Exhibit 13.0
CONTENTS
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS |
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FINANCIAL STATEMENTS |
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CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS) |
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BOARD OF DIRECTORS AND EXECUTIVE OFFICERS |
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CORPORATE PROFILE AND RELATED INFORMATION
TF Financial Corporation (the “Company”) is the parent company of Third Federal Bank and its subsidiaries Third Delaware Corporation and Teragon Financial Corporation (collectively, “Third Federal” or the “Bank”), TF Investments Corporation, and Penns Trail Development Corporation. At December 31, 2005, total assets were approximately $660.8 million. The Company was formed as a Delaware corporation in March 1994 at the direction of the Bank to acquire all of the capital stock that Third Federal issued upon its conversion from the mutual to stock form of ownership (the “Conversion”) and concurrent $52.9 million initial public offering effective July 13, 1994. At December 31, 2005, total stockholders’ equity was approximately $62.6 million. The Company is a unitary savings and loan holding company which, under existing laws, generally is not restricted in the types of business activities in which it may engage, provided that Third Federal retains a specified amount of its assets in housing-related investments. Third Federal is a federally chartered stock savings bank headquartered in Newtown, Pennsylvania, which was originally chartered in 1921 under the name “Polish American Savings Building and Loan Association.” Deposits of Third Federal have been federally insured since 1935 and are currently insured up to the maximum amount allowable by the Federal Deposit Insurance Corporation (the “FDIC”). Third Federal is a community-oriented institution offering a variety of financial services to meet the needs of the communities that it serves. As of December 31, 2005 Third Federal operated branch offices in Bucks and Philadelphia counties, Pennsylvania and Mercer County, New Jersey. Third Federal attracts deposits (approximately $470.5 million at December 31, 2005) from the general public and uses such deposits, together with borrowings mainly from the Federal Home Loan Bank of Pittsburgh (approximately $121.3 million at December 31, 2005) and other funds, to originate loans secured by first mortgages and junior liens on owner-occupied, one-to-four family residences, and to originate loans secured by commercial real estate, including construction loans.
Stock Market Information
Since its issuance in July 1994, the Company’s common stock has been traded on the Nasdaq National Market. The daily stock quotation for the Company is listed in the Nasdaq National Market published in The Wall Street Journal, The Philadelphia Inquirer, and other leading newspapers under the trading symbol of “THRD.” The number of shareholders of record of common stock as of March 7, 2006, was approximately 500. This does not reflect the number of persons or entities who held stock in nominee or “street” name through various brokerage firms.
Dividend Policy
The Company’s ability to pay dividends to stockholders is dependent in part upon the dividends it receives from Third Federal. Among other limitations, Third Federal may not declare or pay a cash dividend on any of its stock if the effect thereof would cause Third Federal’s regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with Third Federal’s conversion from mutual to stock form, or (2) the regulatory capital requirements imposed by the Office of Thrift Supervision (“OTS”). It is the Company’s policy to pay dividends when it is deemed prudent to do so. The Board of Directors will consider the payment of a dividend on a quarterly basis, after giving consideration to the level of profits for the previous quarter and other relevant information.
Stock Price and Dividend History
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| Quoted market price |
| Dividend paid |
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Quarter ended |
| High |
| Low |
| per share |
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December 31, 2005 |
| $ | 29.67 |
| $ | 27.50 |
| $ | 0.18 |
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September 30, 2005 |
| $ | 28.97 |
| $ | 27.25 |
| $ | 0.18 |
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June 30, 2005 |
| $ | 29.64 |
| $ | 26.75 |
| $ | 0.18 |
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March 31, 2005 |
| $ | 32.09 |
| $ | 28.71 |
| $ | 0.18 |
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December 31, 2004 |
| $ | 33.00 |
| $ | 28.10 |
| $ | 0.17 |
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September 30, 2004 |
| $ | 29.61 |
| $ | 26.52 |
| $ | 0.17 |
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June 30, 2004 |
| $ | 32.47 |
| $ | 28.00 |
| $ | 0.17 |
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March 31, 2004 |
| $ | 34.22 |
| $ | 31.00 |
| $ | 0.15 |
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1
SELECTED FINANCIAL INFORMATION AND OTHER DATA
At December 31,
(Dollars in thousands, except per share data)
Financial Position |
| 2005 |
| 2004 |
| 2003 |
| 2002 |
| 2001 |
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Total assets |
| $ | 660,839 |
| $ | 628,966 |
| $ | 606,752 |
| $ | 721,032 |
| $ | 711,204 |
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Loans receivable, net |
| 490,959 |
| 442,195 |
| 404,649 |
| 370,092 |
| 377,635 |
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Mortgage-backed securities available for sale, at fair value |
| 83,511 |
| 103,610 |
| 106,774 |
| 115,243 |
| 99,763 |
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Mortgage-backed securities held to maturity, at amortized cost |
| 10,177 |
| 14,900 |
| 23,630 |
| 54,592 |
| 93,367 |
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Investment securities available for sale, at fair value |
| 30,401 |
| 17,625 |
| 14,443 |
| 27,243 |
| 22,671 |
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Investment securities held to maturity, at amortized cost |
| 4,690 |
| 7,027 |
| 10,389 |
| 14,563 |
| 9,866 |
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Cash and cash equivalents(1) |
| 3,821 |
| 7,900 |
| 8,241 |
| 100,580 |
| 69,139 |
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Deposits |
| 470,521 |
| 459,903 |
| 459,343 |
| 442,558 |
| 422,052 |
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Advances from the Federal Home Loan Bank and other borrowings |
| 121,260 |
| 102,747 |
| 86,853 |
| 207,359 |
| 222,359 |
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Retained earnings |
| 61,610 |
| 57,428 |
| 52,626 |
| 59,978 |
| 56,370 |
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Total stockholders’ equity |
| 62,648 |
| 61,155 |
| 55,480 |
| 62,840 |
| 57,975 |
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Book value per common share |
| $ | 23.08 |
| $ | 22.30 |
| $ | 21.37 |
| $ | 25.31 |
| $ | 23.51 |
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Tangible book value per common share |
| $ | 21.46 |
| $ | 20.57 |
| $ | 19.56 |
| $ | 23.34 |
| $ | 21.44 |
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At or for the year ended December 31,
Summary of Operations |
| 2005 |
| 2004 |
| 2003 |
| 2002 |
| 2001 |
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Interest income |
| $ | 33,965 |
| $ | 31,221 |
| $ | 32,377 |
| $ | 40,455 |
| $ | 46,747 |
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Interest expense |
| 11,532 |
| 8,866 |
| 15,252 |
| 22,660 |
| 26,908 |
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Net interest income |
| 22,433 |
| 22,355 |
| 17,125 |
| 17,795 |
| 19,839 |
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Provision for loan losses |
| 540 |
| 600 |
| 330 |
| 988 |
| 500 |
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Non-interest income |
| 2,728 |
| 2,608 |
| 2,690 |
| 3,304 |
| 3,172 |
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Non-interest expense |
| 16,168 |
| 15,329 |
| 28,703 |
| 13,414 |
| 14,708 |
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Net income (loss) |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) | $ | 5,092 |
| $ | 5,733 |
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Earnings (loss) per common share—basic |
| $ | 2.25 |
| $ | 2.44 |
| $ | (2.30 | ) | $ | 2.06 |
| $ | 2.32 |
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Earnings (loss) per common share—diluted |
| $ | 2.20 |
| $ | 2.33 |
| $ | (2.30 | ) | $ | 1.91 |
| $ | 2.19 |
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Performance Ratios and Other Selected Data |
| 2005 |
| 2004 |
| 2003 |
| 2002 |
| 2001 |
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Return on average assets |
| 0.96 | % | 1.06 | % | n.m. |
| 0.71 | % | 0.82 | % |
Return on average equity |
| 10.16 | % | 11.58 | % | n.m. |
| 8.47 | % | 10.42 | % |
Average equity to average assets |
| 9.40 | % | 9.16 | % | 9.01 | % | 8.34 | % | 7.83 | % |
Average interest rate spread |
| 3.62 | % | 3.79 | % | 2.57 | % | 2.44 | % | 2.74 | % |
Non-performing loans to total assets |
| 0.24 | % | 0.15 | % | 0.38 | % | 0.53 | % | 0.53 | % |
Non-performing loans to total loans |
| 0.32 | % | 0.22 | % | 0.56 | % | 1.03 | % | 0.99 | % |
Allowance for loan losses to non-performing loans |
| 166.31 | % | 240.31 | % | 92.51 | % | 53.86 | % | 52.22 | % |
Allowance for loan losses to total loans |
| 0.54 | % | 0.52 | % | 0.52 | % | 0.54 | % | 0.52 | % |
Bank regulatory capital |
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Core |
| 8.37 | % | 8.13 | % | 7.29 | % | 6.85 | % | 6.95 | % |
Tangible |
| 8.37 | % | 8.13 | % | 7.29 | % | 6.85 | % | 6.95 | % |
Risk based |
| 15.04 | % | 15.67 | % | 14.47 | % | 15.25 | % | 14.95 | % |
Dividend payout ratio(2) |
| 32.73 | % | 28.33 | % | n.m. |
| 31.41 | % | 26.48 | % |
n.m. = not meaningful
(1) Consists of cash, cash due from banks, interest-bearing deposits with original maturities of less than three months, and federal funds sold.
