Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from__________to__________
Commission File Number 0-49952
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 06-1504091
------------------------------- ------------------
(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.)
12 E. BROAD STREET, HAZLETON, PENNSYLVANIA 18201-6591
------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570) 459-3700
Securities registered under Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by a check mark if the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (i.e. persons other than directors and executive officers of the
registrant) was $67,356,015 based upon the closing price of $18.40 on the Nasdaq
Stock Market as of the last business day of the registrant's most recently
completed second fiscal quarter.
The number of shares of common stock outstanding as of December 28, 2004 was
3,660,653.
NORTHEAST PENNSYLVANIA FINANCIAL CORP.
FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I
Item 1 Business..................................................................... 2
Item 2 Properties................................................................... 13
Item 3 Legal Proceedings............................................................ 15
Item 4 Submission of Matters to a Vote of Security Holders.......................... 15
PART II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchase of Equity Securities........................................ 16
Item 6 Selected Financial Data...................................................... 17
Item 7 Management's Discussion and Analysis of Financial Condition and Results of
Operation................................................................... 19
Item 7A Quantitative and Qualitative Disclosures About Market Risk................... 38
Item 8 Financial Statements and Supplementary Data.................................. 38
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................. 74
Item 9A Controls and Procedures...................................................... 74
Item 9B Other Information............................................................ 74
PART III
Item 10 Directors and Executive Officers of the Registrant........................... 75
Item 11 Executive Compensation....................................................... 76
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters......................................................... 80
Item 13 Certain Relationships and Related Transactions............................... 83
Item 14 Principal Accountant Fees and Services....................................... 83
PART IV
Item 15 Exhibits and Financial Statement Schedules................................... 84
SIGNATURES................................................................... 86
PART I
FORWARD LOOKING STATEMENTS
In addition to historical information, our 10-K may include certain
"forward-looking statements" within the meaning of the federal securities laws.
Such forward-looking statements may be identified by the use of such words as
"intend," "believe," "expect," "anticipate," "should," "plan," "estimate" and
"potential." These forward-looking statements include, but are not limited to,
estimates and expectations of future performance based on current management
expectations. Northeast Pennsylvania Financial Corp.'s (the "Company,"
"Northeast Pennsylvania" or the "Registrant") actual results could differ
materially from such management expectations. Factors that could cause future
results to vary from current management expectations include, but are not
limited to, general economic conditions, legislative and regulatory changes,
monetary and fiscal policies of the federal government, changes in tax policies,
rates and regulations of federal, state and local tax authorities, changes in
interest rates, deposit flows, the cost of funds, demand for loan products,
demand for financial services, competition, changes in the quality or
composition of the Company's loan and investment portfolios, changes in
accounting principles, policies or guidelines, and other economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices. Because of the risks and uncertainties
inherent in forward-looking statements, readers are cautioned not to place undue
reliance on them, whether included in this report or made elsewhere from time to
time by the Company or on its behalf. Subject to applicable law and regulation,
the Company assumes no obligation to update any forward-looking statements.
ITEM 1. BUSINESS
GENERAL
The Company is a Delaware corporation and is a thrift holding company
for First Federal Bank (the "Bank"), a federally chartered capital stock savings
bank regulated by the Office of Thrift Supervision ("OTS"), Abstractors, Inc.,
which is a title insurance agency, NEP Trust Co. (the "Trust Co."), which offers
trust, estate and asset management services and products and Higgins Insurance
Associates, Inc. ("Higgins"), which provides insurance and investment products
to individuals and businesses. The Company's executive offices are located at
12 East Broad Street, Hazleton, Pennsylvania 18201.
The Company's operations are primarily conducted through the Bank. These
operations have been and continue to be attracting retail deposits from the
general public in the areas surrounding its 16 full service community offices
and investing those deposits, together with funds generated from operations and
borrowings, primarily in one-to-four family mortgage loans, consumer loans,
commercial loans and multi-family and commercial real estate loans. The Company
has attempted to diversify and expand its loan products to better serve its
customer base by placing a greater emphasis on its consumer lending and
commercial lending, primarily to small businesses and municipalities.
The Company's revenues are derived from four principal business
activities: banking, insurance, investments and trust services. First Federal
Bank's revenues are derived principally from interest on its loans, and to a
lesser extent, interest and dividends on its investment and mortgage-related
securities and through other non-interest income. Investment income is generated
through annuity sales and commissions on investment sales. Insurance premium
income is generated through sales of commercial lines, property and casualty and
employee benefits insurance policies to businesses and individuals. The Trust
Co. continues to expand its customer base with assets under management of
$167.1 million at September 30, 2004. The Company's primary sources of funds are
deposits, principal and interest payments on loans and mortgage related
securities, FHLB advances and other borrowings and proceeds from the sale of
loans.
Effective January 1, 2004, the Bank sold the deposits and property of
its branch office located in Danville, Pennsylvania to the First National Bank
of Berwick, Berwick, Pennsylvania. For further information regarding this sale
and transfer, please see Note 23 to the Consolidated Financial Statements
included in Item 8 of this Form 10-K.
AGREEMENT AND PLAN OF MERGER
On December 8, 2004, KNBT Bancorp, Inc. ("KNBT"), the parent company of
Keystone Nazareth Bank & Trust Company, entered into an Agreement and Plan of
Merger (the "Merger Agreement") pursuant to which the Company will merge with
and into KNBT. Concurrently with the merger, it is expected that the Bank will
merge with and into Keystone Nazareth Bank & Trust Company.
Under the terms of the Agreement, the Company's stockholders may elect
to receive either $23.00 of KNBT common stock or $23.00 in cash in exchange for
their shares of Northeast Pennsylvania common stock, subject to an overall
requirement that 50% of the total outstanding Company Common Stock be exchanged
for KNBT Common Stock and 50% for cash. To the extent they receive shares of
KNBT, the transaction is expected to be tax-free to Northeast Pennsylvania
stockholders.
The number of shares of KNBT common stock into which each Northeast
Pennsylvania share will be exchanged will be based on the price of KNBT common
stock over a measurement period prior to the closing.
Page 2
In addition, each director of Northeast Pennsylvania entered into a
Shareholder Agreement with KNBT, pursuant to which each person agreed, among
other things, to vote his or her shares of Company common stock in favor of the
Merger Agreement at a meeting of shareholders of the Company to be called to
consider and approve the Merger Agreement.
The transaction is expected to close in the second quarter of 2005. It
is subject to certain conditions, including the approval of stockholders and the
receipt of regulatory approval.
MARKET AREA AND COMPETITION
The Company is a community-oriented banking institution offering a
variety of retail financial products and services to meet the needs of the
communities it serves. The Company's lending and deposit gathering is
concentrated in its market area consisting of a seven county region in
Northeastern and Central Pennsylvania.
The Company maintains its headquarters in Hazleton. The Company's six
banking offices in Luzerne County, including Hazleton, accounted for
$299.9 million or 62% of the Company's total deposits at September 30, 2004.
Hazleton is situated approximately 100 miles from Philadelphia and New York City
and approximately 50 miles from Allentown and the Wilkes-Barre/Scranton area.
The Company also maintains two banking offices in Bloomsburg (Columbia County),
one each in Lehighton and Weatherly (both in Carbon County), one in
Brodheadsville (Monroe County) and one each in Frackville, Pottsville,
Shenandoah, and Schuylkill Haven (all in Schuylkill County).
The economy of the greater Hazleton area is characterized by diversified
light manufacturing and is the site of production facilities for several major
manufacturers including Union Camp, Hershey-Cadbury Chocolates, Quebecor and
Hazleton Pumps, Inc. As a consequence, the manufacturing sector employs more
than one third of the area's work force. The Hazleton area has excellent access
to major highway transportation routes including Interstates 80 and 81 as well
as rail transportation. The population of Luzerne County has remained relatively
static and has one of the oldest average ages for all counties in the United
States. The southern end of Schuylkill County is proving to be a growth area as
individuals and companies which were previously based in the Allentown-Berks
county areas are relocating to the southern end of Schuylkill County.
Notwithstanding such growth, the overall population in the Company's market area
is relatively small and, in recent years, has grown slowly, and the unemployment
rate in the area is greater than the national average. Monroe County, the
location of the Brodheadsville banking branch, is dominated by the Pocono
Mountains, making the area one of the Mid-Atlantic's most popular resort areas.
The Company faces significant competition both in generating loans and
in attracting deposits. Its most direct competition for deposits has
historically come from savings banks and associations, commercial banks and
credit unions. In addition, the Bank faces increasing competition for deposits
from non-bank institutions such as brokerage firms and insurance companies in
such investments as short-term money market funds, corporate and government
securities funds, mutual funds and annuities. At June 30, 2004, which is the
most recent date for which data is available from the Federal Deposit Insurance
Corporation, the Bank held approximately 6.25% of the deposits in Luzerne County
and, approximately 5.67% of the deposits in Schuylkill County, which was the
fifth largest market share out of 19 financial institutions with offices in
Luzerne county and the fifth largest market share out of 18 financial
institutions with offices in Schuylkill county. In addition, the Bank's
competition includes banks owned by large bank holding companies, such as PNC
Financial Services Group, Inc., Wachovia Corporation, M&T Bank Corporation and
Bank of America Corporation that are significantly larger and have significantly
greater resources than the Bank that allows them to offer a wider variety of
products and services.
