
    631       643  
Total interest expense
    3,126       3,311  
                 
NET INTEREST INCOME
    4,549       4,380  
                 
PROVISION FOR LOAN LOSSES
    475       31  
                 
NET INTEREST INCOME  AFTER PROVISION FOR LOAN LOSSES
    4,074       4,349  
                 
OTHER INCOME
               
Service charges and fees
    244       233  
Bank-owned life insurance income
    151       95  
Other operating income
    35       4  
Gain on sale of other real estate owned
    6       1  
Gain on sale of loans
    6       2  
Gain on sale of bank premises and equipment
    -       2  
Gain on sale of investment securities
    8       1  
Impairment losses on investment securities
    (38 )     -  
TOTAL OTHER INCOME
    412       338  
                 
OTHER EXPENSE
               
Salaries and employee benefits
    2,129       2,050  
Occupancy and equipment expense
    656       675  
FDIC insurance expense
    240       14  
Professional services expense
    408       349  
Other expenses
    649       617  
Loss (recovery) from accounting errors
    (468 )     475  
TOTAL OTHER EXPENSE
    3,614       4,180  
                 
INCOME BEFORE INCOME TAXES
    872       507  
                 
INCOME TAX EXPENSE
    85       153  
                 
NET INCOME
  $ 787     $ 354  
                 
Weighted average number of shares outstanding
    1,376,069       1,518,560  
Earnings per share, basic and diluted
  $ 0.57     $ 0.23  

See notes to consolidated financial statements.

 
33

 

North Penn Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity
For the Years ended December 31, 2009 and 2008

(In thousands, except per share amounts)
 
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Unearned
ESOP
Shares
   
Accum-
ulated
Other
Comp-
rehensive
Income
 (Loss)
   
Treasury
Stock
   
Total
 
Balance, December 31, 2007
  $ 158     $ 13,433     $ 7,742     $ (1,059 )   $ (90 )   $ -     $ 20,184  
Comprehensive (loss):
                                                       
Net income
    -       -       354       -       -       -       354  
Unrealized losses on securities, net of income taxes
    -       -       -       -       (370 )     -       (370 )
Comprehensive (loss)
                                                    (16 )
ESOP shares released
    -       (27 )     -       79       -       -       52  
Restricted Stock Awards
    -       74       -       -       -       -       74  
Purchase of Treasury Stock
                                            (805 )     (805 )
Cash dividend - $0.12 per share
    -       -       (191 )     -       -       -       (191 )
                                                         
Balance, December 31, 2008
    158       13,480       7,905       (980 )     (460 )     (805 )     19,298  
                                                         
Comprehensive income:
                                                       
Net income
    -       -       787       -       -       -       787  
Unrealized gain on securities, net of income taxes
    -       -       -       -       458       -       458  
Comprehensive income
    -       -       -       -       -       -       1,245  
ESOP shares released
    -       (3 )     -       73       -       -       70  
Restricted stock awards
    -       103       -       -       -       -       103  
Purchase of treasury stock
    -       -       -       -       -       (1,295 )     (1,295 )
Cash dividend - $0.12 per share
    -       -       (151 )     -       -       -       (151 )
                                                         
Balance, December 31, 2009
  $ 158     $ 13,580     $ 8,541     $ (907 )   $ (2 )   $ (2,100 )   $ 19,270  

See notes to consolidated financial statements.

 
34

 
 
North Penn Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2009 and 2008

(In thousands)
 
2009
   
2008
 
Operating Activities:
           
Net income
  $ 787     $ 354  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation
    232       259  
Provision for loan losses
    475       31  
Deferred income tax benefit
    (245 )     -  
Amortization of securities (net of accretion)
    4       19  
Increase in cash surrender value of life insurance
    (151 )     (25 )
Gain on sale of  investment securities
    (8 )     (1 )
Gain on sale of bank premises and equipment
    -       (2 )
Gain on other real estate owned
    (6 )     (1 )
Gain on sale of loans held for sale
    (6 )     (2 )
Impairment loss on investment securities
    38       -  
ESOP expense
    70       52  
Stock option expense
    103       70  
Changes in:
               
Prepaid FDIC insurance
    (604 )     -  
Accrued interest income and other assets
    (85 )     (77 )
Accrued interest expense and other liabilities
    111       109  
Net Cash Provided by Operating Activities
    715       786  
                 
Investing Activities:
               
Purchase bank premises and equipment
    (71 )     (235 )
Proceeds from sale of bank premises and equipment
    -       11  
Proceeds from sale of other real estate owned
    117       100  
Sale of securities “available for sale”
    76       28  
Purchase of securities “available for sale”
    (3,027 )     (9,860 )
Matured or called securities “available for sale”
    2,593       940  
Redemptions of mortgage-backed securities “available for sale”
    1,904       1,387  
Purchase of restricted stock
    (53 )     (30 )
Net increase in loans to customers
    (9,114 )     (10,348 )
Proceeds from sale of loans held for sale
    690       776  
Purchase of life insurance policies
            (702 )
Net Cash Used in Investing Activities
    (6,885 )     (17,933 )
                 
Financing Activities:
               
Net increase in deposits
    24,902       15,470  
Net increase (decrease) in short term borrowings
    (7,648 )     1,769  
Treasury stock purchased
    (1,295 )     (805 )
Cash dividends paid
    (151 )     (191 )
Net Cash Provided by Financing Activities
    15,808       16,243  
Net increase (decrease) in Cash and Cash Equivalents
    9,638       (904 )
                 
Cash and Cash Equivalents, January 1
  $ 2,274     $ 3,178  
Cash and Cash Equivalents, December 31
  $ 11,912     $ 2,274  
                 
Supplementary Schedule of Cash Flow Information:
               
Cash paid during the period for:
               
Interest
  $ 3,126     $ 3,272  
Income taxes
    133       146  
                 
Non-cash investing and financing activities:
               
Transfer from loans to other real estate owned
    199       -  

See notes to consolidated financial statements.
 
 
35

 

Notes to Consolidated Financial Statements

Note 1 - Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

North Penn Bancorp, Inc. is the holding company for North Penn Bank (Bank).  The common stock trades on the OTC Bulletin Board under the symbol “NPBP.OB”.  The Bank operates from five offices under a Pennsylvania savings bank charter and provides financial services to individuals and corporate customers primarily in Northeastern Pennsylvania.  The Bank’s primary deposit products are savings and demand deposit accounts and certificates of deposit.  Its primary lending products are real estate, commercial and consumer loans.

Basis of Financial Statement Presentation

The accompanying consolidated financial statements include the accounts of North Penn Bancorp, Inc., its wholly-owned subsidiary, North Penn Bank and North Penn Bank’s wholly-owned subsidiaries, Norpenco, Inc. and North Penn Settlement Services, LLC. These entities are collectively referred to herein as the Company.  All significant intercompany accounts and transactions have been eliminated in consolidation. Norpenco, Inc.’s sole activities are purchasing bank stocks and receiving dividends on such stocks. North Penn Settlement Services, LLC, receives non interest income from providing title search work.

The accounting policies of the Company conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the 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 revenue and expenses during the reporting period.  Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.  In connection with the determination of the allowance for loses on loans and foreclosed real estate, management periodically obtains independent appraisals for significant properties.

Recent Accounting Pronouncements

FASB ASC 820-10 — In February 2008, the FASB issued new guidance impacting FASB ASC 820-10, Fair Value Measurements and Disclosures (FASB Staff Position No. 157-2). The staff position delays the effective date of FASB ASC 820-10 (SFAS No. 157) for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The delay expired January 1, 2009, and the expiration of the delay did not have a material impact on the Company’s consolidated financial positions or results of operations.
 
 
36

 

FASB ASC 805 — In December 2007, the FASB issued new guidance impacting FASB ASC 805, Business Combinations (SFAS No 141® — Business Combinations). The new guidance establishes principles and requirements for how an acquiring company (1) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree, (2) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (3) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The new standard became effective for the Company on January 1, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 810-10 — In December 2007, the FASB issued FASB ASC 810-10, Consolidation (Statement No. 160 — Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51). FASB ASC 810-10 requires the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled and presented in the consolidated balance sheet within equity, but separate from the parent’s equity. It also requires the amount of consolidated net income attributable to the parent and the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of income. The new standard became effective for the Company on January 1, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 815-10 — In March 2008, the FASB issued FASB ASC 815-10, Derivatives and Hedging (Statement No. 161 —Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133). FASB ASC 815-10 requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related items are accounted for and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The new standard became effective for the Company on January 1, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 855 — In May 2009, the FASB issued FASB ASC 855, Subsequent Events (Statement No. 165 — Subsequent Events). FASB ASC 855 establishes the period after the balance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in financial statements and the circumstances under which an entity shall recognize events or transactions that occur after the balance sheet date. FASB ASC 855 also requires disclosure of the date through which subsequent events have been evaluated. The Company adopted this standard for the interim reporting period ending June 30, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 860 — In June 2009, the FASB issued new guidance impacting FASB ASC 860, Transfers and Servicing (Statement No. 166 — Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140). The new guidance removes the concept of a qualifying special-purpose entity and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The new standard will become effective for the Company on January 1, 2010. The Company is currently evaluating the impact of adopting the new standard on the consolidated financial statements.

FASB ASC 810-10 — In June 2009, the FASB issued new guidance impacting FASB ASC 810-10, Consolidation (Statement No. 167 —Amendments to FASB Interpretation No. 46®). The new guidance amends tests for variable interest entities to determine whether a variable interest entity must be consolidated. FASB ASC 810-10 requires an entity to perform an analysis to determine whether an entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This standard requires ongoing reassessments of whether an entity is the primary beneficiary of a variable interest entity and enhanced disclosures that provide more transparent information about an entity’s involvement with a variable interest entity. The new guidance will become effective for the Company on January 1, 2010 and the Company is currently evaluating the impact of adopting the standard on the consolidated financial statements.