(2) Payout ratio is dividends paid for the period divided by earnings per common share—diluted.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND
RESULTS OF OPERATIONS
General. The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and is intended to assist in understanding and evaluating the major changes in the financial position and results of operations of the Company with a primary focus on an analysis of operating results.
The Company may from time to time make written or oral “forward-looking statements”, including statements contained in the Company’s filings with the Securities and Exchange Commission, in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such as statements of the Company’s plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services; the willingness of users to substitute competitors’ products and services for the Company’s products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes, acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.
The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
The Company’s income on a consolidated basis is derived substantially from its investment in its subsidiary, Third Federal. The earnings of Third Federal depend primarily on its net interest income. Net interest income is affected by the interest income that Third Federal receives from its loans and investments and by the interest expense that Third Federal incurs on its deposits, borrowings and other sources of funds. In addition, the mix of Third Federal’s interest-bearing assets and liabilities can have a significant effect on Third Federal’s net interest income; loans generally have higher yields than securities; retail deposits generally have lower interest rates than other borrowings.
Third Federal also receives income from service charges and other fees and occasionally from sales of investment securities and real estate owned. Third Federal incurs expenses in addition to interest expense in the form of salaries and benefits, deposit insurance premiums, property operations and maintenance, advertising and other related business expenses.
Critical Accounting Policies
Certain critical accounting policies of the Company require the use of significant judgment and accounting estimates in the preparation of the consolidated financial statements and related data of the Company. These accounting estimates require management to make assumptions about matters that are highly uncertain at the time the accounting estimate is made.
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Management believes that the most critical accounting policy requiring the use of a significant amount of accounting estimates and judgment is the determination of the allowance for loan losses. Allowances are established based on pools of similar loans, delinquencies, loss experience, economic conditions generally and as they may affect individual borrowers, and other factors. Individual loans are evaluated based on cash flows or value of the underlying collateral, or both. All of these evaluation factors are subject to a high degree of uncertainty. If the financial condition and collateral values of a significant amount of debtors should deteriorate more than the Company has estimated, present allowances for loan losses may be insufficient and additional provisions for loan losses may be required. In addition, a single loan loss of a substantial amount may significantly reduce the allowance. The allowance for loan losses was $2,641,000 at December 31, 2005.
Financial Condition and Changes in Financial Condition
Assets. The Company’s total assets at December 31, 2005 were $660.8 million, an increase of $31.9 million during the year. This increase in total assets is essentially due to a $48.8 million increase in loans receivable, funded in part by a $14.4 million reduction in investment and mortgage-backed securities, in part by an $18.5 million increase in advances from the Federal Home Loan Bank (“FHLB”), and in part by a $10.6 million increase in deposits.
The Company’s loans receivable at December 31, 2005 were $491.0 million, a $48.8 million or 11.0% increase since December 31, 2004. During 2005 there were $96.6 million of principal payments of existing loans in the loans receivable portfolio; however, offsetting this reduction was the origination of $147.6 million in predominately commercial real estate loans and single-family residential first and second mortgage loans.
Mortgage-backed securities available for sale decreased by $20.1 million during 2005 due to $27.0 million in repayments throughout 2005 of the underlying mortgages comprising such securities, partially offset by the purchases of $9.0 million of such securities. The remaining net change in the portfolio was caused by $2.1 million amortization of purchase premiums and fair value adjustments. Mortgage-backed securities held to maturity decreased by $4.7 million during 2005 due to prepayment of the underlying mortgages comprising the securities.
Investment securities available for sale increased by $12.8 million during the year. The Company purchased $13.2 million of such securities, mainly bank-qualified municipal bonds, during 2005. The remaining net change in the portfolio was caused by $0.4 million amortization of purchase premiums and fair value adjustments.
The Company’s cash and cash equivalents were $3.8 million at December 31, 2005. It is the Company’s current intent to keep cash and cash equivalents at a minimal level and use its line of credit at the FHLB to fund its day-to-day cash needs, if necessary.
Liabilities. The Company’s total liabilities were $598.2 million at December 31, 2005, an increase of $30.4 million during 2005. Total deposits increased by $10.6 million, and certificates of deposit were 31.8% of total deposits at year end 2005. Advances from the FHLB increased by $18.5 million. It is the current intent of the Company to fund a portion of its interest-bearing assets, not funded by deposits, with longer term advances from the FHLB, and fund its day-to-day cash needs and shorter term interest-bearing assets not otherwise funded with deposits using draws on its line of credit with the FHLB. Thus, during 2005 advances from the FHLB due in four years and beyond increased slightly to $48.9 million even though $16.3 million of advances at December 31, 2004 moved from a four year maturity horizon to a three year or less maturity horizon at December 31, 2005. In addition, at December 31, 2005 the Bank’s line of credit at the FHLB was $30 million of which $16.2 million was drawn.
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Stockholders’ equity. Total consolidated stockholders’ equity increased by $1.5 million to $62.6 million at December 31, 2005. The increase is largely the result of $6.2 million in net income less $2.0 million in cash dividends paid to the Company’s common stockholders and a $1.3 million other comprehensive loss, mainly due to the fair value adjustment on available for sale securities. In addition there was a $0.8 million increase in stockholders’ equity attributable to the exercise of stock options for 49,975 shares. The Company also purchased 95,172 shares of common stock, held in treasury, reducing stockholders’ equity by $2.8 million. Finally, there was a $0.5 million increase due to the allocation of 17,025 shares to participants in the Company’s employee stock ownership plan.
Average Balance Sheet. The following table sets forth information (dollars in thousands) relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. The yields and costs are computed by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively for the periods indicated.
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| 2005 |
| 2004 |
| 2003 |
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| Average |
| Interest |
| Average |
| Average |
| Interest |
| Average |
| Average |
| Interest |
| Average |
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ASSETS |
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Interest-earning assets: |
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Loans receivable(1) |
| $ | 462,389 |
| $ | 27,570 |
| 5.96 | % | $ | 423,482 |
| $ | 24,359 |
| 5.75 | % | $ | 378,414 |
| $ | 23,372 |
| 6.18 | % |
Mortgage-backed securities |
| 108,029 |
| 4,875 |
| 4.51 | % | 128,759 |
| 5,696 |
| 4.42 | % | 154,721 |
| 6,725 |
| 4.35 | % | ||||||
Investment securities(2) |
| 37,357 |
| 1,774 |
| 4.75 | % | 30,969 |
| 1,377 |
| 4.45 | % | 62,747 |
| 1,966 |
| 3.13 | % | ||||||
Other interest-earning assets(3) |
| 1,910 |
| 59 |
| 3.09 | % | 1,127 |
| 14 |
| 1.24 | % | 45,590 |
| 474 |
| 1.04 | % | ||||||
Total interest-earning assets |
| 609,685 |
| 34,278 |
| 5.62 | % | 584,337 |
| 31,446 |
| 5.38 | % | 641,472 |
| 32,537 |
| 5.07 | % | ||||||
Non interest-earning assets |
| 34,215 |
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| 34,645 |
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| 33,839 |
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Total assets |
| $ | 643,900 |
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| $ | 618,982 |
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| $ | 675,311 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Interest-bearing liabilities: |
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Deposits |
| 465,521 |
| 7,599 |
| 1.63 | % | 465,097 |
| 5,925 |
| 1.27 | % | 449,925 |
| 7,044 |
| 1.57 | % | ||||||
Advances from the FHLB and borrowings |
| 111,628 |
| 3,933 |
| 3.52 | % | 91,660 |
| 2,941 |
| 3.21 | % | 160,325 |
| 8,208 |
| 5.12 | % | ||||||
Total interest-bearing liabilities |
| 577,149 |
| 11,532 |
| 2.00 | % | 556,757 |
| 8,866 |
| 1.59 | % | 610,250 |
| 15,252 |
| 2.50 | % | ||||||
Non interest-bearing liabilities |
| 6,199 |
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| 5,536 |
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| 4,195 |
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Total liabilities |
| 583,348 |
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| 562,293 |
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| 614,445 |
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Stockholders’ equity |
| 60,552 |
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| 56,689 |
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| 60,866 |
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Total liabilities and stockholders’ equity |
| $ | 643,900 |
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| $ | 618,982 |
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| $ | 675,311 |
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Net interest income |
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| $ | 22,746 |
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| $ | 22,580 |
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| $ | 17,285 |
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Interest rate spread(4) |
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| 3.62 | % |
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| 3.79 | % |
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| 2.57 | % | ||||||
Net yield on interest-earning assets(5) |
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| 3.73 | % |
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| 3.86 | % |
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| 2.69 | % | ||||||
Ratio of average interest-earning assets to average interest- bearing liabilities |
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| 106 | % |
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| 105 | % |
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| 105 | % |
(1) Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.
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(2) Tax equivalent adjustments to interest on investment securities were $313,000, $225,000 and $160,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.
(3) Includes interest-bearing deposits in other banks.
(4) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.
Rate/Volume Analysis. The following table presents, for the periods indicated, the change in interest income and interest expense (in thousands) attributed to (i) changes in volume (changes in the weighted average balance of the total interest-earning asset and interest-bearing liability portfolios multiplied by the prior year rate), and (ii) changes in rate (changes in rate multiplied by prior year volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately based on the absolute value of changes due to volume and changes due to rate.