The Company's competition for loans comes principally from commercial
banks, savings banks, credit unions, mortgage brokers, mortgage banking
companies and insurance companies. Its most direct competition for deposits has
historically come from savings banks and associations, commercial banks and
credit unions. In addition, the Bank faces increasing competition for deposits
from non-bank institutions such as brokerage firms and insurance companies in
such instruments as short-term money market funds, corporate and government
securities funds, mutual funds and annuities.
Competition has also increased as a result of the lifting of
restrictions on the interstate operations of financial institutions, as a result
of legislative, regulatory and technological changes and the continuing trend of
consolidation in the financial services industry. Technological advances, for
example, have lowered barriers to market entry, allowed banks to expand their
geographic reach by providing services over the Internet and made it possible
for non-depository institutions to offer products and services that
traditionally have been provided by banks. The Gramm-Leach-Bliley Act, which
permits affiliation among banks, securities firms and insurance companies also
changed the competitive environment in which the Bank conducts business.
In addition, the Company recognizes that its customer base increasingly
focuses on convenience and access to services. The Company has addressed these
customer needs through the implementation of electronic banking services and
enhanced voice response capabilities, a computerized loan origination and
document system and the issuance of debit cards. The Company continues to
evaluate and enhance its service and delivery systems in order to better serve
its retail and business customers.
Page 3
LENDING ACTIVITIES
GENERAL. The information relating to the composition and maturity of the
Bank's loan portfolio appears in "Loans" under Item 7 of this Form 10-K and is
incorporated herein by reference.
ORIGINATION AND SALE OF LOANS. The Bank's lending activities are
conducted primarily by its loan personnel operating at its branch and loan
origination offices. All loans originated by the Bank are underwritten pursuant
to the Bank's policies and procedures. The Bank originates both adjustable-rate
and longer-term and shorter-term fixed-rate loans. The Bank's ability to
originate fixed or adjustable-rate loans is dependent upon the relative customer
demand for such loans, which is affected by the current and expected future
level of interest rates. It is currently the policy of the Bank to sell newly
originated fixed-rate one-to-four family mortgages with maturities greater than
15 years with retained servicing. Additionally, the Bank from time to time may
sell certain loans to manage its interest-rate risk position in light of its
overall asset/liability management strategy.
ONE-TO-FOUR FAMILY MORTGAGE LENDING. The Bank currently offers both
fixed-rate and adjustable-rate mortgage ("ARM") one-to-four family mortgage
loans with maturities up to 30 years. One-to-four family mortgage loan
originations are generally obtained from the Bank's in-house loan
representatives, from existing or past customers, and through referrals from
members of the Bank's local communities.
The origination of ARM loans, as opposed to fixed-rate residential
mortgage loans, helps reduce the Bank's exposure to increases in interest rates.
However, adjustable-rate loans generally pose credit risks not inherent in
fixed-rate loans, primarily because as interest rates rise, the underlying
payments of the borrower rise, thereby increasing the potential for default.
Periodic and lifetime caps on interest rate increases help to reduce the credit
risks associated with adjustable-rate loans but also limit the interest rate
sensitivity of such loans.
Most one-to-four family mortgage loans are underwritten according to
Fannie Mae and Freddie Mac guidelines. In recent years, the Bank began offering
one-to-four family mortgage loans which, when underwritten, did not fully meet
established Fannie Mae or Freddie Mac standards, for example, the standard
regarding income to debt ratios for the borrower and thus are not saleable in
the secondary market. Mortgage loans originated by the Bank generally include
due-on-sale clauses that provide the Bank with the contractual right to deem the
loan immediately due and payable in the event the borrower transfers ownership
of the property without the Bank's consent. Due-on-sale clauses are an important
means of adjusting the yields on the Bank's fixed-rate mortgage loan portfolio
and the Bank has generally exercised its rights under these clauses. The Bank
requires fire, casualty, title and, in certain cases, flood insurance on all
properties securing real estate loans made by the Bank.
MULTI-FAMILY AND COMMERCIAL REAL ESTATE LENDING. The Bank originates
fixed-rate and adjustable-rate multi-family and commercial real estate loans
that generally are secured by properties used for business purposes or a
combination of residential and retail purposes.
Pursuant to the Bank's underwriting policies a multi-family mortgage or
commercial real estate loan may be made in an amount up to 80% of the lower of
the appraised value or sales price of the underlying property with terms
generally ranging from 15 to 25 years.
The factors considered by the Bank in granting these loans include: the
net operating income of the mortgaged premises before debt service and
depreciation; the debt coverage ratio (the ratio of net earnings to debt
service); and the ratio of loan amount to appraised value. The Bank has
generally required that the properties securing commercial real estate loans
have debt service coverage ratios of at least 125%.
The Bank's largest multi-family and commercial real estate loan at
September 30, 2004 was a $593,000 loan secured by real estate and was performing
according to its original terms. Loans secured by multi-family and commercial
real estate generally have larger loan values and involve greater risks than
one- to four-family residential mortgage loans. Payments on loans secured by
such properties are often dependent on successful management and operation of
the properties. Repayment of such loans may be subject to a greater extent to
adverse conditions in the real estate market or the economy. The Bank seeks to
minimize these risks in a variety of ways, including strict adherence to its
underwriting standards, limiting the size of such loans and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank also
obtains loan guarantees from financially capable parties. The Bank's lending
personnel or an agent of the Bank inspect all of the properties securing the
Bank's multi-family and commercial real estate loans before the loan is made.
The Bank also obtains appraisals on each property in accordance with applicable
regulations.
Page 4
CONSTRUCTION LENDING. The Bank also offers residential construction
loans. Such loans have been for presold one- to four-family residences for the
construction phase and convert into permanent financing. The Bank generates
residential construction loans primarily through direct contact with borrowers
or home builders, and these loans involve properties located in the Bank's
primary market area. Such loans require that the Bank review plans,
specifications and cost estimates and that the home builder be approved by the
Bank. The amount of construction advances, together with the sum of previous
disbursements, may not exceed the percentage of completion of the construction.
The maximum loan-to-value limit applicable to such loans is generally 80%.
The Bank's largest construction loan at September 30, 2004 was a
$5.0 million loan secured by all of the improved and unimproved building lots
and amenities of a resort community located in Hazleton, Pennsylvania. This loan
was performing according to its original terms at September 30, 2004.
Construction financing is generally considered to involve a higher degree of
credit risk than long-term financing on owner-occupied real estate. The risk of
loss on construction loans is dependent largely upon the accuracy of the value
of the property at completion of the construction compared to the estimated cost
of construction and other assumptions. If the estimate of construction costs
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to protect the value of the property.
Construction financing is generally considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of
the initial estimate of the property's value at completion of construction and
the estimated cost (including interest) of construction. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of construction costs proves to be inaccurate, the Bank may be required
to advance funds beyond the amount originally committed to permit completion of
the building. If the estimate of value proves to be inaccurate, the Bank may be
confronted, at or before the maturity of the loan, with a building having a
value that is insufficient to assure full repayment. If the Bank is forced to
foreclose on a building before or at completion due to a default, there can be
no assurance that the Bank will be able to recover all of the unpaid balance of,
and accrued interest on, the loan as well as related foreclosure and holding
costs.
CONSUMER LENDING. The Bank offers consumer loans, which include home
equity loans, home equity lines of credit, direct and indirect automobile loans,
education loans and other consumer loans. The Bank's home equity loans are
generated primarily through the Bank's retail branch offices. The Bank generally
offers home equity loans with a term of 180 months or less. The Bank also offers
home equity lines of credit with terms up to 20 years, the last 10 years of
which require full amortization of the principal balance. The maximum loan
amount for both home equity loans and home equity lines of credit, is subject to
a combined loans-to-value ratio of 80%.
The Bank also offers automobile loans, both on a direct and an indirect
basis (through new and used car dealers). The indirect automobile loans are
originated by dealers in accordance with underwriting standards pre-established
by the Bank and are serviced by the Bank. The Bank also offers loans on
recreational vehicles and boats and other consumer loans, deposit-secured loans,
and other personal and unsecured loans.
Consumer loans tend to bear higher rates of interest and have shorter
terms to maturity than first lien residential mortgage loans. Nationally,
consumer loans have historically tended to have a higher rate of default.
Additionally, consumer loans generally involve greater risk than residential
mortgage loans, particularly in the case of loans that are unsecured or secured
by rapidly depreciating assets such as automobiles. In these cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy.
