U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended JUNE 30, 2003
- - 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: 0-49706
WILLOW GROVE BANCORP, INC.
--------------------------
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 80-0034942
- --------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employee Identification No.)
incorporation or organization)
WELSH AND NORRISTOWN ROADS
MAPLE GLEN, PENNSYLVANIA 19002
------------------------------
(Address of Principal Executive Offices)
Registrant's telephone number: (including area code) (215) 646-5405
--------------
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (par value $0.01 per share)
----------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer(as defined
in Exchange Act Rule 12b-2).
YES [X] NO [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on September 22, 2003 was $138,733,111 (8,480,019 shares at $16.36
per share). Although directors and executive officers of the Registrant and
certain employee benefit plans were assumed to be "affiliates" of the Registrant
for purposes of the calculation, the classification is not to be interpreted as
an admission of such status.
As of September 22, 2003 there were 10,230,808 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
- -----------------------------------
1. Portions of the Definitive Proxy Statement for the 2003 Annual Meeting
of Stockholders are incorporated by reference in Part III.
Willow Grove Bancorp, Inc.
FORM 10-K
For the Fiscal Year Ended June 30, 2003
INDEX
PART I
Item 1. Business 1
Item 2. Properties 32
Item 3. Legal Proceedings 33
Item 4. Submission of Matters to a Vote of Security Holders 33
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 34
Item 6. Selected Financial Data 35
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 37
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 48
Item 8. Financial Statements and Supplementary Data 54
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 88
Item 9A. Control and Procedures 88
PART III
Item 10. Directors and Executive Officers of the Registrant 88
Item 11. Executive Compensation 88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 89
Item 13, Certain Relationships and Related Transactions 89
Item 14. Principal Accounting Fees and Services 89
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports of Form 8-K 90
Signatures 92
ii
Forward Looking Statements
This Form 10-K contains certain forward-looking statements and
information based upon our beliefs as well as assumptions we have made. In
addition, to those and other portions of this document, the words "anticipate,"
"believe," "estimate," "expect," "intend," "should," and similar expressions, or
the negative thereof, as they relate to us are intended to identify
forward-looking statements. Such statements reflect our current view with
respect to future looking events and are subject to certain risks, uncertainties
and assumptions. Factors that could cause future results to vary from current
management expectations include, but are not limited to, general economic
conditions, legislative and regulatory changes, hostilities involving the United
States, monetary and fiscal policies of the federal government, changes in tax
policies, rates and regulations of federal, state and local tax authorities,
changes in interest rates, deposit flows, the cost of funds, demand for loan
products, demand for financial services, competition, changes in the quality or
composition of the Company's loan and investment portfolios, changes in
accounting principles, policies or guidelines, and other economic, competitive,
governmental and technological factors affecting our operations, markets,
products, services and fees. Should one or more of these risks or uncertainties
materialize or should underlying assumptions prove incorrect, actual results may
vary materially from those described herein as anticipated, believed, estimated,
expected or intended. We do not intend to update these forward-looking
statements.
PART I
Item 1. Business
General. Willow Grove Bancorp, Inc. (the "Company"), a Pennsylvania corporation,
was formed to facilitate the reorganization of Willow Grove Bank (the "Bank")
from the two-tier mutual holding company form to the stock holding company form
of organization. The reorganization was completed on April 3, 2002. The Company
issued 6,414,125 shares of common stock in a subscription offering and issued
4,869,375 shares of common stock in exchange for the stock held by the
shareholders of the former Willow Grove Bancorp, Inc., the federally chartered
stock-form mid-tier holding company. The Bank, which is now a wholly-owned
subsidiary of the Company, was originally organized in 1909. In December 1998,
the Bank was reorganized from a federally chartered mutual savings bank into a
federally chartered stock savings bank in the mutual holding company form of
ownership with a "mid-tier" holding company. The Bank is primarily engaged in
attracting deposits from the general public and using those funds to invest in
loans and securities. At the present time, the business of the Company is
primarily the business of the Bank. In September 2000, Willow Grove Investment
Corporation ("WGIC"), a Delaware corporation was formed as a wholly owned
subsidiary of the Bank to hold and manage certain securities investments of the
Bank. In May 2003, Willow Grove Insurance Agency, LLC (the "Agency"), a
Pennsylvania limited liability company was formed by the Bank to conduct
permitted fixed rate annuity transactions for the Bank.
References in this document to "we," "our" or "us" refer to Willow
Grove Bancorp, Inc. together with its subsidiary, Willow Grove Bank, unless the
context otherwise requires.
In recent years, we have concentrated our business plan on the
following primary goals - changing operations to a full-service community bank,
continuing steady growth and maintaining a high level of asset quality. We
intend to continue our growth through internal means, and to the extent
opportunities are available and deemed prudent by management, through
acquisitions of other institutions. We believe our business plan will continue
to enhance shareholder value.
Our principal sources of funds are deposits, repayment of loans and
mortgage-backed securities, maturities of investments and interest-bearing
deposits, funds provided from operations and funds borrowed from outside sources
such as the Federal Home Loan Bank ("FHLB") of Pittsburgh. These funds are
primarily used for the origination of various loan types including,
single-family residential, commercial real estate and multi-family residential
mortgage loans, construction real estate loans, home equity loans, consumer
loans and commercial business loans. Our major source of income is the interest
payments received on our loan and securities portfolios, while our major expense
is interest paid on deposit accounts.
1
The Office of Thrift Supervision ("OTS") is the Bank's chartering
authority and primary regulator. The Bank is also regulated by the Federal
Deposit Insurance Corporation ("FDIC"), the administrator for the Savings
Association Insurance Fund ("SAIF"). The Bank is also subject to reserve
requirements established by the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board" or "FRB"), and we are a member of the FHLB of
Pittsburgh, one of the regional banks comprising the FHLB System.
Our executive offices are located at Welsh and Norristown Roads, Maple
Glen, Pennsylvania, and our telephone number is (215) 646-5405. The office for
Willow Grove Investment Corporation is 1105 Market Street, Suite 1300,
Wilmington, Delaware. The office for Willow Grove Insurance Agency, LLC are
located at Welsh and Norristown Roads, Maple Glen, Pennsylvania.
Second Step Conversion
On April 3, 2002 Willow Grove Bank completed its reorganization from
the two-tier mutual holding company form of organization to the stock form of
organization (the "April 2002 Reorganization"). The former Willow Grove Bancorp,
Inc. was a federally chartered mid-tier mutual holding company with
approximately 56.9% of its stock being held by Willow Grove Mutual Holding
Company and the remaining 43.1% being held by public shareholders. As part of
the April 2002 Reorganization, the former Willow Grove Bancorp, Inc., the
federal corporation, was merged into Willow Grove Bank and the current Willow
Grove Bancorp Inc., a Pennsylvania corporation, was incorporated by the Bank for
the purpose of becoming the holding company for the Bank. Willow Grove Bancorp,
Inc., the new Pennsylvania corporation, through a public subscription offering,
sold 6,414,125 shares of stock at $10.00 per share and issued 4,869,375 to the
stockholders of Willow Grove Bancorp, Inc., the former federal corporation,
which represented an exchange of 2.28019 shares of its stock for each share of
the former company. Willow Grove Bank is now the wholly-owned subsidiary of
Willow Grove Bancorp, Inc., the Pennsylvania corporation. All per share data and
information prior to April 3, 2002 refers to the former Willow Grove Bancorp,
Inc., the federal corporation and has been restated to reflect the effect of the
increased shares resulting from the share issuance and exchange resulting from
the April 2002 Reorganization.
Available Information
The Company files annual, quarterly and special reports, proxy
statements and other information with the Securities and Exchange Commission
("SEC"). Our SEC filings are available to the public at the SEC's web site at
http://www.sec.gov. Members of the public may also read and copy any document we
file at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington,
D.C. 20549. You can request copies of these documents by writing to the SEC and
paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for
more information about the operation of the public reference room. In addition,
our stock is listed for trading on the Nasdaq National Market and trades under
the symbol "WGBC". You may find additional information regarding Willow Grove
Bancorp, Inc. at www.nasdaq.com. In addition to the foregoing, we maintain a web
site at www.willowgrovebank.com. We make available on our Internet web site
copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and any amendments to such documents as soon as
reasonably practicable after we file such material with or furnish such
documents to the SEC.
Market Area and Competition
Our main office is in Montgomery County, Pennsylvania, approximately 20
miles north of downtown Philadelphia. The primary market areas that we serve
are: Montgomery County, Bucks County and the northeast section of Philadelphia
that borders these counties. To a lesser extent, we provide services to areas of
Chester and Delaware counties, the remainder of the City of Philadelphia, and
central and southern New Jersey.
Most of our direct competition for attracting deposits and originating
loans has historically come from savings associations, other savings banks,
commercial banks and credit unions. We face additional competition for deposits
from short-term money market funds and other corporate and government securities
funds, mutual funds, and other non-financial institutions such as securities
brokerage firms and insurance companies. Locally, in the three counties where
our banking offices reside we estimate that we compete with approximately 84
other financial institutions and 55 offices of securities brokers in our market
service area.
2
Lending Activities
General. At June 30, 2003 our net loan portfolio totaled $413.8 million
or 48.96% of our total assets. Historically, our primary emphasis has been the
origination of loans secured by first liens on single-family (one-to four-units)
residences. In recent years, we have changed the focus of our lending to place
more emphasis on home equity loans, construction, commercial real estate and
multi-family residential loans and commercial business loans. At June 30, 2003,
commercial real estate and multi-family residential loans amounted to $155.9
million, or 37.14% of our total loan portfolio. As of that date, construction
loans were $36.2 million or 8.62% of our loan portfolio; commercial business
loans totaled $20.5 million or 4.90% of the total loan portfolio. Loans secured
by liens on single-family residential properties include first mortgage loans
totaling $131.8 million, or 31.40% of the loan portfolio, and $73.0 million of
home equity loans and lines of credit, which accounted for 17.39% of the loan
portfolio at June 30, 2003.