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| 2005 vs 2004 |
| 2004 vs 2003 |
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| Volume |
| Rate |
| Net |
| Volume |
| Rate |
| Net |
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Interest income: |
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Loans receivable, net |
| $ | 2,297 |
| $ | 914 |
| $ | 3,211 |
| $ | 2,662 |
| $ | (1,675 | ) | $ | 987 |
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Mortgage-backed securities |
| (933 | ) | 112 |
| (821 | ) | (1,147 | ) | 118 |
| (1,029 | ) | ||||||
Investment securities |
| 299 |
| 98 |
| 397 |
| (1,224 | ) | 635 |
| (589 | ) | ||||||
Other interest-earning assets |
| 14 |
| 31 |
| 45 |
| (537 | ) | 77 |
| (460 | ) | ||||||
Total interest-earning assets |
| 1,677 |
| 1,155 |
| 2,832 |
| (246 | ) | (845 | ) | (1,091 | ) | ||||||
Interest expense: |
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Deposits |
| 5 |
| 1,669 |
| 1,674 |
| 231 |
| (1,350 | ) | (1,119 | ) | ||||||
Advances from the FHLB and borrowings |
| 684 |
| 308 |
| 992 |
| (2,814 | ) | (2,453 | ) | (5,267 | ) | ||||||
Total interest-bearing liabilities |
| 689 |
| 1,977 |
| 2,666 |
| (2,583 | ) | (3,803 | ) | (6,386 | ) | ||||||
Net change in net interest income |
| $ | 988 |
| $ | (822 | ) | $ | 166 |
| $ | 2,337 |
| $ | 2,958 |
| $ | 5,295 |
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Comparison of Years Ended December 31, 2005 and December 31, 2004
Net Income. Net income was $6.2 million for the year ended December 31, 2005 compared with net income of $6.6 million for the year ended December 31, 2004. The decrease in net income of $0.4 million when comparing the year 2005 with 2004 is largely attributable a $0.8 million increase in non-interest expense, which was not entirely offset by a $0.1 million increase in net interest income and a $0.1 million increase in non-interest income.
Total Interest Income. For the year ended December 31, 2005, total interest income increased to $34.0 million compared to $31.2 million for the year ended December 31, 2004. The $2.8 million increase in interest income was mainly the result of the $38.9 increase in the average balances of loans receivable.
In addition, beginning in June 2004, the Federal Open Market Committee raised the federal funds rate thirteen times by a total of 325 basis points through year end 2005. During 2005, the federal funds rate, and thus the prime rate, rose by 200 basis points while longer term interest rates relevant to the Company’s loan origination activities, as measured by 5 year and 10 year U S Treasury securities, rose by approximately 65 to 15 basis points, respectively. The higher prime rate had a positive effect on the Bank’s interest income because of the positive effect on the Bank’s adjustable rate and prime-based loans. At December 31, 2005 the Company had $65.2 million in floating rate, prime-based construction, home equity, and other loans. In addition, while longer term rates were higher, permitting the Company to raise
7
its prices on fixed rate loans, these rates were still relatively low historically, and thus new loan production at the Company exceeded expectations.
Total Interest Expense. Total interest expense increased to $11.5 million from $8.9 million for the year ended December 31, 2005 compared to 2004. During 2005 the Bank raised the interest rates paid on many of its deposit products in order to retain existing deposit relationships, attract new deposit relationships, and generally respond to the extreme competitive pricing pressures throughout the Company’s deposit markets. As a result, the average interest rate paid on deposits rose by 36 basis points during 2005 compared with 2004, and produced a $1.7 million increase in interest expense.
Interest paid on advances from the FHLB increased by $1.0 million during 2005 compared with 2004, largely because of the need to borrow from the FHLB in order to fund the Company’s lending activities from sources other than deposit growth.
Allowance for Loan Losses. The allowance for loan losses was approximately $2.6 million at December 31, 2005 and $2.3 million at December 31, 2004. The provision for loan losses was $540,000 during 2005 compared with $600,000 during 2004. Net recoveries of previously charged off loans were $206,000 during 2005 compared to net charge-offs of $404,000 during 2004. While management maintains the allowance for losses at a level which it considers to be adequate to provide for probable losses, there can be no assurance that further additions will not be made to the allowance and that such losses will not exceed the estimated amounts.
Non-Interest Income. Total non-interest income was $2.7 million during 2005 compared with $2.6 million during 2004. The increase is due to an increase in gain on sales of loans.
Non-Interest Expense. Total non-interest expense increased by $0.8 million during 2005 compared to 2004. Employee compensation and benefits increased by $480,000 during 2005 compared to 2004. Most of this increase was due to normal salary increases and increased staff, and higher incentive related compensation; $124,000 of the increase was due to an increase in pension plan expense. Advertising expense increased by $118,000 due to an increase in the Bank’s marketing efforts, and an expansion of the media used, to advertise its image, products, and services. Professional fees increased by $199,000 largely due to costs related to the Company’s concerted efforts to greatly enhance and improve the technology infrastructure and related security.
Income Tax Expense. The Company’s effective tax rate was 27.2% during 2005 compared to 27.3% during 2004. These effective tax rates are lower than the Company’s marginal tax rate of 34% largely due to the tax-exempt income associated with the Company’s investments in tax-exempt municipal bonds and bank-owned life insurance.
Comparison of Years Ended December 31, 2004 and December 31, 2003
Net Income. Net income was $6.6 million for the year ended December 31, 2004. Net loss was $5.8 million for the year ended December 31, 2003. The increase in net income of $12.4 million when comparing the year 2004 with 2003 is largely attributable to the debt refinancing transaction described in the next paragraph, which produced a net loss for 2003 of $9.3 million after considering the income tax benefit associated with the transaction.
During the third quarter of 2003, the Company completed a series of transactions (the “debt refinancing”) that resulted in the repayment and refinancing of $187.4 million of Federal Home Loan Bank borrowings which carried a weighted average interest rate of 5.46%. $80 million of these borrowings were refinanced at 3.23%; the remaining $107.4 million was repaid. A prepayment fee of $13.8 million was assessed by the Federal Home Loan Bank. A portion of the funds used to repay these borrowings came from the sale of $70.2 million of investment securities available for sale and $9.5 million of mortgage-backed securities available for sale, which had been yielding a combined 1.93%. The loss on the sale of
8
these securities was $0.4 million. Management believed that it was in the best interest of the Company’s shareholders and the Bank’s employees and customers to replace these high-cost borrowings in order to improve the Company’s future net interest income and thus its overall financial performance.
Pre-tax income was $9.0 million for 2004. After adjusting for the $14.2 million pre-tax cost of the debt refinancing, pre-tax income was $5.0 million for 2003. This $4.0 million increase in adjusted pre-tax income for 2003 compared to pre-tax income for 2004 is mainly attributable to a $5.2 million increase in net interest income, less a $0.3 million increase in provisions for loan losses and a $0.4 million increase in operating expenses, as described more fully below.
Total Interest Income. For the year ended December 31, 2004, total interest income decreased to $31.2 million compared to $32.4 million for the year ended December 31, 2003. The $1.2 million decrease in interest income was mainly the result of the decrease in the average balances of mortgage-backed securities and other interest-earning assets during 2004 compared with 2003, largely due to the effect of the debt refinancing, and also due to the high rate of mortgage-backed security repayments that occurred in 2003 because of near-record low mortgage interest rates that existed throughout much of 2003. Offsetting these net decreases in interest income was the positive effect of a $45.1 million increase in the average balance of loans receivable during 2004 when compared to 2003, although the continued high level of loan prepayments and refinancing caused the average rate on loans receivable to decrease by 43 basis points during 2004 when compared to 2003.
Total Interest Expense. Total interest expense decreased to $8.9 million from $15.3 million for the year ended December 31, 2004 compared to 2003. $1.4 million of this decrease is primarily the result of low market interest rates during 2003 and, consequently, the Company had lowered the interest rates paid on most of its deposit products in order to keep them in line with short-term market interest rates. However, by the end of 2004 the Company had begun to raise the interest rates on its deposit products to maintain competitive pricing.
Interest paid on advances from the FHLB decreased by $5.3 million during 2004 compared with 2003, largely because of the debt refinancing transaction.
Allowance for Loan Losses. The allowance for loan losses was approximately $2.3 million at December 31, 2004 and $2.1 million at December 31, 2003. The provision for loan losses was $600,000 during 2004 compared with $330,000 during 2003. Charge-offs were $404,000 during 2004 compared to $266,000 during 2003. While management maintains Third Federal’s allowance for losses at a level which it considers to be adequate to provide for probable losses, there can be no assurance that further additions will not be made to the allowance and that such losses will not exceed the estimated amounts.
Non-Interest Income. Total non-interest income was $2.6 million during 2004 compared with $2.7 million during 2003. Service fees and other operating income increased by $0.2 million largely due to the introduction of new deposit account services. Gains on sales of real estate and securities were $0 during 2004 compared to $0.3 million during 2003.
Non-Interest Expense. Total non-interest expense, excluding the $13.8 million debt prepayment fee paid during 2003, increased by $0.4 million during 2004 compared to 2003. Employee compensation and benefits increased by $583,000 during 2004 compared to 2003. Approximately $252,000 of this increase was due to normal salary increases and increased staff, and $271,000 of the increase was due to an increase in incentive compensation expenses. Advertising expense increased by $104,000 due to an increase in the Bank’s marketing efforts, and an expansion of the media used, to advertise its image, products, and services. During 2004 the Company incurred approximately $40,000 of expense due to the commencement of implementation of compliance with the Sarbanes-Oxley Act of 2002.
