UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 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 December 31, 2002.
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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 0-11526
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FIRST COLONIAL GROUP, INC.
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(Name of Registrant as specified in its charter)
Pennsylvania 23-2228154
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
76 South Main Street, Nazareth, Pennsylvania 18064
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 610-746-7300
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Securities registered pursuant to Section 12 (b) of the Exchange Act:
None
Securities registered pursuant to Section 12 (g) of the Exchange Act:
Common Stock, $5.00 Par Value
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(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
during the preceeding 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 ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ---
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes __ No X
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The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold on June 28, 2002, the last business day of the registrant's most
recently completed second fiscal quarter was $43,136,000. (1)
The number of shares of the Issuer's common stock, par value $5.00 per
share, outstanding as of March 17, 2003 was 2,231,974.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the Company's Proxy Statement to be filed in connection
with its 2003 Annual Meeting of Shareholders are incorporated by reference in
Part III of this Report.
Other documents incorporated by reference are listed in the Exhibit Index.
(1) The aggregate dollar amount of the voting stock set forth equals the
number of shares of the registrant's Common Stock outstanding, reduced by the
amount of Common Stock held by executive officers, directors and shareholders
owning in excess of 10% of the registrant's Common Stock, multiplied by the last
sale price for the registrant's Common Stock on June 28, 2002, the last business
day of the registrant's most recently completed second quarter. Includes an
aggregate of 162,103 shares, with an aggregate market value of $3,858,000, held
by the Trust Department of Nazareth National Bank & Trust Company in Trust for
persons other than executive officers, directors and 10% shareholders of the
registrant. The information provided shall in no way be construed as an
admission that any officer, director or 10% shareholder may be deemed an
affiliate of the registrant or that such person is the beneficial owner of the
shares reported as being held by him, and any such inference is hereby
disclaimed. The information provided herein is included solely for record
keeping purposes of the Securities and Exchange Commission.
PART I
Item 1. Business
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Forward Looking Information
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The information contained in this Annual Report contains forward looking
statements (as such term is defined in the Securities Exchange Act of 1934 and
the regulations thereunder), including, without limitation, the discussion of
the planned merger with Keystone Savings Bank, statements as to future loan and
deposit volumes, the allowance and provision for possible loan losses, future
interest rates and their effect on the Company's financial condition or results
of operations, the classification of the Company's investment portfolio,
statements as to litigation and the amount of reserves, statements as to trends,
and other statements which are not historical facts or as to the Company's, the
Bank's or management's intentions, plans, beliefs, expectations or opinions.
Such forward looking statements are subject to risks and uncertainties and may
be affected by various factors which may cause actual results to differ
materially from those in the forward looking statements including, without
limitation, the risk that the transactions contemplated by the Agreement and
Plan of Merger with Keystone Savings Bank may not be completed, the effect of
economic conditions and related uncertainties, the effect of interest rates on
the Company and the Bank, Federal and state government regulation, competition,
changes in accounting standards and policies, and the results of litigation.
These and other risks, uncertainties and other factors are discussed in this
Annual Report or in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002, a copy of which may be obtained from the Company upon request
and without charge (except for the exhibits thereto).
Recent Developments - Merger Agreement
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On March 6, 2003, First Colonial Group, Inc. and Keystone Savings Bank
announced that they had signed an Agreement and Plan of Merger ("Merger
Agreement") to combine, forming the largest locally controlled bank in the
greater Lehigh Valley-Poconos market area.
The resulting bank, Keystone Nazareth Bank & Trust Company, and its newly
created bank holding company, KNBT Bancorp, Inc., will have combined assets of
more than $1.6 billion and 36 branches covering Lehigh, Northampton, Monroe and
Carbon counties. Both banks will continue to operate independently until the
close of the transaction, which is expected to occur in the fourth quarter of
2003.
The transaction involves the conversion of Keystone Savings Bank from a
mutual savings bank to a stock institution; the formation of a holding company,
KNBT Bancorp, Inc.; and the mergers of First Colonial Group into KNBT Bancorp,
Inc. and Nazareth National Bank into Keystone Savings Bank. Each share of First
Colonial will be valued at $37 and exchanged for shares of KNBT Bancorp, Inc.,
common stock based on the initial public offering ("IPO") price of KNBT
Bancorp's common stock.
The transaction is subject to certain conditions, including the receipt of
various regulatory approvals, as well as the approval of First Colonial Group's
shareholders and Keystone Savings Bank's depositors.
Jeffrey P. Feather, chairman of the board of trustees of Keystone Savings
Bank, will serve as chairman of the newly created holding company and bank. Six
members of the First Colonial
Group board will join nine members of the Keystone Savings board to form a new
15-member KNBT Bancorp, Inc. board.
Scott V. Fainor, currently president and chief executive officer of
Nazareth National Bank and First Colonial Group, will become the president and
chief executive officer of Keystone Nazareth Bank & Trust Company and KNBT
Bancorp, Inc., effective upon completion of the transaction.
All branches from both banks are slated to remain open. Also, within the
past six months, both banks have embarked on multi-branch expansion programs
that are expected to continue. Together, the banks currently employ 602 people.
As part of this transaction, a multi-million dollar charitable foundation
will be formed to help fund local projects and programs of civic, charitable and
cultural organizations throughout the region.
Each of the directors of First Colonial Group has agreed to vote their
shares of First Colonial Group in favor of the merger, and each of the trustees
of Keystone Savings Bank has agreed to vote their deposits in favor of the
conversion.
The proposed merger will be submitted to First Colonial Group's
shareholders for their consideration. KNBT Bancorp and First Colonial Group will
file a registration statement, a proxy statement/prospectus and other relevant
documents concerning the proposed transaction with the SEC. Shareholders of
First Colonial are urged to read the registration statement and the proxy
statement/prospectus when it becomes available and any other relevant documents
filed with the SEC, as well as any amendments or supplements to those documents,
because they will contain important information, before making any decision
regarding the merger. Shareholders of First Colonial will be able to obtain a
free copy of the proxy statement/prospectus, as well as other filings containing
information about KNBT Bancorp, Keystone Savings and First Colonial Group, at
the SEC's Internet site (http://www.sec.gov). Copies of the proxy
statement/prospectus can be obtained, without charge, by directing a request to
the Secretary of First Colonial, First Colonial Group, Inc., 76 South Main
Street, Nazareth, Pennsylvania 18064 (610-861-5721).
First Colonial Group and its directors and executive officers may be deemed
to be participants in the solicitation of proxies from the shareholders of First
Colonial Group in connection with the merger. Information about the directors
and executive officers of First Colonial Group and their ownership of First
Colonial Group common stock is set forth in the proxy statement, for First
Colonial Group's 2002 annual meeting of shareholders, as filed with the SEC on a
Schedule 14A. Additional information about the interests of those participants
may be obtained from reading the definitive proxy statement/prospectus regarding
the proposed merger when it becomes available.
Investment Considerations
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In analyzing whether to make or to continue an investment in the Company,
investors should consider, among other factors, the following:
The Company may not be able to complete the transactions contemplated by
the Merger Agreement with Keystone Savings Bank. On March 6, 2003, the Company
and Keystone Savings Bank announced that they had signed an Agreement and Plan
of Merger to combine to form Keystone Nazareth Bank & Trust Company, and a newly
created bank holding
company, KNBT Bancorp, Inc. The transaction is subject to certain conditions,
including the receipt of various federal and state regulatory approvals, as well
as the approval of the Company's shareholders and Keystone Savings Bank's
depositors. The Company cannot assure you that all such required approvals will
be obtained or that the other conditions to closing will be satisfied or waived.
If the transactions contemplated by the Merger Agreement are not completed, it
could have an adverse effect on the market price of the Company's common stock.
We are subject to additional risks following completion of the merger with
Keystone Savings Bank. If management of Keystone Nazareth Bank & Trust Company,
and its newly created bank holding company, KNBT Bancorp, Inc are not able to
successfully integrate the merging banks, the resulting bank may not be able to
realize expected operating efficiencies, eliminate redundant costs or operate
the business profitably. The integration of the banks is subject to a number of
risks, including risks that:
o The integration could divert management's attention from the daily
operations of the bank and otherwise require additional management,
operational and financial resources;
o the conversion of the merging banks' computer and operating systems
into one system may take longer or cost more than expected;
o the resulting bank may be unable to retain depositors, clients or key
employees of the merging banks; and
o the merging banks might have additional liabilities and problems that
were not anticipated at the time of the merger.
Economic Conditions and Related Uncertainties. Commercial banking is
affected, directly and indirectly, by local, domestic, and international
economic and political conditions, and by governmental monetary and fiscal
policies. Conditions such as inflation, recession, unemployment, volatile
interest rates, tight money supply, real estate values, international conflicts
and other factors beyond the Company's control, may adversely affect the
potential profitability of the Company. Any future rises in interest rates,
while increasing the income yield on the Company's earning assets, may adversely
affect loan demand and the cost of funds and, consequently, the profitability of
the Company. Any future decreases in interest rates may adversely affect the
Company's profitability because such decreases may reduce the amounts which the
Company may earn on its assets. Economic downturns could result in the
delinquency of outstanding loans. Management does not expect any one particular
factor to affect the Company's results of operations. However, a downtrend in
several areas, including real estate, construction and consumer spending, could
have an adverse impact on the Company's ability to remain profitable.
Effect of Interest Rates on the Bank and the Company. The operations of
financial institutions such as the Company are dependent to a large degree on
net interest income which is the difference between interest income from loans
and investments and interest expense on deposits and borrowings. An
institution's net interest income is significantly affected by market rates of
interest which in turn are affected by prevailing economic conditions, by the
fiscal and monetary policies of the federal government and by the policies of
various regulatory agencies. At December 31, 2002, total interest earning assets
maturing or repricing within one year was greater than total interest bearing
liabilities maturing or repricing during the same time period by $17,610,000,
representing a positive cumulative one-year gap of 1.09%. If interest rates
fall, the Company could experience a decrease in net interest income. Like all
financial institutions, the Company's balance sheet is affected by fluctuations
in interest rates. Volatility in interest rates can also result in
disintermediation, which is the flow of funds away from financial institutions
into direct investments, such as U. S. Government and corporate securities and
other investment vehicles, including mutual funds, which, because of the absence
of federal insurance premiums and reserve requirements, generally pay higher
rates of return than financial institutions. See "Item 7. Management's
Discussion of Financial Condition and Results of Operations", and "Item 7.A.