The types of loans that we originate are subject to federal and state
laws and regulations. Interest rates and fees charged on these loans are
affected primarily by the demand for loans by borrowers and the supply of funds
available for lending purposes and rates and fees charged by our competitors.
Local, national and international economic conditions and their effect on the
monetary policies of the Federal Reserve Board, legislative and tax policies and
budgetary matters of local, state, and federal governmental bodies affect the
supply of funds available and the demand for loans.
3
Loan Portfolio Composition. The following table sets forth the
composition of the loan portfolio at the dates indicated. This data does not
include single family loans classified as held for sale which amounted to $5.3
million, $1.6 million, $2.6 million, $35.8 million, and zero at June 30, 2003,
2002, 2001, 2000 and 1999, respectively.
June 30, 2003 June 30, 2002 June 30, 2001 June 30, 2000 June 30, 1999
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Amount of total Amount of total Amount of total Amount of total Amount of total
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Mortgage loans:
Single-family $131,821 31.40% $181,454 40.40% $198,310 43.17% $206,340 48.04% $231,498 61.16%
Commercial real estate 155,892 37.14 134,294 29.90 128,613 28.00 102,513 23.86 65,707 17.36
and multi-family
Construction 36,191 8.62 29,306 6.52 27,724 6.04 14,973 3.49 7,773 2.05
Home equity 72,990 17.39 75,016 16.70 75,060 16.34 72,217 16.81 54,090 14.29
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage loans 396,894 94.55 420,070 93.52 429,707 93.55 396,043 92.20 359,068 94.86
Consumer loans 2,324 0.55 10,081 2.24 9,688 2.11 7,818 1.82 6,431 1.70
Commercial business loans 20,549 4.90 19,067 4.24 19,925 4.34 25,683 5.98 13,023 3.44
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable 419,767 100.00% 449,218 100.00% 459,320 100.00% 429,544 100.00% 378,522 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
Allowance for loan losses (5,312) (4,626) (4,313) (3,905) (3,138)
Deferred loan fees (656) (737) (808) (699) (800)
-------- -------- -------- -------- --------
Loans receivable, net $413,799 $443,855 $454,199 $424,940 $374,584
======== ======== ======== ======== ========
4
Contractual Principal Repayments and Interest Rates. The following
table sets forth scheduled contractual amortization of the loan portfolio at
June 30, 2003. Demand loans, loans having no schedule of repayments and no
stated maturity and overdraft loans are reported as due in one year or less.
At June 30, 2003, the amount due within
--------------------------------------------------------------------------------------
more than more than more than more than
1 year 1 year to 3 years to 5 years to 10 years to more than
or less 3 years 5 years 10 years 20 years 20 years Total
-------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Mortgage loans:
Single-family and $ 3,626 $ 3,356 $ 13,418 $ 30,366 $ 68,596 $ 85,449 $204,811
home equity
Commercial real 5,007 9,752 9,706 25,837 96,180 9,410 155,892
estate and
multi-family
Construction 21,502 10,642 2,061 -- 1,714 272 36,191
-------- -------- -------- -------- -------- -------- --------
Total mortgage loans 30,135 23,750 25,185 56,203 166,490 95,131 396,894
Consumer 185 1,014 717 176 48 184 2,324
Commercial business 6,227 2,044 4,667 5,163 789 1,659 20,549
-------- -------- -------- -------- -------- -------- --------
Total $ 36,547 $ 26,808 $ 30,569 $ 61,542 $167,327 $ 96,974 $419,767
======== ======== ======== ======== ======== ======== ========
Of the $383.2 million of loan principal repayments due after June 30,
2004, $230.7 million have fixed rates of interest and $152.5 million have
adjustable rates of interest.
Lending Activity. Our lending activities are subject to underwriting
standards and origination procedures which have been approved by our Board of
Directors. We process, underwrite and originate single-family residential
mortgage loans on both a retail and wholesale basis. We have developed a network
of approximately 25 active residential mortgage brokers and mortgage bankers to
support our wholesale production system. These correspondents identify, process
and close loans on our behalf based upon rates and terms that we provide to them
on a regular basis which correlate to our assessment of our demand for various
types of loans. The correspondents forward completed loan applications for our
review. Based upon this review, we will determine whether to reject the loan if
it fails to meet our prescribed standards or acquire the loan for our portfolio
or for sale into the secondary market. Depending upon the various programs we
have with the correspondents, loans will be classified as either purchased or
originated. When the correspondent advances funds for the closing of a loan we
have committed to purchase, it is classified as "purchased". When we provide the
funds for the closing of the loan, it is classified as "originated". In either
case, we may retain the loan in our portfolio or sell it (on either a servicing
released or retained basis) in the secondary market. Retail production is
supported through bank loan officers who obtain loan applications through our
branch network and referrals from local builders, real estate brokers and
financial consultants. Single-family residential mortgage loans generally are
required to be underwritten in accordance with Federal Home Loan Mortgage
Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA")
guidelines (this facilitates resale into the secondary market). We also acquire
loans that do not conform to FHLMC/FNMA guidelines ("non-conforming" loans) for
the portfolio. Non-conforming loans that we place in the portfolio include, but
are not limited to, sub-prime, investor loans and non-FNMA "A" paper.
Non-conforming loans are underwritten according to our alternative underwriting
guidelines. We believe that our underwriting guidelines are consistent with
industry standards. These non-conforming loans account for approximately 24.7%
of our single-family loan portfolio.
In addition to originating loans, the Bank periodically purchases
participation interests in larger balance loans, typically multi-family and
commercial real estate mortgage loans and construction loans from other
financial institutions in our market area. These participations are reviewed for
compliance with our underwriting standards before they are purchased. Recently
the Bank has considered purchasing larger pools of high quality single-family
5
residential loans that may include local or geographically dispersed loans. Any
purchased loan pool would be subject to our due diligence review and would
conform to our internal underwriting standards.
Our loan underwriting function is managed at our main office. The
majority of our conforming loans are contractually underwritten by any one of
several private mortgage insurance companies to ensure saleability in the
secondary market. From time to time we also underwrite conforming loans based on
our internal capacity and market conditions. We require a current appraisal
prepared by an independent appraiser or an acceptable alternative property
valuation on all new mortgage loans. We require title insurance on loans secured
by real estate with the exception of certain single-family residential loans
originated under $150,000 and most home equity loans originated under $100,000.
Hazard insurance is required on all real estate loans. Flood insurance is also
required for all loans secured by properties located in a designated flood area.
Our loan policy authorizes certain officers to approve loans up to
certain designated amounts, not exceeding $500,000, collectively, in the case of
the President and Chief Operating Officer. Loans exceeding individual or
collective limits must be approved by: the Management Loan Committee consisting
of the President, Chief Operating Officer, other executive officers and other
Bank lending vice-presidents; the Director's Loan Committee, consisting of three
outside directors, the President, the Chief Operating Officer and Chief Lending
Officer or the full Board of Directors. The Director's Loan Committee and the
full Board of Directors are also provided with summaries of new loan activity on
a routine basis.
As a federal savings bank, we are limited in the amount of loans we
make to any one borrower. This amount is equal to 15% of the Bank's unimpaired
capital and surplus (in our case, this amount would be approximately $13.7
million at June 30, 2003), although there are provisions that would allow us to
lend an additional 10% of unimpaired capital and surplus if the loans are
secured by readily marketable securities. Our aggregate loans to any one
borrower have been within these limits. At June 30, 2003, our three largest
credit relationships with an individual borrower and related entities amounted
to $11.6 million, $7.7 million and $7.2 million; all the loans included in these
relationships were performing in accordance with their terms and conditions.
The following table shows the activity in our loan portfolio during the
periods indicated.
6
Year ended June 30,
---------------------------------------
2003 2002 2001
--------- --------- ---------
(Dollars in thousands)
Loans held at the beginning of the period (1) $ 449,218 $ 459,320 $ 429,544
Originated and purchased for portfolio:
Mortgage loans
Single-family 91,904 43,841 27,867
Commercial real estate and multi-family 46,768 23,341 30,591
Construction 28,854 32,369 27,758
Home equity 53,419 36,725 27,985
Consumer loans 2,669 10,371 8,873
Commercial business loans 13,488 11,057 21,675
--------- --------- ---------
Total originations and purchases for portfolio 237,102 157,704 144,749
Transfer of loans from portfolio to held for sale (43,451) -- --
Amortization (222,711) (166,852) (107,525)
Charge-offs (391) (954) (7,448)
--------- --------- ---------
Net change in loans (29,451) (10,102) 29,776
--------- --------- ---------
Total loans held at the end of the period $ 419,767 $ 449,218 $ 459,320
========= ========= =========
(1) Excludes loans classified as held for sale at the time of origination.
Single-Family Residential Loans. We utilize bank loan officers and a
network of mortgage brokers and bankers to originate and buy conventional
single-family (one-to-four-units) mortgage loans. During the year ended June 30,
2003, single-family residential loans originated to be kept in our portfolio
amounted to $91.9 million. In addition, we originated $80.1 million of
single-family residential mortgage loans for resale in the secondary market. Our
total single-family residential mortgage loans originated for portfolio or
resale amounted to $172.0 million in the year ended June 30, 2003, of which
$103.2 million were originated through our wholesale network and the remaining
$68.8 million was originated through our retail sources. Conventional loans are
loans that are neither insured by the Federal Housing Administration ("FHA") nor
partially guaranteed by the Department of Veterans Affairs ("VA"). The majority
of our single-family mortgage loans are secured by properties located in our
primary lending area which includes Montgomery, Bucks and Philadelphia Counties,
Pennsylvania. Our residential lending areas have expanded to include
northeastern Pennsylvania, central and southern New Jersey and Delaware. At June
30, 2003, single-family mortgage loans amounted to $131.8 million, or 31.40% of
our total loan portfolio. Due to our strategic plan to diversify the loan
portfolio, the single-family portion of our loan portfolio has decreased during
the past five years. However, we expect future changes in this portfolio to
include increases from the balances at June 30, 2003.