COMMERCIAL LENDING. The Bank makes commercial business loans primarily
in its market area to a variety of professionals, sole proprietorships and small
businesses. The Bank offers a variety of commercial lending products, including
term loans for fixed assets and working capital, revolving lines of credit,
letters of credit, and Small Business Administration guaranteed loans. Interest
rates charged generally are based on the prime rate as published in the Wall
Street Journal. Prior to making commercial business loans, the borrower is
required to provide the Bank with sufficient information to allow a prudent loan
decision to be made. Such information generally includes financial statements
and projected cash flows, and is reviewed to evaluate debt service capability.
Commercial business loans are generally secured by a variety of collateral,
including real estate, personal property and fixed assets and frequently are
supported by personal guarantees. In addition, the Bank actively participates in
industrial loans arranged through the Greater Wilkes-Barre Industrial Fund and
CanDo, Inc. a Hazleton area industrial fund.
The Bank's largest commercial business loan at September 30, 2004 was a
$7.3 million loan secured by the fixed assets at a manufacturing facility. This
loan was performing in accordance with its original terms at September 30, 2004.
Commercial business loans generally involve higher credit risks than loans
secured by real estate. Unlike residential mortgage loans, which generally are
made on the basis of the borrower's ability to make repayment from his or her
employment or other income, and which are secured by real property whose value
tends to be more easily ascertainable, commercial loans are of higher risk and
Page 5
typically are made on the basis of the borrower's ability to make repayment from
the cash flow of the borrower's business. As a result, the availability of funds
for the repayment of commercial loans may be substantially dependent on the
success of the business itself. Further, any collateral securing such loans may
depreciate over time, may be difficult to appraise and may fluctuate in value
based on the success of the business.
LOAN APPROVAL PROCEDURES AND AUTHORITY. The Board of Directors
establishes the lending policies and the levels of loan approval authority for
employees of the Bank and oversees the Bank's lending activities. The Board of
Directors has established an Executive Committee and a Risk Committee which,
among other things, oversee the lending activities of the Bank and manages a
committee of loan officers that have initial oversight over certain loans. All
loans exceeding certain prescribed limits are reported to the Risk Management
and Executive Committee of the Board.
NONPERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES. The information
relating to the Bank's nonperforming assets and allowance for loan losses
appears in Item 7 of this Form 10-K the "Nonperforming Assets" and "Allowance
for Loan Losses" sections of Management's Discussion and Analysis of Financial
Condition and Results of Operations and is incorporated herein by reference.
INVESTMENT ACTIVITIES
The above captioned information appears in the "Investment Activities"
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations and is incorporated herein by reference.
SOURCE OF FUNDS
Information relating generally to the Bank's source of funds and a
description of the Bank's deposits appears in Item 7 of this Form 10-K under
"Sources of Funds" section of Management's Discussion and Analysis of Financial
Condition and Results of Operations and is incorporated herein by reference.
BORROWINGS. The Bank utilizes advances from the Federal Home Loan Bank
of Pittsburgh (the "FHLB") as well as other borrowings as a supplement to retail
deposits to fund its operations. Such advances are collateralized primarily by
the Bank's mortgage loans and mortgage-related securities and secondarily by the
Bank's investment in the capital stock of the FHLB of Pittsburgh. FHLB advances
are made pursuant to several different credit programs, each of which has its
own interest rate and range of maturities. The maximum amount that the FHLB of
Pittsburgh will advance to member institutions, including the Bank, fluctuates
from time to time in accordance with the policies of the FHLB of Pittsburgh. See
"Regulation-Federal Home Loan Bank System." At September 30, 2004, the Bank had
$243.9 million in outstanding FHLB advances, compared to $258.9 million at
September 30, 2003. The Bank had $135.3 million of additional borrowing capacity
from the FHLB at September 30, 2004. Other borrowings consist of overnight
retail repurchase agreements, which for the periods presented were immaterial,
and repurchase agreements. Repurchase agreements are treated as financings with
the obligations to repurchase securities sold reflected as a liability in the
balance sheet. The dollar amount of securities underlying the agreements remains
recorded as an asset, although the securities underlying the agreements are
delivered to the brokers who arranged the transactions. In certain instances,
the broker may have sold, loaned, or disposed of the securities to other parties
in the normal course of their operations, and have agreed to deliver to the Bank
substantially similar securities at the maturity of the agreements. Securities
underlying sales of securities under repurchase agreements consisted of
investment securities that had an amortized cost of $21.9 million and a market
value of $22.2 million at September 30, 2004. At September 30, 2004, the Bank
had $20 million in outstanding repurchase agreements. The Bank had no such
agreements outstanding as of September 30, 2003.
The following table sets forth certain information regarding the Bank's borrowed
funds on the dates indicated:
AT OR FOR THE FISCAL YEARS ENDED
SEPTEMBER 30,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
FHLB advances and other borrowings:
Average balance outstanding $ 251,955 $ 210,360 $ 208,579
Maximum amount outstanding at any month-end
during the period 293,688 259,430 215,855
Balance outstanding at end of period 264,293 259,430 211,605
Weighted average interest rate during the period 4.20% 5.69% 5.69%
Weighted average interest rate at end of period 4.44% 4.78% 5.57%
Page 6
SUBSIDIARY ACTIVITIES
The Company has six active wholly-owned subsidiaries: the Bank,
incorporated under the laws of the United States; Abstractors, Inc., the Trust
Co., and Higgins, each of which are incorporated under Pennsylvania law; and NEP
Capital Trust I and NEP Capital Trust II, each of which is incorporated under
Delaware law. Abstractors, Inc. is a title insurance agency with total assets of
$451,000 at September 30, 2004. The Trust Co., offers trust estate and asset
management services and products and had total assets of $1.1 million and
$167.1 million of trust assets under management at September 30, 2004. Higgins
provides insurance and investment products to individuals and businesses and had
total assets of $1.4 million at September 30, 2004. NEP Capital Trust I and NEP
Capital Trust II were established in connection with the issuance of trust
preferred securities. The proceeds of the offerings were used to purchase
debentures from the Company.
PERSONNEL
As of September 30, 2004, the Company had 246 full-time equivalent
employees, none of whom were covered by a collective bargaining agreement.
Management believes that the Company has good relations with its employees and
there are no pending or threatened labor disputes.
REGULATION AND SUPERVISION
As a savings and loan holding company, the Company is required by
federal law to file reports with and otherwise comply with, the rules and
regulations of the OTS. The Bank is subject to extensive regulation, examination
and supervision by the OTS, as its chartering agency, and the Federal Deposit
Insurance Corporation (the "FDIC"), as the deposit insurer. The Bank is a member
of the Federal Home Loan Bank ("FHLB") System. The Bank's deposit accounts are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the
FDIC concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations.
Certain of the regulatory requirements applicable to the Bank and to the
Company are referred to below or elsewhere herein. The description of statutory
provisions and regulations applicable to savings associations and their holding
companies set forth in this Form 10-K does not purport to be complete
descriptions of such statutes and regulations and their effects on the Bank and
the Company are qualified in its entirety by reference to such statutes and
regulations.
FEDERAL SAVINGS INSTITUTION AND REGULATIONS
BUSINESS ACTIVITIES. The activities of federal savings institutions are
governed by the federal laws and regulations. These laws and regulations
delineate the nature and extent of the activities in which federal associations
may engage. In particular, many types of lending authority for federal
associations, e.g., commercial, non-residential real property loans and consumer
loans, are limited to a specified percentage of the institution's capital or
assets.
LOANS-TO-ONE-BORROWER. Federal law provides that, savings institutions
are generally subject to the national bank limit on loans-to-one borrower.
Generally, this limit is 15% of the Bank's unimpaired capital and surplus, plus
an additional 10% of unimpaired capital and surplus, if such loan is secured by
specified readily marketable collateral. At September 30, 2004, the largest
aggregate amount of loans-to-one borrower was $7.3 million, which was less than
the Bank's general limit on loans-to-one borrower which was $10.5 million.
QTL TEST. Federal law requires savings institutions to meet a qualified
thrift lending ("QTL") test. Under the test, a savings association is required
to either qualify as a "domestic building and loan association" under the
Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total
assets less: (i) specified liquid assets up to 20% of total assets; (ii)
intangibles, including goodwill; and (iii) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed and related
securities) in at least 9 months out of each 12-month period. A savings
association that fails the QTL test is subject to certain operating restrictions
and may be required to convert to a bank charter. As of September 30, 2004, the
Bank maintained 92.1% of its portfolio assets in qualified thrift investments
and, therefore, met the QTL test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered as "qualified thrift investments."