Quantitative and Qualitative Disclosure About Market Risk".
Federal and State Government Regulations. The operations of the Company and
the Bank are heavily regulated and will be affected by present and future
legislation and by the policies established from time to time by various federal
and state regulatory authorities. In particular, the monetary policies of the
Federal Reserve Board have had a significant effect on the operating results of
banks in the past, and are expected to continue to do so in the future. Among
the instruments of monetary policy used by the Federal Reserve Board to
implement its objectives are changes in the discount rate charged on bank
borrowings and changes in the reserve requirements on bank deposits. It is not
possible to predict what changes, if any, will be made to the monetary policies
of the Federal Reserve Board or to existing federal and state legislation or the
effect that such changes may have on the future business and earnings prospects
of the Company.
During the past several years, significant legislative attention has been
focused on the regulation and deregulation of the financial services industry.
Non-bank financial institutions, such as securities brokerage firms, insurance
companies and money market funds, have been permitted to engage in activities
which compete directly with traditional bank business.
Accounting Standards. The operations of the Company and the Bank are
affected by accounting standards issued by the Financial Accounting Standards
Board ("FASB") which the Company is required to adopt. The adoption of such
standards can have the effect of reducing the Company's earnings and capital.
Information on current FASB standards that affect the Company can be found in
the Notes to Consolidated Financial Statements contained under the caption,
"Item 8. Financial Statements and Supplementary Data".
Competition. The Company faces strong competition from many other banks,
savings institutions and other financial institutions which have branch offices
or otherwise operate in the Company's market area, as well as many other
companies now offering a range of financial services. Most of these competitors
have substantially greater financial resources than the Company including a
larger capital base which allows them to attract customers seeking larger loans
than the Bank is able to make. In addition, many of the Bank's competitors have
higher legal lending limits than does the Bank. Particularly intense competition
exists for sources of funds including savings and retail time deposits and for
loans, deposits and other services that the Bank offers. As a result of the
recent repeal of the Glass-Steagall Act which separated commercial and
investment banking industries, all banking organizations, including the Company,
are likely to face an increase in competition. See "Supervision and Regulation"
- - "Gramm-Leach-Bliley Act".
Allowance for Loan Losses. The Company has established an allowance for
loan losses which management believes to be adequate to offset probable losses
on the Company's existing loans. However, there is no precise method of
predicting loan losses. There can be no assurance that any future declines in
real estate market conditions, general economic conditions or changes in
regulatory policies will not require the Company to increase its allowance for
loan losses through a charge to earnings resulting in reduced profitability.
Dividends. While the Board of Directors presently intends to follow a
policy of paying cash dividends, the dividend policy will be reviewed
periodically in light of future earnings, regulatory restrictions and other
considerations. No assurance can be given, therefore, that cash
dividends will be paid in the future. See the information contained under the
caption in "Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters".
Market for Common Stock. While the Company's common stock is listed on the
Nasdaq Stock Market, there is no assurance that an active trading market for the
Company's common stock will exist at a particular time. See the information
contained under the caption in "Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters".
"Anti-Takeover" and "Anti-Greenmail" Provisions and Management
Implications. The Articles of the Company presently contain certain provisions
which may be deemed to be "anti-takeover" and "anti-greenmail" in nature in that
such provisions may deter, discourage or make more difficult the assumption of
control of the Company by another corporation or person through a tender offer,
merger, proxy contest or similar transaction or series of transactions. The
overall effects of the "anti-takeover" and "anti-greenmail" provisions may be to
discourage, make more costly or more difficult, or prevent a future takeover
offer, prevent shareholders from receiving a premium for their securities in a
takeover offer, and enhance the possibility that a future bidder for control of
the Company will be required to act through arms-length negotiation with the
Company's Board of Directors. Copies of the Company's Articles of the
Incorporation are on file with the SEC and Pennsylvania Department of State.
Stock Not an Insured Deposit. Investments in the shares of the Company's
common stock are not deposits insured against loss by the FDIC or any other
entity.
Bespeaks Caution Doctrine. Investor should be aware that the U. S. Court of
Appeals for the Third Circuit in In Re: Donald J. Trump Casino Securities
Litigation Taj Mahal, (No. 92-5350 filed October 14, 1993) adopted a legal
doctrine entitled the "Bespeaks Caution Doctrine" which may prevent them from
recovering from the Company based upon material misrepresentations or omissions
contained in the Company's disclosure documents to the extent that such
documents contained sufficient cautionary statements to apprise investors of the
risks of an investment in the Company's securities. The foregoing investment
considerations may have the effect of bringing this document, as well as other
Company disclosure documents, within the purview of the "Bespeaks Caution
Doctrine".
General
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First Colonial Group, Inc. (the "Company) is a Pennsylvania business
corporation which is registered as a bank holding company under the Bank Holding
Company Act of 1956, as amended (the "Holding Company Act"). The Company was
incorporated on December 30, 1982 for the purpose of acquiring Nazareth National
Bank and Trust Company (the "Bank") and thereby enabling the Bank to operate
within a bank holding company structure. The Company became an active bank
holding company on November 25, 1983 when it acquired the Bank. The Bank is a
wholly-owned subsidiary of the Company. In July, 1986, the Company established
it's wholly-owned subsidiary, First C. G. Company, Inc. This subsidiary is a
Delaware business corporation formed for the purpose of investing in various
types of securities. On June 26, 2002, the Company established its subsidiary,
First Colonial Statutory Trust I. This subsidiary is a Connecticut business
trust formed for the purpose of issuing a Trust Preferred Security.
The Company's principal activities consist of owning and supervising the
Bank, which engages in a full service commercial and consumer banking and trust
business. The Company, through the Bank, derives substantially all of its income
from the furnishing of banking and banking-related services. The Bank has its
principal banking office as well as eight branch offices in Northampton County,
five branch offices in Monroe County and three branch offices in Lehigh County,
Pennsylvania.
The Company is a legal entity separate and distinct from the Bank. The
rights of the Company, and thus the rights of the Company's creditors and
shareholders, to participate in distributions of the assets or earnings of the
Bank, are necessarily subject to the prior claims of creditors of the Bank,
except to the extent that claims of the Company itself as a creditor may be
recognized. Such claims on the Bank by creditors other than the Company include
obligations relating to federal funds purchased and certain other borrowings, as
well as deposit liabilities.
The Company directs the policies and coordinates the financial resources of
the Bank. The Company provides and performs various technical, advisory and
auditing services for the Bank, coordinates the Bank's general policies and
activities, and participates in the Bank's major business decisions.
As of December 31, 2002 the Company, on a consolidated basis, had total
assets of $611,592,000, total deposits of $472,798,000, and total shareholders'
equity of $40,314,000.
Nazareth National Bank and Trust Company
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History and Business
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The Bank was incorporated under the laws of the United States of America as
a national bank in 1897 under its present name. Since that time, the Bank has
operated as a banking institution doing business at several locations in
Northampton County, Monroe County and Lehigh County, Pennsylvania. The Bank is a
member of the Federal Reserve System.
As of December 31, 2002, the Bank had total assets of $607,599,000, total
deposits of $478,154,000 and total shareholders' equity of $45,049,000. Its
deposits are insured by the Bank Insurance Fund ("BIF") maintained by the
Federal Deposit Insurance Corporation (the "FDIC") to the maximum extent
permitted by law.
The Bank engages in a full service commercial and consumer banking and
trust business. The Bank, with its main office at 76 South Main Street,
Nazareth, Pennsylvania, also provides services to its customers through its
branch network of seventeen full service banks, which includes drive-in
facilities at most locations, ATMs at each branch office (except the Main Street
Nazareth branch) and bank-by-mail services. Nine of the Bank's full service
offices are located in Northampton County, Pennsylvania. Five offices are
located in Monroe County, Pennsylvania. Three offices are located in Lehigh
County, Pennsylvania. The Bank is currently constructing a new full service
branch at the site of the free-standing ATM's at Northampton Crossings Shopping
Center. In addition, the Bank has signed a lease and received regulatory
approval to establish a new branch at 9th and Hamilton Streets, Allentown,
Lehigh County, Pennsylvania and the Bank has acquired land at Hope Road and
Freemansburg Avenue, Bethlehem Township, Northampton County, Pennsylvania for a
branch location. The Bank is also considering other branch locations.
The Bank's services include accepting time, demand and savings deposits,
including NOW accounts (Flex Checking), regular savings accounts, money market
accounts, super money market accounts (an account that pays a higher rate of
interest for high balances), fixed rate certificates of deposit and club
accounts, including the Vacation Club, the College Club(R) and the Christmas
Club. The Bank offers Mastercard(R) and VISA(R), as well as a Constant Cash
account (a pre-approved line of credit activated by writing checks against a
checking account) and the First Colonial Club(R) and Quality Checking(R)
(deposit package programs which provide checking accounts with other services
including credit card protection, discount travel, shopping services and other
related financial services). Its services also include making secured and
unsecured commercial and consumer loans, financing commercial transactions
either directly or through regional industrial development corporations, making
construction and mortgage loans, and renting safe deposit facilities. Additional
services include making residential mortgage loans (both fixed rate and variable
rate), home equity lines of credit, revolving credit loans with overdraft
checking protection, small business loans, student loans, recreational vehicles
and new and used car and truck loans.
The Bank's business loans include seasonal credit and collateral loans and
term loans as well as accounts receivable and inventory financing. Most of the
Bank's commercial customers are small to medium size businesses operating in
Northampton, Lehigh and Monroe Counties, Pennsylvania, with concentrations in
the Nazareth, Allentown, Bethlehem, Brodheadsville, Easton, and Stroudsburg
areas of Pennsylvania.
Trust and Wealth Management services provided by the Bank include services
as executor and trustee under wills and deeds, as guardian, custodian and as
trustee and agent for pension, profit sharing and other employee benefit trusts
as well as various investment, pension and estate planning services.
The Bank has a relatively stable deposit base and no material amount of
deposits is obtained from a single depositor or group of depositors (including
Federal, state and local governments). The Bank has not experienced any
significant seasonal fluctuations in the amount of its deposits.