Single-family residential mortgage loans which we purchase or originate
for sale generally are underwritten with terms conforming to FHLMC/FNMA
guidelines. Loans purchased or originated for our portfolio, may conform to
these guidelines, may exceed the conforming loan amount for those agencies, or
may otherwise not comply with the underwriting standards of the agencies for a
variety of reasons, including credit risk. Recently we have been more active in
selling conforming loans, in excess of our portfolio needs, in the secondary
market. We have generally sold loans to three national investors who purchase
our loans primarily on a best efforts, servicing released basis. This
arrangement, although not eliminating all risks associated with secondary market
activity, can provide an additional source of non-interest income. As of June
30, 2003, $5.3 million of our single-family residential mortgage loans were
classified as held-for-sale. During the year ended June 30, 2003, we sold an
aggregate of $74.8 million of single-family residential mortgage loans at a gain
of $1.2 million while for the year ended June 30, 2002, we had loan sales of
$77.8 million at a gain of $519,000. Although we anticipate continuing sales of
loans in the secondary market, there can be no assurance that this activity will
continue as currently
7
structured or result in the realization of non-interest income. Low interest
rates among other factors have led to the increased sales activity over the past
two years.
Interest rates on our single-family residential mortgage loans either
are fixed for the life of the loan ("fixed-rate") or are subject to adjustment
at certain pre-determined dates throughout the life of the loan ("ARM"). Our
fixed-rate loans generally mature in 10, 15, 20 or 30 years, and have equal
monthly payments to repay the loan with interest by the end of the loan term. At
June 30, 2003, the fixed-rate portion of our residential mortgage loan portfolio
which includes single-family real estate loans and home equity loans, totaled
$151.0 million which was 73.7% of the total single-family residential loans plus
home equity loans outstanding at that date.
We offer a variety of ARM loans. These loans have a pre-determined
interest rate for a specified period of time ranging from one to ten years.
After this initial period, the interest rate will adjust on a periodic basis in
accordance with a designated index such as the one-year US Treasury yield
adjusted to a constant maturity ("CMT") plus a stipulated margin. Also, ARM
loans generally carry an annual limit for rate changes of 1% or 2%, and a
maximum amount the rate can increase or decrease from the initial rate of 4% to
6% during the life of the loan. From time to time, we offer ARM loans with an
initial rate less than the fully-indexed rate (the index at the time of
origination plus the stipulated margin). These loans are underwritten based upon
the borrower making payments calculated at the fully-indexed rate. Our ARM loans
require that any payment adjustment caused by a change in the interest rate
result in full amortization of the loan by the end of the original loan term,
and no portion of the payment increase is permitted to be added to the principal
balance of the loan, so-called negative amortization. At June 30, 2003, $53.8
million or 26.3% of our residential mortgage loan portfolio, which includes
single-family real estate loans and home equity loans, were adjustable rate.
ARM loans decrease some of the risks associated with changing interest
rates. However, increases in the amount of a borrower's payment due to interest
rate increases may affect the borrower's ability to repay the loan increasing
the potential for default. To date, we have not experienced a material impact as
a result of this additional credit risk associated with ARM loans, and believe
that this risk is less than the interest rate risk of holding fixed-rate loans
in a rising interest rate environment.
Such factors as consumer preferences, the general level of interest
rates, competition, and the availability of funds affect the amount of ARM loans
we originate. Although we anticipate that we will continue to offer ARM loans,
there can be no assurance that we can originate a sufficient amount of such
loans to increase or maintain the percentage of such loans in our portfolio.
Generally the largest single-family mortgage loan we originate or
purchase does not exceed $500,000. In addition, our maximum loan-to-value ratio
(the rate of the loan amount to the lesser of the appraised value or sales price
- - "LTV") is 95%. Some special first time homebuyer programs have loan to value
ratios of 100%. In all cases when the loan to value ratio exceeds 80%, we
require the borrower to maintain private mortgage insurance until the loan
balance is reduced to 80% of current market value.
Home Equity Loans. In recent years, we have increased our emphasis on
the origination of home equity loans and lines of credit, due to their shorter
maturities (the maximum term of our home equity loans is 20 years with the
exception of purchase money second mortgage loans whose maximum term may be up
to 30 years) and higher interest rates. A home equity loan is a fixed-rate loan
where the borrower receives the total loan amount at a closing and makes monthly
payments to repay the loan within a specific time period. Home equity lines of
credit are a revolving line of credit with a variable rate and no stated
maturity date. The borrower may draw on this account (up to the maximum credit
amount) and repay this line at any time. At June 30, 2003 we had $73.0 million
or 17.39% of the total loan portfolio in home equity loans and lines of credit
outstanding. Of the $73.0 million outstanding at June 30, 2003, $11.6 million
were in lines of credit. The unused portion of equity lines of credit was $14.5
million at that date. The low level of interest rates in recent periods has
increased amortization and prepayments on home equity loans. This has resulted
in a slight decline in the outstanding balance of home equity loans held at June
30, 2003 despite increases in the amount of home equity loans originated during
the year.
Home equity loans and lines of credit are secured by the borrower's
residence, and we generally obtain a second lien position on these loans. We
offer home equity programs in amounts, when combined with the first
8
mortgage, up to 100% of the value of the property securing the loan. In addition
to originating home equity loans through our branch offices, we purchase loans
from our network of correspondents.
Commercial Real Estate and Multi-Family Residential Real Estate Loans.
At June 30, 2003 commercial real estate and multi-family residential loans
amounted to $155.9 million or 37.14% of the total loan portfolio. This compares
to $134.3 million or 29.90% at June 30, 2002.
Our commercial real estate and multi-family residential loan portfolio
consists primarily of loans secured by office buildings, retail and industrial
use buildings, strip shopping centers, residential properties with five or more
units, non-FNMA eligible single-family residential investment properties and
other properties used for commercial and multi-family purposes located in our
market area. Our commercial and multi-family real estate loans tend to be
originated in an amount less than $3.0 million but will occasionally exceed that
amount. At June 30, 2003, the average commercial and multi-family residential
loan size was $504,000. The five largest commercial real estate and multi-family
residential loans outstanding at June 30, 2003, were $4.2 million, $4.1 million,
$3.9 million, $3.5 million and $3.4 million and all of such loans were
performing in accordance with their terms. However, during an internal review of
the portfolio in fiscal 2002, it was determined that the debt service coverage
ratio for the loan in the amount of $4.1 million was no longer meeting our
underwriting standards and therefore was classified as substandard. During the
year ended June 30, 2003, our commercial real estate and multi-family loan
portfolio grew by $21.6 million, or 16.1% as the result of originations,
purchases and the conversion of loans from construction to permanent status. The
relatively low interest rate environment during the year ended June 30, 2003
stimulated increased amortization and prepayments which partially offset the
total amount of multi-family and commercial real estate originations of $46.8
million during the year.
Although terms for commercial real estate and multi-family loans vary,
our underwriting standards generally allow for terms up to 20 years with monthly
amortization over the life of the loan and LTV ratios of not more than 80%.
Interest rates are either fixed or adjustable, based upon designated market
indices such as the 5-year Treasury CMT or 5-year FHLB of Pittsburgh advance
rate plus a margin, and fees ranging from 0.5% to 1.5% are generally charged to
the borrower at the origination of the loan. Prepayment fees are generally
charged on most commercial real estate and multi-family loans in the event of
early repayment. Generally we obtain personal guarantees of the principals as
additional collateral for commercial real estate and multi-family real estate
loans.
Commercial real estate and multi-family real estate lending involves
different risks than single-family residential lending. These risks include, but
are not limited to, larger loans to individual borrowers and loan payments that
are dependent upon the successful operation of the project or the borrower's
business. These risks can be affected by supply and demand conditions in the
project's market area of rental housing units, office and retail space,
warehouses, and other commercial space. We attempt to minimize these risks by
limiting our loans to proven businesses, only considering properties with
existing operating performance which can be analyzed, using conservative debt
coverage ratios in our underwriting, and periodically monitoring the operation
of the business or project and the physical condition of the property. As of
June 30, 2003, $48,000, or 0.03% of our commercial real estate and multi-family
residential mortgage loans were on non-accrual status compared to $1.2 million
or 0.88% at June 30, 2002. The decrease was primarily related to an impaired
$675,000 loan subsequently acquired in foreclosure and reclassified as
real-estate owned during fiscal 2003.
Various aspects of a commercial and multi-family loan transaction are
evaluated in our effort to mitigate the additional risk in these types of loans.
In our underwriting procedures, consideration is given to the stability of the
property's cash flow history, future operating projections, current and
projected occupancy levels, location and physical condition. Generally, we
impose a debt service ratio (the ratio of net cash flows from operations before
the payment of debt service to debt service) of not less than 115%. We also
evaluate the credit and financial condition of the borrower, and if applicable,
the guarantor. Appraisal reports prepared by independent appraisers are obtained
on each loan to substantiate the property's market value, and are reviewed by us
prior to the closing of the loan.
Construction Loans. We originate construction loans for residential and
commercial uses within our market area. We generally limit construction loans to
builders and developers with whom we have an established relationship, or who
are otherwise known to officers of the Bank. Construction loans outstanding at
June 30, 2003 were $36.2 million, or 8.62% of total loans, compared to $29.3
million or 6.52% of total loans at June 30, 2002.
9
Our construction loans generally have variable rates of interest, a
maximum term to maturity of three years and LTV ratios less than 80%.
Residential construction loans to developers are made on either a pre-sold or
speculative (unsold) basis. Limits are placed on the number of units that can be
built on a speculative basis based upon the reputation and financial position of
the builder, his/her present obligations, the location of the property and prior
sales in the development and the surrounding area. Generally a limit of two to
six model homes is permitted per project.