Page 7
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations
upon all capital distributions by a savings institution, including cash
dividends, payments to repurchase its shares and payments to stockholders of
another institution in a cash-out merger. Under the regulations, an application
to and the prior approval of the OTS is required before any capital distribution
if the institution does not meet the criteria for "expedited treatment" of
applications under OTS regulations (generally, examination ratings in one of two
top categories), the total capital distributions for the calendar year exceed
net income for that year plus the amount of retained net income for the
preceding two years, the institution would be undercapitalized following the
distribution or the distribution would otherwise be contrary to a statute,
regulation or agreement with the OTS. If an application is not required, the
institution must still give advance notice to the OTS of the capital
distribution, if, like the Bank, it is a subsidiary of a holding company. If the
Bank's capital fell below its regulatory requirements or if the OTS notified it
that it was in need of more than normal supervision, the Bank's ability to make
capital distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution, which would otherwise be permitted by regulation,
if the OTS determines that the distribution would be unsafe or unsound practice.
ASSESSMENTS. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessments, paid on a
semi-annual basis, are based upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
Thrift Financial Report. The assessments paid by the Bank for the year ended
September 30, 2004 totaled $245,000.
BRANCHING. OTS regulations permit federally-chartered savings
associations to branch nationwide under certain conditions. Generally, federal
savings associations may establish interstate networks and geographically
diversify their loan portfolios and lines of business. The OTS authority
preempts any state law purporting to regulate branching by the federal savings
associations.
COMMUNITY REINVESTMENT. Under the Community Reinvestment Act ("CRA"), as
implemented by OTS regulations, a savings institution has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of a savings institution,
to assess the institution's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain applications
by such institution. The CRA also requires all institutions to make public
disclosure of their CRA ratings. The Bank received a "Satisfactory" CRA rating
in its most recent examination.
TRANSACTIONS WITH RELATED PARTIES. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by federal law. The
aggregate amount of covered transactions with any individual affiliate is
limited to 10% of the capital and surplus of the savings institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in federal law. The purchase of low quality assets from affiliates is
generally prohibited. The transactions with affiliates must be on terms and
under circumstances, that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The recently enacted Sarbanes-Oxley Act generally prohibits loans by the
Company to its executive officers and directors. However, the Act contains a
specific exception from such prohibitions for loans by the Bank to its executive
officers and directors in compliance with federal banking regulations
restrictions on such loans. The Bank's authority to extend credit to executive
officers, directors and 10% stockholders ("insiders"), as well as entities such
persons control, is also governed by federal law. Such loans are required to be
made on terms substantially the same as those offered to unaffiliated
individuals and not involve more than the normal risk of repayment. An exception
exists for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
ENFORCEMENT. The OTS has primary enforcement responsibility over savings
institutions and has the authority to bring action against the institution and
all "institution-affiliated parties," including stockholders, and any attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or cease
and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1 million per
day in especially egregious cases. The FDIC has the authority to recommend to
the Director of the OTS that enforcement action be taken with respect to a
particular savings institution. If action is not taken by the
Page 8
Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have
adopted Interagency Guidelines Standards for Safety and Soundness. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the OTS determines that a savings
institution fails to meet any standard prescribed by the guidelines, the OTS may
require the institution to submit an acceptable plan to achieve compliance with
the standard.
CAPITAL REQUIREMENTS. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 4% leverage (core capital) ratio and an 8% risk-based capital ratio.
Core capital is defined as common stockholder's equity (including retained
earnings), certain non-cumulative perpetual preferred stock and related surplus,
minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights ("MSRs") and credit
card relationships. The OTS regulations require that, in meeting the leverage
ratio, tangible and risk-based capital standards institutions generally must
deduct investments in and loans to subsidiaries engaged in activities not
permissible for a national bank. In addition, the OTS prompt corrective action
standards discussed below also establish, in effect, a minimum 2% tangible
capital standard, a 4% leverage ratio, and, together with the risk-based capital
standards itself, a 4% Tier 1 risk-based capital standard.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off balance sheet assets, recourse obligations, direct credit
substitutes and other residual interests are multiplied by a risk-weight factor
of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS
believes are inherent in the type of asset. The components of core capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock, the allowance for loan and lease losses, limited to a maximum
of 1.25% of risk-weighted assets and up to 45% of unrealized gains on
available-for-sale equity securities with readily determinable fair market
value. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.
The OTS also has authority to establish minimum capital requirements in
appropriate cases upon a determination that an institution's capital levels are
or may become inadequate in light of the particular circumstances. At September
30, 2004, the Bank met each of its capital requirements. The following table
presents the Bank's capital position at September 30, 2004. (Dollars in
thousands)
CAPITAL
ACTUAL REQUIRED EXCESS -------------------------
CAPITAL CAPITAL AMOUNT ACTUAL % REQUIRED %
----------- ----------- ---------- ----------- -----------
Tangible $ 61,331 $ 12,426 $ 48,905 7.40% 1.5%
Core (Leverage) 61,331 33,136 28,195 7.40 4.0
Risk-based 65,827 34,936 30,891 15.07 8.0
PROMPT CORRECTIVE REGULATORY ACTION. The OTS is required to take certain
supervisory actions against undercapitalized institutions, the severity of which
depends upon the institution's degree of under capitalization. Generally, a
savings institution that has a total risk-based capital of less than 8% or a
leverage ratio or a Tier 1 capital ratio that is less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
higher examination rating) is considered to be undercapitalized. A savings
institution that has a total risk-based capital less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the OTS is required to appoint a receiver or conservator for an institution that
is critically undercapitalized within specified time frames. The regulation also
provides that a capital restoration plan must be filed with the OTS within
45 days of the date an association receives notice that it is
"undercapitalized," significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions may become
immediately applicable to an undercapitalized institution, including, but not
limited to, increased monitoring by regulators, restrictions on growth, capital
distributions and expansion. The OTS could also take any one of a number of
discretionary supervisory actions, including the issuance of a capital directive
and the replacement of senior executive officers and directors.
INSURANCE OF DEPOSIT ACCOUNTS. The FDIC maintains a risk-based
assessment system by which institutions are assigned to one of three categories
based on the institution's capitalization and one of three subcategories based
on examination ratings and other supervisory information. An institution's
assessment rate depends on the categories to which it is assigned. Assessment
rates for SAIF member institutions are determined semi-annually and currently
range from 0 basis points, for the healthiest institutions to 27
Page 9
basis points, for the riskiest institutions. The Bank's assessment rate for
the fiscal year 2004 was 3 basis points (not including the FICO payment
discussed below) and the premium paid for this period was $122,442. The FDIC has
authority to increase insurance assessments. A significant increase in SAIF
insurance premiums would likely have an adverse effect on the operating expenses
and results of operations of the Bank. Management cannot predict what insurance
assessment rates will be in the future.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 2004,
FICO payments for SAIF members approximated 1.5 basis points.
Insurance of deposits may be terminated by the FDIC upon a finding that
the institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System,
which consists of 12 regional FHLBs. The FHLB provides a central credit facility
primarily for member institutions. The Bank, as a member of the FHLB, is
required to acquire and hold shares of capital stock in the FHLB in an amount at
least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the FHLB, whichever is greater. The Bank was in
compliance with this requirement with an investment in FHLB stock at September
30, 2004, of $13.0 million. FHLB advances must be secured by specified types of
collateral and all long-term advances may only be obtained for the purpose of
providing funds for residential housing finance. At September 30, 2004, the Bank
had $243.9 million in FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the years ended September 30, 2004, 2003 and 2002
dividends from the FHLB to the Bank amounted to approximately $179,000,
$312,000, and $439,000, respectively. If dividends were reduced, the Bank's net
interest income would likely also be reduced. Recent legislation has changed the
structure of the Federal Home Loan Banks' funding obligations for insolvent
thrifts, revised the capital structure of the Federal Home Loan Banks and
implemented entirely voluntary membership for Federal Home Loan Banks.
Management cannot predict the effect that these changes may have with respect to
its Federal Home Loan Bank membership.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally require
that reserves be maintained against aggregate transaction accounts as follows:
for accounts aggregating $47.6 million or less (subject to adjustment by the
Federal Reserve Board) the reserve requirement is 3%; and for accounts greater
than $47.6 million, the reserve requirement is 10%. The first $7.0 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with these requirements.
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company
within the meaning of federal law. Under prior law, a unitary savings and loan
holding company, such as the Company, was not generally restricted as to the
types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender, as previously described. The
Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a
savings institution after May 4, 1999 unless it engages only in the financial
activities permitted for financial holding companies or those permitted under
the law for multiple savings and loan holding companies as described below.
Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan
holding companies may only engage in such activities. The Gramm-Leach-Bliley
Act, however, grandfathered the unrestricted authority of activities with
respect to unitary savings and loan holding companies existing prior to May 4,
1999, so long as the holding company's savings institution subsidiary continues
to comply with the qualified thrift lender test. The Company qualifies for the
grandfathering. Upon any non-supervisory acquisition by the Company of another
savings institution, or savings bank that meets the qualified thrift lender test
and is deemed to be a savings institution by the Office of Thrift Supervision,
the Company would become a multiple savings and loan holding company (if the
acquired institution is held as a separate subsidiary) and would generally be
limited to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the
OTS, and certain activities authorized by OTS regulation. However, the OTS has
issued an interpretation concluding that multiple savings and loan holding
companies may also engage in activities permitted for financial holding
companies.