Competition
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All phases of the Bank's business are highly competitive. The Bank's market
area is the primary trade area of Northampton and Lehigh Counties (known as the
Lehigh Valley), and Monroe County, Pennsylvania with concentrations in the
Nazareth, Allentown, Bethlehem, Brodheadsville, Easton, and Stroudsburg areas.
In order to keep pace with its competition and the continuing growth of these
areas, the Bank will be establishing several new branches in 2003 and may, in
the future, consider establishing additional new branches, although no assurance
can be given that any new branches will be opened or if opened, that they will
be successful. The Bank competes with local commercial banks as well as other
commercial banks with branches in the Bank's market area. The Bank considers its
major competition to be Ambassador/Lafayette Bank, headquartered in Easton,
Pennsylvania, with branches in Nazareth, Bethlehem and Allentown, Pennsylvania;
Keystone Savings Bank, headquartered in Bethlehem, Pennsylvania with branches in
Nazareth, Easton and Allentown, Pennsylvania; United Trust Bank, headquartered
in Bridgewater, New Jersey with branches in Easton, Pennsylvania, and Bethlehem
Pennsylvania; Wachovia Bank, NA, headquartered in Charlotte, North Carolina,
with branch offices in Easton, Bethlehem, Stroudsburg and Allentown,
Pennsylvania; Fleet National Bank, headquartered in Providence, Rhode Island,
with branches in Bethlehem, Easton and Allentown, Pennsylvania; and PNC Bank
headquartered in Pittsburgh, Pennsylvania, with branches in Nazareth,
Brodheadsville, Stroudsburg, Easton and Allentown, Pennsylvania.
The Bank, along with other commercial banks, competes with respect to its
lending activities, as well as in attracting demand deposits, with savings
banks, savings and loan associations, insurance companies, regulated small loan
companies, credit unions and the issuers of commercial paper and other
securities, such as shares in money market funds. The Bank also competes with
insurance companies, investment counseling firms, mutual funds and other
business firms and individuals in the corporate trust and investment management
services. Many of the Bank's competitors have financial resources larger than
the Bank's.
As a result of the recent repeal of the Glass-Steagall Act which separated
the commercial and investment banking industries, all banking organizations are
likely to face an increase in competition. See "Supervision and Regulation" -
"Recent Regulation".
Management believes that the Bank is generally competitive with all
competing financial institutions in its service areas with respect to interest
rates paid on time and savings deposits, service charges on deposit accounts and
interest rates charged on loans.
First C. G. Company, Inc.
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In July 1986, the Company established a wholly-owned subsidiary, First C.
G. Company, Inc., a Delaware corporation, for the purpose of investing in
various types of securities. As of December 31, 2002, First C. G. Company, Inc.
had total assets of $4,486,000, of which $3,218,000 was invested in common
stocks and $1,093,000 in loans to the Bank's ESOP and most of the remaining
assets were in interest-bearing bank deposits. The total shareholders' equity at
December 31, 2002 was $4,452,000.
First Colonial Statutory Trust I
- --------------------------------
On June 26, 2002, the Company established its subsidiary, First Colonial
Statutory Trust I, a Connecticut business trust for the purpose of issuing
$15,000,000 of Trust Preferred Securities. First Colonial Statutory Trust I had
total assets of $15,477,000 at December 31, 2002. At December 31, 2002 the Trust
had trust preferred debt outstanding of $15,000,000 and total equity of
$464,000.
Supervision and Regulation
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Bank holding companies and banks are extensively regulated under both
federal and state law. The regulatory framework is intended primarily for the
protection of depositors, other customers and the federal deposit insurance
funds and not for the protection of shareholders. To the extent that the
following information describes statutory and regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in applicable laws or regulations may have a
material effect on the business and prospects of the Company and the Bank.
The Company
-----------
The Company is registered as a "bank holding company" under the Bank
Holding Act of 1956, as amended (the "Holding Company Act"), and is, therefore,
subject to supervision and regulation by the Board of Governors of the Federal
Reserve Board (the "Federal Reserve Board"). The Company is also regulated by
the Pennsylvania Department of Banking.
Under the Holding Company Act, the Company is required to secure the prior
approval of the Federal Reserve Board before it can merge or consolidate with
any other bank holding company or acquire all or substantially all of the assets
of any bank or acquire direct or indirect ownership or control of any voting
shares of any bank that is not already majority owned by it, if after such
acquisition, it would directly or indirectly own or control more than 5% of the
voting shares of such bank.
The Company is generally prohibited under the Holding Company Act from
engaging in, or acquiring direct or indirect ownership or control of more than
5% of the voting shares of any company engaged in non-banking activities unless
the Federal Reserve Board, by order or regulation, has found such activities to
be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. In making such determination, the Federal Reserve Board
considers whether the performance of these activities by a bank holding company
can reasonably be expected to produce benefits to the public, which outweigh
possible adverse effects.
Satisfactory financial condition, particularly with regard to capital
adequacy, and satisfactory Community Reinvestment Act ratings are generally
prerequisites to obtaining federal regulatory approval to make acquisitions. The
Bank currently is rated "satisfactory" under the Community Reinvestment Act.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
(the "1991 Act"), a bank holding company is required to guarantee that any
"undercapitalized" (as such term is defined in the statute) insured depository
institution subsidiary will comply with the terms of any capital restoration
plan filed by such subsidiary with its appropriate federal banking agency to the
lesser of (i) an amount equal to 5% of the institution's total assets at the
time the institution became undercapitalized, or (ii) the amount which is
necessary (or would have been necessary) to bring the institution into
compliance with all capital standards as of the time the institution failed to
comply with such capital restoration plan.
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
contains a "cross-guarantee" provision that could result in any insured
depository institution owned by the Company being assessed for losses incurred
by the FDIC in connection with assistance provided to, or the failure of, any
other depository institution owned by the Company. Also, under Federal Reserve
Board policy, the Company is expected to act as a source of financial strength
to each of its banking subsidiaries and to commit resources to support each such
bank in circumstances where such bank might not be in a financial position to
support itself. Consistent with the "source of strength" policy for subsidiary
banks, the Federal Reserve Board has stated that, as a matter of prudent
banking, a bank holding company generally should not maintain a rate of cash
dividends unless its net income available to common shareholders has been
sufficient to fully fund the dividends and the prospective rate of earnings
retention appears to be consistent with the corporation's capital needs, asset
quality and overall financial condition.
Under the Holding Company Act, the Company is required to file periodic
reports and other information concerning its operations with, and is subject to
examination by, the Federal Reserve Board. In addition, under the Banking Code
of 1965, the Pennsylvania Department of Banking has the authority to examine the
books, records and affairs of any Pennsylvania bank holding company or to
require any documentation deemed necessary to ensure compliance with the Banking
code.
The Company is under the jurisdiction of the Securities and Exchange
Commission and various state securities commissions for matters relating to the
offering and sale of its securities, and is subject to the Securities and
Exchange Commission's rules and regulations relating to periodic reporting,
reporting to shareholders, proxy solicitation and insider trading.
There are various legal restrictions on the extent to which the Company and
its non-bank subsidiary can borrow or otherwise obtain credit from its banking
subsidiary. In general, these restrictions require that any such extensions of
credit must be secured by designated amounts of specified collateral and are
limited, as to any one of the Company or such non-bank subsidiary, to ten
percent of the lending bank's capital stock and surplus, and as to the Company
and its non-bank subsidiary in the aggregate, to 20 percent of such lending
bank's capital stock and surplus. Further, a bank holding company and its
subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
The Bank
--------
The Bank, as a national bank, is subject to The National Bank Act. The Bank
is also subject to the supervision of, and is regularly examined by, the Office
of the Comptroller of the Currency of the United States (the "OCC") and is
required to furnish quarterly reports to the OCC. The approval of the OCC is
required for the establishment of additional branch offices by any national
bank, subject to applicable state law restrictions. Under current Pennsylvania
law, banking institutions located in Pennsylvania, such as the Bank, may
establish branches within any county in the Commonwealth, subject to the prior
regulatory approval.
Under the Community Reinvestment Act, as amended ("CRA"), a bank 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. 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 CRA. CRA
requires the applicable regulatory agency to assess an 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 requires
public disclosure of an institution's CRA rating and requires that the
applicable regulatory agency provide a written evaluation of an institution's
CRA performance utilizing a four-tiered descriptive rating system. An
institution's CRA rating is considered in determining whether to grant charters,
branches and other deposit facilities, relocations, mergers, consolidations and
acquisitions. Performance less than satisfactory may be the basis for denying an
application. In addition, under applicable regulations a bank having a less than
satisfactory rating is not entitled to participate on the bid list for FDIC
offerings. For its most recent examination, the Bank received an "outstanding"
rating.
As a national bank, the Bank is a member of the FDIC and a member of the
Federal Reserve System and, therefore, is subject to additional regulation by
these agencies. Some of the aspects of the lending and deposit business of the
Bank which are regulated by these agencies include personal lending, mortgage
lending and reserve requirements. The operations of the Bank are also subject to
numerous Federal, state and local laws and regulations which set forth specific
restrictions and procedural requirements with respect to interest rates on
loans, the extension of credit, credit practices, the disclosure of credit terms
and discrimination in credit transactions.
The Bank is subject to certain limitations on the amount of cash dividends
it can pay. See "Note S - Regulatory Matters" in the Notes to Consolidated
Financial Statements which appears elsewhere herein.
The OCC has authority under the Financial Institutions Supervisory Act to
prohibit national banks from engaging in any activity which, in the OCC's
opinion, constitutes an unsafe or unsound practice in conducting their
businesses. The Federal Reserve Board has similar authority with respect to the
Company and the Company's non-bank subsidiary.
Substantially all of the deposits of the Bank are insured up to applicable
limits by the Bank Insurance Fund ("BIF") of the FDIC and are subject to deposit
insurance assessments to maintain the BIF. The insurance assessments are based
upon a matrix that takes into account a bank's capital level and supervisory
rating. Effective January 1, 1996, the FDIC reduced the
insurance premiums it charged on bank deposits insured by the BIF to the
statutory minimum of $2,000 annually for "well-capitalized" banks.