 
37

 
 
FASB ASC 105-10 — In June 2009, the FASB issued FASB ASC 105-10, Generally Accepted Accounting Principles (Statement No. 168 — The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles). The new guidance replaces SFAS No. 162 and establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”). Rules and interpretative releases of the Securities and Exchange Commission under federal securities laws are also sources of authoritative GAAP for SEC registrants. The new standard became effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this statement did not have a material impact on the Company’s consolidated financial position or results of operations. Technical references to generally accepted accounting principles included in the Notes to Consolidated Financial Statements are provided under the new FASB ASC structure with the prior terminology included parenthetically.

FASB ASC 715-20-50 — In December 2008, the FASB issued new guidance impacting FASB ASC 715-20-50, Compensation Retirement Benefits — Defined Benefit Plans — General (FASB Staff Position No. 132®- 1, Employers’ Disclosures about Postretirement Benefit Plan Assets). This provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The guidance requires disclosure of the fair value of each major category of plan assets for pension plans and other postretirement benefit plans. This standard becomes effective for the Company on January 1, 2010. The Company is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact

FASB ASC 825-10-50 — In April 2009, the FASB issued new guidance impacting FASB ASC 825-10-50, Financial Instruments (FASB Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments). This guidance amends existing GAAP to require disclosures about fair values of financial instruments for interim reporting periods as well as in annual financial statements. The guidance also amends existing GAAP to require those disclosures in summarized financial information at interim reporting periods. The Company adopted this standard for the interim reporting period ending March 31, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 320-10 — In April 2009, the FASB issued new guidance impacting FASB ASC 320-10, Investments — Debt and Equity Securities (FASB Staff Position No. FAS 115-2, Recognition and Presentation of Other-Than-Temporary Impairments). This guidance amends the other-than-temporary impairment guidance in U.S. generally accepted accounting principles for debt securities. If an entity determines that it has an other-than-temporary impairment on a security, it must recognize the credit loss on the security in the income statement. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. FASB ASC 320-10 expands disclosures about other-than-temporary impairment and requires that the annual disclosures in existing generally accepted accounting principles be made for interim reporting periods. The Company adopted this guidance for the interim reporting period ending March 31, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 820 — In April 2009, the FASB issued new guidance impacting FASB ASC 820, Fair Value Measurements and Disclosures (FASB Staff Position No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly). This provides additional guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased when compared with normal market activity for the asset or liability. A significant decrease in the volume or level of activity for the asset or liability is an indication that transactions or quoted prices may not be determinative of fair value because transactions may not be orderly. In that circumstance, further analysis of transactions or quoted prices is needed, and an adjustment to the transactions or quoted prices may be necessary to estimate fair value. The Company adopted this guidance for the interim reporting period ending March 31, 2009 and it did not have a material impact on the Company’s consolidated financial position or results of operations.
 
 
38

 

SAB 111 — In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (“SAB 111”). SAB 111 amends Topic 5.M in the Staff Accounting Bulletin series entitled Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities. On April 9, 2009, the FASB issued new guidance impacting FASB ASC 320-10, Investments — Debt and Equity Securities (FASB Staff Position No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments). SAB 111 maintains the previous views related to equity securities and amends Topic 5.M to exclude debt securities from its scope. SAB 111 was effective for the Company as of March 31, 2009. There was no material impact to the Company’s consolidated financial position or results of operations upon adoption.

SAB 112 — In June 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 112 (“SAB 112”). SAB 112 revises or rescinds portions of the interpretative guidance included in the Staff Accounting Bulletin series in order to make the interpretative guidance consistent with the recent pronouncements by the FASB, specifically FASB ASC 805 and FASB ASC 810-10 (SFAS No. 141® and SFAS No. 160). SAB 112 was effective for the Company as of June 30, 2009. There was no material impact to the Company’s consolidated financial position or results of operations upon adoption.

FASB ASC 323 — In November 2008, the FASB Emerging Issues Task Force reached a consensus on FASB ASC 323, Investments — Equity Method and Joint Ventures (Issue No. 08-6, Equity Method Investment Accounting Considerations). The new guidance clarifies the accounting for certain transactions and impairment considerations involving equity method investments. An equity investor shall not separately test an investee’s underlying assets for impairment but will recognize its share of any impairment charge recorded by an investee in earnings and consider the effect of the impairment on its investment. An equity investor shall account for a share issuance by an investee as if the investor had sold a proportionate share of its investment, with any gain or loss recognized in earnings. The new guidance became effective for the Company on January 1, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 350 — In November 2008, the FASB Emerging Issues Task Force reached a consensus on FASB ASC 350, Intangibles — Goodwill and Other (Issue No. 08-7, Accounting for Defensive Intangible Assets). The new guidance clarifies how to account for defensive intangible assets subsequent to initial measurement. The guidance applies to acquired intangible assets in situations in which an entity does not intend to actively use an asset but intends to hold the asset to prevent others from obtaining access to the asset. A defensive intangible asset should be accounted for as a separate unit of accounting with an expected life that reflects the consumption of the expected benefits related to the asset. The benefit from holding a defensive intangible asset is the direct and indirect cash flows resulting from the entity preventing others from using the asset. The new guidance was effective for intangible assets acquired on or after January 1, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 260-10 — In June 2008, the FASB issued new guidance impacting FASB ASC 260-10, Earnings Per Share (FSP No. EITF 03-06-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities). This new guidance concluded that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders and therefore are considered participating securities for purposes of computing earnings per share. Entities that have participating securities that are not convertible into common stock are required to use the “two-class” method of computing earnings per share. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. This new guidance was effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. This new guidance became effective for the Company on January 1, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.
 
 
39

 

FASB ASC 820-10 — In August 2009, the FASB issued an update (ASC No. 2009-05, Measuring Liabilities at Fair Value) impacting FASB ASC 820-10, Fair Value Measurements and Disclosures. The update provides clarification about measuring liabilities at fair value in circumstances where a quoted price in an active market for an identical liability is not available and the valuation techniques that should be used. The update also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. This update became effective for the Company for the reporting period ending September 30, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 820-10 — In September 2009, the FASB issued an update (ASC No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or its equivalent)) impacting FASB ASC 820-10, Fair Value Measurements and Disclosures. The amendments in this update permit, as a practical expedient, a reporting entity to measure the fair value of an investment that is within the scope of the amendments in this update on the basis of the net asset value per share of the investment (or its equivalent) if the net asset value of the investment is calculated in a manner consistent with the measurement principles of Topic 946, Financial Services-Investment Companies. The amendments in this update also require disclosures by major category of investment about the attributes of investments within the scope of the amendments in this update, such as the nature of any restrictions on the ability to redeem an investment on the measurement date. This update becomes effective for the Company for interim and annual reporting periods ending after December 15, 2009. The Company is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

FASB ASC 505-20 — In January 2010, the FASB issued an update (ASC No. 2010-01, Accounting for Distributions to Shareholders with Components of Stock and Cash) impacting FASB ASC 505-20, Equity - Stock Dividends and Stock Splits. The amendments in this update clarify that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in earnings per share and is not a stock dividend. This update became effective for the Company for interim and annual periods ending after December 15, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 810-10 — In January 2010, the FASB issued an update (ASC No. 2010-02, Accounting and Reporting for Decreases in Ownership of a Subsidiary - a Scope Clarification) impacting FASB ASC 810-10, Consolidation. The amendments in this update address implementation issues related to the changes of ownership provisions originally issued as FASB Statement 160. It also improves the disclosures related to retained investments in a deconsolidated subsidiary or a preexisting interest held by an acquirer in a business combination. This update became effective for the Company for interim and annual periods ending after December 15, 2009 and did not have a material impact on the Company’s consolidated financial position or results of operations.

FASB ASC 820-10 — In January 2010, the FASB issued an update (ASC No. 2010-06, Improving Disclosures about Fair Value Measurements) impacting FASB ASC 820-10, Fair Value Measurements and Disclosures. The amendments in this update require new disclosures about significant transfers in and out of Level 1 and Level 2 fair value measurements. The amendments also require a reporting entity to provide information about activity for purchases, sales, issuances and settlements in level 3 fair value measurements and clarify disclosures about the Level of disaggregation and disclosures about inputs and valuation techniques. This update becomes effective for the Company for interim and annual reporting periods beginning after December 15, 2009. The Company is currently evaluating the impact of adopting the new guidance on the consolidated financial statements.
 
Investment Securities

The Company’s investments in securities are classified in two categories and accounted for as follows:

Securities Held-to-Maturity   Bonds, notes and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts.

Securities Available-for-Sale Bonds, notes, debentures and equity securities not classified as securities to be held-to-maturity and are carried at fair value with unrealized holding gains and losses, net of tax, reported as a separate component of other comprehensive income until realized.  The Company classifies all new purchases of securities as “available-for-sale”.

 
40

 
 
Purchase premiums and discounts are recognized in interest income on the straight-line basis over the term of the securities, which approximates the interest method.  Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and are reported as other income in the Statements of Income.

The Company has no derivative financial instruments required to be disclosed under FASB ASC 815-10 Derivatives and Hedging (SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.)

Restricted Securities

Restricted equity securities consist of stock in Federal Home Loan Bank of Pittsburgh (“FHLB-Pittsburgh”) and, Atlantic Central Bankers Bank (“ACBB”) and do not have a readily determinable fair value because their ownership is restricted, and they can be sold back only to the FHLB-Pittsburgh, ACBB, or to another member institution. Therefore, these securities are classified as restricted equity investment securities, carried at cost, and evaluated for impairment. At December 31, 2009, the Company held $1,106,000 in stock of FHLB-Pittsburgh, and $37,000 in stock of ACBB. At December 31, 2008, the Company held $1,053,000 in stock of the FHLB-Pittsburgh and $37,000 in stock of ACBB.