Page 10
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution, or holding company thereof, without prior written approval of the
OTS and from acquiring or retaining control of a depository institution that is
not insured by the FDIC. In evaluating applications by holding companies to
acquire savings institutions, the OTS must consider the financial and managerial
resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, except: (i) the approval of interstate supervisory acquisitions by
savings and loan holding companies, and (ii) the acquisition of a savings
institution in another state if the laws of the state of the target savings
institution specifically permit such acquisitions. The states vary in the extent
to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not currently subject to
specific capital requirements or specific restriction on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The Bank
must notify the OTS 30 days before declaring any dividend to the Company. In
addition, the financial impact of a holding company on its subsidiary
institution is a matter that is evaluated by the OTS and the agency has
authority to order cessation of activities or divestiture of subsidiaries deemed
to pose a threat to the safety and soundness of the institution.
ACQUISITION OF THE COMPANY. Under the Federal Change in Bank Control Act
("CIBCA"), a notice must be submitted to the OTS if any person (including a
company), or group acting in concert, seeks to acquire "control" of a savings
and loan holding company. Under certain circumstances, a change of control may
occur, and prior notice is required, upon the acquisition of 10% or more of the
Company's outstanding voting stock, unless the OTS has found that the
acquisition will not result in a change of control of the Company. Under the
CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking
into consideration certain factors, including the financial and managerial
resources of the acquirer and the anti-trust effects of the acquisition. Any
company that so acquires control would then be subject to regulation as a
savings and loan holding company.
TRUST COMPANY REGULATION
The Trust Co. is chartered under the laws of Pennsylvania and the
Pennsylvania Department of Banking is responsible for its regulation,
supervision and examination. Pennsylvania law governs the activities and
investments of the Trust Co. as well as its administration of trust accounts.
The Trust Co. limits its activities to trust, fiduciary and related activities
and is not insured by the FDIC. The Pennsylvania Department of Banking maintains
authority to issue orders and suspend directors, officers or employees for
violations of law or regulations or unsafe practices and to take possession as
receiver or conservator of any institution for violations, unsafe practices or
condition or insolvency. The Trust Co. pays assessments to the Pennsylvania
Department of Banking, which in fiscal 2004 amounted to $2,500.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a September 30
fiscal year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary and
does not purport to be a comprehensive description of the tax rules applicable
to the Bank or the Company. Neither the Company nor the Bank has been audited by
the IRS in the past five years.
BAD DEBT RESERVE. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Bank's deductions with respect
to "qualifying real property loans," which are generally loans secured by
certain interest in real property, were computed using an amount based on the
Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable
income, computed with certain modifications and reduced by the amount of any
permitted addition to the non-qualifying reserve. Due to the Bank's loss
experience, the Bank generally recognized a bad debt deduction equal to 8% of
taxable income.
In August 1996, the provisions repealing the above thrift bad debt rules
were passed by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminated the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also required that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(the last taxable year beginning before January 1, 1988). The Bank had
previously recorded a deferred tax liability equal to the bad debt recapture and
as such, the new rules had no
Page 11
effect on net income or federal income tax expense. For taxable years that began
after December 31, 1995, the Bank's bad debt deduction was equal to net
charge-offs. The new rules allowed an institution to suspend the bad debt
reserve recapture for the 1996 and 1997 tax years if the institution's lending
activity for those years was equal to or greater than the institution's average
mortgage lending activity for the six taxable years preceding 1996. For this
purpose, only home purchase and home improvement loans were included and the
institution could have elected to have the tax years with the highest and lowest
lending activity removed from the average calculation. If an institution was
permitted to postpone the reserve recapture, it had to begin its six year
recapture no later than the 1998 tax year. The unrecaptured base year reserves
were not subject to recapture as long as the institution continued to carry on
the business of banking. In addition, the balance of the pre-1988 bad debt
reserves continued to be subject to a provision of present law referred to below
that required recapture in the case of certain excess distributions to
stockholders.
DISTRIBUTIONS. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made: (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method, or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock, and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not be
considered to result in a distribution from the Bank's bad debt reserve. Thus,
any dividends to the Company that would reduce amounts appropriated to the
Bank's bad debt reserve and deducted for federal income tax purposes would
create a tax liability for the Bank. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. Thus if
the Bank makes a "non-dividend distribution," then approximately one and
one-half times the amount so used would be includable in gross income for
federal income tax purposes, assuming a 34% corporate income tax rate (exclusive
of state and local taxes). The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserve.
CORPORATE ALTERNATIVE MINIMUM TAX. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset
by net operating loss carryovers of which the Company currently has none. AMTI
is increased by an amount equal to 75% of the amount by which the Company's
adjusted current earnings exceeds its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). In addition, for
taxable years beginning after June 30, 1986 and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modifications)
over $2.0 million is imposed on corporations, including the Company, whether or
not an Alternative Minimum Tax ("AMT") is paid. The Company does not expect to
be subject to the AMT.
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
STATE AND LOCAL TAXATION
The Company and its non-thrift Pennsylvania subsidiaries are subject to
the Pennsylvania Corporation Net Income Tax and Capital Stock and Franchise Tax.
The state Corporate Net Income Tax rate for fiscal years ended 2004, 2003 and
2002 was 9.99% and was imposed on the Company's and its non-thrift subsidiaries'
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock Tax is a property tax imposed at the rate of .699% of
a corporation's capital stock value, which is determined in accordance with a
fixed formula. The Company is also required to file an annual report with and
pay an annual franchise tax to the State of Delaware.
The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax
Act (the "MTIT"), as amended, to include thrift institutions having capital
stock. Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the
Bank from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with generally accepted
accounting principles prevailing in the United States ("GAAP") with certain
adjustments. The MTIT, in computing GAAP income, allows for the exclusion of
interest earned on Pennsylvania and federal securities, while disallowing a
percentage of a thrift's interest expense deduction in the proportion of
interest income on those securities to the overall interest income of the Bank.
Net operating losses, if any, thereafter can be carried forward three years for
MTIT purposes. Neither the Company nor the Bank have been audited by the
Commonwealth of Pennsylvania in the last five years.
Page 12
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive
officers of the Company and its subsidiaries as of September 30, 2004 who are
not directors.
NAME AGE AS OF 9/30/04 POSITION
- ----------------- ----------------- -----------------------------------------
Jerry D. Holbrook 48 Chief Financial Officer and Secretary of
the Bank and Company since 2003. From
2000 to 2002, Chief Financial Officer of
E-Duction, a financial services start-up
company located in the metropolitan area
of Philadelphia, Pennsylvania. Prior to
2000, 15 years of senior level banking
experience at First USA Bank (JP Morgan
Chase) and WSFS Financial Corporation,
both located in Wilmington, Delaware.
Leo R. Loftus 49 Senior Vice President and Chief Lending
Office at First Federal Bank since
September 2003. Prior to that, Senior
Vice President - Commerical Lender at
First Federal Bank.
ITEM 2. PROPERTIES
The Company currently conducts its business through 16 full service
community offices located in Luzerne, Carbon, Columbia, Monroe and Schuylkill
counties in Northeast Pennsylvania. Abstractors, Inc. and Northeast Pennsylvania
Trust Co. conduct their business in the downtown Hazleton area. The following
table sets forth the Company's offices as of September 30, 2004. The Kingston,
Pennsylvania branch office listed below was opened in December 2004 and,
accordingly, has no book value or deposits at September 30, 2004.
Original Net Book Value of
Year Property or Leasehold
Leased Leased or Date of Lease Improvements at Total Deposits
Location or Owned Acquired Expiration September 30, 2004 September 30,2004
- ---------------------------------- -------- ---------- -------------- --------------------- -----------------
(Dollars In Thousands)
ADMINISTRATIVE/HOME OFFICE:
12 E. Broad Street
Hazleton, PA 18201 Owned 1947 - $ 3,460 $ 159,369
BRANCH OFFICES:
Bloomsburg Office:
17 E. Main Street
Bloomsburg, PA 17815 Owned 1963 - 398 23,750
Shenandoah Office:
5 N. Main Street
Shenandoah, PA 17976 Owned 1968 - 424 41,051
Page 13
Pottsville Office:
111 E. Norwegian Street
Pottsville, PA 17901 Owned 1968 - 652 23,467
Lehighton Office:
111 N. First Street
Lehighton, PA 18235 Owned 1977 - 55 24,416
Schuylkill Mall Office (1):
611 Schuylkill Mall
Frackville, PA 17931 Leased 1978 2004 254 20,565
Laurel Mall Office:
240 Laurel Mall
Hazleton, PA 18201 Leased 1994 2005 181 71,217
Gould's IGA Office:
669 State Route 93, Suite 5
Sugarloaf, PA 18249 Leased 1995 2005 50 19,349
Mountaintop Office:
360 S. Mountain Boulevard
Mountaintop, PA 18707 Owned 1997 - 741 20,753
Scott Township Office:
2691 Columbia Blvd.
Bloomsburg, PA 17815 Owned 1998 - 911 16,294
Brodheadsville Office:
760 Route 209 &
Weir Lake Road
Brodheadsville, PA 18322 Leased 2000 2005 42 8,520
Back Mountain Office:
196 N. Main Street
Shavertown, PA 18708 Owned 2001 - 1,143 14,183
Weatherly Office:
140 Carbon Street
Weatherly, PA 18255 Owned 2001 - 83 13,128
Drums Office:
Route 309, 24 South
Hunter Highway
Drums, PA 18222 Owned 2001 - 218 14,653
Laurel Mall Satellite Office:
345 Laurel Mall, Route 93
Hazleton, PA 18201 Leased 2001 2005 291 397
Schuylkill Haven Office:
333 Center Avenue
Schuylkill Haven, PA 17972 Owned 2002 - 360 12,329
Kingston Office:
183 Market Street
Suite 100
Kingston, PA 18704 Leased 2004 2009 - -
Page 14
TITLE INSURANCE AGENCY
Abstractors, Inc. (2)
25 W. Broad Street
Hazleton, PA 18201 Owned 2001 month-to-month - N/A
TRUST COMPANY
NEP Trust Co. (2)
31 W. Broad Street
Hazleton, PA 18201 Owned 2001 month-to-month - N/A
INSURANCE AGENCY
Higgins Insurance Associates, Inc.
115 S. Centre Street
Pottsville, PA 17901 Leased 2001 2010 - N/A
(1) The Company is presently in negotiations to extend its lease for the
Schuylkill Mall office by one year.
(2) The Bank owns the building and provides intercompany leases to NEP Trust
Company and Abstractors, Inc.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings, in the aggregate, are believed by management to be
immaterial to the Company's financial condition or results of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Page 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR REGISTRANT'S COMMON EQUITY
The Company's common stock is traded on the Nasdaq Stock Market under
the symbol NEPF. At September 30, 2004, the Company had 1,482 registered common
stockholders of record. The following table sets forth the range of high and low
bid information for each quarterly period within the two most recent fiscal
years as well as the quarterly dividends paid.
The closing market price of the common stock at September 30, 2004 was
$16.51.
STOCK PRICE RANGE
------------------
Low High Dividends
-------- -------- ---------
2004
1st quarter $ 17.50 $ 20.00 $ 0.06
2nd quarter 17.01 19.75 0.06
3rd quarter 16.80 18.39 0.06
4th quarter 16.25 17.74 0.06
---------
$ 0.24
2003
1st quarter $ 13.96 $ 17.05 $ 0.12
2nd quarter 14.67 17.42 0.12
3rd quarter 15.00 16.75 0.12
4th quarter 14.77 18.47 0.12
---------
$ 0.48
The Company's dividend policy is impacted by, among other things, our
views on potential future capital requirements relating to balance sheet growth,
the expansion of the Bank's branch distribution channel, investments and
acquisitions and legal risks. The Company is also subject to the requirements of
Delaware law which limits dividends to an amount not to exceed the surplus or
net profits of the Company. Additionally, the Company agreed to limit its
quarterly dividends to $.06 per share in the Definitive Agreement and Plan of
Merger dated December 8, 2004 with KNBT Bancorp, Inc.
RECENT SALES OF UNREGISTERED SECURITIES
Under the Agreement, dated December 7, 2000, by and among, Northeast
Pennsylvania Financial Corp., James Clark, James McCann, Joseph P. Schlitzer,
John W. Sink and Higgins Insurance Associates, Inc., in consideration for the
purchase of Higgins Insurance Associates, Inc., Northeast Pennsylvania is
required to issue on each of the December 31, 2001, 2002, 2003 and 2004, an
amount of shares of common stock equal to $100,000 provided that certain
performance measures have been met. This resulted in the Company issuing
6,568, 6,369, and 5,206 shares of common stock on December 2001, 2002 and 2003,
respectively. These shares were not registered under the Securities Act of 1933,
as amended.
Page 16
PURCHASES OF EQUITY SECURITIES
The following table sets forth information regarding the Company's
repurchases of its common stock during the quarter ended September 30, 2004.
TOTAL NUMBER
OF SHARES
PURCHASED MAXIMUM
AS PART OF NUMBER OF SHARES
TOTAL PUBLICLY THAT MAY YET BE
NUMBER OF AVERAGE ANNOUNCED PURCHASED UNDER
SHARES PRICE PAID PLANS OR THE PLAN OR
PERIOD PURCHASED PER SHARE PROGRAMS PROGRAMS (1)(2)
- --------------------------- --------- ----------- ------------ ----------------
July 2004
Beginning date: July 1 195,000 $ 17.20 195,000 4,000
Ending date: July 31
August 2004
Beginning date: August 1 -- $ -- -- --
Ending date: August 31
September 2004
Beginning date: September 1 1,000 $ 16.50 1,000 3,000
Ending date: September 30
--------- ----------- --------- ---------
Total 196,000 $ 17.20 196,000 N/A
- ----------
(1) On May 26, 2004, the Board of Directors authorized the repurchase of 5% of
the Company's outstanding shares, or approximately 209,000 shares, from time to
time, subject to market conditions. This plan will continue until it is
completed or terminated by the Board of Directors.
(2) The Company agreed to postpone any future repurchases of its common stock on
December 8, 2004 when it executed the Agreement and Plan of Merger with KNBT
Bancorp, Inc.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial and other data of the Company set
forth below is derived in part from, and should be read in conjunction with, the
Consolidated Financial Statements of the Company and Notes thereto presented
elsewhere in this Annual Report on Form 10-K. Prior periods have been restated
to reflect the correction of certain accounting errors which were discovered in
July and September 2003. See Note 2 to the Consolidated Financial Statements for
additional information regarding the restatement.
Page 17
AT SEPTEMBER 30,
-------------------------------------------------------------------
(IN THOUSANDS)
AS RESTATED AS RESTATED AS RESTATED
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
SELECTED CONSOLIDATED FINANCIAL DATA:
Total assets $ 836,035 $ 896,295 $ 901,945 $ 807,373 $ 636,490
Cash and cash equivalents 26,938 20,142 25,302 9,060 6,295
Loans, net (1) 403,584 489,986 488,316 498,076 415,315
Securities held-to-maturity:
Investment securities, net 998 3,555 3,652 17,842 30,336
Securities available-for-sale:
Mortgage-related securities, net 326,981 210,965 225,287 138,467 53,076
Investment securities, net 30,242 115,661 102,599 105,181 104,398
Deposits 483,441 547,305 606,412 515,735 419,671
FHLB Advances 243,867 258,901 208,421 204,441 137,461
Total equity 58,458 58,357 65,125 74,380 72,123
Assets acquired through foreclosure 315 1,022 547 390 173
Nonperforming assets and
troubled debt restructurings 7,184 13,501 4,747 5,113 3,672
FOR THE FISCAL YEARS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
(IN THOUSANDS)
AS RESTATED AS RESTATED AS RESTATED
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
SELECTED OPERATING DATA:
Total interest income $ 40,962 $ 45,364 $ 52,633 $ 53,398 $ 44,493
Interest expense 19,856 25,188 28,988 31,314 26,531
----------- ----------- ----------- ----------- -----------
Net interest income 21,106 20,176 23,645 22,084 17,962
Provision for loan losses 1,444 6,852 2,766 1,681 1,467
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 19,662 13,324 20,879 20,403 16,495
Noninterest income:
Net gain on sale of securities 1,292 1,319 308 333 37
Other 10,043 8,657 7,768 4,982 1,859
Noninterest expense 23,611 29,199 24,639 19,655 14,471
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 7,386 (5,899) 4,316 6,063 3,920
Income tax expense (benefit) 2,299 (1,829) 1,620 1,861 373
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 5,087 $ (4,070) $ 2,696 $ 4,202 $ 3,547
=========== =========== =========== =========== ===========
Diluted earnings (loss) per share $ 1.26 $ (1.08) $ 0.63 $ 0.89 $ 0.73
=========== =========== =========== =========== ===========
(See footnotes on next page)
Page 18
AT OR FOR THE FISCAL YEARS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
As Restated As Restated As Restated
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
SELECTED OPERATING DATA (2):
PERFORMANCE RATIOS:
Average yield on interest-earning assets (3) 5.05% 5.46% 6.60% 7.52% 7.42%
Average rate paid on interest-bearing
liabilities 2.61 3.21 3.91 4.79 4.81
Average interest rate spread (4) 2.44 2.25 2.69 2.73 2.61
Net interest margin (5) 2.64 2.48 3.01 3.20 3.16
Ratio of interest-earning assets to
interest-bearing liabilities 108.03 107.50 109.15 111.04 112.74
Efficiency ratio (6) 72.78 96.84 77.67 71.74 72.87
Return on average assets 0.59 (0.46) 0.32 0.55 0.55
Return on average equity 8.62 (6.27) 3.89 5.57 4.93
Ratio of average equity to average assets 6.82 7.30 8.13 9.93 11.16
Common stock dividend payout ratio (diluted)(7) 19.05 nm 73.02 42.70 41.10
BANK CAPITAL RATIOS:
Risk-based capital
Tier 1 capital (required 4.0%) 13.82% 9.27% 9.45% 10.72% 15.97%
Total (required 8.0%) 15.07 10.52 10.45 11.65 17.16
Core capital (required 4.0%) 7.40 6.17 5.81 6.50 9.25
OTHER:
Stock price at year end $ 16.51 $ 17.50 $ 14.75 $ 14.45 $ 11.50
Common stock dividends declared per share $ 0.24 $ 0.48 $ 0.46 $ 0.38 $ 0.30
Employees 272 280 283 246 194
(1) Loans, net, represent gross loans receivable net of the allowance for loan
losses, loans in process and deferred loan origination fees and exclude
loans held-for-sale. The allowance for loan losses at September 30, 2004,
2003, 2002, 2001, and 2000 was $8.4 million, $10.2 million, $5.4 million,
$4.5 million, $4.2 million and $2.9 million, respectively.