Capital Regulation
------------------
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial condition and results of
operation. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of the Company's and the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and the Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of Tier
1 capital of at least 4% and total capital, Tier 1 and Tier 2, of 8% of
risk-adjusted assets and of Tier 1 capital from 3% to 5% of average assets
(leverage ratio). The 3% leverage ratio is a minimum for the top-rated banking
organizations without any supervisory, financial or operational weaknesses or
deficiencies and other banking organizations are expected to maintain leverage
capital ratios 100 to 200 basis points above the minimum depending on their
financial condition. Tier 1 capital includes common shareholders' equity and
qualifying perpetual preferred stock together with related surpluses and
retained earnings. Tier 2 capital may be comprised of limited life preferred
stock, qualifying debt instruments, and the allowance for possible loan losses.
Management believes, as of December 31, 2002 that the Company and the Bank meet
all capital adequacy requirements to which they are subject.
The following tables provide a comparison of the Company's and Bank's
capital amounts, risk-based capital ratios and leverage ratios for the periods
indicated.
- -----------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- ----------------------------
at December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------
Total Capital
(To Risk-Weighted Assets)
Company, (Consolidated) $56,032 18.45% $24,301 8.00% $ - -
Bank $46,767 15.63% $23,935 8.00% $ 29,918 10.00%
Tier I Capital
(To Risk-Weighted Assets)
Company, (Consolidated) $50,598 16.66% $12,151 4.00% $ - -
Bank $42,683 14.27% $11,967 4.00% $ 17,951 6.00%
Tier I Capital
(To Average Assets, Leverage)
Company (Consolidated) $50,598 8.81% $22,978 4.00% $ - -
Bank $42,683 7.48% $22,833 4.00% $ 28,541 5.00%
- -----------------------------------------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- ----------------------------
at December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------
Total Capital
(To Risk-Weighted Assets)
Company, (Consolidated) $37,926 15.38% $19,738 8.00% $ - -
Bank $32,931 13.50% $19,515 8.00% $ 24,393 10.00%
Tier I Capital
(To Risk-Weighted Assets)
Company, (Consolidated) $35,662 14.46% $ 9,869 4.00% $ - -
Bank $30,667 12.58% $ 9,757 4.00% $ 14,636 6.00%
Tier I Capital
(To Average Assets, Leverage)
Company (Consolidated) $35,662 7.65% $18,661 4.00% $ - -
Bank $30,667 6.61% $18,575 4.00% $ 23,218 5.00%
- -----------------------------------------------------------------------------------------------------------------------
Gramm-Leach-Bliley Act
----------------------
On November 12, 1999 the Gramm-Leach-Bliley Act (the "Act") became law,
repealing the 1933 Glass-Steagall Act's separation of the commercial and
investment banking industries. The Act expands the range of nonbanking
activities a bank holding company may engage in, while preserving existing
authority for bank holding companies to engage in activities that are closely
related to banking. The new legislation creates a new category of holding
company called a "Financial Holding Company", a subset of bank holding companies
that satisfy the following criteria: (1) all of the depository institution
subsidiaries must be well capitalized and well managed; and (2) the holding
company must have made an effective election to be a financial holding company
to engage in activities that would not have been permissible before the Act. In
order for the election to be effective, all of the depository institution
subsidiaries must have a CRA rating of "satisfactory" or better at its most
recent examination. The Company has not elected to be a financial holding
company. Financial holding companies may engage in any activity that (i) is
financial in nature or incidental to such financial activity or (ii) is
complementary to a financial activity and does not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally. The Act specifies certain activities that are financial in nature.
These activities include - acting as principal, agent or broker for insurance; -
underwriting, dealing in or making a market in securities; and - providing
financial and investment advice. The Federal Reserve Board and the Secretary of
the Treasury have authority to decide whether other activities are also
financial in nature or incidental to financial activity, taking into account
changes in technology, changes in the banking marketplace, competition for
banking services and so on.
The financial activities authorized by the Act may also be engaged in by a
"financial subsidiary" of a national or state bank, except for insurance or
annuity underwriting, insurance company portfolio investments, real estate
investment and development, and merchant banking, which must be conducted in a
financial holding company. In order for the new financial activities to be
engaged in by a financial subsidiary of a national or state bank, the Act
requires each of the parent bank (and its sister-bank affiliates) to be well
capitalized and well managed; the aggregate consolidated assets of all of that
bank's financial subsidiaries may not exceed the lesser of 45% of its
consolidated total assets or $50 billion; the bank must have at least a
satisfactory CRA rating; and, if that bank is one of the 100 largest national
banks, it must meet certain financial rating or other comparable requirements.
The Act establishes a system of financial regulation, under which the
federal banking agencies will regulate the banking activities of financial
holding companies and bank's financial subsidiaries, the Securities and Exchange
Commission will regulate their securities activities and state insurance
regulators will regulate their insurance activities. The Act also provides new
protections against the transfer and use by financial institutions of consumers'
nonpublic, personal information.
National Monetary Policy
------------------------
In addition to being affected by general economic conditions, the earnings
and growth of the Bank and, therefore, the earnings and growth of the Company,
are affected by the policies of regulatory authorities, including the OCC, the
Federal Reserve Board and the FDIC. An important function of the Federal Reserve
Board is to regulate the money supply, credit conditions and interest rates.
Among the instruments used to implement these objectives are open market
operations in United States Government securities, setting the discount rate and
changes in reserve requirements against bank deposits. These instruments are
used in varying combinations to influence overall growth and distribution of
credit, bank loans, investments and deposits, and their use may also affect
interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the Federal Reserve Board have had
a significant effect on the operating results of commercial banks in the past
and are expected to continue to do so in the future. The effects of such
policies upon the future business, earnings and growth of the Company and the
Bank cannot be predicted.
Fair Value of Financial Instruments
-----------------------------------
The Financial Accounting Standards Board ("FASB") issued statement of
financial accounting standards (SFAS) No. 107, "Disclosures About Fair Value of
Financial Instruments", which requires all entities to disclose the estimated
fair value of its assets and liabilities considered to be financial instruments.
Financial instruments consist primarily of securities, loans and deposits. The
Company has provided these disclosures as of December 31, 2002 and 2001 in Note
U of the Notes to Consolidated Financial Statements contained under the caption,
"Item 8. Financial Statements and Supplementary Data".
Accounting for Investment Securities
------------------------------------
The Company classifies its debt and marketable securities into three
categories: trading, available-for-sale, and held-to-maturity as provided by the
Financial Accounting Standards Board Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
(SFAS No. 115). Trading securities are measured at fair value with unrealized
holding gains and losses included in income. The Company had no trading
securities in 2002 and 2001. Available-for-sale securities are stated separately
on the financial statements and are discussed in the following section
"Securities Available-for-Sale". Held-to-maturity securities are carried at
amortized cost and identified as investment securities in the financial
statements. The classification of securities can be found in Note B of the Notes
to Consolidated Financial Statements contained under the caption, "Item 8.
Financial Statements and Supplementary Data".
Employees
---------
As of December 31, 2002, the Company had approximately 229 employees, of
whom 54 were part-time. The Company considers its relationship with its
employees to be good.
Item 2. Description of Property
- ------ -----------------------
The principal banking office of the Bank and the Trust and Wealth
Management offices of the Bank and the Company are located at 76 South Main
Street in the Borough of Nazareth, Northampton County, Pennsylvania, which
building is owned by the Bank. In addition, the Bank owns additional properties
located at 29 South Broad Street, Nazareth, Pennsylvania (Mortgage and
Installment Loan Center); 553 Nazareth Drive, Nazareth, Pennsylvania (Branch
Office); 33 S. Broad Street, Nazareth (Branch Office), 47 Belvidere Street,
Nazareth, Pennsylvania (garage and parking lot), 2000 Sullivan Trail, Easton,
Pennsylvania (Branch Office), 3864 Adler Place, Bethlehem Business Park,
Bethlehem, Pennsylvania (First Colonial Building, Executive and Commercial
Lending and Operations offices), Rt. 209 Brodheadsville, Pennsylvania (Branch
Office), 3856 Easton-Nazareth Highway (Route 248), Lower Nazareth Township,
Easton, Pennsylvania (free-standing, drive-up ATM location), and 4261
Freemansburg Avenue, Bethlehem Township, Easton, Pennsylvania (future branch
location).
The Bank also leases facilities for its branch office located at 44 East
Broad Street, Bethlehem, Pennsylvania; its branch office located at 4510 Bath
Pike in Hanover Township (Bethlehem), Pennsylvania; its branch office located at
101 South Third Street, Easton, Pennsylvania; its branch office located at 1125
N. Ninth Street, Stroudsburg, Pennsylvania; its branch office located at 713
Main Street, Stroudsburg, Pennsylvania; its branch office located in the Hall
Square Retirement Center, 175 W. North Street, Nazareth, Pennsylvania; its
branch office located within Redner's Supermarket, Airport Road, Allentown,
Pennsylvania; and its branch office located within Redner's Supermarket,
Northampton Crossings Shopping Center, Lower Nazareth Township, Pennsylvania;
its branch office located within Wal-Mart's at 355 Lincoln Avenue, East
Stroudsburg, Pennsylvania; its branch office located within Wal-Mart's at 500
Route 940, Mt. Pocono, Pennsylvania; its branch office located within the Giant
Supermarket, 2540 McArthur Road, Whitehall, Pennsylvania; its branch office
located within the Giant Supermarket, 6900 Hamilton Boulevard, Trexlertown,
Pennsylvania; and 9th and Hamilton Streets, Allentown, Pennsylvania (future
branch location).
Item 3. Legal Proceedings
- ------- -----------------
From time-to-time, the Company and the Bank are parties to routine
litigation incidental to their business.
Neither the Company, the Bank nor any of their properties is subject to any
material legal proceedings, nor are any such proceedings known to be
contemplated by any governmental authorities.
Item 4. Submission of Matters to a Vote of Security Holders
- ------ ---------------------------------------------------
No matter was submitted to a vote of shareholders during the fourth quarter
of the fiscal year covered by this report.
Item 4.1: Executive Officers of the Registrant
- --------- ------------------------------------
The following table sets forth certain information, as of March 28, 2003,
concerning the executive officers of the Company and certain executive officers
of the Bank who are not also Directors.