The Company evaluated its holding of restricted stock for impairment and deemed the stock to not be impaired due to the expected recoverability of cost, which equals the value reflected within the Company’s consolidated financial statements. The decision was based on several items ranging from the estimated true economic losses embedded within FHLB’s mortgage portfolio to the FHLB’s liquidity position and credit rating. The Company utilizes the impairment framework outlined in GAAP to evaluate stock for impairment. The following factors were evaluated to determine the ultimate recoverability of the cost of the Company’s restricted stock holdings; (i) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted; (ii) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB; (iii) the impact of legislative and regulatory changes on the institutions and, accordingly, on the customer base of the FHLB; (iv) the liquidity position of the FHLB; and (v) whether a decline is temporary or whether it affects the ultimate recoverability of the FHLB stock based on (a) the materiality of the carrying amount to the member institution and (b) whether an assessment of the institution’s operational needs for the foreseeable future allow management to dispose of the stock. Based on the analysis of these factors, the Company determined that its holdings of restricted stock were not impaired at December 31, 2009 and 2008.

Loans

Loans are stated at the principal amount outstanding, net of any unearned income, and the allowance for loan losses. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to yield using the interest method over the contractual lives of the loans. Interest on mortgage and commercial loans is calculated at the time of payment based on the current outstanding balance of the loan.  Interest on consumer loans is recognized on the simple interest method.

The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions.
 
 
41

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payments delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Uncollectible interest on loans that are contractually past due 90 days or more is credited to an allowance established through management’s periodic evaluation. The allowance is established by a charge to interest income equal to all previously accrued interest on these loans, and income is subsequently recognized thereafter only to the extent that cash payments are received until, in management’s judgment, the borrower’s ability to make periodic interest and principal payments resumes on a contractual basis in which case the loan is returned to accrual status.

Mortgage Partnership Finance Program
 
The Bank participates in the Mortgage Partnership Finance (MPF) Program of the Federal Home Loan Bank of Pittsburgh (FHLB). The program is intended to provide member institutions with an alternative to holding fixed-rate mortgages in their loan portfolios or selling them in the secondary market. An institution participates in the MPF Program by either originating individual loans on a “flow” basis as an agent for the FHLB pursuant to the “MPF 100 Program” or by selling, as a principal, closed loans owned by an institution to the FHLB pursuant to one of the FHLB’s closed-loan programs. Under the MPF Program(s), credit risk is shared by the participating institution and the FHLB by structuring the loss exposure in several layers, with the participating institution being liable for losses after application of an initial layer of losses (after any private mortgage insurance) is absorbed by the FHLB, subject to an agreed-upon maximum amount of such secondary credit enhancement which is intended to be in an amount equivalent to a “AA” credit risk rating by a rating agency. The participating institution may also be liable for certain first layer losses after a specified period of time. The participating institution receives credit enhancement fees from the FHLB for providing this credit enhancement and continuing to manage the credit risk of the MPF Program loans. Participating institutions are also paid specified servicing fees for servicing the loans.

Transfers involving sales with the Bank acting as principal are accounted for in accordance with FASB ASC 860-10 Transfers and Servicing (SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities) with the recognition of gains and losses on the sale and related mortgage servicing rights.

The credit enhancement feature of the MPF Program is accounted for by the Bank as a financial guarantee in accordance with FASB ASC 460-10 Guarantees (FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others) and reported on the balance sheet at its initial fair value. Subsequent changes in the recorded guarantee amount would result from termination of any portion or all of the guarantee, additional guarantees being issued or increases in the expected losses resulting from the guarantee. Such changes in recorded amounts are recognized in the consolidated statements of income or as an increase in the offsetting guarantee fees receivable account in the case of additional guarantees being issued.

Loan Servicing

The Company generally retains the right to service mortgage loans sold to others.  The cost allocated to the mortgage servicing rights retained has been recognized as a separate asset and is being amortized in proportion to and over the period of estimated net servicing income.

 
42

 

Mortgage servicing rights are periodically evaluated for impairment based on the fair value of those rights.  Fair values are estimated using discounted cash flows based on current market rates of interest and current expected future prepayment rates.  For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans.  The Company stratifies its capitalized mortgage servicing rights based on the term of the underlying loans.  The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum, exceed their fair value.

Premises and Equipment

The Company operates from one leased and four owned facilities.  Land is carried at cost.  Premises and equipment are stated at cost less accumulated depreciation.  Provision for depreciation, computed on the straight-line method and accelerated method, is charged to operating expenses over the estimated useful lives of the assets.  Maintenance and repairs are charged to operating expense as incurred.
The estimated useful lives used to compute depreciation are as follows:

   
Years
 
Buildings
  19 – 39  
Furniture and equipment
  5 – 10  

Foreclosed Real Estate

Foreclosed real estate is carried at the lower of cost or fair value at the time of foreclosure.  Management periodically performs valuations and a loss is recognized by a charge to operations if the carrying value of a property exceeds its net realizable value.  Additional costs associated with holding the properties are expensed as incurred.  The balance of foreclosed real estate was $88,000 at December 31, 2009. There was no foreclosed real estate at December 31, 2008.

Bank Owned Life Insurance

The Company invests in Bank Owned Life Insurance (BOLI) with split-dollar life provisions. Purchases of BOLI provide life insurance coverage on certain employees with the Company being the owner and beneficiary of the policies.

Treasury Stock

Stock held in treasury is accounted for using the cost method which treats stock held in treasury as a reduction to total stockholders’ equity.  The cost basis for subsequent sales of treasury shares is determined using a first-in, first-out method.

Postretirement Employee Benefits

The Company provides postretirement benefits in the form of term life insurance and health insurance coverage for a limited period of time.  The costs are funded as incurred and are not significant to the accompanying consolidated financial statements.

Advertising Expenses

Advertising costs are expensed as incurred. Advertising expense for the year ended December 31, 2009 were $43,000 compared to $46,000 for the year ended December 31, 2008.
 
43

 
Income Taxes
 
Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.

The Company adopted the provisions of FASB ASC 740-1-25 Income Taxes Recognition (FIN 48, Accounting for Uncertainty in Income Taxes,) on January 1, 2007.  When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company does not have any unrecognized tax benefits at December 31, 2009 and 2008 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of income. No interest or penalties for income taxes were recognized during the years ended December 31, 2009 and 2008.
 
Cash Flows

For purposes of the Statements of Cash Flows, cash and due from banks include cash on hand, demand deposits at other financial institutions (including cash items in process of clearing) and federal funds sold.  Cash flows from loans and deposits are reported net.

The Company may, from time to time, maintain correspondent bank balances in excess of $250,000 each.  Management is not aware of any evidence that would indicate that such deposits are at risk.

Earnings Per Share

Basic earnings per share is computed on the weighted average number of common shares outstanding during each year, adjusted for unearned shares of the ESOP, as prescribed in FASB – ASC 260-10 Earnings per share SFAS No. 128, Earnings Per Share.   Diluted earnings per share include common shares issuable upon exercise of employee stock options (Note 10) as follows:

December 31, 2009
 
Income
(Numerator)
   
Shares
(Denominator)
   
Per-Share
Amount
 
Basic EPS
                 
Income available
  $ 787,257       1,376,069     $ 0.57  
Options includable
    -       7,125       -  
Diluted  EPS
  $ 787,527       1,383,194     $ 0.57  

December 31, 2008
 
Income
(Numerator)
   
Shares
(Denominator)
   
Per-Share
Amount
 
Basic EPS
                 
Income available
  $ 354,000       1,518,560     $ 0.23  
Options includable
    -       101       -  
Diluted  EPS
  $ 354,000       1,518,661     $ 0.23  
 
 
44

 

Reclassifications

Certain amounts in the consolidated financial statements for 2008 have been reclassified to conform to presentations used in the 2009 consolidated financial statements. Such reclassifications had no effect on the company’s consolidated financial position or net income.
 
Subsequent Events

Management has evaluated subsequent events through March 31, 2010, the date the consolidated statements were issued.  On March 23, 2010, the Board of Directors of North Penn Bancorp, Inc., the holding company for North Penn Bank, declared a quarterly cash dividend of $.04 per share and a special cash dividend of $0.05 per share on its outstanding common stock, both dividends payable on or about April 30, 2010 to stockholders of record as of the close of business on April 15, 2010.
 
Note 2 - Investment Securities

The amortized cost and fair value of investment securities at December 31 are as follows (in thousands):

   
2009
 
   
Amortized
Cost
   
Gross
unrealized
gains
   
Gross
unrealized
losses
   
Fair value
 
Available-for-sale
                       
U.S. Agency securities
  $ 1,500     $ 18     $ -     $ 1,518  
Mortgage-backed securities
    2,662       89       -       2,751  
State & political subdivisions
    8,719       142       6       8,855  
Other bonds
    4,969       164       43       5,090  
Total debt securities
    17,850       413       49       18,214  
Equity securities
    1,591       15       422       1,184  
Total available-for-sale
  $ 19,441     $ 428     $ 471     $ 19,398  

   
2008
 
   
Amortized
Cost
   
Gross
unrealized
gains
   
Gross
unrealized
losses
   
Fair value
 
Available-for-sale
                       
U.S. Agency securities
  $ 3,000     $ 16     $ -     $ 3,016  
Mortgage-backed securities
    5,074       68       -       5,142  
State & political subdivisions
    8,529       20       338       8,211  
Other bonds
    3,017       38       189       2,866  
Total debt securities
    19,620       142       527       19,235  
Equity securities
    1,371       11       324       1,058  
Total available-for-sale
  $ 20,991     $ 153     $ 851     $ 20,293  

The amortized cost and fair value of debt securities at December 31, 2009, by contractual maturity, are shown below (in thousands).  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
45

 

   
Securities Available for Sale
 
   
Amortized
Cost
   
Fair Value
 
Due in one year or less
  $ 3,690     $ 3,737  
Due after one year through five years
    4,655       4,709  
Due after five years through ten years
    5,192       5,382  
Due after ten years
    4,313       4,387  
Total debt securities
  $ 17,850     $ 18,215  

There were no aggregate investments with a single issuer (excluding the U.S. Government and its agencies) which exceeded ten percent of consolidated shareholders’ equity at December 31, 2009. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s or Standard and Poors. The typical exceptions may be local issues which may not be rated, but would be secured by the full faith and credit obligations of the communities that would issue these securities. The state and political subdivision investments are actively traded in a liquid market.