Income Tax Expense. The Company’s effective tax rate was 27.3% (tax expense) during 2004 compared to 36.7% (tax benefit) during 2003. The high effective tax (benefit) rate during 2003 is due to the
9
pre-tax loss for the year produced by the debt refinancing, which pre-tax loss produces a tax benefit at a 34% rate, further increased by the elimination of net non-taxable income from the pre-tax loss.
Liquidity and Capital Resources
Liquidity. The Company’s liquidity is a measure of its ability to fund loans, pay withdrawals of deposits and other cash outflows, and pay dividends in an efficient, cost-effective manner. The Company’s primary sources of funds are cash on hand and dividends from its wholly-owned Bank. The Bank’s primary sources of funds are deposits, borrowings, and scheduled amortization and prepayment of loan and mortgage-backed security principal.
The Bank endeavors to fund its operations internally but has, when deemed prudent, borrowed funds from the Federal Home Loan Bank. As of December 31, 2005, such borrowed funds totaled $121.3 million. The amount of these borrowings that will mature during the twelve months ending December 31, 2006 is $32.7 million. At December 31, 2005 the Bank had a $30 million line of credit, $13.8 million of which was unused, and up to approximately $300 million of additional collateral-based borrowing capacity at the Federal Home Loan Bank.
The amount of certificate accounts that are scheduled to mature during the twelve months ending December 31, 2006, is approximately $92.4 million. To the extent that these deposits do not remain at the Bank upon maturity, the Bank believes that it can replace these funds with deposits, excess liquidity, advances from the FHLB or other borrowings. It has been the Bank’s experience that substantial portions of such maturing deposits remain at the Bank.
At December 31, 2005, the Bank had outstanding commitments to originate loans or fund unused lines of credit of $72.1 million. The loan commitments will be funded during the twelve months ending December 31, 2006. The unused lines of credit can be funded at any time. Funds required to fill these commitments will be derived primarily from current excess liquidity, deposit inflows or loan and security repayments. At December 31, 2005, the Bank had $1.1 million outstanding commitments to sell loans.
The Company also has obligations under lease agreements. Payments required under such lease agreements will be approximately $401,000 during the year ending December 31, 2006.
The following table combines the Company’s contractual obligations and commitments to make future payments as of December 31, 2005.
|
| Payments due by period |
| |||||||||||||
|
| Total |
| Less than |
| 1-3 |
| 4-5 |
| After |
| |||||
|
| (in thousands) |
| |||||||||||||
Contractual obligations: |
|
|
|
|
|
|
|
|
|
|
| |||||
FHLB advances |
| $ | 121,260 |
| $ | 32,672 |
| $ | 39,688 |
| $ | 43,105 |
| $ | 5,795 |
|
Time deposits |
| 149,673 |
| 92,402 |
| 41,248 |
| 15,409 |
| 614 |
| |||||
Operating leases |
| 1,724 |
| 401 |
| 599 |
| 279 |
| 445 |
| |||||
Total contractual obligations |
| $ | 272,657 |
| $ | 125,475 |
| $ | 81,535 |
| $ | 58,793 |
| $ | 6,854 |
|
|
| Amount of commitment expirations by period |
| |||||||||||||
Commitments: |
|
|
|
|
|
|
|
|
|
|
| |||||
Extensions of credit |
| $ | 69,822 |
| $ | 22,272 |
| $ | 8,338 |
| $ | 499 |
| $ | 38,713 |
|
Letters of credit |
| 2,220 |
| 2,220 |
| — |
| — |
| — |
| |||||
Loans sold with recourse |
| 74 |
| — |
| — |
| — |
| 74 |
| |||||
Total commitments |
| $ | 72,116 |
| $ | 24,492 |
| $ | 8,338 |
| $ | 499 |
| $ | 38,787 |
|
10
Capital Resources. Under current regulations, the Bank must have core capital equal to 4% of adjusted total assets and risk-based capital equal to 8% of risk-weighted assets, of which 1.5% must be tangible capital, excluding goodwill and certain other intangible assets. On December 31, 2005, the Bank met its three regulatory capital requirements.
Management believes that under current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of the Bank, such as increased interest rates or a downturn in the economy in areas in which the Bank operates, could adversely affect future earnings and as a result, the ability of the Bank to meet its future minimum capital requirements.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars, without consideration for changes in the relative purchasing power of money over time caused by inflation. Unlike industrial companies, nearly all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, since such goods and services are affected by inflation. In the current interest rate environment, liquidity and the maturity structure of the Bank’s assets and liabilities are critical to the maintenance of acceptable performance levels.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk Management
The Bank has established an Asset/Liability Management Committee (ALCO) for the purpose of monitoring and managing market risk, which is defined as the risk of loss of net interest income or economic value arising from changes in market interest rates and prices.
The type of market risk which most affects the Company’s financial instruments is interest rate risk, which is best quantified by simulating the hypothetical change in net interest income that would occur under specific changes in interest rates. Substantially all of the Bank’s interest-bearing assets and liabilities are exposed to interest rate risk. Loss of economic value is measured using reports generated by the Office of Thrift Supervision (“OTS”), using input from the Bank, wherein the current net portfolio value of the Bank’s interest-sensitive assets and liabilities is measured at different hypothetical interest rate levels centered on the current term structure of interest rates. Gap reports prepared by the Bank are used to measure the net amount of assets and liabilities repricing, pre-paying and maturing during future periods. ALCO evaluates the simulation results, the OTS model results and the “gap” reports and will make adjustments to the Bank’s planned activities if in its view there is a need to do so.
The Bank’s exposure to interest rate risk results from, among other things, the difference in maturities in interest-earning assets and interest-bearing liabilities. Since the Bank’s assets currently have a longer maturity than its liabilities, the Bank’s earnings could be negatively impacted during a period of rising interest rates. Alternatively, in periods of falling interest rates the Bank’s mortgage loans will prepay at an increasing rate and caused the Bank to reinvest these cash flows in periods of low interest rates, also negatively affecting the Bank’s earnings. The relationship between the interest rate sensitivity of the Bank’s assets and liabilities is continually monitored by management.
Fundamentally, the Bank prices and originates loans, and prices and originates its deposits including CD’s at market interest rates. Volumes of such loans and deposits at various maturity and repricing
11
horizons will vary according to customer preferences as influenced by the term structure of market interest rates. The Bank utilizes its investment and mortgage-backed security portfolios available for sale to generate additional interest income, to managing its liquidity, and to manage its interest rate risk. These securities are readily marketable and provide the Bank with a cash flow stream to fund asset growth or liability maturities. In addition, if management determines that it is advisable to do so, the Bank can lengthen or shorten the average maturity of all interest-bearing assets through the selection of fixed rate or variable rate securities, respectively.
The Bank utilizes advances from the FHLB in managing its interest rate risk and as a tool to augment deposits in funding asset growth. The Bank may utilize these funding sources to better match its fixed rate interest-bearing assets with longer maturities or repricing characteristics.
The nature of the Bank’s current operations is such that it is not subject to foreign currency exchange or commodity price risk. Additionally, neither the Company nor the Bank owns any trading assets. At December 31, 2005, the Bank did not have any hedging transactions in place such as interest rate swaps, caps, or floors, although these derivatives are often used by banks to manage interest rate risk.
The Company’s bank subsidiary is a savings bank regulated by the OTS and has policies or procedures in place for measuring interest rate risk. These policies and procedures stipulate acceptable levels of interest rate risk. As part of its interest rate risk management, the Bank uses the Interest Rate Risk Exposure Report, which is generated quarterly by the OTS. This report forecasts the interest rate sensitivity of net portfolio value (“NPV”) under alternative interest rate environments. The NPV is defined as the net present value of the Bank’s existing assets, liabilities and off-balance sheet instruments. The calculated estimates of change in NPV at December 31, 2005 are as follows:
Change in Interest Rates |
| NPV Amount |
| % Change |
| Policy Limitation |
| |
|
| (In Thousands) |
|
|
|
|
| |
+300 Basis Points |
| $ | 52,947 |
| -37 | % | +/- 50 | % |
+200 Basis Points |
| $ | 63,731 |
| -24 | % | +/- 35 | % |
+100 Basis Points |
| $ | 73,974 |
| -12 | % | +/- 25 | % |
Flat Rates |
| $ | 84,194 |
| 0 | % | 0 | % |
-100 Basis Points |
| $ | 91,406 |
| +9 | % | +/- 20 | % |
-200 Basis Points |
| $ | 91,564 |
| +9 | % | +/- 30 | % |
Management believes that the assumptions utilized by OTS in evaluating the vulnerability of the Company’s net portfolio value to changes in interest rates are reasonable; however, the interest rate sensitivity of the Bank’s assets and liabilities as well as the estimated effect of changes in interest rates on NPV could vary substantially if different assumptions are used or actual experience differs from the experience on which the assumptions were based. In the event the Bank should measure an excessive decline in its NPV as the result of an immediate and sustained change in interest rate, it has a number of options which it could utilize to remedy that situation. The Bank could restructure its investment portfolio through sale or purchase of securities with more favorable repricing attributes. It could also emphasize loan products with appropriate maturities or repricing attributes, or it could attract deposits or obtain borrowings with desired maturities.