(2) To the extent applicable, all ratios are based on average daily balances.
(3) Calculations of yield are presented on a taxable equivalent basis using the
combined Federal and state income tax rate of 40%.
(4) The average interest rate spread represents the difference between the
weighted average yield on average interest-earning assets and the weighted
average cost of average interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) Calculated as non-interest expense divided by the sum of total income less
interest expense.
(7) The dividend payout ratio equals dividends paid per share divided by net
income per share. Since the Company reported a net loss for 2003, this ratio
was not meaningful.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION AND BUSINESS
The Company's results of operations are dependent primarily on the results of
operation of the Bank and thus are dependent to a significant extent on net
interest income, which is the difference between the income earned on its loan
and investment portfolios and its cost of funds, consisting of the interest paid
on deposits and borrowings. However, non-interest income has become a
significant contributor to the Company's results of operations mainly due to
fees earned by non-bank subsidiaries. Results of operations are also affected by
the Company's provision for loan losses, loan and security sales activities,
service charges and other fee income, and noninterest expense. The Company's
noninterest expense principally consists of compensation and employee benefits,
office occupancy and equipment expense, data processing, professional fees, and
advertising and business promotion expenses. Results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities.
Page 19
The Company's results of operations have been restated for the years ended
September 30, 2002 through 1998 to reflect the correction of accounting errors
discovered in July and September 2003. These errors primarily related to the
Company's indirect automobile loan portfolio, mortgage and consumer loan
portfolios, employee health and welfare benefit plans and certain operating
expenses, which are more fully described in Note 2 to the Consolidated Financial
Statements. The net effect of such restatements was to reduce net interest
income, increase operating expenses and decrease retained earnings for prior
periods. The following discussion of the Company's business reflects these
restatements.
The following discussion and analysis is presented on a consolidated basis and
focuses on the major components of the Company's operations and significant
changes in the results of operations for the periods presented. The discussion
should be read in conjunction with the Company's Consolidated Financial
Statements and accompanying notes thereto presented elsewhere in this Annual
Report on Form 10-K.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies that govern the
application of principles generally accepted in the United States in the
preparation of its financial statements. Significant accounting policies are
described in the Footnotes to the Consolidated Financial Statements. The Company
believes the allowance for loan losses is a critical accounting policy that
requires the most significant judgments and estimates used in the preparation of
the Consolidated Financial Statements. For further discussion of the allowance
for loan losses, see "Financial Condition - Allowance for Loan Losses." Although
we believe 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.
MANAGEMENT STRATEGY
The long-term strategy of the Company has been to become a high-performing
financial service company focusing on its customer needs for high-quality
financial products and services. The Bank provides residential and commercial
real estate, commercial and consumer lending services, as well as retail deposit
and cash management services. Lending activities are funded primarily with
retail deposits and borrowings. To promote long-term financial strength and
profitability, the Company's operating strategy has been focused on originating
high-quality consumer and small-business commercial loans and deposit
relationships. The Company also manages an investment portfolio of high-quality
mortgage-related securities and investment securities, which are funded with
long-term Federal Home Loan Bank advances and deposits. The Company currently
sells newly originated fixed-rate residential mortgages in the secondary market.
In September 2003, the Board of Directors initiated several management and
operational changes including appointing two seasoned bank executives to lead
the Company. Thomas Petro was appointed as President and Chief Executive Officer
after the resignation of the former President and Chief Executive Officer and
Jerry Holbrook was appointed as Chief Financial Officer. The Company's new
management team has repositioned the balance sheet and improved earnings by
divesting certain fixed-rate residential mortgage loans and investment
securities and reinvesting these proceeds in similar assets that are
interest-rate sensitive. The Company also evaluated alternatives to restructure
a portion of its long-term fixed-rate FHLB borrowings to improve net interest
income and effectively manage the Bank's interest-rate risk position. This
resulted in the Bank entering into interest-rate swap contracts whereby such
long-term fixed-rate advances were swapped to variable rates. In addition, the
Bank has developed loan and deposit pricing systems to support its long-term
strategy of increasing core deposits in its local market areas while expanding
the loan portfolio through new originations, commercial loan participations and
strategic purchases of high-quality loan receivables.
MANAGEMENT OF INTEREST RATE RISK AND MARKET RISK ANALYSIS
The principal objective of the Bank's interest rate risk management is to
evaluate the interest rate risk included in certain balance sheet accounts,
determine the level of risk appropriate given the Bank's business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. Through
such management, the Bank seeks to reduce the vulnerability of its operations to
changes in interest rates. The Bank's Asset Liability Committee (the "ALCO") is
responsible for reviewing the Bank's asset/liability policies and interest rate
risk position. The ALCO meets on a monthly basis and reports trends and the
Bank's interest rate risk position to the Risk Management Committee of the Board
of Directors. The extent of the movement of interest rates is an uncertainty
that could have a negative impact on the earnings of the Bank.
Management believes that reducing its exposure to interest rate fluctuations
within certain limits will enhance long-term profitability. However, the Bank's
strategies may adversely impact net interest income due to lower initial yields
on some of its adjustable rate loans and securities in comparison to longer-term
fixed-rate investments and whole loans. To promote a higher yield on its
investment securities, while at the same time addressing the Bank's interest
rate risk management policies, the Bank has
Page 20
invested a portion of its portfolio of investment securities in longer-term
(more than five years) Federal agency obligations, which have call features.
Given the rates of such securities in comparison to current market interest
rates, the Bank anticipates the majority of such securities may be called prior
to their contractual maturity. The Bank also uses the derivatives markets to
manage interest-rate risk from time-to-time primarily by engaging in interest
rate swaps to manage interest rate risk on its borrowings. Under the Agreement
and Plan of Merger, the Bank must obtain KNBT's approval before entering into or
modifying any interest rate caps on swap agreements or arrangements. At
September 30, 2004, there were $40.0 million in notional amount of derivative
contracts in effect.
NET PORTFOLIO VALUE. The Company's interest rate sensitivity is primarily
monitored by management through the use of a model, which generates estimates of
the change in the Company's net portfolio value ("NPV") over a range of interest
rate scenarios. NPV is the present value of expected cash flows from assets,
liabilities, and off-balance sheet contracts. The NPV ratio, under any interest
rate scenario, is the NPV divided by the market value of assets in the same
scenario. The model estimates loan prepayment rates, reinvestment rates, and
deposit decay rates. The Office of Thrift Supervision ("OTS") also produces a
similar analysis using its own model, based upon data submitted on the Bank's
quarterly Thrift Financial Reports, the results of which vary from the Company's
internal model primarily due to differences in assumptions utilized.
The following table sets forth the Company's NPV model as of September 30, 2004.
NPV AS % OF PORTFOLIO
Change in NET PORTFOLIO VALUE VALUE OF ASSETS
Interest Rates -----------------------------------------------------------
In Basis Points NPV
(Rate Shock) Amount $ Change % Change Ratio Change(1)
- --------------- --------- --------- -------- --------- ---------
($ in thousands)
+300 $ 65,965 $ (18,984) (22.35)% 8.41% (171)
+200 74,005 (10,944) (12.88) 9.21 (91)
+100 80,862 (4,087) (4.81) 9.83 (29)
0 84,949 - - 10.12 -
-100 83,649 (1,300) (1.53) 9.82 (30)
(1) Expressed in basis points.
The following table sets forth the Company's NPV model as of September 30, 2003.
NPV AS % OF PORTFOLIO
Change in NET PORTFOLIO VALUE VALUE OF ASSETS
Interest Rates -----------------------------------------------------------
In Basis Points NPV
(Rate Shock) Amount $ Change % Change Ratio Change(1)
- --------------- --------- --------- -------- --------- ---------
($ in thousands)
+300 $ 63,654 $ (39,635) (38.37)% 7.58% (361)
+200 75,326 (27,963) (27.07) 8.71 (248)
+100 83,779 (19,510) (18.89) 9.44 (175)
0 103,289 - - 11.19 -
-100 87,614 (15,675) (15.18) 9.48 (171)
(1) Expressed in basis points.