Prior to committing to a construction loan, we require that an
independent appraiser prepare an appraisal of the property. We also review and
inspect each project at its inception and prior to every disbursement of loan
proceeds. Disbursements are made after inspections based upon a percentage of
project completion. Monthly payment of interest is required on all construction
loans.
We also make construction loans for the acquisition and development of
land for sale (i.e. roads, sewer and water lines). We make these loans only in
conjunction with a commitment for a construction loan for the units to be built
on the site. These loans are secured by a lien on the property and are limited
to a LTV ratio of 75% of the appraised value. The loans have a variable rate of
interest and require monthly payments of interest. The principal of the loan is
repaid as units are sold and released. All of our loans of this type are in our
market area and are to developers with whom we have established relationships.
In most cases, we also obtain personal guarantees from the borrowers.
Construction and land loans generally are considered to involve a
higher level of risk than single-family residential lending, due to the
concentration of principal in a limited number of loans and borrowers and the
effect of economic conditions on developers, builders and projects. Additional
risk is also associated with construction lending because of the inherent
difficulty in estimating both a property's value at completion and the estimated
cost (including interest) to complete a project. The nature of these loans is
such that they are more difficult to evaluate and monitor. In addition,
speculative construction loans to a builder are not pre-sold and thus pose a
greater potential risk than construction loans to individuals on their personal
residences. At June 30, 2003, our five largest construction loans had
outstanding balances of $4.3 million, $2.3 million, $2.3 million, $2.0 million
and $2.0 million and all were performing in accordance with the terms of their
agreements with the exception of the $4.3 million loan representing a 25.3% loan
participation on the construction of a commercial real estate office building
located in Montgomery County in the suburbs of Philadelphia. The loan which has
a loan-to-value ratio of 88.0%, is secured by a property which is approximately
50% tenant occupied but has fallen behind original leasing projections
necessitating two extensions of the original maturity date of November 2002 to
October 2003, and as a result has been classified as substandard. It is
anticipated that an additional two year extension will be granted upon
expiration of the current extension.
In order to mitigate some of the risks inherent to construction
lending, we inspect properties under construction, review construction progress
prior to advancing funds, work with builders who have established relationships,
and obtain personal guarantees from the principals.
Commercial Business Loans. At June 30, 2003, we had $20.5 million in
commercial business loans (4.90% of gross loans outstanding) compared to $19.1
million at June 30, 2002, an increase of $1.4 million or 7.3%. During the year
ended June 30, 2003, we originated or advanced additional funds on business
lines of credit in the amount of $10.8 million. These originations were offset
by increased amortization and prepayments of loans primarily due to the low
interest rate environment. We began originating loans to small-to-mid-sized
businesses in our market area in May 1997. Since that time, we have hired
commercial lenders to actively solicit commercial business loans as well as
commercial real estate and multi-family real estate loans. During fiscal 2002
and 2003, we generally did not originate new commercial business loans in
amounts exceeding $250,000. Management undertook a process designed to enhance
the Company's commercial business lending function. During fiscal 2003 we hired
a Chief Lending Officer, experienced in business lending, and a Credit Risk
Manager whose responsibilities include reviewing existing systems and policies,
establishing or improving procedures, where necessary, and training new and
existing personnel with respect to the origination and oversight of commercial
business loans. Such steps were taken in anticipation of a renewal in fiscal
2004 of the Company's efforts to increase originations of commercial business
loans in excess of $250,000. During fiscal 2003, the Company restricted its
originations of new commercial business loans in excess of $250,000. Only eight
such loans were originated after they had been reviewed and approved by the full
10
board of directors. The Company expects that in fiscal 2004 it will gradually
increase the amount of its originations of commercial business loans in excess
of $250,000 as it fully implements its enhanced policies and procedures with
respect to such loans. In addition to our commercial loan officers, we use our
business development officers working from several of our branch locations to
actively solicit potential customers in the Bank's market area. No assurance can
be given as to the volume of new commercial loans originated in the future. This
portfolio may decline in the near term as previously originated larger balance
loans are repaid and replaced with smaller balance new originations. We believe
that these types of loans assist in our asset/liability management since they
generally provide shorter maturities and/or adjustable rates of interest in
addition to generally having higher rates of return which are designed to
compensate for the additional credit risk associated with these loans.
Generally, the Bank provides secured revolving lines of credit for
short term working capital support of a business's accounts receivables and
inventory. Typically the secured revolving line of credit is collateralized
based upon an advance rate of up to 75% of eligible accounts receivable and up
to 30% of finished goods inventory. Secured term loan financing is provided for
the acquisition of fixed business assets, such as real property, vehicles,
equipment and machinery. Generally, we provide financing up to 80% of the
purchase price for the new fixed assets and 70% of book value for pre-owned
fixed assets. In addition to business assets pledged as collateral, most
commercial business loans are personally guaranteed by the principal owner(s) of
the borrower. Interest rates are adjustable, indexed to a published prime rate
of interest or fixed. At June 30, 2003, the Bank's five largest commercial
business loans were $849,000, $560,000 $448,000, $407,000 and $335,000 and all
such loans were performing in accordance with their terms with the exception of
the $849,000 loan which was delinquent 61 days. The total credit relationship
associated with this borrower is $953,000. The Bank is carefully monitoring this
loan and understands that the borrower is experiencing financial difficulties.
Management believes that certain additional provisions to its allowance for loan
losses may be necessary in the quarter ending September 30, 2003 due to this
loan. At June 30, 2003 the average balance of the Bank's commercial business
loans was $84,000.
Generally, commercial business loans have been characterized as having
higher risks associated with them than single-family mortgage loans. We have
hired individuals, experienced in this type of lending, and have implemented
policies and procedures which we deem to be prudent. As of June 30, 2003, the
Bank had $360,000 of non-accrual commercial business loans compared to $724,000
at June 30, 2002. Charge-offs of commercial business loans amounted to $103,000
during the year ended June 30, 2003 compared to $769,000 in the year ended June
30, 2002.
Other Consumer Lending Activities. In our efforts to provide a full
range of financial services to our customers, we offer various types of consumer
loans primarily consisting of loans secured by automobiles and to a much lesser
extent deposit account loans, and unsecured personal loans. In addition to
originating consumer loans we facilitate the funding of student loans through
our banking offices in conjunction with American Education Services
("AES/PHEAA"). Consumer loans are originated and facilitated primarily through
existing and walk-in customers and direct advertising. At June 30, 2003, $2.3
million, or 0.55% of our total loan portfolio consisted of these types of loans.
This compares to $10.1 million of consumer loans, or 2.24% of the total loan
portfolio at June 30, 2002. The decline was exclusively related to $7.8 million
received from the liquidation of our education loan portfolio.
Consumer loans, other than loans secured by deposit accounts, generally
have higher interest rates and shorter terms than residential loans, however
they have additional credit risk due to the type of collateral securing the loan
or in some cases the absence of collateral. In the fiscal year ended June 30,
2003, there were charge-offs, net of recoveries totaling $4,000 related to other
consumer loans. This compares to $162,000 in net consumer loan charge-offs in
the fiscal year ended June 30, 2002.
Asset Quality
General. As a part of our efforts to maintain asset quality, we have
developed and implemented an asset classification system in conjunction with
federal regulations. All of our assets are subject to this classification
system. Loans are periodically reviewed and the classifications reviewed at
least quarterly by the Asset Quality Committee of the Board of Directors.
11
When a borrower fails to make a scheduled payment, we attempt to cure
the deficiency by making personal contact with the borrower. Initial contacts
are generally made 16 days after the date the payment is due. In most cases,
deficiencies are promptly resolved. If the delinquency continues, late charges
are assessed and additional efforts are made to collect the deficiency. We
generally work with borrowers to resolve such problems, however, when the
account becomes 90 days delinquent, we institute foreclosure or other
proceedings, as necessary, to minimize any potential loss.
On loans which we consider the collection of principal or interest
payments doubtful, we cease the accrual of interest income ("non-accrual"
loans). On loans more than 90 days past due, as to principal and interest
payments, it is our policy to discontinue accruing additional interest and
reverse any interest currently accrued (unless we determine that the loan
principal and interest are fully secured and in the process of collection). On
occasion, we may take this action earlier if the financial condition of the
borrower raises significant concern with regard to his/her ability to service
the debt in accordance with the terms of the loan. Interest income is not
accrued on these loans until the borrower's financial condition and payment
record demonstrate an ability to service the debt.
Real estate which we acquire as a result of foreclosure or deed-in-lieu
of foreclosure is classified as real estate owned until sold. Real estate owned
is recorded at the lower of cost or fair value less estimated selling cost.
Costs associated with acquiring and improving a foreclosed property are usually
capitalized to the extent that the carrying value does not exceed fair value
less estimated selling costs. Holding costs are charged to expense. Gains and
losses on the sale of real estate owned are reflected in operations, as
incurred.
Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated. The amounts presented represent the
total outstanding principal balances of the related loans rather than the actual
payment amounts that are past due.
At At
June 30, 2003 June 30, 2002
--------------------- ---------------------
30 to 60 to 30 to 60 to
59 days 89 days 59 days 89 days
-------- -------- -------- --------
(Dollars in thousands)
Mortgage loans:
Single-family $ 2,218 $ 603 $ 2,449 $ 566
Commercial real estate and multi-family 205 -- 767 --
Construction -- -- -- --
Home equity 158 12 192 --
Consumer loans -- 1 9 16
Commercial business loans 1,203 104 412 35
-------- -------- -------- --------
Total loans receivable $ 3,784 $ 720 $ 3,829 $ 617
======== ======== ======== ========
Loans delinquent 30 to 89 days amounted to $4.5 million at June 30,
2003 compared to $4.4 million at June 30, 2002. Increases in the amount of
delinquent commercial business loans were offset by decreases in delinquent
commercial real estate loans and to a lesser extent single-family mortgage
loans. Management continues to regularly monitor all delinquent loan activity.
Management does not consider the current level of delinquencies to be of any
significant concern as, based upon past experience, most of such loans are
expected to return to fully performing status without going to non-accrual
status. In any event, management believes that for the most part these loans are
adequately collateralized.