Positions Positions
Name/Age with the Company with the Bank
- -------------------------------- ----------------------------------- --------------------------------------
Reid L. Heeren Treasurer since January, 1987; Executive Vice President and
61 (a) Vice President since April, 1985 Chief Financial Officer since
August, 1997; Senior Vice President
and Chief Financial Officer since
January, 1987; Cashier since
November, 1984
Tomas J. Bamberger None Executive Vice President and
61 (b) Senior Loan Officer since September,
1997
Robert M. McGovern None Executive Vice President,
64 (c) Senior Trust Officer
since February, 1999
David W. Hughes None Executive Vice President, Marketing
55 (d) and Branch Administration since
March, 2001
Marna Hayden None Senior Vice President,
65 (e) Human Resources
since January, 1999;
Vice President of Human
Resources since November,
1982; Assistant Vice President,
Personnel and Public Relations
Director since October, 1976
Carl F. Kovacs None Senior Vice President,
52 (f) Information Technology and
General Operations
since November, 2002
- --------------------------------
(a) Mr. Heeren was previously Senior Vice President, Chief Financial Officer and
Cashier of the Bank from January 1987 to August 1997 and Vice President, Finance
of the Bank from November, 1984 to January, 1987. Prior to November, 1984, Mr.
Heeren was employed by the American Bank and Trust Company, headquartered in
Reading, Pennsylvania, as Vice President for Financial Management (September,
1982 to November, 1984) and was Vice President, Community Banking, Chester
County, Pennsylvania (March, 1982 to September, 1982).
(b) Mr. Bamberger was previously Executive Vice President and Senior Loan
Officer of First Valley Bank/Summit Bank (PA) from February 1984 to September
1997. Prior to that, he was Senior Vice President and Senior Loan Officer of the
First National Bank of Allentown from March 1982 to February 1984. Mr. Bamberger
started his banking career in October 1967 at Girard Bank in Philadelphia. He
was a Vice President and Divisional Manager in commercial lending when he left
in February 1982.
(c) Mr. McGovern was previously Vice President and Senior Trust Specialist of
First Union National Bank from April 1998 to February 1999. Prior to that, Mr.
McGovern was Vice President/Trust of CoreStates Bank from 1996 to 1998. From
1985 until 1996, Mr. McGovern was employed by Meridian Bank, most recently as
Vice President until it was acquired by CoreStates Bank in 1996.
(d) Mr. Hughes was previously Senior Team Lender, Retail Banking, at Patriot
Bank from 1999 to 2001; Regional Vice President, Retail Banking, Corestates
Bank/First Union from 1992 to 1999; Executive Vice President at Lehigh Valley
Bank from 1991 to 1992; Regional Vice President, Retail Banking at Girard
Bank/Mellon Bank from 1983 to 1991.
(e) Ms. Hayden was previously Employment Manager, Alexander's Department Store
in New York, New York from 1967 to 1969 and was Personnel Manager, Alexander's
Rent-a-Car in New York, New York from 1965 to 1967.
(f) Mr. Kovacs was previously Senior Vice President for Strategic Planning and
Internal Compliance from January 2002 to November 2002. Prior to that he was
Site Manager, Aurum Technology, Inc. from September 2001 to January 2002; Vice
President, Regional Sales Marketing Leader, First Union Bank from 1997 to March
2001; Vice President, Statement Services Manager, First Union Bank from 1996 to
1997; Vice President Statement Services/Signature Verification Manager, Global
Processing Alliance from 1994 to 1996; Vice President, Encoding/Transportation
Manager, First Fidelity Bank from 1991 to 1994; Vice President, Director of
General Operations, Merchants Bank from 1986 to 1991.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------ ---------------------------------------------------------------------
First Colonial Group, Inc. common stock trades on the Nasdaq National
Market under the trading symbol FTCG. In newspaper listings, First Colonial
Group, Inc. shares are frequently listed as "First Colnl" or "First Col Group".
At the close of business on December 31, 2002, there were 750 shareholders of
record.
The declaration and payment of dividends is at the sole discretion of the
Board of Directors, and their amount depends upon the earnings, financial
condition, and capital needs of the Company and the Bank and certain other
factors including restrictions arising from Federal banking laws and regulations
(see "Note S - Regulatory Matters" in the "Notes to Consolidated Financial
Statements").
The following table sets forth for the periods indicated high and low sale
prices reported for the Company's common stock and the respective dividends
declared per common share. The last sale price was $22.70 in December 2002 and
$21.38 in December 2001. Stock prices and dividends per share have been restated
to reflect the 5% stock dividends of May 2002 and June 2001 (see "Note T -
Equity Transactions" in the "Notes to Consolidated Financial Statements"
contained in "Item 8. Financial Statements and Supplementary Data").
- --------------------------------------------------------------------------
Cash Dividends
High Low Declared
- --------------------------------------------------------------------------
2001
First Quarter $15.08 $ 12.24 $ 0.1724
Second Quarter 15.57 13.37 0.1724
Third Quarter 19.29 14.14 0.1810
Fourth Quarter 23.76 16.76 0.1810
-------------
TOTAL $ 0.7068
- --------------------------------------------------------------------------
2002
First Quarter $24.00 $ 20.24 $ 0.1810
Second Quarter 25.24 21.81 0.1810
Third Quarter 25.81 18.00 0.1900
Fourth Quarter 25.00 22.59 0.1900
-------------
TOTAL $ 0.7420
- --------------------------------------------------------------------------
Except as previously reported, the Company did not sell any of its equity
securities during 2002 that were not registered under the Securities Act of
1933.
For information regarding the Company's equity compensation plans, see Item
12.
Item 6. Selected Financial Data
- ------- -----------------------
- ------------------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL DATA
(Dollars in Thousands, except per share data)
As of and For the Year Ended December 31, 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED SUMMARY OF INCOME
Interest Income $ 29,530 $ 30,035 $ 29,287 $ 26,353 $ 25,367
Interest Expense 12,410 13,969 13,947 11,449 10,871
------------ -------------- -------------- -------------- -------------
Net Interest Income 17,120 16,066 15,340 14,904 14,496
Provision for Possible Loan Losses 1,541 580 375 375 450
Gains on the Sale of Mortgage Loans 1,122 346 59 157 398
Other Income, Excluding Securities
and Loan Sale Gains 4,532 4,332 4,089 3,635 3,460
Securities Gains, Net 1,253 929 174 563 722
Other Expenses 17,611 16,728 16,945 14,673 14,563
------------ -------------- -------------- -------------- -------------
Income Before Income Taxes 4,875 4,365 2,342 4,211 4,063
Income Taxes 877 808 270 929 1,031
------------ -------------- -------------- -------------- -------------
Net Income $ 3,998 $ 3,557 $ 2,072 $ 3,282 $ 3,032
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Dividends Paid $ 1,597 $ 1,489 $ 1,406 $ 1,321 $ 1,275
Cash Dividends Paid Per Share 0.74 0.70 0.67 0.64 0.61
Dividends Paid to Net Income 39.95 % 41.86 % 67.86 % 40.25 % 42.05 %
PER SHARE DATA
Basic Income $ 1.85 $ 1.69 $ 0.99 $ 1.59 $ 1.45
Diluted Net Income 1.82 1.68 0.99 1.58 1.44
Basic Average Common Shares Outstanding 2,169,410 2,109,821 2,094,421 2,067,540 2,089,572
Dilutive Average Common Shares Outstanding 2,216,049 2,115,510 2,096,759 2,071,352 2,098,656
CONSOLIDATED BALANCE SHEET DATA
Total Assets $611,592 $465,144 $443,051 $391,889 $ 358,496
Loans (Net of Unearned Discount) 255,844 225,757 226,944 202,258 212,437
Mortgage Loans Held-for-Sale 1,263 3,808 - - 603
Deposits 472,798 379,886 353,190 324,480 294,549
Securities Sold Under Agreements to Repurchase 8,801 8,380 7,215 1,730 5,094
Debt (Short-Term and Long-Term) 67,921 34,804 39,695 30,000 20,000
Guaranteed Preferred Beneficial Interest in the
Company's Subordinated Debentures 15,000 - - - -
Shareholders' Equity 40,314 35,326 33,521 28,243 31,717
Book Value Per Share 18.18 16.96 17.08 15.28 18.17
SELECTED CONSOLIDATED RATIOS Net Income To:
Average Total Assets 0.77 % 0.79 % 0.50 % 0.86 % 0.86 %
Average Shareholders' Equity 10.62 % 10.10 % 7.04 % 10.90 % 9.79 %
Tier 1 Capital to Average Assets (Leverage) 8.81 % 7.65 % 8.00 % 8.32 % 8.60 %
- ------------------------------------------------------------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following financial review and analysis are intended to assist in
understanding and evaluating the major changes in the financial condition and
earnings performance of First Colonial Group, Inc. (the "Company") with a
primary focus on the analysis of operating results for the years ended December
31, 2002, 2001 and 2000. The Company's consolidated earnings are derived
primarily from the operations of the Company's subsidiaries Nazareth National
Bank and Trust Company (the "Bank"), First C. G. Company, Inc. ("First C. G.")
and First Colonial Statutory Trust I (the "Statutory Trust I"). The information
below should be read in conjunction with the Company's consolidated financial
statements and accompanying notes thereto, and other detailed information
appearing elsewhere in this report. Additional financial information can be
found in the Company's Annual Report on Form 10-K, a copy of which may be
obtained upon request. During the two most recent fiscal years, there have been
no changes in or disagreements with the Company's accountants on accounting and
financial disclosure. The information concerning share and per share data
included in this discussion have been restated to reflect the 5% stock dividends
paid in May 2002, June 2001 and June 2000.
Forward Looking Statements
The information contained in this Annual Report contains forward
looking statements (as such term is defined in the Securities Exchange Act of
1934 and the regulations thereunder), including, without limitation, the
discussion of the planned merger with Keystone Savings Bank, statements as to
future loan and deposit volumes, the allowance and provision for possible loan
losses, future interest rates and their effect on the Company's financial
condition or results of operations, the classification of the Company's
investment portfolio, statements as to litigation and the amount of reserves,
statements as to trends, and other statements which are not historical facts or
as to the Company's, the Bank's or management's intentions, plans, beliefs,
expectations or opinions. Such forward looking statements are subject to risks
and uncertainties and may be affected by various factors which may cause actual
results to differ materially from those in the forward looking statements
including, without limitation, the risk that the transactions contemplated by
the Agreement and Plan of Merger with Keystone Savings Bank may not be
completed, the effect of economic conditions and related uncertainties, the
effect of interest rates on the Company and the Bank, Federal and state
government regulation, competition, changes in accounting standards and
policies, and the results of litigation. These and other risks, uncertainties
and other factors are discussed in this Annual Report or in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002, a copy of which may be
obtained from the Company upon request and without charge (except for the
exhibits thereto).