Proceeds from sales of available-for-sale securities totaled $76,000 and $28,000 during 2009 and 2008, respectively.  Gross gains realized from the sale of securities totaled $8,000 and $1,000 for the years ended December 31, 2009 and 2008, respectively.

Securities available-for-sale with amortized costs and fair values of $11,312,000 and $11,030,000 at December 31, 2009 and $12,726,000 and $12,395,000, at December 31, 2008 were pledged as collateral on public deposits with the FHLBank of Pittsburgh.
 
The gross fair value and unrealized losses of the Company’s investments, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at December 31, 2009 and 2008 are as follows (in thousands):

December 31,
2009
 
Less than 12 months
   
12 months or more
   
Totals
 
   
Fair
Value
   
Unrealized
losses
   
Fair
Value
   
Unrealized
losses
   
Fair
Value
   
Unrealized
losses
 
U.S. Agency securities
  $ -     $ -     $ -     $ -     $ -     $ -  
Mortgage-backed securities
    -       -       -       -       -       -  
State & political subdivisions
    293       6       -       -       293       6  
Other bonds
                    921       43       921       43  
Equity securities
    354       114       575       308       929       422  
Total
  $ 647     $ 120     $ 1,496     $ 351     $ 2,143     $ 471  

December 31,
2008
 
Less than 12 months
   
12 months or more
   
Totals
 
   
Fair
Value
   
Unrealized
losses
   
Fair
Value
   
Unrealized
losses
   
Fair
Value
   
Unrealized
losses
 
U.S. Agency securities
  $ -     $ -     $ -     $ -     $ -     $ -  
Mortgage-backed securities
    -       -               -       -       -  
State & political subdivisions
    6,678       338       -       -       6,678       338  
Other bonds
    1,795       189       -       -       1,795       189  
Equity securities
    490       87       454       237       944       324  
Total
  $ 8,963     $ 614     $ 454     $ 237     $ 9,417     $ 851  
 
46

 
The table at December 31, 2009 includes 20 securities that have losses for less than twelve months and 31 securities that have been in an unrealized loss position for twelve or more months.

U.S. Agency Securities  There were no unrealized losses on the Company’s investments in direct obligations of U.S. government agencies at December 31, 2009.

Mortgage-Backed Securities   There were no unrealized losses on the Company’s investments in federal agency mortgage-backed securities at December 31, 2009.

State & Political Subdivisions   There was one unrealized loss in state and municipal subdivision security for less than twelve months at December 31, 2009.

Other Bonds   There was one unrealized loss in other bonds for twelve months or more at December 31, 2009.

Equity Securities At December 31, 2009, there were unrealized losses in 19 equity securities for the less than twelve month category and unrealized losses in 30 equity securities for twelve months or more.

The Company invests in various forms of agency debt including mortgage backed securities and callable debt. The mortgage backed securities are issued by FHLMC (Federal Home Loan Mortgage Company) of FNMA (Federal National Mortgage Association). The municipal securities consist of general obligations and revenue bonds. The equity securities consist of stocks in other bank holding companies.  The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid to offer spreads in the market place and credit premiums for various types of agency debt. These factors change continuously and therefore the market value of these securities may be higher or lower that the Company’s carrying value at any measurement date. Management does not believe any of their 51 securities in an unrealized position as of December 31, 2009 represents an other-than-temporary impairment. The Company has the ability to hold the remaining securities contained in the above table for a time necessary to recover the cost.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC 320 (SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities). In determining OTTI under the FASB 320 (SFAS No. 115) model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost , (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions; and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgement and is based on the information available to management at a point in time.

When other-than-temporary impairment occurs, the amount of the other-than-temporary impairment recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the other-than-temporary impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total other-than-temporary impairment related to the other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall become the new amortized cost basis of the investment.

 
47

 
 
The Company’s investment in equity securities consists entirely of bank stocks.  The unrealized losses are from forty bank stocks due to market fluctuation.  The Company also reviews investment debt securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”).  An impairment that is an “other-than-temporary-impairment” is a decline in the fair value of an investment below its amortized cost attributable to factors that indicate the decline will not be recovered over the anticipated holding period of the investment. Other-than-temporary-impairments result in reducing the security’s carrying value by the amount of credit loss. The credit component of the other-than-temporary impairment loss is realized through the statement of income and the remainder of the loss remains in other comprehensive income.  After our review, we concluded that two securities were impaired. OTTI losses of $38,000 on these securities were recognized during the fourth quarter 2009.  In accordance, with FASB ASC 320, the impairment was deemed credit related and run entirely through the statement of  income.

Note 3 - Loans Receivable

Loans receivable consist of the following at December 31, 2009 and 2008 (in thousands):

   
2009
   
2008
 
Real estate mortgages
           
Construction and land development
  $ 327     $ 546  
Residential, 1 – 4 family
    47,439       44,986  
Residential, multi-family
    908       1,147  
Commercial
    60,269       53,448  
Total real estate mortgages
    108,943       100,127  
Commercial
    3,368       1,796  
Consumer
    3,719       5,353  
Total loans
    116,030       107,276  
Allowance for loan losses
    1,484       1,170  
Total loans, net
  $ 114,546     $ 106,106  

The Bank is subject to a loans-to-one-borrower limitation of 15% of capital funds.  At December 31, 2009, the loans-to-one-borrower limitation was $2,500,500.  At December 31, 2009, there were no loans outstanding or committed to any one borrower that individually or in the aggregate exceeds that limit.

The Bank lends primarily to customers in its local market area.  Most loans are mortgage loans, which include loans secured by commercial and residential real estate and construction loans.  Accordingly, lending activities could be affected by changes in the general economy, the regional economy, or real estate values. At December 31, 2009 and 2008, mortgage loans totaled $108,943,000 and $100,127,000 respectively.  Mortgage loans represent 93.9% of total gross loans at December 31, 2009 and 93.3% of total gross loans at December 31, 2008.

Nonaccrual loans represent loans, which are ninety days or more in arrears or in the process of foreclosure.  These loans totaled approximately $1,774,000 and $1,107,000 at December 31, 2009 and 2008, respectively.  The allowance for loan losses allocated to impaired loans was $345,000 and $42,000 at December 31, 2009 and 2008, respectively.  Additional interest income that would have been earned under the original terms of such loans would have amounted to $45,000 and $30,000 for the years ended December 31, 2009 and 2008, respectively.
 
The following is a summary of the activity of the allowance for loan losses (in thousands):

   
2009
   
2008
 
Balance, beginning of year
  $ 1.170     $ 1,171  
Provision for loan losses
    475       31  
Recoveries
    10       18  
Loans charged-off
    (171 )     (50 )
Balance, end of year
  $ 1,484     $ 1,170  
 
48

 
From time to time, the Company may agree to modify the contractual terms of a borrower’s loan. In cases where such modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. Loans modified in a troubled debt restructuring are placed on non-accrual status until the Company determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate a period of performance according to the restructured terms of six months. At December 31, 2009, there were no loans classified as troubled debt restructurings.

Note 4 – Loan Servicing

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.  The unpaid principal balance of mortgage loans serviced for others was $4,176,000 at December 31, 2009 and $5,147,000 at December 31, 2008.

Note 5 - Premises and Equipment, Net

Premises and equipment at December 31, 2009 and 2008 are summarized as follows (in thousands):

   
2009
   
2008
 
Land and improvements
  $ 1,273     $ 1,273  
Building and improvements
    5,399       5,399  
Furniture and equipment
    1,928       1,858  
      8,600       8,530  
Less:  Accumulated depreciation and amortization
    4,635       4,404  
Premises and equipment, net
  $ 3,965     $ 4,126  

Depreciation expense was $232,000 and $259,000 for the years ended December 31, 2009 and 2008, respectively.

Note 6 - Deposits

Deposits consist of the following major classifications at December 31, 2009 and 2008 (dollars in thousands):

   
2009
   
2008
 
   
Amount
   
% of total
deposits
   
Amount
   
% of total
deposits
 
Non-interest checking
  $ 8,785       7.1 %   $ 6,985       7.0 %
Interest checking
    7,916       6.4       10,221       10.3  
Money market
    7,598       6.1       11,631       11.7  
Savings
    33,779       27.2       26,616       26.9  
Time deposits
    65,977       53.2       43,700       44.1  
Total
  $ 124,055       100 %   $ 99,153       100 %

Time deposit accounts of $100,000 and over totaled approximately $16,844,000 at December 31, 2009. Time deposit accounts of $100,000 and over totaled approximately $10,893,000 at December 31, 2008.

 
49

 

At December 31, 2009 and 2008, scheduled maturities of time deposits were as follows:

Maturing in:
 
2009
   
2008
 
One Year
  $ 53,587     $ 24,008  
Two Years
    6,624       15,053  
Three Years
    2,323       2,081  
Four Years
    841       1,752  
Five Years
    2,602       806  
Thereafter
    -       -  
Total
  $ 65,977     $ 43,700  

Interest expense on deposits consisted of the following for the years ended December 31, 2009 and 2008:

   
2009
   
2008
 
Interest checking
  $ 129     $ 185  
Money market
    102       245  
Savings
    449       577  
Time deposits
    1,815       1,661  
    $ 2,495     $ 2,668  

Note 7 – Other Borrowings

Short-Term Borrowings

The Company has a line of credit with the FHLB for short term borrowings varying from one day to three years.  Advances on this line must be secured by “qualifying collateral” as defined in the agreement and bear interest at fixed or variable rates as determined at the date advances are made.  The line expires in June, 2011.