The change in the NPV model between 2004 and 2003 reflects changes in the
balance sheet mix and the move to a more neutral repricing gap position as a
result of shortening the duration of interest-earning assets and lengthening the
duration of interest-bearing liabilities. This change resulted in the Bank
becoming less sensitive to rising interest rates. Certain shortcomings are
inherent in the methodology used in NPV interest rate risk measurements.
Modeling changes in NPV require the making of certain assumptions that may or
may not reflect the manner in which actual yields and costs respond to changes
in market interest rates. In this regard, the NPV presented assumes that the
composition of the Company's interest sensitive assets and liabilities existing
at the beginning of a period remain constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. Accordingly, NPV measurements provide an
indication of the Company's interest rate risk exposure at a particular point in
time. Such measurements are not intended to, and do not, provide a precise
forecast of the effect of changes in market interest rates on the Company's net
interest income and will differ from actual results.
Page 21
ANALYSIS OF NET INTEREST INCOME
Net interest income is the most significant component of operating income to the
Company. Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them. The interest rate spread is influenced by regulatory, economic and
competitive factors that affect interest rates, loan demand and deposit flows.
Additionally, the level of nonperforming loans impacts the interest rate spread
by reducing the overall yield on the loan portfolio.
AVERAGE BALANCE SHEET. The following table sets forth certain information
relating to the Company for the fiscal years ended September 30, 2004, 2003 and
2002. The average yields and costs are derived by dividing income or expense by
the average balance of interest-earning assets or interest-bearing liabilities,
respectively, for the periods shown. Average balances are derived from average
daily balances. The yields and costs include fees which are considered
adjustments to yields.
Page 22
FOR THE FISCAL YEARS ENDED SEPTEMBER 30,
---------------------------------------------------------------------
(IN THOUSANDS)
2004 2003
--------------------------------- ---------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
--------- --------- --------- --------- --------- ---------
INTEREST-EARNING ASSETS:
Loans (1):
Real estate:
Taxable $ 198,150 $ 12,741 6.43% $ 253,061 $ 17,357 6.86%
Non-taxable (2) 3,791 316 8.34 3,972 326 8.21
Commercial:
Taxable 33,816 1,628 4.82 37,011 2,134 5.77
Non-taxable (2) 6,946 491 7.07 8,244 530 6.43
Consumer 208,751 12,444 5.96 195,959 13,136 6.70
--------- --------- --------- --------- --------- ---------
Total loans $ 451,454 $ 27,620 6.12% $ 498,247 $ 33,483 6.72%
Mortgage-related securities (3) 276,282 10,383 3.76 199,915 6,528 3.27
Investment securities (4):
Taxable 67,294 2,588 3.85 98,362 4,506 4.58
Non-taxable (2) 11,602 859 7.40 19,469 1,376 7.07
Interest-earning deposits 15,370 88 0.57 28,186 220 0.78
--------- --------- --------- --------- --------- ---------
Total interest-earning assets 822,002 $ 41,538 5.05% 844,179 $ 46,113 5.46%
Noninterest-earning assets 43,554 45,522
--------- ---------
Total assets $ 865,556 $ 889,701
========= =========
INTEREST-BEARING LIABILITIES:
Deposits:
Money market and
NOW accounts $ 168,099 $ 1,399 0.83% $ 197,074 $ 2,807 1.42
Savings accounts 95,022 94 0.10 98,278 395 0.40
Certificates of deposit 204,030 6,364 3.12 258,796 8,956 3.46
Brokered CDs 19,470 356 1.83 - - -
--------- --------- --------- --------- --------- ---------
Total deposits $ 486,621 $ 8,213 1.69 $ 554,148 $ 12,158 2.19
FHLB advances and other
borrowings 251,955 10,570 4.20 210,360 11,978 5.69
Trust preferred debt 22,341 1,073 4.80 20,782 1,052 5.06
--------- --------- --------- --------- --------- ---------
Total interest-bearing
liabilities 760,917 19,856 2.61 785,290 25,188 3.21
Non-interest-bearing
liabilities 45,648 39,454
--------- ---------
Total liabilities $ 806,565 $ 824,744
Equity 58,991 64,957
--------- ---------
Total liabilities and equity $ 865,556 $ 889,701
========= =========
Net interest-earning assets $ 61,085 $ 58,889
Net interest income/interest rate
spread (5) $ 21,682 2.44% $ 20,925 2.25%
--------- ---------
Net interest margin (6) 2.64% 2.48%
--------- ---------
Ratio of interest-earning assets to
interest-bearing liabilities 108.03% 107.50%
--------- ---------
FOR THE FISCAL YEARS ENDED
SEPTEMBER 30,
---------------------------------
(in thousands)
AS RESTATED
2002
---------------------------------
Average
Average Yield/
Balance Interest Rate
--------- --------- ---------
INTEREST-EARNING ASSETS:
Loans (1):
Real estate:
Taxable $ 283,768 $ 21,118 7.44%
Non-taxable (2) 4,018 332 8.26
Commercial:
Taxable 26,978 1,885 6.99
Non-taxable (2) 6,623 456 6.88
Consumer 177,832 13,779 7.75
--------- --------- ---------
Total loans $ 499,219 $ 37,570 7.53%
Mortgage-related securities (3) 177,373 8,701 4.91
Investment securities (4):
Taxable 95,787 5,507 5.75
Non-taxable (2) 19,708 1,411 7.16
Interest-earning deposits 16,636 171 1.03
--------- --------- ---------
Total interest-earning assets $ 808,723 $ 53,360 6.60%
Noninterest-earning assets 43,130
---------
Total assets $ 851,853
=========
INTEREST-BEARING LIABILITIES:
Deposits:
Money market and
NOW accounts $ 132,896 $ 2,457 1.85%
Savings accounts 93,114 1,141 1.22
Certificates of deposit 303,365 13,324 4.39
Brokered CDs - - -
--------- --------- ---------
Total deposits $ 529,375 $ 16,922 3.20
FHLB advances and other
borrowings 208,579 11,859 5.69
Trust preferred debt 2,973 207 6.93
--------- --------- ---------
Total interest-bearing
liabilities 740,927 28,988 3.91
Non-interest-bearing
liabilities 41,636
---------
Total liabilities $ 782,563
Equity 69,290
---------
Total liabilities and equity $ 851,853
=========
Net interest-earning assets $ 67,796
Net interest income/interest rate
spread (5) $ 24,372 2.69%
---------
Net interest margin (6) 3.01%
---------
Ratio of interest-earning assets to
interest-bearing liabilities 109.15%
---------
(1) Balances are net of deferred loan origination costs, undisbursed proceeds of
construction loans in process, but include non-performing loans and loans
held-for-sale.
(2) Interest and Yield/Rate are presented on a tax-equivalent basis using a tax
rate of 40%.
(3) Includes mortgage-related securities available-for-sale and
held-to-maturity.
(4) Includes investment securities available for sale and held to maturity,
stock in the FHLB, Freddie Mac and Fannie Mae securities.
(5) Net interest rate spread represents the difference between the
weighted-average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
Page 23
RATE/VOLUME ANALYSIS. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
interest-bearing liabilities have affected the Company's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume (changes
in volume multiplied by prior rate); (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated on a proportional basis between changes in rate and volume.
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------
(IN THOUSANDS)
2004 VS 2003 2003 VS 2002
-------------------------------------- --------------------------------------
Increase Increase
(Decrease) due to (Decrease) due to
--------------------- Total Increase --------------------- Total Increase
Rate Volume (Decrease) Rate Volume (Decrease)
--------- --------- -------------- --------- --------- --------------
INTEREST-EARNING ASSETS:
Loans (1):
Real Estate:
Taxable $ (1,033) $ (3,583) $ (4,616) $ (1,580) $ (2,181) $ (3,761)
Non Taxable (2) 5 (15) (10) (2) (4) (6)
Commercial:
Taxable (332) (174) (506) (221) 470 249
Non Taxable (2) 67 (106) (39) (27) 101 74
Consumer (1,687) 995 (692) (2,634) 1,991 (643)
--------- --------- -------------- --------- --------- --------------
Total loans (2,980) (2,883) (5,863) (4,464) 377 (4,087)
Mortgage-related securities (3) 1,092 2,763 3,855 (3,506) 1,333 (2,173)
Investment securities (4):
Taxable (646) (1,272) (1,918) (1,154) 153 (1,001)
Non Taxable (2) 69 (586) (517) (18) (17) (35)
Interest-earning deposits (49) (83) (132) (26) 75 49
--------- --------- -------------- --------- --------- --------------
Total interest-earning assets (2,514) (2,061) (4,575) (9,168) 1,921 (7,247)
========= ========= ======