Recent Developments - Merger Agreement
On March 6, 2003, First Colonial Group, Inc. and Keystone Savings Bank
announced that they had signed an Agreement and Plan of Merger to combine,
forming the largest locally controlled bank in the greater Lehigh Valley-Poconos
market area.
The resulting bank, Keystone Nazareth Bank & Trust Company, and its
newly created bank holding company, KNBT Bancorp, Inc., will have combined
assets of more than $1.6 billion and 36 branches covering Lehigh, Northampton,
Monroe and Carbon counties. Both banks will continue to operate independently
until the close of the transaction, which is expected to occur in the fourth
quarter of 2003.
The transaction involves the conversion of Keystone Savings Bank from a
mutual savings bank to a stock institution; the formation of a holding company,
KNBT Bancorp, Inc.; and the mergers of First Colonial Group into KNBT Bancorp,
Inc. and Nazareth National Bank into Keystone Savings Bank. Each share of First
Colonial will be valued at $37 and exchanged for shares of KNBT Bancorp, Inc.,
common stock based on the initial public offering ("IPO") price of KNBT
Bancorp's common stock.
The transaction is subject to certain conditions, including the receipt
of various regulatory approvals, as well as the approval of First Colonial
Group's shareholders and Keystone Savings Bank's depositors.
Jeffrey P. Feather, chairman of the board of trustees of Keystone
Savings Bank, will serve as chairman of the newly created holding company and
bank. Six members of the First Colonial Group board will join nine members of
the Keystone Savings board to form a new 15-member KNBT Bancorp, Inc. board.
Scott V. Fainor, currently president and chief executive officer of
Nazareth National Bank and First Colonial Group, will become the president and
chief executive officer of Keystone Nazareth Bank & Trust Company and KNBT
Bancorp, Inc., effective upon completion of the transaction.
All branches from both banks are slated to remain open. Also, within
the past six months, both banks have embarked on multi-branch expansion programs
that are expected to continue. Together, the banks currently employ 602 people.
As part of this transaction, a multi-million dollar charitable
foundation will be formed to help fund local projects and programs of civic,
charitable and cultural organizations throughout the region.
Each of the directors of First Colonial Group has agreed to vote their
shares of First Colonial Group in favor of the merger, and each of the trustees
of Keystone Savings Bank has agreed to vote their deposits in favor of the
conversion.
The proposed merger will be submitted to First Colonial Group's
shareholders for their consideration. KNBT Bancorp and First Colonial Group will
file a registration statement, a proxy statement/prospectus and other relevant
documents concerning the proposed transaction with the SEC. Shareholders of
First Colonial are urged to read the registration statement and the proxy
statement/prospectus when it becomes available and any other relevant documents
filed with the SEC, as well as any amendments or supplements to those documents,
because they will contain important information, before making any decision
regarding the merger. Shareholders of First Colonial will be able to obtain a
free copy of the proxy statement/prospectus, as well as other filings containing
information about KNBT Bancorp, Keystone Savings and First Colonial Group, at
the SEC's Internet site (http://www.sec.gov). Copies of the proxy
statement/prospectus can be obtained, without charge, by directing a request to
the Secretary of First Colonial, First Colonial Group, Inc., 76 South Main
Street, Nazareth, Pennsylvania 18064 (610-861-5721).
First Colonial Group and its directors and executive officers may be
deemed to be participants in the solicitation of proxies from the shareholders
of First Colonial Group in connection with the merger. Information about the
directors and executive officers of First Colonial Group and their ownership of
First Colonial Group common stock is set forth in the proxy statement, for First
Colonial Group's 2002 annual meeting of shareholders, as filed with the SEC on a
Schedule 14A. Additional information about the interests of those participants
may be
obtained from reading the definitive proxy statement/prospectus regarding the
proposed merger when it becomes available.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and the assumptions
that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated probable credit losses. Management's
determination of the adequacy of the allowance is based on periodic evaluations
of the loan portfolio and other relevant factors. However, this evaluation is
inherently subjective as it requires material estimates, including, among
others, expected default probabilities, loss given default, expected commitment
usage, the amounts and timing of expected future cash flows on impaired loans,
mortgages, and general amounts for historical loss experience. The process also
considers economic conditions, uncertainties in estimating losses and inherent
risks in the loan portfolio. All of these factors may be susceptible to
significant change. To the extent actual outcomes differ from management
estimates, additional provisions for loan losses may be required that would
adversely impact earnings in future periods.
With the adoption of SFAS No. 142 on January 1, 2002, the Company
discontinued the amortization of goodwill resulting from acquisition. Goodwill
is now subject to impairment testing at least annually to determine whether
write-downs of the recorded balances are necessary. The Company tests for
impairment based on the goodwill maintained at each defined reporting unit. A
fair value is determined for each reporting unit based on at least one of three
various market valuation methodologies. If the fair values of the reporting
units exceed their book values, no write-down of recorded goodwill is necessary.
If the fair value of the reporting unit is less, an expense may be required on
the Company's books to write down the related goodwill to the proper carrying
value. As of December 31, 2002, the Company determined that no impairment
write-offs were necessary.
In August, 2001, the FASB issued SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. However, SFAS 144 makes changes to
the scope and certain measurement requirements of existing accounting guidance.
SFAS 144 also changes the requirements relating to reporting the effects of a
disposal or discontinuation of a segment of a business. SFAS 144 is effective
for financial statements issued for fiscal
years beginning after December 15, 2001 and interim periods within those fiscal
years. The adoption of this statement is not expected to have a significant
impact on the financial condition or results of operations of the Company.
The Company recognizes deferred tax assets and liabilities for future
tax effects of temporary differences, net operating loss carryforwards and tax
credits. Deferred tax assets are subject to management's judgment based upon
available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount. For further information, see Note A - Summary of
Accounting Policies in the "Notes to Consolidated Financial Statements".
Financial Performance Summary
In 2002, the Company recorded net income of $3,998,000. The 2002 net
income was $441,000 or 12.4% higher than 2001 net income of $3,557,000. The
Company's net income in 2000 was $2,072,000.
Basic earnings per share were $1.85, $1.69 and $0.99 in 2002, 2001 and
2000, respectively. Diluted earnings per share were $1.82 in 2002, $1.68 in 2001
and $0.99 in 2000. Diluted earnings per share include the effect of common stock
equivalents such as options (see Note Q of the "Notes to Consolidated Financial
Statements").
The Company's return on average assets was .77% in 2002 as compared to
..79% in 2001 and .50% in 2000. The return on average equity was 10.62%, 10.10%
and 7.04% in 2002, 2001 and 2000, respectively.
The principal factors affecting the increase in earnings in 2002 were a
$1,054,000 or 6.6% increase in net interest income, an increase of $776,000 or
224.3% on the gains on the sale of residential real estate loans, an increase of
$324,000 or 34.9% on the net gains on the sale of investment securities
available-for-sale, an increase of $251,000 or 10.75% in service charges on
deposit accounts and an increase of $39,000 or 5.5% in other fee income. These
increases in income were offset in part by a decrease in trust and wealth
management fees of $90,000 or 7.0%, and increases of $961,000 or 65.7% in the
provision for possible loan losses, $883,000 or 5.3% in total other expenses and
$69,000 or 8.5% in Federal income taxes.
The increase in 2001 earnings was the result of a $726,000 or 4.7%
increase in net interest income, an increase of $755,000 or 433% in net gains on
the sale of securities, an increase of $287,000 or 486% on the gains on the sale
of residential real estate loans and an increase of $243,000 or 5.9% in all
other income including trust and wealth management fees, deposit service charges
and other fees. Also affecting earnings was a $217,000 or 1.3% decrease in total
other expenses. These
factors improving earnings were offset in part by increases of $205,000 or 54.7%
in the provision for possible loan losses and $538,000 or 199% in Federal income
taxes.
The Company continued to achieve growth in total assets and deposits.
Total assets at December 31, 2002 were $611,592,000 as compared to $465,144,000
at year-end 2001, an increase of $146,448,000 or 31.5%. During 2002, total
deposits grew by 24.5% or $92,912,000 to a year-end total of $472,798,000. Total
deposits at December 31, 2001 were $379,886,000. Total loans amounted to
$255,844,000 and $225,757,000 at December 31, 2002 and 2001, respectively. The
loan increase in 2002 was $30,087,000 or 13.3%. In addition, there were
$1,263,000 of residential real estate loans held-for-sale at December 31, 2002.
There were $3,808,000 such loans at year-end 2001. The allowance for possible
loan losses was $3,084,000 at December 31, 2002 as compared to $2,264,000 at
December 31, 2001. The increase in the allowance for possible loan losses was
$820,000 or 36.2%. In 2002, long-term debt to the Federal Home Loan Bank of
Pittsburgh increased by $33,117,000 or 95.2%. The total long-term debt
outstanding to the Federal Home Loan Bank was $67,921,000 and $34,804,000 at
December 31, 2002 and 2001, respectively. The Company also had $15,000,000 of
guaranteed preferred beneficial interest in the Company's subordinated
debentures at December 31, 2002. There was no such debt at December 31, 2001.