At December 31, 2009, the Company had no overnight funds.  At December 31, 2008, the Company borrowed $7,648,000 in overnight funds with interest at .59%.

 The Company’s maximum overnight borrowing outstanding at any month-end during the year was $3,985,000. The average amount outstanding for the year ended December 31, 2009 amounted to $909,000 and the average interest rate was 1.08%.

Term Borrowings

The Company also has two term loans from the FHLB.  One is a $5 million term loan at a fixed rate of 6.19%, which was issued in July of 2000, and matures July of 2010.  The loan requires monthly interest payments, with the principal due at maturity. The other loan is $7 million issued in July of 2005 and matures July of 2015.  The interest rate is fixed at 4.34%, for two years, at which time the FHLB has the option to convert it to an adjustable rate if the related index reaches the strike rate of 8.00% (0.11% as of December 31, 2009).  Interest is due quarterly and the principal is due at maturity.

All of the above borrowings are secured by the Company’s mortgages.

The Company’s collateralized maximum borrowing capacity with FHLBank of Pittsburgh was $63,471,000 as of December 31, 2009.
 
 
50

 

Note 8 – Retirement Plans

Defined Benefit Plan

The Company participates in the Financial Institution Retirement Fund (the Fund) administered by the Pentegra Group. The Fund operates as a multi-employer plan for accounting purposes under FASB ASC 715 Compensation Retirement Benefits (SFAS) No. 87 Employers’ Accounting for Pensions. As such, the annual pension expense to be recorded is defined as the amount of the required annual contribution.

The Fund covers all employees who have met the stated age and service requirements. A benefit formula provides for retirement benefits that are calculated as a percentage of salary during their working career, as defined. More details can be found in the plan document. In February, 2009, the Bank’s Board of Directors authorized the freezing of benefits within the defined benefit plan as of April 1, 2009.

 For the plan years ending June 30, 2009 and 2008, the required contributions due were $48,000 and $94,000 respectively. The required contribution for Plan year ending June 30, 2010 is $21,000.

401(k) Plan

The Bank also sponsors a 401(k) Plan (the Plan). The Plan covers all employees who meet age and service requirements. Participants in the Plan are permitted to make contributions up to 20% of their compensation. In March, 2009, the Board of Directors approved an increase in matching employees’ contributions within the Bank’s existing 401k plan from 50% of the first 6% to 100% of the first 6% as of April 1, 2009. We estimate that the increased cost of higher matching will be approximately $26,000 for 2009. Employer contributions to the Plan amounted to $45,000 and $26, 000 for the years ended December 31, 2009 and 2008, respectively.

Employee Stock Ownership Plan

In connection with the initial public offering, the Company adopted an employee stock ownership plan for eligible employees of North Penn Bank effective June 1, 2005. Eligible employees who are 21 years old and employed by the Bank as of the effective date of the offering begin participating in the plan as of that date. Thereafter, new employees of the Bank who are 21 years old and have been credited with at least one year of service with North Penn Bank will be eligible to participate in the employee stock ownership plan as of the first entry date following their completion of the plan’s eligibility requirements. The ESOP used $545,000 in proceeds from a term loan obtained from the Company to purchase 58,106 shares of the Company’s common stock. The term loan principal is payable in fifteen equal annual installments. Interest is at prime plus .5% and payable quarterly. Each year, the Bank intends to make discretionary contributions to the ESOP which will be equal to the required principal and interest payments on the term loan. The loan is further paid down by the amount of dividends paid, if any, on the common stock owned by the ESOP.

As part of the Company’s second step conversion, a second ESOP loan in the amount of $680,000 was obtained by North Penn Bank from North Penn Bancorp to purchase an additional 68,000 shares of common stock. The loan is payable in twenty, equal, annual installments. Interest is at 7.75% and payable quarterly. The loan is further paid down by the amount of dividends paid, if any, on the common stock owned by the ESOP.

Shares purchased with the loan proceeds are initially pledged as collateral for the term loan and are held in a suspense account for future allocation among participants. Contributions to the ESOP and shares released from the suspense account will be allocated among participants on the basis of compensation.

The ESOP is accounted for in accordance with FASB ASC 718-40 Compensation – Stock Compensation –Employee Stock Purchase Plans SOP 93-6, Employers’ Accounting for Employee Stock Ownership Plans. The shares pledged as collateral are deducted from stockholders’ equity as unearned ESOP shares in the accompanying consolidated balance sheets. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for EPS computations.

 
51

 

For the year ended December 31, 2009, compensation expense amounted to $82,000.  At December 31, 2009, total ESOP shares amounted to 125,830, with 32,962 shares allocated and 92,868 shares unearned.  The fair value of unearned shares amounted to $859,000 at December 31, 2009.

For the year ended December 31, 2008, compensation expense amounted to $52,000.  At December 31, 2008, total ESOP shares amounted to 125,830, with 25,241 shares allocated and 100,589 shares unearned.  The fair value of unearned shares amounted to $729,000 at December 31, 2008.

Supplemental Executive Retirement Plan

Effective July 1, 2004, the Company established an unfunded supplemental executive retirement plan to provide certain officers with additional benefits upon termination or retirement. The Company expensed $56,000 and $31,000 for the years ended December 31, 2009 and 2008 respectively in the accompanying consolidated financial statements.
.
Note 9 - Omnibus Stock Option Plan

Stock Awards. In May of 2006, the Company's stockholders approved the 2006 Omnibus Stock Option Plan, under which the Company reserved 101,685 shares of common stock for future issuance. The Plan provides for grants of stock options and restricted stock awards. Only present and future employees and directors are eligible to receive incentive awards under the 2006 Omnibus Plan.  The Company believes that such awards better align the interests of its employees with its stockholders.

On May 26, 2009, the Company’s stockholders approved the 2009 Equity Incentive Plan. The Board of Directors has reserved a total of 119,000 shares of common stock for issuance upon the grant or exercise of awards made pursuant to the 2009 Plan.   The Plan provides for grants of stock options and restricted stock awards. All of the Company’s employees, officers, and directors are eligible to participate in the 2009 Plan.

The exercise price and vesting of both plans are determined by the Board of Directors at the date of grant. Options generally vest over five years, and expire ten years after the date of grant. Certain option and stock awards provide for accelerated vesting if there is a change in control (as defined in the Plan).

Stock Grants. Restricted stock grants totaling 5,323 shares were awarded on September 26, 2006 having a fair value of $54,000. The grants vest over five years. The market value as of the grant date of the restricted stock grants is charged to expense as the grants vest. During 2009, 874 shares vested at fair value of $8,900.

Restricted stock grants totaling 21,229 shares were awarded on May 28, 2008 having a fair value of $175,000. The grants vest over five years. During 2009, 4.310 shares vested at a fair value of $36,000. The market value as of the grant date of the restricted stock grants is charged to expense as the grants vest.

On May 9th, 2009, restricted stock grants totaling 500 shares were awarded having a fair value of $4,300.  The grants vest over five years.  The market value as of the grant date of the restricted stock grants is charged to expense as the grants vest.

Restricted stock grants totaling 17,611 shares were awarded on November 4, 2009, having a fair value of $158,000.  The grants vest over five years.  The market value as of the grant date of the restricted stock grants is charged to expense as the grants vest.

 Compensation expense for all stock grants was $49,000 in 2009.

Stock Options. Stock options covering 29,484 shares of common stock were awarded on September 26, 2006. The option awards were granted with an exercise price equal to the average price of the last trade date.  The stock options vest and therefore become exercisable on a pro rata basis annually over five years from the date awarded, commencing September 26, 2007. The options are available to be exercised for a period of ten years after the date awarded.

 
52

 
 
The fair value of each option grant was estimated to be $3.86 on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period:

Dividend Yield (per share)
  $ 0.12  
Volatility (%)
    3.76 %
Risk-free Interest Rate (%)
    4.76 %
Expected Life
 
10 years
 

An additional set of stock options covering 3,766 shares were awarded on October 23, 2007. The option awards were granted with an exercise price equal to the average price of the last trade date.  The stock options vest and therefore become exercisable on a pro rata basis annually over five years from the date awarded, commencing October 27, 2008. The options are available to be exercised for a period of ten years after the date awarded.

The fair value of each option grant was estimated to be $3.64 on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period:

Dividend Yield (per share)
  $ 0.12  
Volatility (%)
    19.00 %
Risk-free Interest Rate (%)
    4.01 %
Expected Life
 
10 years
 

An additional set of stock options covering 34,997 shares were awarded on May 28, 2008. The option awards were granted with an exercise price equal to the average price of the last trade date.  The stock options vest and therefore become exercisable on a pro rata basis annually over five years from the date awarded, commencing May 28, 2009. The options are available to be exercised for a period of ten years after the date awarded.

The fair value of each option grant was estimated to be $3.18 on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period:
 
Dividend Yield (per share)
  $ 0.12  
Volatility (%)
    29.24 %
Risk-free Interest Rate (%)
    1.89 %
Expected Life
 
10 years
 
 
An additional set of stock options covering 1,000 shares were awarded on May 11, 2009. The option awards were granted with an exercise price equal to the average price of the last trade date.  The stock options vest and therefore become exercisable on a pro rata basis annually over five years from the date awarded, commencing May 11, 2010. The options are available to be exercised for a period of ten years after the date awarded.

The fair value of each option grant was estimated to be $3.18 on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period:
 
Dividend Yield (per share)
  $ 0.12  
Volatility (%)
    29.24 %
Risk-free Interest Rate (%)
    1.89 %
Expected Life
 
10 years
 
 
 
53

 

This group of options was forfeited at December 31, 2009.

An additional set of stock options covering 41,872 shares were awarded on November 4, 2009. The option awards were granted with an exercise price equal to the average price of the last trade date.  The stock options vest and therefore become exercisable on a pro rata basis annually over five years from the date awarded, commencing November 4, 2010. The options are available to be exercised for a period of ten years after the date awarded.