Non-Performing Assets. The following table sets forth information with
respect to non-performing assets we have identified, including non-accrual loans
and other real estate owned. The decrease in non-performing assets from $5.8
million at June 30, 2002 to $4.1 million at June 30, 2003 was the result of
decreases in non-accrual single family, multi-family and commercial real estate
mortgage loans, consumer loans and commercial business loans.
12
At June 30,
--------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Accruing loans 90 or more days past due
Mortgage loans $ 367 $ -- $ 42 $ 9 $ 4
Commercial business loans 147 200 -- -- --
Other -- -- 49 -- --
------ ------ ------ ------ ------
Total accruing but 90 or more days past due 514 200 91 9 4
------ ------ ------ ------ ------
Nonaccrual loans
Mortgage loans:
Single-family 1,064 1,897 1,485 828 1,006
Commercial real estate and multi-family 48 1,179 675 140 --
Construction -- -- -- -- --
Home equity 236 55 278 10 37
Consumer 7 104 151 19 8
Commercial business 360 724 966 250 13
------ ------ ------ ------ ------
Total nonaccrual loans 1,715 3,959 3,555 1,247 1,064
------ ------ ------ ------ ------
Performing troubled debt restructurings 1,463 1,512 1,535 -- --
Total non-performing loans 3,692 5,671 5,181 1,256 1,068
Other real estate owned, net 391 85 -- -- --
------ ------ ------ ------ ------
Total non-performing assets $4,083 $5,756 $5,181 $1,256 $1,068
====== ====== ====== ====== ======
Non-performing loans to total loans 0.88% 1.26% 1.13% 0.29% 0.28%
Non-performing assets to total assets 0.48% 0.76% 0.83% 0.22% 0.23%
Classified and Criticized Assets. Federal regulations require that each
insured institution classify its assets on a regular basis. Furthermore, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, based upon their judgment, classify
them. There are three classifications for problem assets: "substandard,"
"doubtful," and "loss". Substandard assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have weaknesses of substandard assets with the additional characteristic that
the weaknesses make collection or liquidation in full on the basis of current
existing facts, conditions and values, questionable, and there is a high
probability of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted. Federal regulations also require another unclassified category
designated "special mention" to be established and maintained for assets that do
not currently expose an insured institution to a sufficient degree of risk to
warrant classification as substandard, doubtful, or loss. At June 30, 2003, we
had $13.3 million of our assets classified as substandard ($1.3 million of
single-family mortgage loans, $5.8 million of multi-family and commercial real
estate loans, $4.4 million of construction loans, $1.5 million of commercial
business loans, $250,000 of home equity loans and $66,000 of consumer loans);
$28,000 of business loans classified as doubtful and no loans classified as
loss. This compares to $13.6 million in assets classified as substandard,
$93,000 classified as doubtful and no assets classified as a loss, at June 30,
2002.
Allowance for Loan Losses. The allowance for loan losses is maintained
at a level we believe is adequate to cover known and inherent losses in the loan
portfolio that are both probable and reasonable to estimate at each reporting
date. Our determination of the adequacy of the allowance is based upon an
evaluation of the portfolio, loss experience, current economic conditions,
volume, growth, composition of the portfolio, and other relevant factors. With
the expansion of our lending activities into commercial real estate, business
and other consumer loans in recent years, we consider industry-wide loss
experience in our process when we determine the adequacy of our allowance
13
for loan losses. We believe that due to the changing mix of our loan portfolio
and our relative lack of historical loss experience with these types of loans,
considering loan loss data from other banking institutions with loan portfolios
similar to ours and in a similar geographic setting will provide us with a more
representative approach to evaluating the credit risks in our loan portfolio.
During the year ended June 30, 2001, based upon a more detailed stratification
of the loan portfolio, we modified the formulas we use to calculate the
allowance on various loan types. In some cases, such as business lending and
home equity lending where the combined LTV exceeds 80%, the percentage used to
calculate the allowance was increased. In other cases, such as single-family
first mortgage lending with LTVs below 60%, the percentage used was decreased.
The overall effect of this modification did not materially impact the amount of
the allowance for loan loss. During the fiscal year ended June 30, 2002 we
modified the methodology for calculating the allowance for loan loss based upon
the guidance provided by the SEC and the Federal Financial Institutions
Examination Council ("FFIEC"). We continue to use historical loss factors for
each loan type and for loans that we consider higher risk for all but
single-family mortgage loans and guaranteed consumer loans, we now add a
component for factors that may not be included in the historical loss
calculation. This component establishes a range for factors such as, but not
limited to, delinquency trends, asset classification trends and current economic
conditions. Management then assesses these conditions and establishes, to the
best of its ability, the allowance for loan loss from within the range
calculated, based upon the facts known at that time. At June 30, 2003, our
allowance for loan loss was in the lower quartile of the range established by
this methodology. The result of this change in methodology is to allocate the
entire allowance for loan loss to specific loan types, whereas prior methodology
had an unallocated component. The change in methodology does not imply that any
portion of the allowance for loan loss is restricted, but the allowance for loan
loss applies to the entire loan portfolio.
The allowance is increased by provisions for loan losses which are
charges against income. As shown in the table below, at June 30, 2003, our
allowance for loan losses amounted to $5.3 million or 143.88% and 1.27% of our
non-performing loans and total loans receivable less deferred fees,
respectively.
Year ended June 30,
--------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Balance - beginning of period $4,626 $4,313 $3,905 $3,138 $2,665
Plus: provisions for loan losses 1,034 1,212 7,856 706 531
Less: charge-offs for
Mortgage loans 284 12 18 51 32
Consumer loans 4 173 72 31 23
Commercial business loans 103 769 7,359 3 3
------ ------ ------ ------ ------
Total charge-offs 391 954 7,449 85 58
------ ------ ------ ------ ------
Plus: recoveries for
Mortgage loans -- -- -- 16 --
Consumer loans -- 11 1 -- --
Commercial business loans 43 44 -- 130 --
------ ------ ------ ------ ------
Total recoveries 43 55 1 146 --
------ ------ ------ ------ ------
Balance - end of period $5,312 $4,626 $4,313 $3,905 $3,138
====== ====== ====== ====== ======
Allowance for loan loss to total end
of period non-performing loans 143.88% 81.57% 83.25% 310.91% 293.82%
Charge-offs to average loans 0.08% 0.21% 1.65% 0.02% 0.02%
Allowance for loan loss to end of
period total loans less deferred fees 1.27% 1.03% 0.94% 0.91% 0.83%
14
Provisions for loan losses for the year ended June 30, 2003 were $1.0
million, a decline from $1.2 million in the prior year. Charge-offs also
decreased from $954,000 in fiscal year 2002 to $391,000 in fiscal year 2003. The
primary reason for the increase in the percent of the allowance for loan loss to
total loans was the increase of commercial real estate and multi-family real
estate loan portfolios as a percentage of the total loan portfolio. We assess
our allowance for loan losses at least quarterly, and make any necessary
provision for losses needed to maintain our allowance for losses at a level
deemed adequate. We believe that the allowance for losses was adequate at June
30, 2003 to cover losses that are both probable and reasonably estimable based
upon the facts and circumstances known to us at that date.
Effective December 21, 1993, the OTS in conjunction with the
Comptroller of the Currency, the FDIC and the Federal Reserve Board issued a
Policy Statement regarding a financial institution's allowance for loan and
lease losses. The Policy Statement, which reflects the position of the
regulatory agencies and does not necessarily constitute generally accepted
accounting principles, includes guidance (i) on our responsibilities for the
assessment and establishment of an adequate allowance; and (ii) for the
agencies' examiners to use in evaluating the adequacy of such allowance and the
policies used to determine such allowance. The Policy Statement also sets forth
quantitative measures for the allowance with respect to assets classified
substandard and doubtful and with respect to the remaining portion of the
institution's portfolio. Specifically, the Policy Statement sets forth the
following quantitative measures which examiners may use to determine the
reasonableness of an allowance: (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio classified substandard; and (iii) for the
portions of the portfolio that have not been classified (including loans
designated special mention), estimated credit losses over the upcoming twelve
months based on facts and circumstances available as of the evaluation date.
While the Policy Statement sets forth this quantitative measure, such guidance
is not intended as a "floor" or "ceiling". Our policy for establishing loan
losses is consistent with the Policy Statement. In July 2001, the SEC issued
Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance
Methodology And Documentation Issues". The guidance in the SAB was effective
immediately and focuses on the documentation the SEC staff normally expects
registrants to prepare and maintain in support of the allowance for loan losses.
Concurrent with the SEC's issuance of SAB No. 102, the federal banking agencies,
represented by the FFIEC issued an interagency policy statement entitled
"Allowance For Loan and Lease Loss Methodologies And Documentation For Banks and
Savings Institutions" ("FFIEC Policy Statement"). The SAB and FFIEC Policy
Statement were the result of an agreement between the SEC and the federal
banking agencies in March 1999 to provide guidance on allowance for loan loss
methodologies and supporting documentation. We believe to the best of our
knowledge that our documentation relating to the allowance for loan loss is
consistent with these pronouncements.
15
We have allocated the allowance for loan losses as shown in the table
below into components by loan types at year end. Due to a change in methodology
there is no unallocated portion of the allowance after June 30, 2001. Through
such allocations, we do not intend to imply that actual future charge-offs will
necessarily follow the same pattern or that any portion of the allowance is
restricted.