In order to measure interest rate risk internally, the Company uses computer programs which enable it to simulate the changes that will occur to the Bank’s net interest income (“NII”) over several interest rate scenarios which are developed by “shocking” market interest rates (i.e. moving them immediately and permanently) up and down in 100 basis point increments from their current levels, and by “ramping” interest rates, i.e. spreading evenly the change over the horizon period. In addition, loan production is adjusted downward in the rates up scenarios.
12
In addition to the level of interest rates, the most critical assumption regarding the estimated amount of the Bank’s NII is the expected prepayment speed of the Bank’s 1-4 family residential loans, and related mortgage-backed securities, the book value of which comprises approximately 64% of the Company’s total assets. For this prepayment speed assumption the Company uses its own experience and median expected prepayment speeds which are obtained from a reliable third party source. The Company also incorporates into its simulations the effects of the interest rate caps and interest rate floors that are part of the majority of the Bank’s variable rate loans. Finally, the Company makes certain assumptions regarding the timing and magnitude of interest rate changes on its non-CD deposits.
The Company uses its business planning forecast as the basis for its NII simulations. Therefore, planned business activities are incorporated into the measurement horizon. Such activities include assumptions about substantial new loan and deposit volumes, the pricing of loan and deposit products, and other assumptions about future activities that may or may not be realized. In order to quantify the Company’s NII exposure, the Company focused on the simulation of net interest income over 24 months in three scenarios: ramped up 200 basis points, shocked up 200 basis points, and shocked down 100 basis points. The results of these simulations are as follows:
At December 31, 2005 |
| Net interest income volatility versus level interest rates |
| ||||
Year ending |
| Ramp UP 200 bp |
| Shocked UP 200 bp |
| Shocked DOWN 100 bp |
|
2006 |
| -0.39 | % | -5.24 | % | -3.64 | % |
2007 |
| -3.55 | % | -3.42 | % | -7.69 | % |
At December 31, 2004 |
| Net interest income volatility versus level interest rates |
| ||||
Year ending |
| Ramp UP 200 bp |
| Shocked UP 200 bp |
| Shocked DOWN 100 bp |
|
2005 |
| +0.39 | % | -4.20 | % | -6.38 | % |
2006 |
| -3.61 | % | -3.89 | % | -12.87 | % |
In addition, the Company prepared “gap” reports in order to show potential mis-matches of repricing or cash flows from the Company’s current interest rate-sensitive assets and liabilities. Negative amounts indicate that there is an excess of rate sensitive liabilities repricing during the period and, generally, the Company’s net interest income would be adversely affected by rising market interest rates. The results of these “gap” measurements are as follows: (in thousands)
|
| GAP: Net rate sensitive assets (liabilities) |
| ||||||||||
At December 31, 2005 |
| 2006 |
| 2007 |
| 2008 |
| 2009 and beyond |
| ||||
Current rates |
| $ | 30,815 |
| $ | 26,844 |
| $ | 22,041 |
| $ | (41,782 | ) |
Shocked down 100 bp |
| $ | 111,647 |
| $ | 62,072 |
| $ | 33,276 |
| $ | (169,077 | ) |
Shocked up 200 bp |
| $ | (21,353 | ) | $ | (599 | ) | $ | 10,491 |
| $ | 49,379 |
|
Ramped up 200 bp |
| $ | 2,161 |
| $ | 11,894 |
| $ | 15,675 |
| $ | 8,188 |
|
|
| GAP: Net rate sensitive assets (liabilities) |
| ||||||||||
At December 31, 2004 |
| 2005 |
| 2006 |
| 2007 |
| 2008 and beyond |
| ||||
Current rates |
| $ | 21,639 |
| $ | 43,790 |
| $ | 12,699 |
| $ | (46,715 | ) |
Shocked down 100 bp |
| $ | 86,949 |
| $ | 71,242 |
| $ | 22,219 |
| $ | (148,997 | ) |
Shocked up 200 bp |
| $ | (40,576 | ) | $ | 8,270 |
| $ | (6,145 | ) | $ | 69,864 |
|
Ramped up 200 bp |
| $ | (4,246 | ) | $ | 29,243 |
| $ | 4,927 |
| $ | 1,489 |
|
Essentially, the Company’s net interest income is highly sensitive to the sustained movement of long-term interest rates because of the resulting effect on the prepayment speeds of the Company’s mortgage-related earning assets. In the interest rates up scenarios, prepayment speeds slow and the Company becomes more sensitive to rising interest rates. In addition, the flattening of the yield curve, which has occurred over the past two years has required the Bank to reprice upward a large amount of its savings and money market accounts in order to prevent the outflows of these funds. Thus, the Bank has experienced
13
margin compression, and expects this situation to continue given the level of interest rates that existed at December 31, 2005. However, these assumptions and measurements are highly subjective in nature and are not intended to be a forecast of net interest income under any rate scenario for the years 2006, 2007 or for any other period.
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123(R) (SFAS 123 R), “Share-Based Payment.” This statement establishes standards for the accounting for transactions in which the entity exchanges its equity instruments in exchange for goods and services and addresses transactions in which an entity incurs liabilities in exchange for goods and services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. Under SFAS123(R), all forms of share-based payments to employees, including employee stock options, will be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award will generally be measured at fair value at the grant date. The grant-date fair value of employee share options and similar instruments will be estimated using option pricing models. Current accounting guidance requires that the expense relating to so-called fixed plan employee stock options only be disclosed in the footnotes to the financial statements. The Company plans on implementing SFAS 123(R) on January 1, 2006 using the modified prospective method whereby the cost of share-based awards not vested as of the adoption date will be recorded in results of operations over the remaining vesting period; the Company intends to use a straight-line methodology. At the present time the Company estimates that the adoption of SFAS
123(R) will reduce net income by approximately $274,000 during the year ending December 31, 2006.
In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 requires an entity to recognize a liability for the fair value of a legal obligation to perform asset-retirement activities that are conditional on a future event if the amount can be reasonably estimated. The Interpretation provides guidance to evaluate whether fair value is reasonably estimable. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. FIN 47 is not expected to have a material impact on the Company’s financial position or results of operations.
In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS 154.) SFAS 154 changes the accounting for and reporting of a voluntary change in an accounting principle and replaces ABP Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” Under Opinion No. 20, most changes in an accounting principle were reported in the income statement of the period of change as a cumulative adjustment. However, under SFAS 154, a voluntary change in an accounting principle must be shown retrospectively in the financial statements, if practicable, for all periods presented. In cases where retrospective application is impracticable, an adjustment to the assets, liabilities and a corresponding adjustment to retained earnings can be made as of the beginning of the earliest period for which retrospective application is practicable rather than being reported in the income statement. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years ending after December 15, 2005. The adoption of SFAS 154 did not have a material impact on the Company’s financial position or results of operations.
In November, 2005, the FASB issued staff position FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The staff position replaced the guidance in paragraphs 10-18 of EITF Issue 03-1 with references to already established other-than-temporary impairment guidance as is set forth in FASB Statement 115, “Accounting for Certain
14
Investments in Debt and Equity Securities”, Staff Accounting Bulletin 59, “Accounting for Non-current Marketable Equity Securities” and APB Opinion 18, “The Equity Method of Accounting for Investments in Common Stock.” FSP FAS 115-1 clarified that an investor should recognize an impairment loss no later than when the impairment is considered other than temporary, even if a decision to sell has not been made. FSP FAS 115-1 was effective for other-than-temporary impairment analysis conducted in periods after September 15, 2005. The adoption of FSP FAS 115-1 did not have a material impact on the Company’s financial position or results of operations.
15
FINANCIAL STATEMENTS AND REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TF FINANCIAL CORPORATION AND SUBSIDIARIES
December 31, 2005 and 2004
16
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Shareholders of TF Financial Corporation
We have audited the accompanying consolidated statements of financial position of TF Financial Corporation and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of TF Financial Corporation and Subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP |
|
Philadelphia, Pennsylvania | |
March 15, 2006 |
17
TF Financial Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
|
| December 31 |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
ASSETS |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 3,821 |
| $ | 7,900 |
|
Certificates of deposit in other financial institutions |
| 40 |
| 38 |
| ||
Investment securities available for sale—at fair value |
| 30,401 |
| 17,625 |
| ||
Investment securities held to maturity (fair value of $4,707 and $7,188 as of December 31, 2005 and 2004, respectively) |
| 4,690 |
| 7,027 |
| ||
Mortgage-backed securities available for sale—at fair value |
| 83,511 |
| 103,610 |
| ||
Mortgage-backed securities held to maturity (fair value of $10,385 and $15,546 as of December 31, 2005 and 2004, respectively) |
| 10,177 |
| 14,900 |
| ||
Loans receivable, net (including loans held for sale of $68 and $680 as of December 31, 2005 and 2004, respectively) |
| 490,959 |
| 442,195 |
| ||
Federal Home Loan Bank stock—at cost |
| 7,432 |
| 7,460 |
| ||
Accrued interest receivable |
| 3,048 |
| 2,500 |
| ||
Premises and equipment, net |
| 6,289 |
| 5,963 |
| ||
Core deposit intangible asset, net of accumulated amortization of $2,741 and $2,611 as of December 31, 2005 and 2004, respectively |
| 83 |
| 213 |
| ||
Goodwill |
| 4,324 |
| 4,324 |
| ||
Other assets |
| 16,064 |
| 15,211 |
| ||
TOTAL ASSETS |
| $ | 660,839 |
| $ | 628,966 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| ||
Liabilities |
|
|
|
|
| ||
Deposits |
| $ | 470,521 |
| $ | 459,903 |
|
Advances from the Federal Home Loan Bank |
| 121,260 |
| 102,747 |
| ||
Advances from borrowers for taxes and insurance |
| 1,915 |
| 1,778 |
| ||
Accrued interest payable |
| 2,052 |
| 1,638 |
| ||
Other liabilities |
| 2,443 |
| 1,745 |
| ||
Total liabilities |
| 598,191 |
| 567,811 |
| ||
Stockholders’ equity |
|
|
|
|
| ||
Preferred stock, no par value; 2,000,000 shares authorized at December 31, 2005 and 2004, none issued |
| — |
| — |
| ||
Common stock, $0.10 par value; 10,000,000 shares authorized, 5,290,000 shares issued, 2,714,173 and 2,742,345 shares outstanding at December 31, 2005 and 2004, respectively, net shares in treasury: 2005—2,390,943; 2004—2,345,746 |
| 529 |
| 529 |
| ||
Retained earnings |
| 61,610 |
| 57,428 |
| ||
Additional paid-in capital |
| 53,048 |
| 51,675 |
| ||
Unearned restricted stock |
| (1,080 | ) | — |
| ||
Unearned ESOP shares |
| (1,849 | ) | (2,019 | ) | ||
Treasury stock—at cost |
| (47,920 | ) | (46,081 | ) | ||
Accumulated other comprehensive income (loss) |
| (1,690 | ) | (377 | ) | ||
Total stockholders’ equity |
| 62,648 |
| 61,155 |
| ||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
| $ | 660,839 |
| $ | 628,966 |
|
The accompanying notes are an integral part of these statements.