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED COMPARATIVE STATEMENT ANALYSIS
(Dollars in Thousands) For the Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------------------- ------------------------------- ----------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
-------------------------------------- ------------------------------- ----------------------------
ASSETS
INTEREST-EARNING ASSETS
Interest-Bearing Balances
with Banks $ 9,743 $ 146 1.50 % $ 4,787 $ 154 3.22 % $ 2,281 $ 141 6.18%
Federal Funds Sold 729 11 1.51 427 14 3.28 328 23 7.01
Investment Securities
Taxable 192,816 9,847 5.11 152,604 9,516 6.24 139,283 9,440 6.78
Non-Taxable (1) 44,458 3,143 7.07 37,232 2,661 7.15 30,142 2,374 7.88
Loans (1) (2) 246,113 17,513 7.12 228,458 18,651 8.16 214,856 18,171 8.46
Allowance for Loan Losses (2,590) - - (2,394) - - (2,474) - -
------------- --------- --------- ----------- ------------ ----------
Net Loans 243,523 17,513 7.19 226,065 18,651 8.25 212,382 18,171 8.56
------------- --------- --------- ----------- ------------ ----------
Total Interest-Earning Assets 491,269 30,660 6.24 421,115 30,996 7.36 384,416 30,149 7.84
Non-Interest Earning Assets 28,643 - - 29,395 - - 31,926 - -
------------- --------- -------- --------- ----------- ------- ------------ ---------- -----
TOTAL ASSETS,
INTEREST INCOME $ 519,912 30,660 $450,510 30,996 6.88 $ 416,342 30,149 7.24
------------- --------- --------- ----------- ------------ ----------
LIABILITIES
INTEREST-BEARING LIABILITIES
Interest-Bearing Deposits
Demand Deposits $ 58,496 373 0.64 $ 55,087 492 0.89 $ 53,151 536 1.01
Money Market Deposits 72,259 965 1.34 20,041 619 3.09 13,461 375 2.79
Savings & Club Deposits 62,752 1,553 2.47 65,079 1,362 2.09 62,834 1,392 2.22
CDs over $100,000 6,519 215 3.30 7,334 356 4.86 5,886 305 5.18
All Other Time Deposits 162,228 6,617 4.08 162,303 8,692 5.36 157,164 8,806 5.60
------------- --------- --------- ----------- ------------ ---------
Total Interest-Bearing Deposits 362,254 9,723 2.68 309,844 11,521 3.72 292,496 11,414 3.90
Securities Sold Under Agreements
to Repurchase 10,500 185 1.76 12,591 366 2.90 7,226 332 4.59
Other Short-Term Debt 243 4 1.65 1,919 93 4.85 3,994 256 6.41
Long-Term Debt 36,810 2,082 5.66 34,104 1,989 5.83 31,377 1,945 6.20
Guaranteed Preferred Beneficial
Interests in Company's
Subordinated
Debentures 7,685 416 5.41 - - - - - -
------------- --------- ---------- ----------- ---------- ------------
Total Interest-Bearing
Liabilitites 417,492 12,410 2.97 358,458 13,969 3.90 335,093 13,947 4.16
NON-INTEREST-BEARING LIABILITIES
Non-Interest-Bearing Deposits 57,938 - - 48,959 - - 43,893 - -
Other Liabilities 6,838 - - 7,887 - - 7,913 - -
------------- --------- ---------- ----------- ---------- ------------
TOTAL LIABILITIES 482,268 12,410 2.57 415,303 13,969 3.36 386,899 13,947 3.60
SHAREHOLDERS' EQUITY 37,644 - - 35,207 - - 29,443 - -
------------- --------- ---------- ----------- ---------- ------------
TOTAL LIABILITIES &
SHAREHOLDERS' EQUITY,
INTEREST EXPENSE $ 519,912 12,410 2.39 $ 450,510 13,969 3.10 $ 416,432 13,947 3.35
------------- --------- ---------- ----------- ---------- ------------
NET INTEREST INCOME $18,250 $ 17,027 $ 16,202
--------- ----------- ------------
Net Interest Spread (3) 3.27 3.46 3.68
Effect of Interest-Free Sources
Used to Fund Earning Assets 0.44 0.58 0.53
NET INTEREST MARGIN (4) 3.71 % 4.04 % 4.21%
--------- ---------- --------
- ------------------------------------------------------------------------------------------------------------------------------------
(1) The indicated interest income and average yields are presented on a taxable
equivalent basis. The taxable equivalent adjustments included above are
$1,130,000, $961,000 and $862,000 for the years 2002, 2001 and 2000,
respectively. The effective tax rate used for the taxable equivalent
adjustment was 34%.
(2) Loan fees of $(279,000), $(162,000) and $285,000 for the years 2002, 2001
and 2000, respectively, are included in interest income. Average loan
balances include non-accruing loans of $1,351,000, $1,019,000 and
$1,048,000 and average loans held-for-sale of $2,658,000, $1,934,000 and
$90,000 for the years 2002, 2001 and 2000, respectively.
(3) Net interest spread is the arithmetic difference between yield on
interest-earning assets and the rate paid on interest-bearing liabilities.
(4) Net interest margin is computed by dividing net interest income by average
interest-earning assets.
Average Balances
The "Consolidated Comparative Statement Analysis" table sets forth a
comparison of average daily balances, interest income and interest expense on a
fully taxable equivalent basis and interest rates calculated for each major
category of interest-earning assets and interest-bearing liabilities. For
purposes of this analysis, the computations in the "Consolidated Comparative
Statement Analysis" were prepared using the Federal statutory rate of 34%; there
are no state or local taxes on income applicable to the Company. For further
information relating to the effective income tax rate of the Company, see Note K
of the "Notes to Consolidated Financial Statements". Interest income on loans
included loan (expenses) and fees of $(279,000), $(162,000), and $285,000 for
the years ended December 31, 2002, 2001 and 2000, respectively.
Net Interest Income
Net interest income is the difference between the interest income on
loans, investments and other interest-earning assets, and the interest paid on
deposits and other interest-bearing liabilities. Net interest income is the
primary source of earnings for the Company. Therefore, changes in this category
can be essential to the overall net income of the Company. The net interest
income, on a fully taxable equivalent basis, amounted to $18,250,000 for 2002,
an increase of $1,223,000 or 7.2% over $17,027,000 in 2001. As shown in the
"Rate/Volume Analysis" table, the increase in net interest income in 2002 was
attributable to higher net interest income of $2,786,000 due to changes in
volume and a reduction in net interest income of $1,563,000 due to changes in
rates. The volume-related change resulted primarily from increases in investment
securities and average balances for loans (see discussions on "Loan Portfolio"
and "Mortgage Loans Held-for-Sale"), partially offset by an increase in money
market deposits, debt and demand, savings and club deposits. The rate-related
change was primarily the result of the decrease of interest earned on investment
securities and loans being greater than the decrease of interest rates paid on
deposits and debt.
The net interest income, on a fully taxable equivalent basis, in 2001
increased $825,000 or 5.1% over the 2000 figure of $16,202,000. This increase
was the result of growth in investments and loans, reduced in part by increases
in time deposits and debt. Also affecting 2000 net income was the decrease in
interest rates earned on loans and investments being greater than the decrease
on the interest rates paid on deposits and debt.
The net interest margin, a measure of net interest income performance, is
determined by dividing net interest income by total interest-earning assets. The
net interest margin was 3.71% for 2002, 4.04% for 2001 and 4.21% for 2000. The
decrease in 2002 was the result of the 1.12% decrease in the average rate earned
on interest-earning assets being greater than the 0.93% decrease in the average
interest
rate paid on interest-bearing liabilities. The result was a decline in the
interest spread, the difference of interest earned on assets less the interest
paid on deposits and debt. The interest spread was 3.27%, 3.46% and 3.68% for
2002, 2001 and 2000, respectively. The impact on earnings by the reduction in
the interest spread was diminished in part by the $8,979,000 or 18.3% increase
in 2002 of average non-interest-bearing deposits.
The following table sets forth a "Rate/Volume Analysis", which
segregates in detail the major factors that contributed to the changes in net
interest income for the years ended December 31, 2002 and 2001, as compared to
the respective previous periods, into amounts attributable to both rate and
volume variances. In calculating the variances, the changes were first
segregated into (1) changes in volume (change in volume times the old rate), (2)
changes in rates (change in rate times the old volume) and (3) changes in
rate/volume (changes in rate times the change in volume). The changes in
rate/volume have been allocated in their entirety to the change in rates. The
interest income included in the "Rate/Volume Analysis" table has been adjusted
to a fully taxable equivalent amount using the Federal statutory tax rate of
34%. Non-accruing loans have been used in the daily average balances to
determine changes in interest income due to volume. Loan fees included in the
interest income calculation are not material.
- ------------------------------------------------------------------------------------------------------------------------------------
RATE/VOLUME ANALYSIS
(Dollars in Thousands) (Fully Taxable Equivalent)
- ------------------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) in Year Ended December 31,
2002 to 2001 2001 to 2000
Change Due To: Change Due To:
TOTAL RATE VOLUME TOTAL RATE VOLUME
------------------------------------------------------------- ----------------------------------------------------
Interest Income
Interest-Bearing Balances
With Banks $ (8) $ (167) $ 159 $ 13 $ (142) $ 155
Federal Funds Sold (3) (13) 10 (9) (16) 7
Investment Securitie 814 (2,229) 3,043 363 (1,060) 1,423
Loans (1,139) (2,580) 1,441 480 (670) 1,150
------------ ------------- ------------ ------------ ------------- ------------
Total Interest Income (336) (4,989) 4,653 847 (1,888) 2,735
------------ ------------- ------------ ------------ ------------- ------------
Interest Expense
Demand Deposits, Savings
& Clubs (516) (679) 163 (74) (81) 7
Money Market Deposit 934 (385) 1,319 244 60 184
Time Deposits (2,216) (2,169) (47) (63) (431) 368
Securities Sold Under
Agreements to Repurchase (181) (120) (61) 34 (213) 247
Short-Term Debt (89) (8) (81) (163) (30) (133)
Long-Term Debt 93 (65) 158 44 (125) 169
Guaranteed Preferred
Beneficial Interest
in Company's
Subonated Debentures 416 - 416 - - -
------------ ------------- ------------ ------------ ------------- ------------
Total Interest Expense (1,559) (3,426) 1,867 22 (820) 842
------------ ------------- ------------ ------------ ------------- ------------
Increase in Net
Interest Income $1,223 $(1,563) $ 2,786 $ 825 $(1,068) $ 1,893
- ------------------------------------------------------------------------------------------------------------------------------------
Market Risk
As a financial institution, the Company's primary component of market
risk is interest rate volatility. Fluctuations in interest will ultimately
impact both the level of income and expense recorded on a large portion of the
Company's assets and liabilities, and the market value of all interest-earning
assets, other than those which possess a short term to maturity. Since most of
the Company's interest-bearing assets and liabilities are located at the Bank,
the majority of the Company's interest rate risk is at the Bank level. As a
result, most interest rate risk management procedures are performed at the Bank
level (see discussion on "Interest Rate Sensitivity").