June 30, 2003 June 30, 2002 June 30, 2001 June 30, 2000 June 30, 1999
------------------- ------------------- ------------------- ------------------- -------------------
Percent of Percent of Percent of Percent of Percent of
loan type to loan type to loan type to loan type to loan type to
Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans
------ ------------ ------ ------------ ------ ------------ ------ ------------ ------ ------------
(Dollars in thousands)
Mortgage loans:
Single-family $ 161 31.40% $ 255 40.40% $ 239 43.17% $ 591 48.04% $ 598 61.16%
Commercial real estate 2,705 37.14 2,239 29.90 1,454 28.00 1,230 23.86 695 17.36
and multi-family
Construction 1,156 8.62 937 6.52 554 6.04 299 3.49 346 2.05
Home equity 430 17.39 472 16.70 437 16.34 482 16.81 359 14.29
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total mortgage loans 4,452 94.55 3,903 93.52 2,684 93.55 2,602 92.20 1,998 94.86
Consumer loans 70 0.55 70 2.24 86 2.11 38 1.82 29 1.70
Commercial business loans 790 4.90 653 4.24 656 4.34 382 5.98 186 3.44
Unallocated -- -- -- -- 887 n/a 883 n/a 925 n/a
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total $5,312 100.00% $4,626 100.00% $4,313 100.00% $3,905 100.00% $3,138 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
16
Securities Activities
General. Our investment policy is designed, among other things, to
assist us in our asset/liability management strategies. It emphasizes principal
preservation, favorable returns, maintaining liquidity and flexibility, and
minimizing credit risk. The policy permits investments in US Government and
agency securities, investment grade corporate bonds and commercial paper,
municipal bonds, various types of mortgage-backed securities, certificates of
deposit and federal funds sold to financial institutions approved by our Board
of Directors, equity investments in the FHLB of Pittsburgh, the FNMA, the FHLMC,
and mutual funds with investments in the above described investments.
Currently, we are not participating in hedging programs, interest rate
swaps, caps, collars or other activities involving the use of off-balance sheet
financial derivatives. Also, we do not purchase mortgage-backed derivative
instruments that would be characterized "high-risk" under OTS regulations at the
time of purchase, nor do we purchase corporate obligations, which are not rated
investment grade. Although permissible by our policy, currently we do not own
any corporate bonds regardless of rating.
In order to maintain a high degree of flexibility with our investment
securities, prior to January 2002, all of our investment securities were
classified as Available For Sale ("AFS") pursuant to Statement of Financial
Accounting Standards No. 115. In January 2002 we changed the classification on
our municipal bond portfolio from AFS to Held to Maturity ("HTM"). This
accounting pronouncement requires us to classify a security as AFS, Held to
Maturity, or trading, at the time of acquisition. Securities being classified as
HTM must be purchased with the intent and ability to hold that security until
its final maturity, and can be sold prior to maturity only under rare
circumstances. HTM securities are accounted for based upon the historical cost
of the security. AFS securities can be sold at any time based upon our needs or
judgment as to market changes. AFS securities are accounted for at fair value,
unrealized gains and losses on these securities, net of income tax effects, are
reflected in the stockholders' equity section of our Statement of Financial
Condition.
At June 30, 2003, our investment securities amounted to $309.2 million,
or 36.59% of total assets. This includes a $1.9 million unrealized gain, net of
income tax, on those investment securities classified as AFS. The portfolio
consists primarily of US government agency securities, most with callable
features and agency mortgage-backed pass-through securities. Other investments
include municipal bonds, equity investments in the FHLB of Pittsburgh, other
equity securities and a mutual fund consisting of adjustable-rate
mortgage-backed securities.
The following table sets forth information on the carrying value and
the amortized cost of our securities classified as held to maturity and
available for sale at the dates indicated.
17
At June 30,
-------------------------------------------------------------------------------------
2003 2002 2001
---- ---- ----
Amortized Market Amortized Market Amortized Market
Cost value Cost value Cost value
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Held to maturity:
Municipal bonds $ 17,320 $ 17,995 $ 13,973 $ 14,117 $ -- $ --
---------- ---------- ---------- ---------- ---------- ----------
Total held to maturity 17,320 17,995 13,973 14,117 -- --
---------- ---------- ---------- ---------- ---------- ----------
Amortized Carrying Amortized Carrying Amortized Carrying
Cost value Cost value Cost value
---------- ---------- ---------- ---------- ---------- ----------
Available for sale:
FHLB stock 9,252 9,252 5,042 5,042 3,434 3,434
Equity securities 6,477 6,410 4,472 4,421 4,442 4,404
US Gov't agency securities 76,980 78,205 75,692 76,693 43,722 43,798
Mortgage-backed securities 196,184 198,018 166,445 168,531 75,905 75,834
Municipal bonds -- -- -- -- 2,903 2,888
---------- ---------- ---------- ---------- ---------- ----------
Total available for sale 288,893 291,885 251,651 254,687 130,406 130,358
---------- ---------- ---------- ---------- ---------- ----------
Total securities $ 306,213 $ 309,880 $ 265,624 $ 268,804 $ 130,406 $ 130,358
========== ========== ========== ========== ========== ==========
Mortgage-Backed Securities. At June 30, 2003, we had mortgage-backed
securities totaling $198.0 million compared to $168.5 million at June 30, 2002.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages. Mortgages are sold by various
originators to intermediaries (generally agencies of the US Government and
government sponsored enterprises) that pool and repackage the mortgages and sell
participation interests in the pools to investors. The servicer of the mortgage
loan collects the principal and interest payments and passes those payments
through to the intermediary who then remits the payment to the investor. The US
Government agencies and government sponsored enterprises, primarily the
Government National Mortgage Association ("GNMA"), FNMA and FHLMC, guarantee the
timely payment of principal and interest on these securities.
Mortgage-backed securities are issued in stated principal amounts and
are backed by mortgage loans within a specific interest rate range, but may have
varying maturity dates. The underlying pool of mortgages may be comprised of
either fixed-rate or adjustable-rate mortgage loans. Each mortgage-backed
security pool will also differ based upon the actual level of prepayment
experienced by the underlying mortgage loans.
At June 30, 2003, the weighted average life of our mortgage-backed
securities was approximately 3.2 years, based upon our assumptions related to
the future prepayments of the underlying mortgages. Prepayments that are greater
than those projected will shorten the remaining term of the security, while a
decrease in the amount of prepayments will lengthen the amount of time until the
security matures. Prepayments depend on many factors, including the type of
mortgage, the coupon rate, the geographic region, and the general level of
market interest rates. During periods of rising interest rates, if the coupon
rates of the underlying mortgages are less than prevailing market rates offered
on mortgages, refinancings will decrease and prepayments of the mortgages
underlying the security will decline. Conversely, when market interest rates are
falling, and the coupon rate on the underlying mortgage exceeds the prevailing
market interest rate for mortgages offered, refinancings tend to increase which
will increase the amount of prepayments of the underlying mortgages. During the
year ended June 30, 2003, prepayments on mortgage-backed securities exceeded
$60.3 million compared to $28.0 million for the year ended June 30, 2002. This
increase in prepayments is primarily related to the general level of interest
rates which has been favorable for refinancing activity.
18
Our average yield on our mortgage-backed securities was 3.95% at June
30, 2003. This yield is computed by decreasing/increasing the amount of interest
income collected on the security by the amortization/accretion of the
premium/discount associated with the acquisition of the security. In accordance
with generally accepted accounting principles, premiums/discounts are
amortized/accreted over the estimated remaining life of the security. The yield
on the security may vary if the prepayment assumptions used to determine the
remaining life differ from actual prepayment experiences. These assumptions are
reviewed on a periodic basis to reflect actual prepayments.
US Government Agency Securities and Municipal Bonds. At June 30, 2003,
we had $78.2 million, which includes approximately $1.2 million in unrealized
gains, in securities issued by US government agencies, primarily the FHLB, FNMA,
FHLMC and the Federal Farm Credit Bank compared to $76.7 million at June 30,
2002. Most of these securities have call features that allow the issuer to
redeem these securities at par value prior to their stated maturity. Generally,
if the prevailing market interest rate on new issue callable agency securities
with similar maturities exceeds the coupon rate of the security with the call
feature, the call will not be exercised. Conversely, if the prevailing market
interest rate for new issue agency callable securities with similar maturities
is below the coupon rate of the security with the call feature, the call will be
exercised and the bond will be redeemed. When calls are exercised and bonds
redeemed prior to their maturity, we face the risk of re-investing those
proceeds into other investments with lower yields or longer terms.
Our Municipal bonds were classified as held to maturity at June 30,
2003 and are recorded at an amortized cost basis of $17.3 million. The market
value of these securities at June 30, 2003 was $18.0 million. These municipal
bonds include issues from various townships and school districts located in
Pennsylvania.
The following table sets forth certain information regarding the
contractual maturities (without regard to any call provisions) of the carrying
value of our US government agency securities and municipal bonds at June 30,
2003. The yields on tax-exempt bonds have not been adjusted to taxable
equivalent yield.
Carrying Average
value yield
---------- ---------
(Dollars in thousands)
Maturing in:
One year or less $ 2,999 5.08%
One to five years 52,737 3.69
Five to ten years 22,974 3.90
Over ten years 15,590 4.70
-------- -----
Total $ 94,300 3.95%
======== =====
Other Investments. Other than mortgage-backed securities and US
Government agency securities, we have investments in various equity securities
and mutual funds. At June 30, 2003, $9.7 million was invested in equity
securities and $6.0 million was invested in mutual funds. The equity securities
include stock in the FHLB of Pittsburgh and equity securities of several
publicly traded companies. FHLB stock at June 30, 2003 was $9.3 million and the
other equity investments amounted to $477,000. The mutual fund investment of
$6.0 million is backed primarily by investments in adjustable-rate
mortgage-backed securities.
Sources of Funds
General. Deposits are the primary source of funds for our lending and
investment activities. In addition to deposits, we obtain funds from the
amortization and prepayments on our loan and mortgage-backed security portfolio,
maturities of investments, and borrowings. Scheduled loan amortization is a
relatively stable source of funds. However, competition and the general level of
interest rates and market conditions significantly influence deposit inflows and
outflows. Borrowings may be used on a short-term basis to compensate for
reductions in other funding sources. On a longer-term basis, borrowings may be
used for general business purposes.