18
TF Financial Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands, except per share data) |
| |||||||
Interest income |
|
|
|
|
|
|
| |||
Loans, including fees |
| $ | 27,570 |
| $ | 24,359 |
| $ | 23,372 |
|
Mortgage-backed securities |
| 4,875 |
| 5,696 |
| 6,725 |
| |||
Investment securities |
| 1,461 |
| 1,152 |
| 1,806 |
| |||
Interest-bearing deposits and other |
| 59 |
| 14 |
| 474 |
| |||
|
|
|
|
|
|
|
| |||
TOTAL INTEREST INCOME |
| 33,965 |
| 31,221 |
| 32,377 |
| |||
|
|
|
|
|
|
|
| |||
Interest expense |
|
|
|
|
|
|
| |||
Deposits |
| 7,599 |
| 5,925 |
| 7,044 |
| |||
Borrowings |
| 3,933 |
| 2,941 |
| 8,208 |
| |||
|
|
|
|
|
|
|
| |||
TOTAL INTEREST EXPENSE |
| 11,532 |
| 8,866 |
| 15,252 |
| |||
|
|
|
|
|
|
|
| |||
NET INTEREST INCOME |
| 22,433 |
| 22,355 |
| 17,125 |
| |||
Provision for loan losses |
| 540 |
| 600 |
| 330 |
| |||
|
|
|
|
|
|
|
| |||
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |
| 21,893 |
| 21,755 |
| 16,795 |
| |||
|
|
|
|
|
|
|
| |||
Non-interest income |
|
|
|
|
|
|
| |||
Service fees, charges and other operating income |
| 2,570 |
| 2,600 |
| 2,372 |
| |||
Gain on sale of real estate |
| — |
| — |
| 110 |
| |||
Gain on sale of investment and mortgage-backed securities |
| — |
| — |
| 208 |
| |||
Gain on sale of loans |
| 158 |
| 8 |
| — |
| |||
|
|
|
|
|
|
|
| |||
TOTAL NON-INTEREST INCOME |
| 2,728 |
| 2,608 |
| 2,690 |
| |||
|
|
|
|
|
|
|
| |||
Non-interest expense |
|
|
|
|
|
|
| |||
Employee compensation and benefits |
| 9,249 |
| 8,769 |
| 8,186 |
| |||
Occupancy and equipment |
| 2,645 |
| 2,518 |
| 2,488 |
| |||
Federal deposit insurance premium |
| 64 |
| 70 |
| 72 |
| |||
Professional fees |
| 814 |
| 615 |
| 609 |
| |||
Marketing and advertising |
| 773 |
| 655 |
| 551 |
| |||
Other operating |
| 2,493 |
| 2,547 |
| 2,847 |
| |||
Amortization of core deposit intangible asset |
| 130 |
| 155 |
| 185 |
| |||
Debt prepayment fee |
| — |
| — |
| 13,765 |
| |||
|
|
|
|
|
|
|
| |||
TOTAL NON-INTEREST EXPENSE |
| 16,168 |
| 15,329 |
| 28,703 |
| |||
|
|
|
|
|
|
|
| |||
INCOME (LOSS) BEFORE INCOME TAXES |
| 8,453 |
| 9,034 |
| (9,218 | ) | |||
|
|
|
|
|
|
|
| |||
Income tax expense (benefit) |
| 2,300 |
| 2,467 |
| (3,384 | ) | |||
|
|
|
|
|
|
|
| |||
NET INCOME (LOSS) |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) |
Earnings (loss) per share—basic |
| $ | 2.25 |
| $ | 2.44 |
| $ | (2.30 | ) |
Earnings (loss) per share—diluted |
| $ | 2.20 |
| $ | 2.33 |
| $ | (2.30 | ) |
The accompanying notes are an integral part of these statements.
19
TF Financial Corporation and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2005, 2004 and 2003
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Accumulated |
|
|
|
|
| |||||||||
|
| Common Stock |
| Additional |
| Unearned |
| Unearned |
|
|
|
|
| other |
|
|
|
|
| |||||||||||
|
|
|
| Par |
| paid-in |
| restricted |
| ESOP |
| Treasury |
| Retained |
| comprehensive |
|
|
| Comprehensive |
| |||||||||
|
| Shares |
| value |
| capital |
| stock |
| shares |
| stock |
| Earnings |
| income (loss) |
| Total |
| income (loss) |
| |||||||||
Balance at December 31, 2002 |
| 2,482,586 |
| $ | 529 |
| $ | 51,647 |
| $ | — |
| $ | (2,401 | ) | $ | (48,809 | ) | $ | 59,978 |
| $ | 1,896 |
| $ | 62,840 |
|
|
| |
Allocation of ESOP shares |
| 20,549 |
| — |
| 401 |
| — |
| 205 |
| — |
| — |
| — |
| 606 |
|
|
| |||||||||
Cash dividends—common stock |
| — |
| — |
| — |
| — |
| — |
| — |
| (1,518 | ) | — |
| (1,518 | ) |
|
| |||||||||
Exercise of options |
| 92,902 |
| — |
| (618 | ) | — |
| — |
| 1,766 |
| — |
| — |
| 1,148 |
|
|
| |||||||||
Income tax benefit arising from stock compensation |
| — |
| — |
| 552 |
| — |
| — |
| — |
| — |
| — |
| 552 |
|
|
| |||||||||
Other comprehensive loss, net of taxes |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| (2,314 | ) | (2,314 | ) | $ | (2,314 | ) | ||||||||
Net loss for the year ended December 31, 2003 |
| — |
| — |
| — |
| — |
| — |
| — |
| (5,834 | ) | — |
| (5,834 | ) | (5,834 | ) | |||||||||
Comprehensive loss |
| — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| $ | (8,148 | ) | ||||||||
Balance at December 31, 2003 |
| 2,596,037 |
| $ | 529 |
| $ | 51,982 |
| — |
| $ | (2,196 | ) | $ | (47,043 | ) | $ | 52,626 |
| $ | (418 | ) | $ | 55,480 |
|
|
| ||
Allocation of ESOP shares |
| 17,688 |
| — |
| 354 |
| — |
| 177 |
| — |
| — |
| — |
| 531 |
|
|
| |||||||||
Purchase of treasury stock |
| (166,305 | ) | — |
| — |
| — |
| — |
| (4,725 | ) | — |
| — |
| (4,725 | ) |
|
| |||||||||
Cash dividends—common stock |
| — |
| — |
| — |
| — |
| — |
| — |
| (1,765 | ) | — |
| (1,765 | ) |
|
| |||||||||
Exercise of options |
| 294,925 |
| — |
| (2,277 | ) | — |
| — |
| 5,687 |
| — |
| — |
| 3,410 |
|
|
| |||||||||
Income tax benefit arising from stock compensation |
| — |
| — |
| 1,616 |
| — |
| — |
| — |
| — |
| — |
| 1,616 |
|
|
| |||||||||
Other comprehensive income, net of taxes |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| 41 |
| 41 |
| $ | 41 |
| ||||||||
Net income for the year ended December 31, 2004 |
| — |
| — |
| — |
| — |
| — |
| — |
| 6,567 |
| — |
| 6,567 |
| 6,567 |
| |||||||||
Comprehensive income |
| — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| $ | 6,608 |
| ||||||||
Balance at December 31, 2004 |
| 2,742,345 |
| $ | 529 |
| $ | 51,675 |
| — |
| $ | (2,019 | ) | $ | (46,081 | ) | $ | 57,428 |
| $ | (377 | ) | $ | 61,155 |
|
|
| ||
Allocation of ESOP shares |
| 17,025 |
| — |
| 324 |
| — |
| 170 |
| — |
| — |
| — |
| 494 |
|
|
| |||||||||
Purchase of treasury stock |
| (95,172 | ) | — |
| — |
| — |
| — |
| (2,830 | ) | — |
| — |
| (2,830 | ) |
|
| |||||||||
Cash dividends—common stock |
| — |
| — |
| — |
| — |
| — |
| — |
| (1,971 | ) | — |
| (1,971 | ) |
|
| |||||||||
Restricted stock grant |
| — |
| — |
| 1,095 |
| (1,095 | ) | — |
| — |
| — |
| — |
| — |
|
|
| |||||||||
Compensation expense—restricted shares |
| — |
| — |
| — |
| 15 |
| — |
| — |
| — |
| — |
| 15 |
|
|
| |||||||||
Exercise of options |
| 49,975 |
| — |
| (190 | ) | — |
| — |
| 991 |
| — |
| — |
| 801 |
|
|
| |||||||||
Income tax benefit arising from stock compensation |
| — |
| — |
| 144 |
| — |
| — |
| — |
| — |
| — |
| 144 |
|
|
| |||||||||
Other comprehensive loss, net of taxes |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| (1,313 | ) | (1,313 | ) | $ | (1,313 | ) | ||||||||
Net income for the year ended December 31, 2005 |
| — |
| — |
| — |
| — |
| — |
| — |
| 6,153 |
| — |
| 6,153 |
| 6,153 |
| |||||||||
Comprehensive income |
| — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| $ | 4,840 |
| ||||||||
Balance at December 31, 2005 |
| 2,714,173 |
| $ | 529 |
| $ | 53,048 |
| $ | (1,080 | ) | $ | (1,849 | ) | $ | (47,920 | ) | $ | 61,610 |
| $ | (1,690 | ) | $ | 62,648 |
|
|
|
The accompanying notes are an integral part of this statement
20
TF Financial Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