The fair value of each option grant was estimated to be $2.79 on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the applicable period:
 
Dividend Yield (per share)
  $ 0.12  
Volatility (%)
    29.24 %
Risk-free Interest Rate (%)
    1.89 %
Expected Life
 
6.25 years
 
 
Exercise prices of options outstanding at December 31, 2009 ranged from $8.25 to $10.21.  The outstanding options at December 31, 2009 have an intrinsic value, which is the amount of the underlying stock exceeds the exercise price, of $55,000

During the year ended December 31, 2009, the Company recorded options expense of $54,000 included in “Salaries and employee benefits” on the accompanying consolidated financial statements. As of December 31, 2009, there was approximately $521,000 of total unrecognized compensation cost related to unvested options and grants. That cost is expected to be recognized over a weighted-average period of 5 years. The Company plans on obtaining shares to be issued upon exercise of stock options through authorized common stock.

   
Number of
Shares
   
Weighted –
Average
Exercise Price
   
Weighted –
Average
Remaining
Contractual Term
 
Outstanding, January 1, 2009
    62,879     $ 10.19       -  
Granted
    43,258     $ 8.99       -  
Exercised
    -       -       -  
Forfeited or expired
    (1,500 )   $ 8.67       -  
Outstanding, December 31, 2009
    104,637     $ 9.44       8.7  
Exercisable, December 31, 2009
    23,761     $ 10.37       7.4  
 
   
Stock Options
   
Restricted Stock
 
Nonvested shares
 
Number
of Shares
   
Weighted-
Average
Grant-Date
Fair Value
   
Number
of
Shares
   
Weighted-
Average
Grant-Date
Fair Value
 
Nonvested,  January 1, 2009
    52,080     $ 3.40       22,992     $ 8.47  
Granted
    42,872     $ 2.79       18,111     $ 8.99  
Vested
    (12,576 )   $ 3.84       (4,949 )   $ 8.90  
Forfeited
    (1,500 )   $ 3.71       (750 )   $ 8.67  
Nonvested, December 31, 2009
    80,876     $ 3.40       35,404     $ 8.81  
 
 
54

 
 
Note 10 - Income Taxes

The Company and its subsidiary file a consolidated Federal income tax return.  North Penn Bancorp, Inc. and Norpenco, Inc. each file a Pennsylvania corporate tax report and North Penn Bank files a Pennsylvania Mutual Thrift Earnings Report.

Retained earnings at December 31, 2009 and 2008, included approximately $1.2 million representing accumulated bad debt reserves in excess of actual experience, for which no provision for Federal income taxes has been made, in accordance with FASB ASC 740-10-25 Income Taxes – Recognition and Accounting Principles Board Statement No. 23, Accounting for Income Taxes – Special Areas...  These amounts represent an allocation of income to bad debt deductions for tax purposes only.  If anything other than tax bad debt losses are charged to this accumulated bad debt reserve, taxable income would be created at the then-current corporate tax rates.  The unrecorded deferred income tax liability related to this at 34% was $418,000 at December 31, 2009 and 2008. The Company’s liquidity and capital position causes management to believe that these tax restrictions will not be violated.

Total income tax expense (benefit) for the years ended December 31, 2009 and 2008, is as follows (in thousands):

   
2009
   
2008
 
Federal:
           
Currently payable
  $ 234     $ 86  
Deferred tax benefit
    (240 )     -  
Total Federal taxes
    (6 )     86  
                 
State:
               
Currently payable
    96       67  
Deferred tax expense
    (5 )     -  
Total State taxes
    91       67  
Total income tax expense
  $ 85     $ 153  

A reconciliation of income taxes at statutory rates (34% for both years) to the actual income tax provision reported in the Consolidated Statements of Income is as follows (in thousands):

   
2009
   
2008
 
Tax expense at statutory rate on pretax income
  $ 296     $ 172  
Bank owned life insurance income
    (51 )     (18 )
State income taxes
    91       67  
Tax exempt interest income
    (111 )     (87 )
Tax effect of deferred compensation asset
    (90 )     -  
Tax effect of other items, net
    (50 )     19  
Applicable income tax expense
  $ 85     $ 153  
Effective tax rate
    10 %     30 %
 
 
55

 
 
Significant deferred tax assets and liabilities at December 31, 2009 and 2008 are as follows (dollars in thousands):

   
2009
   
2008
 
Deferred tax assets:
           
Allowance for loan losses
  $ 480     $ 354  
Contribution carryover
    94       129  
Deferred compensation
    90       -  
AMT credits
    79       -  
Unrealized security losses
    41       238  
Other
    66       -  
      850       721  
Less valuation allowance
    (145 )     (64 )
Total
  $ 705     $ 657  

The Company has provided valuation allowances of $66,000 on contribution carryforwards and $79,000 on AMT credit carryforwards to reduce the total amount that management believes will ultimately be realized.  Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carry forwards are expected to be available to reduce taxable income.

Note 11 – Accumulated Other Comprehensive Income

Accumulated other comprehensive income(loss) of $458,000 and ($370,000) for years ended December 31, 2009 and 2008, respectively, consisted entirely of unrealized gains and losses on available-for-sale securities, net of tax.

A reconciliation of other comprehensive income(loss) for the years ended December 31, 2009 and 2008, are as follows (dollars in thousands):

   
2009
 
   
Before-Tax
Amount
   
Tax Benefit
(Expense)
   
Net-of-Tax
Amount
 
Unrealized losses on available-for-sale securities:
                 
Unrealized holding losses arising during the year
  $ 693     $ (230 )   $ 463  
Less: Reclassification adjustment for net Gains realized in income
    (8 )     (3 )     (5 )
Net unrealized losses
  $ 685     $ (227 )   $ 458  

   
2008
 
   
Before-Tax
Amount
   
Tax Benefit
(Expense)
   
Net-of-Tax
Amount
 
Unrealized losses on available-for-sale securities:
                 
Unrealized holding losses arising during the year
  $ (560 )   $ 191     $ (369 )
Less: Reclassification adjustment for net Gains realized  in income
    1       -       1  
Net unrealized gains
  $ (561 )   $ 191     $ (370 )

Note 12 - Guarantees
 
FASB ASC 460-10 Guarantees FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45), requires certain guarantees to be recorded at fair value as a liability at inception and when a loss is probable and reasonably estimable, as those terms are defined in FASB ASC 450 Contingencies SFAS Statement No. 5, Accounting for Contingencies (FAS 5) and also requires a guarantor to make significant new disclosures even when the likelihood of making any payments under the guarantee is remote.
 
 
56

 
 
In September 2006, the Bank executed a Mortgage Partnership Finance (MPF) Master Commitment (the Commitment) with the FHLBank of Pittsburgh (FHLB) to deliver $10.0 million of mortgage loans and to guarantee the payment of any realized losses that exceed the FHLB’s first loss account for mortgages delivered under the Commitment.  The Bank receives credit enhancement fees from the FHLB for providing this guarantee and continuing to manage the credit risk of the MPF Program mortgage loans.  The term of the Commitment and guarantee per the Master Commitment is through September 25, 2009. The maximum potential amount of future payments that the Bank is required to make under the guarantee is $450,000. Under the Commitment, the Bank agrees to service the loans and therefore, is responsible for any necessary foreclosure proceedings.  Any future recoveries on any losses would not be paid by the FHLB under the Commitment.  The Bank has not experienced any losses under these guarantees.

Note 13 - Commitments and Contingencies

Financial Instruments With Off-Balance-Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business.  These financial instruments include commitments to extend credit to meet the financing needs of its customers.  Such commitments have been made in the normal course of business and at current prevailing market terms.  The commitments, once funded, are principally to originate commercial loans and other loans secured by real estate.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  The Company does not anticipate any losses as a result of these transactions.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets.

Commitments issued to potential borrowers of the Bank at December 31, 2009 and 2008 were as follows (dollars in thousands):

   
2009
   
2008
 
Fixed-rate commitments
  $ 30     $ 625  
Variable/adjustable-rate commitments
    1,674       4,651  
Total
  $ 1,704     $ 5,276  

Interest rates range from 5.625% to 6.125% for fixed rate commitments at December 31, 2009.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  These commitments include loans-in-process, available borrowings under commercial line of credit agreements and available borrowings under home equity agreements.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Operating lease

The Company has an operating lease for commercial space for its Abington Branch.  The lease commenced upon occupancy in April 1999 for a ten year period with five options to renew for three years each.  The annual lease cost is composed of minimum rent per square foot, plus a proportionate share of certain operating costs and a flat fee for the drive-up/ATM area, plus cost of living adjustments at renewal. The Company has been granted a limited right of first refusal for purchase.

 
57

 
 
The future minimum rental commitments under this lease at December 31, 2009 are as follows:
2010
    50  
2011
    49  
         
Total
  $ 99  

Note 14 - Fair Value Disclosures
 
Fair Value Measurements
 
Effective January 1, 2008, the Company adopted FASB ASC 820 Fair Value Measures and Disclosures SFAS No. 157, Fair Value Measurements, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. This standard establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined in the standard hierarchy are as follows:
 
Level
I:Quoted prices are available in active markets for identical assets or liabilities as of the record date.
 
Level
II:Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
 
Level
III:Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation
 
Investments available for sale are recorded at fair value on a recurring basis. Loans held for sale are recorded at fair value on a nonrecurring basis based on the lower of cost or market.
 
The following required disclosure of the estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies.  However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value.  Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange.  The use of different market assumptions and/or estimation methodologies may have a material effect in the estimated fair value amounts.

The methods and assumptions used to estimate the fair values of each class of financial instrument are as follows:

Cash and cash equivalents:  The carrying amount of cash and cash equivalents approximate their fair value.

Available-for-sale and held-to-maturity securities:  Fair values for securities are based on bid prices received from securities dealers.  Restricted equity securities are carried at cost, which approximates fair value.