19
Deposits
As shown in the table below, during the year ended June 30, 2003,
certificates of deposit fell as a percentage of total deposits from 57.7% to
51.1% while other core deposit accounts increased to 48.9% of total deposits
from 42.3% of deposits at June 30, 2002.
At June 30,
--------------------------------------------
2003 2002
---- ----
Percent Percent
Amount of total Amount of total
-------- -------- -------- --------
(Dollars in thousands)
Savings accounts (passbooks, $ 86,447 14.7% $ 73,218 13.8%
statements and clubs)
Money market accounts 79,280 13.5 47,752 9.0
Certificates of deposit 299,794 51.1 305,807 57.7
Checking accounts:
Interest-bearing 51,541 8.8 40,045 7.6
Non-interest-bearing 69,581 11.9 62,930 11.9
-------- ------- -------- -------
Total $586,643 100.0% $529,752 100.0%
======== ======= ======== =======
During the year ended June 30, 2003, total deposits increased by $56.9
million or 10.7% compared to an increase of $32.7 million, or 6.6% for the year
ended June 30, 2002.
Year ended June 30,
----------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Beginning balance $529,752 $497,030 $452,857
Net increase in deposits 45,268 16,979 27,942
Interest credited 11,623 15,743 16,231
-------- -------- --------
Total increase in deposits 56,891 32,722 44,173
-------- -------- --------
Ending balance $586,643 $529,752 $497,030
======== ======== ========
The following table sets forth by various interest rate categories, the
amount of certificates of deposit at the dates indicated.
20
At June 30,
--------------------
2003 2002
-------- --------
(Dollars in thousands)
Interest rates:
- --------------------
from 0.00% to 2.99% $181,942 $106,833
from 3.00% to 3.99% 56,897 71,310
from 4.00% to 4.99% 43,394 76,275
from 5.00% to 6.99% 17,101 48,853
7.00% and over 460 2,536
-------- --------
Total $299,794 $305,807
======== ========
Shown below are the amount and remaining term to maturity for
certificates of deposit as of June 30, 2003.
Amounts maturing in
--------------------------------------------------------------------------------
Over six
months Over one Over two
Six months through one year through years through Over three
or less year two years three years years
------------ ------------ ------------ ------------- ------------
Interest rates: (Dollars in thousands)
- -------------------
from 0.00% to 2.99% $ 92,502 $ 49,925 $ 32,814 $ 4,011 $ 2,690
from 3.00% to 3.99% 8,532 10,206 21,224 3,989 12,946
from 4.00% to 4.99% 10,578 7,762 15,015 3,602 6,437
from 5.00% to 6.99% 11,836 3,703 863 558 141
7.00% and over 460 -- -- -- --
------------ ------------ ------------ ------------ ------------
Total $ 123,908 $ 71,596 $ 69,916 $ 12,160 $ 22,214
============ ============ ============ ============ ============
At June 30, 2003 the total amount of outstanding certificates of
deposit in amounts greater than or equal to $100,000 was $57.0 million. The
following table provides information regarding the maturity of these
certificates of deposit.
Amounts maturing in
--------------------------------------------------------------------------------
Over three Over six
Three months months
months or through six through one Over one
less months year year Total
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
$ 16,587 $ 11,189 $ 10,352 $ 18,846 $ 56,974
Borrowings.
We use outside borrowings to supplement our funding needs. We also use
borrowings in revenue enhancement programs that allow us to take advantage of
arbitrage opportunities when investment returns exceed the cost of borrowings.
At June 30, 2003 we had $132.5 million in borrowings outstanding, all of which
were from the FHLB of Pittsburgh. Advances from the FHLB of Pittsburgh are
secured by our investment in FHLB stock and a portion of our residential
mortgage loan portfolio. The FHLB of Pittsburgh provides an array of borrowing
programs which include: fixed or variable rate programs; various fixed terms
ranging from overnight to 20 years; and other programs that have callable or
putable features attached to them. We intend to continue to utilize borrowings
in the future as an alternative source of funds.
21
The following table sets forth certain information regarding our
outside borrowings for the periods indicated.
At or for the year ended
--------------------------------
June 30, 2003 June 30, 2002
------------- -------------
(Dollars in thousands)
FHLB advances:
Average balance outstanding for the period $ 129,633 $ 73,830
Maximum outstanding at any month end 139,132 100,800
Balance outstanding at end of the period 132,557 97,824
Average interest rate for the period 4.57% 5.58%
Interest rate at the end of the period 3.84% 5.05%
At June 30, 2003 the maturity of our FHLB advances ranged from July
2003 to May 2013. Certain advances also require monthly payments of principal.
At June 30, 2003, $70.5 million of FHLB advances were callable at the option of
the FHLB within certain parameters, of which $56.5 million could be called
within one year. Of the $70.5 million of FHLB advances that are callable at the
discretion of the FHLB, $37.5 million of these advances could be called only if
an index exceeded a specific pre-determined rate.
Subsidiaries. Willow Grove Bank, a federally chartered stock savings bank, is
the wholly owned subsidiary of Willow Grove Bancorp, Inc. The Bank has two
direct subsidiaries, Willow Grove Investment Corporation and Willow Grove
Insurance Agency. WGIC is a Delaware corporation formed in 2000 to hold and
manage certain securities investments of the Bank. At June 30, 2003, assets
under management at WGIC totaled $229.4 million. The Agency, formed in May 2003,
is a Pennsylvania limited liability company that conducts fixed rate annuity
transactions for the Bank.
Employees. At June 30, 2003, we had 182 full-time employees, and 63 part-time
employees. None of our employees are represented by a collective bargaining
group, and we believe that our relationship with our employees is good.
22
REGULATION
Set forth below is a brief description of certain laws and regulations
which are applicable to Willow Grove Bancorp and Willow Grove Bank. The
description of these laws and regulations, as well as descriptions of laws and
regulations contained elsewhere herein, does not purport to be complete and is
qualified in its entirety by reference to the applicable laws and regulations.
General
Willow Grove Bank, as a federally chartered savings institution, is
subject to federal regulation and oversight by the Office of Thrift Supervision
extending to all aspects of its operations. Willow Grove Bank also is subject to
regulation and examination by the Federal Deposit Insurance Corporation, which
insures the deposits of Willow Grove Bank to the maximum extent permitted by
law, and requirements established by the Federal Reserve Board. Federally
chartered savings institutions are required to file periodic reports with the
Office of Thrift Supervision and are subject to periodic examinations by the
Office of Thrift Supervision and the Federal Deposit Insurance Corporation. The
investment and lending authority of savings institutions is prescribed by
federal laws and regulations, and such institutions are prohibited from engaging
in any activities not permitted by such laws and regulations. Such regulation
and supervision primarily is intended for the protection of depositors and not
for the purpose of protecting stockholders.
The Office of Thrift Supervision regularly examines Willow Grove Bank
and prepares reports for consideration by its Board of Directors on any
deficiencies that it may find in the bank's operations. The Federal Deposit
Insurance Corporation also has the authority to examine Willow Grove Bank in its
role as the administrator of the Savings Association Insurance Fund. Willow
Grove Bank's relationship with its depositors and borrowers also is regulated to
a great extent by both federal and, to a lesser extent, state laws, especially
in such matters as the ownership of savings accounts and the form and content of
Willow Grove Bank's mortgage requirements. The Office of Thrift Supervision's
enforcement authority over all savings institutions and their holding companies
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the Office of Thrift Supervision. Any change in such laws or
regulations, whether by the Federal Deposit Insurance Corporation, Office of
Thrift Supervision or Congress, could have a material adverse impact on us and
Willow Grove Bank and our operations.
Willow Grove Bancorp, Inc.
Willow Grove Bancorp is a registered savings and loan holding company
under Section 10 of the Home Owners' Loan Act, as amended and subject to Office
of Thrift Supervision examination and supervision as well as certain reporting
requirements. In addition, because Willow Grove Bank's deposits are insured by
the Savings Association Insurance Fund maintained by the Federal Deposit
Insurance Corporation, Willow Grove Bank is subject to certain restrictions in
dealing with us and with other persons affiliated with the Bank.
Generally the Home Owners' Loan Act prohibits a savings and loan
holding company, such as us, directly or indirectly, from (1) acquiring control
(as defined) of a savings institution (or holding company thereof) without prior
Office of Thrift Supervision approval, (2) acquiring more than 5% of the voting
shares of a savings institution (or holding company thereof) which is not a
subsidiary, subject to certain exceptions, without prior Office of Thrift
Supervision approval, or (3) acquiring through a merger, consolidation or
purchase of assets of another savings institution (or holding company thereof)
or acquiring all or substantially all of the assets of another savings
institution (or holding company thereof) without prior Office of Thrift
Supervision approval or (4) acquiring control of an uninsured institution. A
savings and loan holding company may not acquire as a separate subsidiary a
savings institution which has its principal offices outside of the state where
the principal offices of its subsidiary institution is located, except (a) in
the case of certain emergency acquisitions approved by the Federal Deposit
Insurance Corporation, (b) if the holding company controlled (as defined) such
savings institution as of March 5, 1987 or (c) when the laws of the state in
which the savings institution to be acquired is located specifically authorize
such an acquisition. No director or officer of a savings and loan holding
company or person owning or controlling more than
23
25% of such holding company's voting shares may, except with the prior approval
of the Office of Thrift Supervision, acquire control of any savings institution
which is not a subsidiary of such holding company.
Willow Grove Bank
Insurance of Accounts. The deposits of Willow Grove Bank are insured to
the maximum extent permitted by the Savings Association Insurance Fund, which is
administered by the Federal Deposit Insurance Corporation, and are backed by the
full faith and credit of the U.S. Government. As insurer, the Federal Deposit
Insurance Corporation is authorized to conduct examinations of, and to require
reporting by, insured institutions. It also may prohibit any insured institution
from engaging in any activity the Federal Deposit Insurance Corporation
determines by regulation or order to pose a serious threat to the Federal
Deposit Insurance Corporation. The Federal Deposit Insurance Corporation also
has the authority to initiate enforcement actions against savings institutions,
after giving the Office of Thrift Supervision an opportunity to take such
action.