The Company and the Bank operate as a community banking institution
primarily in the counties of Northampton, Lehigh and Monroe, Pennsylvania. As a
result of its location and nature of operations, the Company is not subject to
foreign currency exchange or commodity price risk. The Bank makes real estate
loans primarily in the counties adjacent to its operations and thus is subject
to risks associated with those local economies. The Bank holds a concentration
of residential real estate loans (42.4% of total loans) and commercial loans
supported by real estate (24.8% of total loans) and consumer/installment loans
(23.0% of total loans) in its loan portfolio. Loans for recreational vehicles
represent 48% of the consumer/installment loans and 11% of total loans (see
Note R of the "Notes to Consolidated Financial Statements"). The Bank's loans
are subject to interest and economic risks. The Bank also originates residential
real estate loans for sale in the secondary market. Such loans are identified as
"Mortgage Loans Held-for-Sale" on the Company's Balance Sheet and are subject to
interest rate risk (see discussion on "Mortgage Loans Held-for-Sale"). The
Company does not own any trading assets and does not have any hedging
transactions in place such as interest rate swaps (see discussions on
"Investment Securities" and "Securities Available-for-Sale").
Interest Rate Sensitivity
Interest rate sensitivity is a measure of the extent to which net
interest income would change due to changes in the level of interest rates. The
objective of interest rate sensitivity management is to reduce a company's
vulnerability to future interest rate fluctuations and to enhance consistent
growth of net interest income. The Bank's Asset/Liability Management Committee
meets semi-monthly to examine, among other subjects, interest rates for various
products and interest sensitivity.
Rate sensitivity arises from the difference between the volumes of
assets which are rate-sensitive as compared to the volumes of liabilities which
are rate-sensitive. A comparison of interest-rate-sensitive assets to
interest-rate-sensitive liabilities is monitored by the Bank on a regular basis
using several time periods. The mismatch of assets and liabilities in a specific
time frame is referred to as interest sensitivity gap. Generally, in an
environment of rising interest rates, a negative gap (interest sensitive
liabilities being greater than interest sensitive assets in a given period of
time) will decrease net interest income, and in an environment of falling
interest rates, a negative gap will increase net interest income.
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST SENSITIVITY ANALYSIS 0-90 91-180 181-365 1-5 Over 5
(Dollars in Thousands) as of December 31, 2002 Days Days Days Years Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-Bearing Deposits with Banks $ 5,002 $ - $ - $ - $ - $ 5,002
Federal Funds Sold 2,000 - - - - 2,000
Investment Securities 31,274 24,263 41,180 149,460 67,601 313,778
Loans 37,581 18,301 25,452 101,861 69,565 252,760
Loans Held-for-Sale 1,263 - - - - 1,263
Other Assets 20,741 - - - 16,048 36,789
------------ ------------ ------------- ------------- --------------- -------------
TOTAL ASSETS $97,861 $42,564 $ 66,632 $ 251,321 $ 153,214 $ 611,592
-----------------------------------------------------------------------------------------
Non-Interest-Bearing Deposits (1) $ - $ - $ - $ - $ 64,150 $ 64,150
Interest-Bearing Deposits 52,680 47,361 65,950 83,601 159,056 408,648
Securities Sold Under Agreements
to Repurchase 8,801 - - - - 8,801
Long-Term Debt 5,024 656 8,968 27,023 26,250 67,921
Guaranteed Preferred Beneficial Interests
in Company's Subordinated Debentures - - - - 15,000 15,000
Other Liabilities - - - - 6,758 6,758
Capital - - - - 40,314 40,314
------------ ------------ ------------- ------------- --------------- -------------
TOTAL LIABILITIES AND CAPITAL $66,505 $48,017 $74,918 $ 110,624 $ 311,528 $ 611,592
-----------------------------------------------------------------------------------------
Net Interest Sensitivity Gap $31,356 $ (5,453) $ (8,286) $ 140,697 $(158,314) $ -
Cumulative Interest Sensitivity Gap $31,356 $25,903 $ 17,617 $ 158,314 $ - $ -
Cumulative Gap RSA/RSL 147.1% 122.6% 109.3% 152.8% 100.0%
(1) Historically, non-interest-bearing deposits reflect insignificant change in
deposit trends and, therefore, the Company classifies these deposits over
five years.
- ------------------------------------------------------------------------------------------------------------------------------------
Assets and liabilities are allocated to a specific time period based on
their scheduled repricing date or on an historical basis. At December 31, 2002,
assets of $207,057,000 (33.9% of total assets) were subject to interest rate
changes within one year. This compares to assets subject to interest rate
changes within one year of $149,885,000 (32.2% of total assets) at the end of
2001 and $162,221,000 (36.6% of total assets) at the end of 2000. Liabilities
subject to rate change within one year were $189,440,000, $151,885,000 and
$169,639,000 in 2002, 2001 and 2000, respectively. A positive one-year gap
position of $17,617,000 existed as of December 31, 2002. The gap positions at
December 31, 2001 and 2000 were negative $2,000,000 and negative $7,418,000,
respectively. The ratio of rate-sensitive assets to rate-sensitive liabilities
for the one-year time frame was 1.09 at the end of 2002, compared to .99 at the
end of 2001 and .96 at the end of 2000. The "Interest Sensitivity Analysis"
table presents a sensitivity gap analysis of the Company's assets and
liabilities at December 31, 2002 for five time-intervals. The Company's positive
gap position for the one-year time frame in 2002 was the result of an increase
in interest-bearing deposits with banks, Federal Funds sold, shorter maturities
in investment securities and loans and an increase in some longer-term deposits.
The change in the deposit mix was due to the growth of non-interest bearing
deposits and some longer-term certificates of deposits. The change in loan
maturities was due in part to the sale of residential mortgage loans and
increases in shorter-term commercial loans. The change in the investment
securities was the result of sales of longer-term securities and the
reinvestment in shorter-term securities. Management intends to continue to
purchase short-term rate securities, make adjustable rate and short-term
commercial loans, market longer-term certificates of deposit and sell fixed-rate
mortgage loans to maintain an acceptable gap position.
While using the interest sensitivity gap analysis is a useful
management tool because it considers the quantity of assets and liabilities
subject to repricing in a given time period, it does not consider the relative
sensitivity to market interest-rate changes that are characteristic of various
interest-rate-sensitive assets and liabilities. Consequently, even though the
Company currently has a positive gap position because of the unequal sensitivity
of these assets and liabilities, management believes that this position will not
materially impact earnings in a changing rate environment. For example, changes
in the prime rate on variable commercial loans may not result in an equal change
in the rate of money market deposits or short-term certificates of deposit. A
simulation model is therefore used to estimate the impact of various changes,
both upward and downward, in market interest rates and volumes of assets and
liabilities on the Bank's net income. This model produces an interest rate
exposure report that forecasts changes in the market value of portfolio equity
under alternative interest rate environments. The market value of portfolio
equity is defined as the present value of the Company's existing assets,
liabilities and off-balance sheet instruments. The calculated estimates of
changes in the market value of portfolio equity at December 31, 2002 are as
follows:
-------------------------------------------
At December 31, 2002
-------------------------------------------
Percent of Change
in Market Value
Changes in Rate of Portfolio Equity
--------------- ---------------------
+300 basis points (5.4)%
+200 basis points (3.2)%
+100 basis points 14.1%
Flat Rate 0.0%
-100 basis points 10.0%
-200 basis points 16.1%
-300 basis points 26.8%
-------------------------------------------
The assumptions used in evaluating the vulnerability of the Company's
earnings and capital to changes in interest rates are based on management's
consideration of past experience, current position and anticipated future
economic conditions. The interest rate sensitivity of the Company's assets and
liabilities as well as the estimated effect of changes in interest rates on the
market value of portfolio equity could vary substantially if different
assumptions are used or actual experience differs from the assumptions on which
the calculations were based.
Service Charges and Other Income
Service charge income on deposit accounts amounted to $2,586,000 in
2002 compared to $2,335,000 in 2001 and $2,019,000 in 2000. In 2002, the service
charges on deposit accounts increased by $251,000 or 10.7% over 2001 and the
2001 increase over 2000 was $316,000 or 15.7%. The increases in 2002 and 2001
were primarily the result of increases in the number of deposit accounts and
increases in the usage of the Bank's debit card.
In 2002, the Company had gains on the sale of mortgage loans of
$1,122,000 as compared to gains of $346,000 in 2001. In 2000, there were gains
on the sale of mortgage loans of $59,000 (see discussion on "Mortgage Loans
Held-for-Sale").
Other operating income was $749,000 in 2002, as compared to $710,000 in
2001, an increase of $39,000 or 5.5%. Other operating income for 2000 was
$825,000.
Trust and Wealth Management Division
Revenue from the Bank's Trust and Wealth Management Division operations
was $1,197,000 in 2002, as compared to $1,287,000 in 2001. This was a decrease
of $90,000 or 7.1%. The reduction in the Trust and Wealth Management revenue was
the result of a reduction in the market values of the securities on which fees
are assessed offset in part by growth in the assets held by the Bank for its
customers. The Trust and Wealth Management Division revenue for 2000 was
$1,245,000. Trust assets are held by the Bank for its customers in a fiduciary
or agency capacity, and thus, are not included in the financial statements of
the Company. Fees are assessed by the Trust Division to some customers based on
the market value of the assets held in the customers' account. As a result,
changing market values will impact the revenues earned from Trust operations.
Other Expenses
Salaries and employee benefits represent a significant portion of
non-interest expense. These expenses, amounting to $9,055,000, increased by
$831,000 or 10.1% in 2002 compared to $8,224,000 in 2001. These expenses in 2001
amounted to an increase of $787,000 or 10.6% over the $7,437,000 reported in
2000. The increase in 2002 was primarily due to salary increases of
approximately 4%, increases in Lending and Trust division's staff and an
increase in cash bonuses paid to all employees. Salary expense in 2001 increased
due to normal salary increases of approximately 3%, cash bonuses paid to all
employees and the full year's expense related to the opening of the branches in
Mount Pocono, Whitehall and Trexlertown.
Occupancy and equipment expenses were $2,463,000