Loans:  The fair value of all loans is estimated by the net present value of the future expected cash flows.

Deposit liabilities:  The fair value of demand deposits, NOW accounts, savings accounts, and money market deposits is estimated by the net present value of the future expected cash flows.  For certificates of deposit, the discount rates used reflect the Bank’s current market pricing.  The discount rates used for nonmaturity deposits are the current book rate of the deposits.

 
58

 

Other borrowings:  The fair value of other borrowings is estimated using the rates currently offered for similar borrowings.

Accrued interest:  The carrying amounts of accrued interest approximate their fair values.

Off-balance-sheet instruments:  Commitments to extend credit are generally short-term and are priced to market at the time of funding.  Therefore, the estimated fair value of these financial instruments is nominal prior to funding.
 
The following table presents the assets reported on the consolidated balance sheets at their fair value as of December 31, 2009 by level within the fair value hierarchy. As required by FASB ASC 820 Fair value Measures and Disclosures, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
Assets measured at fair value on a recurring basis (in thousands):
 
   
December 31, 2009
 
   
Level I
   
Level II
   
Level III
   
Total
 
Assets:
                       
Securities available-for-sale
  $ 1,187     $ 18,211     $ -     $ 19,398  

   
December 31, 2008
 
   
Level I
   
Level II
   
Level III
   
Total
 
Assets:
                       
Securities available-for-sale
 
$
1,022
   
$
19,235
   
$
36
   
$
20,293
 

Fair Value of Financial Instruments

The estimated fair value of the Company’s financial instruments at December 31, 2009 and 2008 was as follows (in thousands):

   
2009
   
2008
 
   
Carrying
Amount
   
Estimated
Fair value
   
Carrying
Amount
   
Estimated
Fair value
 
Financial assets:
                       
Cash and cash equivalents
  $ 11,912       11,912     $ 2,274       2,274  
Investments available for sale
    19,398       19,398       20,293       20,293  
Restricted equity securities
    1,143       1,143       1,090       1,090  
Loans
    114,546       114,483       107,276       111,291  
Accrued interest receivable
    665       665       676       676  
Total financial assets
  $ 147,664       147,601     $ 131,609       135,624  
                                 
Financial liabilities:
                               
Deposits
  $ 124,055       122,608     $ 99,153       99,577  
Other borrowings
    12,000       12,378       19,648       20,701  
Accrued interest payable
    1,002       1,002       251       251  
Total financial liabilities
  $ 137,057       135,988     $ 119,052       120,529  
Off-balance sheet liabilities:
                               
Commitments to extend credit
  $ 5,251       5,251     $ 2,224       2,224  
 
 
59

 

Note 15 - Related-Party Transactions

The Company routinely enters into banking transactions with its directors and officers.  Such transactions are made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and do not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.  A summary of loans to directors and officers and related parties is as follows for the years ended December 31, 2009 and 2008 (dollars in thousands):

   
2009
   
2008
 
Beginning balance
  $ 1,327     $ 1,334  
Additions
    -       647  
Collections
    (260 )     (654 )
Ending balance
  $ 1,067     $ 1,327  

Note 16 - Litigation

As previously reported, the Company’s financial results for the fourth quarter 2008 included a pre-tax charge of $475,000 for losses attributable to accounting errors.  The Company has continued reviewing, and strengthening where necessary, its internal control procedures.  On November 13, 2009,the Company recognized a net recovery of $468,000 from its insurance carrier in settlement of the Company’s insurance claim.

At December 31, 2009, the Company was neither engaged in any existing nor aware of any pending legal proceedings.  From time to time, the Company is a party to legal proceedings within the normal course of business wherein it enforces its security interest in loans made by it, and other maters of a similar nature.

Note 17 - Dividend Policy

Company

The Company paid a quarterly cash dividend of $0.03 in 2009.  Payments of cash dividends to our stockholders may be dependent on the payment of a cash dividend from the Bank to the Company.  The payment of cash dividends by the Bank to the Company is limited by regulations of the FDIC and the Pennsylvania Department of Banking.  The Company’s future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors including future earnings, financial conditions, cash needs, and general business conditions.  Holders of common stock will be entitled to receive dividends as and when declared by the board of directors out of funds legally available for that purpose.

Bank

The amount of dividends that may be paid by the Bank depends upon the Bank’s earnings and capital position.  The Bank may not make a distribution that would constitute a return of capital during the three-year term of the business plan submitted in connection with the stock offering.  The Bank may not make a capital distribution if, after making the distribution, it would be under capitalized.

Any payment of dividends by the Bank that would be deemed to be drawn out of its bad debt reserves would require the Bank to pay federal income taxes at the then current tax rate on the amount deemed distributed.  We do not contemplate any distribution by the Bank that would result in this type of tax liability.
 
 
60

 

As a state bank subject to the regulations of the FDIC, the Bank must obtain approval for any dividend if the total of all dividends declared in any calendar year would exceed the total of its net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years, less any required transfers to surplus.  In addition, the Bank may not pay a dividend in an amount greater than its retained earnings then on hand after deducting its losses and bad debts.  For this purpose, bad debts are generally defined to include the principal amount of loans which are in arrears with respect to interest by six months or more unless such loans are fully secured and in the process of collection.  Moreover, for purposes of this limitation, the Bank is not permitted to add the balance in its allowance for loan loss account to its undivided profits then on hand; however, it may net the sum of its bad debts as so defined against the balance in its allowance for loan loss account and deduct from undivided profits only bad debts as so defined in excess of that amount.

In addition, the FDIC is authorized to determine under certain circumstances relating to the financial condition of a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof.  The payment of dividends that deplete a bank’s capital base could be deemed to constitute such an unsafe or unsound practice.

Note 18 - Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory – and possible additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined).  Management believes, as of December 31, 2009, the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2009, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below.  There are no conditions or events since that notification that management believes have changed the Bank’s category.

 
61

 


The Bank’s actual capital amounts and ratios at December 31, 2009and 2008 are presented in the following table (dollars in thousands):

   
Actual
   
For capital adequacy
purposes
   
To be well capitalized
under prompt
corrective action
provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
At December 31, 2009:
                                   
Total Capital (to Risk-Weighted Assets):
                                   
North Penn Bank
  $ 18,151       15.07 %  
>$9,634
   
>8.0
 
>$12,042
   
>10.0
Tier 1 Capital (to Risk-Weighted Assets):
                                       
North Penn Bank
  $ 16,667       13.84 %  
>$4,817
   
>4.0
 
>$7,225
   
>6.0
Tier 1 Capital (to Average Assets):
                                       
North Penn Bank
  $ 16,667       11.35 %  
>$5,874
   
>4.0
 
>$7,343
   
>5.0
Risk-Weighted Assets:
  $ 120,425                                  
Average Assets:
  $ 146,866                                  
Reconciliation of GAAP Capital to Regulatory Capital
                                       
Total Equity Capital December 31, 2009
  $ 16,670                                  
Plus: Unrealized Gain/Loss on Investments
    (2 )                                
Less: Disallowed Servicing Rights
    (1 )                                        
Total Tier Capital December 31, 2009
  $ 16,667                                          
Plus: Allowance for loan losses
    1,484                                          
Total Risk-based Capital December 31, 2009
  $ 18,151                                          
                                                 
At December 31, 2008:
                                               
Total Capital (to Risk-Weighted Assets):
                                               
North Penn Bank
  $ 16,706       15.05 %  
>$8,878
   
>8.0
 
>$11,098
   
>10.0
Tier 1 Capital (to Risk-Weighted Assets):
                                               
North Penn Bank
  $ 15,536       14.00 %  
>$4,439
   
>4.0
 
>$6,659
   
>6.0
Tier 1 Capital (to Average Assets):
                                               
North Penn Bank
  $ 15,536       11.57 %  
>$5,370
   
>4.0
 
>$6,713
   
>5.0
Risk-Weighted Assets:
  $ 110,977                                          
Average Assets:
  $ 134,261                                          
Reconciliation of GAAP Capital to Regulatory Capital
                                               
Total Equity Capital December 31, 2008
  $ 15,390                                          
Plus: Unrealized Gain/Loss on Investments
    147                                          
Less: Disallowed Servicing Rights
    (1 )                                        
Total Tier Capital December 31, 2008
  $ 15,536                                          
Plus: Allowance for loan losses
    1,170                                          
Total Risk-based Capital December 31, 2008
  $ 16,706                                          

Note 19 - Parent Company Financial Information

Condensed financial information of North Penn Bancorp, Inc. (parent company only) was as follows:

BALANCE SHEETS
(Amounts in thousands)
   
December 31,
 
   
2009
   
2008
 
Assets
               
Cash
  $ 848     $ 2,483  
Investment in subsidiary
    16,671       15,390  
Bank premises, net
    1,155       1,216  
Deferred income taxes
    27       65  
Due from subsidiary bank
    684       286  
Other assets
    69       8  
Total assets
  $ 19,454     $ 19,448  
                 
Liabilities and Stockholders’ Equity
               
Accrued income taxes and other liabilities
  $ 184     $ 150  
Total liabilities
    184       150  
Preferred Stock
    -       -  
Common stock
    158       158  
Additional paid-in-capital
    13,580       13,480  
Retained earnings
    8,541       7,905  
Unearned ESOP shares
    (907 )     (980 )
Accumulated other comprehensive loss
    (2 )     (460 )
Treasury stock- at cost
    (2,100 )     (805 )
Total stockholders’ equity
    19,270       19,298  
Total Liabilities and Stockholders’ Equity
  $ 19,454     $ 19,448  
 
 
62

 
 
STATEMENTS OF INCOME
(Amounts in thousands)
   
2009
   
2008
 
Income
           
Interest income
  $ 66     $ -  
Other  income
    61       34  
Total income
    127       34  
                 
Expenses
               
Occupancy and equipment expense-depreciation
    61       73  
Other expenses
    106       94  
Total expenses
    167       167  
                 