Under current Federal Deposit Insurance Corporation regulations,
Savings Association Insurance Fund-insured institutions are assigned to one of
three capital groups which are based solely on the level of an institution's
capital - "well capitalized," "adequately capitalized," and "undercapitalized" -
which are defined in the same manner as the regulations establishing the prompt
corrective action system discussed below. These three groups are then divided
into three subgroups which reflect varying levels of supervisory concern, from
those which are considered to be healthy to those which are considered to be of
substantial supervisory concern. The matrix so created results in nine
assessment risk classifications, with rates during the last six months of 2001
ranging from zero for well capitalized, healthy institutions, such as Willow
Grove Bank, to 27 basis points for undercapitalized institutions with
substantial supervisory concerns.
In addition, all institutions with deposits insured by the Federal
Deposit Insurance Corporation are required to pay assessments to fund interest
payments on bonds issued by the Financing Corporation, a mixed-ownership
government corporation established to recapitalize the predecessor to the
Savings Association Insurance Fund. The assessment rate for the second quarter
of 2003 was .004% of insured deposits and is adjusted quarterly. These
assessments will continue until the Financing Corporation bonds mature in 2019.
The Federal Deposit Insurance Corporation may terminate the deposit
insurance of any insured depository institution, including Willow Grove Bank, if
it determines after a hearing that the institution has engaged or is engaging in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, order or any
condition imposed by an agreement with the Federal Deposit Insurance
Corporation. It also may suspend deposit insurance temporarily during the
hearing process for the permanent termination of insurance, if the institution
has no tangible capital. If insurance of accounts is terminated, the accounts at
the institution at the time of the termination, less subsequent withdrawals,
shall continue to be insured for a period of six months to two years, as
determined by the Federal Deposit Insurance Corporation. Management is aware of
no existing circumstances which would result in termination of Willow Grove
Bank's deposit insurance.
Regulatory Capital Requirements. The Office of Thrift Supervision
capital requirements consist of a "tangible capital requirement," a "leverage
capital requirement" and a "risk-based capital requirement." The Office of
Thrift Supervision is authorized to impose capital requirements in excess of
those standards on individual institutions on a case-by-case basis.
Under the tangible capital requirement, a savings bank must maintain
tangible capital in an amount equal to at least 1.5% of adjusted total assets.
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), plus a specified amount of purchased mortgage
servicing rights.
Under the leverage capital requirement adopted by the Office of Thrift
Supervision, savings banks must maintain "core capital" in an amount equal to at
least 3.0% of adjusted total assets. Core capital is defined as common
stockholders' equity (including retained earnings), non-cumulative perpetual
preferred stock, and minority interests in the equity accounts of consolidated
subsidiaries, plus purchased mortgage servicing rights valued at the lower of
90% of fair market value, 90% of original cost or the current amortized book
value as determined under generally accepted accounting principles, and
"qualifying supervisory goodwill," less non-qualifying intangible assets.
24
Under the risk-based capital requirement, a savings bank must maintain
total capital (which is defined as core capital plus supplementary capital)
equal to at least 8.0% of risk-weighted assets. A savings bank must calculate
its risk-weighted assets by multiplying each asset and off-balance sheet item by
various risk factors, which range from 0% for cash and securities issued by the
United States Government or its agencies to 100% for repossessed assets or loans
more than 90 days past due. Qualifying one- to four-family residential real
estate loans and qualifying multi-family residential real estate loans (not more
than 90 days delinquent and having an 80% or lower loan-to-value ratio), which
at June 30, 2003, represented 45.4% of the total loans receivable of Willow
Grove Bank, are weighted at a 50% risk factor. Supplementary capital may
include, among other items, cumulative perpetual preferred stock, perpetual
subordinated debt, mandatory convertible subordinated debt, intermediate-term
preferred stock, and general allowances for loan losses. The allowance for loan
losses includable in supplementary capital is limited to 1.25% of risk-weighted
assets. The amount of supplementary capital that can be included is limited to
100% of core capital.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital, in addition to the adjustments
required for calculating core capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
non-residential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. However, in calculating
regulatory capital, institutions can add back unrealized losses and deduct
unrealized gains net of taxes, on debt securities reported as a separate
component of capital calculated according to generally accepted accounting
principles.
Office of Thrift Supervision regulations establish special
capitalization requirements for savings banks that own service corporations and
other subsidiaries, including subsidiary savings banks. According to these
regulations, certain subsidiaries are consolidated for capital purposes and
others are excluded from assets and capital. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks, engaged solely in mortgage-banking activities, or engaged in
certain other activities solely as agent for its customers are "includable"
subsidiaries that are consolidated for capital purposes in proportion to Willow
Grove Bank's level of ownership, including the assets of includable subsidiaries
in which Willow Grove Bank has a minority interest that is not consolidated for
generally accepted accounting principles purposes. For excludable subsidiaries,
the debt and equity investments in such subsidiaries are deducted from assets
and capital. At June 30, 2003, Willow Grove Bank had no investments subject to a
deduction from tangible capital.
Under currently applicable Office of Thrift Supervision policy, savings
institutions must value securities available for sale at amortized cost for
regulatory capital purposes. This means that in computing regulatory capital,
savings institutions should add back any unrealized losses and deduct any
unrealized gains, net of income taxes, on debt securities reported as a separate
component of capital calculated according to generally accepted accounting
principles.
At June 30, 2003, Willow Grove Bank exceeded all of its regulatory
capital requirements, with tangible, core and risk-based capital ratios of
10.2%, 10.2% and 20.8%, respectively.
The Office of Thrift Supervision and the Federal Deposit Insurance
Corporation generally are authorized to take enforcement action against a
savings bank that fails to meet its capital requirements, which action may
include restrictions on operations and banking activities, the imposition of a
capital directive, a cease-and-desist order, civil money penalties or harsher
measures such as the appointment of a receiver or conservator or a forced merger
into another institution. In addition, under current regulatory policy, a
savings bank that fails to meet its capital requirements is prohibited from
paying any dividends.
Prompt Corrective Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991, the federal banking regulators are required
to take prompt corrective action if an insured depository institution fails to
satisfy certain minimum capital requirements, including a leverage limit, a
risk-based capital requirement, and any other measure of capital deemed
appropriate by the federal banking regulator for measuring the capital adequacy
of an insured depository institution. All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
management fees if the institution would thereafter fail to satisfy the minimum
levels for any of its capital requirements.
25
Under the Federal Deposit Insurance Corporation Improvement Act an
institution is deemed to be (a) "well capitalized" if it has total risk-based
capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more,
has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any
order or final capital directive to meet and maintain a specific capital level
for any capital measure, (b) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of
4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well capitalized,"
(c) "undercapitalized" if it has a total risk-based capital ratio that is less
than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1
leverage capital ratio that is less than 4.0% (3.0% under certain
circumstances), (d) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less
than 3.0%, and (e) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. Under specified
circumstances, a federal banking agency may reclassify a well capitalized
institution as adequately capitalized and may require an adequately capitalized
institution or an undercapitalized institution to comply with supervisory
actions as if it were in the next lower category (except that the Federal
Deposit Insurance Corporation may not reclassify a significantly
undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan
which meets specified requirements with its appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. A federal banking agency must provide the
institution with written notice of approval or disapproval within 60 days after
receiving a capital restoration plan, subject to extensions by the agency. An
institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. In addition, undercapitalized institutions are subject to various
regulatory restrictions, and the appropriate federal banking agency also may
take any number of discretionary supervisory actions.
At June 30, 2003, Willow Grove Bank was in the "well capitalized"
category for purposes of the above regulations.
Safety and Soundness Guidelines. The Office of Thrift Supervision and
the other federal bank regulatory agencies have established guidelines for
safety and soundness, addressing operational and managerial standards, as well
as compensation matters for insured financial institutions. Institutions failing
to meet these standards may be required to submit compliance plans to their
appropriate federal regulators. The Office of Thrift Supervision and the other
agencies have also established guidelines regarding asset quality and earnings
standards for insured institutions. Willow Grove Bank believes that it is in
compliance with these guidelines and standards.
Capital Distributions. Office of Thrift Supervision regulations govern
capital distributions by savings institutions, which include cash dividends,
stock repurchases and other transactions charged to the capital account of a
savings institution to make capital distributions. A savings institution must
file an application for Office of Thrift Supervision approval of the capital
distribution if any of the following occur or would occur as a result of the
capital distribution (1) the total capital distributions for the applicable
calendar year exceed the sum of the institution's net income for that year to
date plus the institution's retained net income for the preceding two years, (2)
the institution would not be at least adequately capitalized following the
distribution, (3) the distribution would violate any applicable statute,
regulation, agreement or Office of Thrift Supervision-imposed condition, or (4)
the institution is not eligible for expedited treatment of its filings. If an
application is not required to be filed, savings institutions which are a
subsidiary of a holding company (as well as certain other institutions) must
still file a notice with the Office of Thrift Supervision at least 30 days
before the board of directors declares a dividend or approves a capital
distribution.
Branching by Federal Savings Institutions. Office of Thrift Supervision
policy permits interstate branching to the full extent permitted by statute
(which is essentially unlimited). Generally, federal law prohibits federal
savings institutions from establishing, retaining or operating a branch outside
the state in which the federal institution has its home office unless the
institution meets the IRS' domestic building and loan test (generally, 60% of a
thrift's assets must be housing-related) ("IRS Test"). The IRS Test requirement
does not apply if: (a) the branch(es) result(s) from an emergency acquisition of
a troubled savings institution (however, if the troubled savings institution is
acquired by a bank holding company, does not have its home office in the state
of the bank holding
26
company bank subsidiary and does not qualify under the IRS Test, its branching
is limited to the branching laws for state-chartered banks in the state where
the savings institution is located); (b) the law of the state where the branch
would be located would permit the branch to be establis