Loss before income tax expense and equity in undistributed earnings of subsidiary
    (40 )     (133 )
                 
Income tax expense
    -       9  
                 
Loss before equity in undistributed earnings of subsidiary
    (40 )     (142 )
                 
Equity in undistributed earnings of subsidiary
    827       496  
                 
Net income
  $ 787     $ 354  

STATEMENTS OF CASH FLOWS
           
(Amounts in thousands)
           
             
 
 
2009
   
2008
 
Operating activities:
               
Net income
  $ 787     $ 354  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation expense
    61       73  
Deferred income tax provision
    38       -  
Undistributed income of subsidiary
    (827 )     (496 )
Increase in other assets
    (61 )     (154 )
Increase in due from bank-operating
    (274 )     -  
Increase in other liabilities
    34       59  
Net cash used in operating activities
    (242 )     (164 )
                 
Investing activities:
    -       -  
                 
Financing activities:
               
ESOP share released
    53       52  
Cash dividends paid
    (151 )     (191 )
Purchase of treasury stock
    (1,295 )     (805 )
                 
Net cash used in financing activities
    (1,393 )     (944 )
                 
Net decrease in cash and cash equivalents
    (1,635 )     (1,108 )
                 
Cash and cash equivalents January 1
    2,483       3,591  
Cash and cash equivalents December 31
  $ 848     $ 2,483  
 
 
63

 
 
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

On August 13, 2009, McGrail Merkel Quinn & Associates resigned as North Penn Bancorp, Inc.'s (the "Company") independent registered public accounting firm. McGrail Merkel Quinn & Associates' report on the Company's consolidated financial statements for the two fiscal years ended December 31, 2008 and 2007 did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles.

During the fiscal years ended December 31, 2008 and 2007, as well as the interim period preceding the resignation of McGrail Merkel Quinn & Associates, there were no disagreements or reportable events of the kind described in Item 304(a)(1)(v) of Regulation S-K of the Securities and Exchange Commission (the "Commission") between the Company and McGrail Merkel Quinn & Associates on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of McGrail Merkel Quinn & Associates, would have caused McGrail Merkel Quinn & Associates to make a reference to the subject matter of the disagreement or reportable event in connection with the issuance of its audit reports.

ITEM 9A(T).  CONTROLS AND PROCEDURES

North Penn Bancorp, Inc., under the supervision and with the participation of its management, including its Chief Executive Officer and the Principal Accounting Officer, evaluated the effectiveness of the design and operation of North Penn’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report.  Based on that evaluation, North Penn’s Chief Executive Officer and Principal Accounting Officer concluded that North Penn’s disclosure controls and procedures are effective.  There were no significant changes to North Penn’s disclosure controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Exchange Act Rule 13a-15(e) defines “disclosure controls and procedures” as controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, and management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 based upon the criteria set forth in a report entitled Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on its assessment, the Company’s management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2009.

 
64

 
 
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

There have been no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B.  OTHER INFORMATION

None.

PART III

ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The names, ages, periods of service as a director, principal occupations, business experience and other directorships of Directors and nominees for director of the Company are set forth in the Company’s definitive proxy statement for the annual meeting of shareholders (“Proxy Statement”) in the section entitled “ITEMS TO BE VOTED ON BY SHAREHOLDERS – Item 1 - Election of Directors,” which information is incorporated herein by reference.

The names, ages, positions held with the Company, periods of service as executive officer, and business experience for executive officers of the Company is set forth in Part I, Item 1, “Description of Business - Executive Officers of the Registrant” to this annual report on Form 10-K, which information is incorporated herein by reference.

Information regarding the identity of the Audit Committee as a separately designated standing committee of the Board and information regarding the status of one or more members of the Audit Committee being an “audit committee financial expert” are set forth in the Proxy Statement in the section entitled “CORPORATE GOVERNANCE AND BOARD MATTERS – Audit Committee,” which information is incorporated herein by reference.

Information regarding compliance with Section 16(a) of the Exchange Act is set forth in the Proxy Statement in the section entitled “OTHER INFORMATION RELATING TO DIRECTORS AND EXECUTIVE OFFICERS – Section 16(a) Beneficial Ownership Reporting Compliance,” which information is incorporated herein by reference.

The Company has adopted a Code of Ethics that applies to directors, officers and employees of the Company and the Bank.  A copy of the Code of Ethics is posted on the Company’s website at www.northpennbank.com.  The Company intends to satisfy the disclosure requirement under Item 9 of Form 8-K regarding an amendment to, or a waiver from, a provision of its Code of Ethics by posting such information on its website.

ITEM 11.  EXECUTIVE COMPENSATION

The information under the caption “EXECUTIVE COMPENSATION” in the Proxy Statement is incorporated by reference in response to this Item 10.  The information under the caption “CORPORATE GOVERNANCE AND BOARD MATTERS – Directors Compensation” in the Proxy Statement is incorporated by reference in response to this Item 10.

 
65

 


ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information under the caption “STOCK OWNERSHIP” in the Proxy Statement is incorporated by reference in response to this Item 11.

Equity Compensation Plan Information

Plan Category
 
Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
   
Weighted-average
exercise price of
outstanding
options, warrants
and rights
   
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans
 
Equity compensation plans approved by security holders
    104,637     $ 9.44       52,996  
Equity compensation plans not approved by security holders
    -       -       -  
Total
    104,637     $ 9.44       52,996  

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information under the caption “OTHER INFORMATION RELATING TO DIRECTORS AND EXECUTIVE OFFICERS – Transactions with Management” is incorporated by reference in response to this Item 12.  The information under the caption “CORPORATE GOVERNANCE AND BOARD MATTERS – Directors Independence” is incorporated by reference in response to this Item 12.

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information under the caption “AUDIT RELATED MATTERS – Auditor Fees” in the Proxy Statement is incorporated by reference in response to this Item 14.

PART IV

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

3.1
 
Articles of Incorporation of North Penn Bancorp, Inc. (Incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form SB-2 (File No. 333-143601))
3.2
 
Bylaws of North Penn Bancorp, Inc. (Incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form SB-2 (File No. 333-143601))
4
 
Specimen Stock Certificate (Incorporated herein by reference to Exhibit 4 to the Company’s Registration Statement on Form SB-2 (File No. 333-143601))
10.1
 
*Amended and Restated Employment Agreement between North Penn Bancorp, Inc., North Penn Bank and Frederick L. Hickman incorporated herein by reference to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended June 30, 2008. (file no. 000-52839)
10.2
 
*Amended and Restated Employment Agreement between North Penn Bancorp, Inc., North Penn Bank and Thomas J. Dziak incorporated herein by reference to Exhibit 10.2 to the Company’s Form 10-KSB for the quarter ended December 31, 2007. (file no. 000-52839)
 
 
66

 
 
10.3
 
*Amended and Restated Employment Agreement between North Penn Bancorp, Inc., North Penn Bank and Thomas A. Byrne incorporated herein by reference to Exhibit 10.3 to the Company’s Form 10-KSB for the quarter ended December 31, 2007. (file no. 000-52839)
10.4
 
*North Penn Bancorp, Inc. 2006 Omnibus Stock Option Plan (Incorporated herein by reference to Appendix A to Schedule 14A Definitive Proxy Statement of North Penn Bancorp, Inc. filed on March 31, 2006 (File No. 000-51234))
10.5
 
North Penn Bancorp, Inc. 2009 Equity Incentive Plan (Incorporated herin by reference to Appendix A to Schedule 14A Definitive Proxy Statement of Northe Penn Bancorp, Inc. filed on April 20, 2009 (File No. 000-52839)
10.6
 
*Supplemental Executive Retirement Agreement dated December 14, 2004 between North Penn Bank and Frederick L. Hickman (Incorporated herein by reference to Exhibit 10.7 to Form 10-K of North Penn Bancorp, Inc. for the year ended December 31, 2006 (File No. 000-51234))
10.7
 
*Supplemental Executive Retirement Agreement dated December 14, 2004 between North Penn Bank and Thomas J. Dziak (Incorporated herein by reference to Exhibit 10.8 to the Company’s Registration Statement on Form SB-2 (File No. 333-143601))
10.8
 
*Supplemental Executive Retirement Agreement dated April 1, 2005 between North Penn Bank and Thomas A. Byrne (Incorporated herein by reference to Exhibit 10.9 to the Company’s Registration Statement on Form SB-2 (File No. 333-143601))
21
 
List of Subsidiaries
23.1
 
Consent of J.H. Williams & Co., LLP
23.2
 
Consent of McGrail Merkel Quinn and Associates
31.1
 
Rule 13a-14(a)/15d-14(a) Certification
32.1
 
Section 1350 Certification

* Management contract or compensatory plan contract or arrangement filed pursuant to Item 601(b)(10)(ii)(A) of Regulation S-B.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
NORTH PENN BANCORP, INC.
 
(Registrant)
     
 
By
/s/ Frederick L. Hickman
   
Frederick L. Hickman
   
President and Chief Executive Officer
   
Principal Executive Officer
     
 
Date
March 31, 2010

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ Gordon S. Florey
 
March 31, 2010
Gordon S. Florey, Director
 
Date
     
/s/ Frederick L. Hickman
 
March 31, 2010
Frederick L. Hickman
 
Date
President, Chief Executive Officer and Director
   
     
/s/ Herbert C. Kneller
 
March 31, 2010
Herbert C. Kneller, Director
 
Date
 
 
67

 

/s/ Virginia D. McGregor
 
March 31, 2010
Virginia D. McGregor, Director
 
Date
     
/s/ Frank H. Mechler
 
March 31, 2010
Frank H. Mechler, Director
 
Date
     
/s/ James W. Reid
 
March 31, 2010
James W. Reid, Director
 
Date
     
/s/ Kevin M. Lamont
 
March 31, 2010
Kevin M. Lamont, Chairman of the Board and Director
 
Date
 
 
68