OPERATING ACTIVITIES |
|
|
|
|
|
|
| |||
Net income (loss) |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |
|
|
|
|
|
|
| |||
Amortization of |
|
|
|
|
|
|
| |||
Mortgage loan servicing rights |
| 8 |
| — |
| 11 |
| |||
Deferred loan origination fees |
| (96 | ) | (50 | ) | (259 | ) | |||
Premiums and discounts on investment securities, net |
| 81 |
| 74 |
| 170 |
| |||
Premiums and discounts on mortgage-backed securities, net |
| 386 |
| 775 |
| 1,527 |
| |||
Premiums and discounts on loans, net |
| 123 |
| 127 |
| 414 |
| |||
Core deposit intangibles |
| 130 |
| 155 |
| 185 |
| |||
Deferred income taxes |
| (403 | ) | (343 | ) | 596 |
| |||
Provision for loan losses and provision for losses on real estate |
| 540 |
| 737 |
| 443 |
| |||
Provision for decrease in fair value of mortgage service rights |
| 1 |
| — |
| — |
| |||
Depreciation of premises and equipment |
| 961 |
| 973 |
| 1,041 |
| |||
Increase in value of bank-owned life insurance |
| (501 | ) | (525 | ) | (553 | ) | |||
Stock-based benefit programs |
| 509 |
| 531 |
| 606 |
| |||
Proceeds from sale of loans originated for sale |
| 9,765 |
| 657 |
| — |
| |||
Origination of loans held for sale |
| (8,995 | ) | (1,329 | ) | — |
| |||
Tax benefit arising from stock compensation |
| 144 |
| 1,616 |
| 552 |
| |||
(Gain) loss on sale of |
|
|
|
|
|
|
| |||
Investment and mortgage-backed securities |
| — |
| — |
| (208 | ) | |||
Real estate acquired through foreclosure |
| — |
| (1 | ) | (23 | ) | |||
Real estate |
| — |
| — |
| (110 | ) | |||
Mortgage loans available for sale |
| (158 | ) | (8 | ) | — |
| |||
Income from mortgage loan derivatives |
| (8 | ) | — |
| — |
| |||
Expense associated with forward loan sales |
| 7 |
| — |
| — |
| |||
(Increase) decrease in |
|
|
|
|
|
|
| |||
Accrued interest receivable |
| (548 | ) | 171 |
| 905 |
| |||
Other assets |
| 763 |
| 3,709 |
| (3,924 | ) | |||
Increase (decrease) in |
|
|
|
|
|
|
| |||
Accrued interest payable |
| 414 |
| (270 | ) | (989 | ) | |||
Other liabilities |
| 758 |
| (10 | ) | (1,427 | ) | |||
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES |
| 10,034 |
| 13,556 |
| (6,877 | ) | |||
21
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
INVESTING ACTIVITIES |
|
|
|
|
|
|
| |||
Loan originations |
| $ | (147,629 | ) | $ | (151,517 | ) | $ | (178,578 | ) |
Purchases of loans |
| — |
| (3,922 | ) | (24,176 | ) | |||
Loan principal payments |
| 96,579 |
| 117,896 |
| 165,855 |
| |||
Principal repayments on mortgage-backed securities held to maturity |
| 4,709 |
| 8,730 |
| 31,013 |
| |||
Principal repayments on mortgage-backed securities available for sale |
| 26,959 |
| 30,099 |
| 62,169 |
| |||
Proceeds from loan sales |
| 1,108 |
| — |
| — |
| |||
(Purchases) and maturities of certificates of deposit in other financial institutions, net |
| (2 | ) | 117 |
| 65 |
| |||
Purchase of investment securities available for sale |
| (13,170 | ) | (3,040 | ) | (98,708 | ) | |||
Purchase of mortgage-backed securities available for sale |
| (8,956 | ) | (27,701 | ) | (82,350 | ) | |||
Purchase of bank-owned life insurance |
| — |
| — |
| (1,500 | ) | |||
Proceeds from maturities of investment securities held to maturity |
| 2,280 |
| 3,295 |
| 4,105 |
| |||
Proceeds from maturities of investment securities available for sale |
| — |
| — |
| 40,000 |
| |||
Proceeds from the sale of investment and mortgage-backed securities available for sale |
| — |
| — |
| 95,193 |
| |||
(Purchase) redemption of Federal Home Loan Bank stock |
| 28 |
| (635 | ) | 4,599 |
| |||
(Purchase) sale of property, equipment and real estate held for investment |
| — |
| 3 |
| 8 |
| |||
Proceeds from sale of real estate |
| — |
| 32 |
| 1,277 |
| |||
Purchase of premises and equipment |
| (1,287 | ) | (668 | ) | (751 | ) | |||
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES |
| (39,381 | ) | (27,311 | ) | 18,221 |
| |||
|
|
|
|
|
|
|
| |||
FINANCING ACTIVITIES |
|
|
|
|
|
|
| |||
Net increase in deposits |
| 10,618 |
| 560 |
| 16,785 |
| |||
Net increase (decrease) in short-term Federal Home Loan Bank advances |
| 7,483 |
| (1,179 | ) | 9,887 |
| |||
Proceeds of long-term Federal Home Loan Bank advances |
| 26,367 |
| 30,000 |
| 80,000 |
| |||
Repayment of long-term Federal Home Loan Bank advances |
| (15,337 | ) | (12,927 | ) | (210,393 | ) | |||
Net increase in advances from borrowers for taxes and insurance |
| 137 |
| 40 |
| 408 |
| |||
Treasury stock acquired |
| (2,830 | ) | (4,725 | ) | — |
| |||
Exercise of stock options |
| 801 |
| 3,410 |
| 1,148 |
| |||
Common stock dividends paid |
| (1,971 | ) | (1,765 | ) | (1,518 | ) | |||
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES |
| 25,268 |
| 13,414 |
| (103,683 | ) | |||
NET DECREASE IN CASH AND CASH EQUIVALENTS |
| (4,079 | ) | (341 | ) | (92,339 | ) | |||
Cash and cash equivalents at beginning of year |
| 7,900 |
| 8,241 |
| 100,580 |
| |||
Cash and cash equivalents at end of year |
| $ | 3,821 |
| $ | 7,900 |
| $ | 8,241 |
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information |
|
|
|
|
|
|
| |||
Cash paid for |
|
|
|
|
|
|
| |||
Interest on deposits and advances from Federal Home Loan Bank |
| $ | 11,118 |
| $ | 9,136 |
| $ | 16,241 |
|
Income taxes |
| $ | 1,475 |
| $ | 1,330 |
| $ | 250 |
|
Non-cash transactions |
|
|
|
|
|
|
| |||
Transfers from loans to real estate acquired through foreclosure |
| $ | — |
| $ | — |
| $ | 1,857 |
|
The accompanying notes are an integral part of these statements.
22
TF Financial Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005 and 2004
NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
TF Financial Corporation (the “Company”) is a unitary savings and loan holding company, organized under the laws of the State of Delaware, which conducts its consumer banking operations primarily through its wholly owned subsidiary, Third Federal Bank (Third Federal or the Bank). Third Federal is a federally chartered-stock savings bank insured by the Federal Deposit Insurance Corporation. Third Federal is a community-oriented savings institution that conducts operations from its main office in Newtown, Pennsylvania, twelve full-service branch offices located in Philadelphia and Bucks counties, Pennsylvania, and three full-service branch offices located in Mercer County, New Jersey. The Bank competes with other banking and financial institutions in its primary market communities, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time deposits and loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.
The Bank is subject to regulations of certain state and federal agencies and, accordingly, those regulatory authorities conduct periodic examinations. As a consequence of the extensive regulation of commercial banking activities, the Bank’s business is particularly susceptible to being affected by state and federal legislation and regulations.
1. Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: TF Investments, Penns Trail Development Corporation and Third Federal, and its wholly owned subsidiaries, Third Delaware Corporation and Teragon Financial Corporation, (collectively, the “Company”). All material intercompany balances and transactions have been eliminated in consolidation.
The accounting policies of the Company conform to accounting principles generally accepted in the United States of America (US GAAP) and predominant practices within the banking industry. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The more significant accounting policies are summarized below.
2. Cash and Cash Equivalents
The Company considers cash, due from banks, federal funds sold and interest-bearing deposits in other financial institutions, with original terms to maturity of less than three months, as cash equivalents for presentation purposes in the consolidated statements of financial position and cash flows. The Company is required to maintain certain cash reserves relating to deposit liabilities. This requirement is ordinarily satisfied by cash on hand.
3. Investment and Mortgage-Backed Securities
The Company accounts for investment and mortgage-backed securities in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and
23
Equity Securities.” The Company classifies its investment, mortgage-backed and marketable equity securities in one of three categories: held to maturity, trading, or available for sale. The Company does not presently engage in security trading activities.
Investment, mortgage-backed and marketable equity securities available for sale are stated at fair value, with net unrealized gains and losses excluded from income and reported in other comprehensive income. Decreases in fair value deemed to be other than temporary are reported as a component of income. Realized gains and losses on the sale of securities are recognized using the specific identification method.
Investment and mortgage-backed securities held to maturity are carried at cost, net of unamortized premiums and discounts, which are recognized in interest income using the interest method. Decreases in fair value deemed to be other than temporary are reported as a component of income. The Company has the ability and it is management’s intention to hold such assets to maturity.
4. Loans Receivable
Loans receivable that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff are stated at unpaid principal balances less the allowance for loan losses, and net of deferred loan origination fees, direct origination costs and unamortized premiums and discounts associated with purchased loans, and unearned income. Loan origination fees and unamortized premiums on mortgage loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for actual prepayments.
Management’s periodic evaluation of the adequacy of the loan loss allowance is based on the Bank’s historical loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions. Actual losses may be higher or lower than historical trends, which vary. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries).
The Bank provides an allowance for accrued but uncollected interest when the loan becomes more than ninety days past due or is identified as impaired. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received until, in management’s judgment, the borrower’s ability to make periodic interest and principal payments is no longer impaired, in which case the loan is returned to accrual status.
The Company accounts for impaired loans in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures.” SFAS No. 114 requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable.
24
The Company adopted FASB Interpretation (FIN) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others”. FIN 45 requires certain disclosures regarding the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor’s obligations under the guarantee. The Bank issues financial and performance letters of credit. Financial letters of credit require the Bank to make payment if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Bank to make payments if the customer fails to perform identified non-financial contractual obligations.
On December 12, 2003, the American Institute of Certified Public Accountants issued Statement of Position No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3). SOP 03-3 requires that acquired impaired loans for which it is probable that the investor will be unable to collect all contractually required payments receivable be recorded at the present value of amounts expected to be received and prohibits carrying over or creation of valuation allowances in the initial accounting for these loans. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. The adoption of SOP 03-3 did not have a material impact on the Company’s results of operations or financial position.
5. Mortgage Loans Held-for-Sale
Mortgages loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value. Any resulting unrealized losses are included in other income. The fair value of the Bank’s loans held as available was valued in excess of cost at December 31, 2005 and 2004.
The Company adopted SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” on July 1, 2004. Implementation issue C13, “When a Loan Commitment Is Included in the Scope of Statement 133” is included in SFAS No. 149. SFAS No. 149 amends SFAS No. 133 to add a scope exception for borrowers (all commitments) and lenders (all commitments except those relating to mortgage loans that will be held for sale). SFAS No. 149 also amends SFAS No. 133 to require a lender to account for as derivatives loan commitments related to mortgage loans that will be held for sale. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2004. The Bank periodically enters into commitments with its customers for loans, which it intends to sell in the future. The Bank’s commitments to extend credit for loans intended for resale were not material at December 31, 2005 and 2004.
On March 2005, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) 105, “Loan Commitments Accounted for as Derivative Instruments.” SAB 105 requires that a lender should not consider the expected cash flows related to loan servicing or include any internally developed intangible assets in determining the fair value of loan commitments accounted for as derivatives. The Company adopted SAB 105 effective for commitments entered into after June 30, 2004. The requirements of SAB 105 apply to the Bank’s mortgage interest rate lock commitments related to loans held for sale. The Company’s application of SAB 105 did not have a material impact of the Company’s financial position or results of operations.
25
6. Transfers of Financial Assets
The Company accounts for the transfer of financial assets in accordance with SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The standard is based on consistent application of a financial-components approach that recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The standard provides consistent guidelines for distinguishing transfers of financial assets from transfers that are secured borrowings.
7. Premises and Equipment
Land is carried at cost. Buildings and furniture, fixtures and equipment are carried at cost less accumulated depreciation. Depreciation is provided by the straight-line method over the estimated useful lives of the assets. The Company accounts for the impairment of long-lived assets in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”. The standard requires recognition and measurement for the impairment of long-lived assets to be held and used or to be disposed of by sale. The Company had no impaired long-lived assets at December 31, 2005 and 2004.
8. Goodwill and Other Intangible Assets
Goodwill does not require amortization but is subject to annual impairment testing. The Company has tested the goodwill for impairment prior to its fiscal year ending December 31, 2005. No impairment has been recognized.
Core deposit intangible asset is the result of the Company’s 1996 acquisition of the deposits of Cenlar Federal Savings Bank. The core deposit intangible acquired is being amortized over 10 years and is scheduled to be fully amortized by September 30, 2006.
9. Benefit Plans
The Company has established an Employee Stock Ownership Plan (ESOP) covering eligible employees with six months of service, as defined by the ESOP. The Company accounts for the ESOP in accordance with the American Institute of Certified Public Accountants’ Statement of Position (SOP) 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” SOP 93-6 addresses the accounting for shares of stock issued to employees by an ESOP. SOP 93-6 requires that the employer record compensation expense in the amount equal to the fair value of shares committed to be released from the ESOP to employees.
The Company has a defined benefit pension plan covering substantially all full-time employees meeting certain requirements. The Company accounts for the defined benefit plan in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” which provides guidance for the various components of pension expense recognized in the income statement and any related employer pension assets or liabilities. Additionally, the Company includes reporting disclosures required by SFAS No. 132R, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”.
26
The Company purchased $10.5 million in life insurance policies on the lives of its executives and officers prior to 2004. The Company is the owner and beneficiary of the policies. The cash surrender values of the policies are approximately $12.8 million and $12.3 million at December 31, 2005 and 2004, respectively.
The Company has stock benefit plans that allow the Company to grant options and stock to employees and directors. The options, which have a term of up to 10 years when issued, vest either immediately or over a three to five year period. The exercise price of each option equals the market price of the Company’s stock on the date of grant. The Company accounts for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar instruments under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Company’s employee stock option plans are accounted for using the intrinsic value method under APB Opinion No. 25. No stock-based compensation expense is reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.
Had compensation cost for the plans been determined based on the fair value of options at the grant dates consistent with the method of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below.
|
| 2005 |
| 2004 |
| 2003 |
| |||
Net income (loss) |
|
|
|
|
|
|
| |||
As reported |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) |
Deduct: stock-based compensation expense determined using the fair value method, net of related tax effects |
| 68 |
| 88 |
| 53 |
| |||
Pro forma |
| $ | 6,085 |
| $ | 6,479 |
| $ | (5,887 | ) |
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per share |
|
|
|
|
|
|
| |||
As reported |
| $ | 2.25 |
| $ | 2.44 |
| $ | (2.30 | ) |
Deduct: stock-based compensation expense determined using the fair value method, net of related tax effects |
| 0.03 |
| 0.03 |
| 0.02 |
| |||
Pro forma |
| $ | 2.22 |
| $ | 2.41 |
| $ | (2.32 | ) |
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per share |
|
|
|
|
|
|
| |||
As reported |
| $ | 2.20 |
| $ | 2.33 |
| $ | (2.30 | ) |
Deduct: stock-based compensation expense determined using the fair value method, net of related tax effects |
| 0.01 |
| 0.02 |
| 0.02 |
| |||
Pro forma |
| $ | 2.19 |
| $ | 2.31 |
| $ | (2.32 | ) |
27
There were no options granted in 2004. The fair value of each option grant during 2005 and 2003 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
| 2005 |
| 2004 |
| 2003 |
| ||
Weighted average assumptions |
|
|
|
|
|
|
| ||
Dividend yield |
| 2.41 | % | N/A |
| 2.09 | % | ||
Expected volatility |
| 22.77 | % | N/A |
| 32.00 | % | ||
Risk-free interest rate |
| 4.34 | % | N/A |
| 3.40 | % | ||
Fair value of options granted during the year |
| $ | 6.15 |
| N/A |
| $ | 9.50 |
|
Expected lives in years |
| 5.14 |
| N/A |
| 6.00 |
| ||
10. Income Taxes
The Company accounts for income taxes under the liability method specified in SFAS No. 109, “Accounting for Income Taxes” whereby deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
11. Advertising Costs
The Company expenses marketing and advertising costs as incurred.
12. Earnings Per Share
The Company follows the provisions of SFAS No. 128, “Earnings Per Share.” Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
28
13. Comprehensive Income
The Company follows SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items. Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of other comprehensive income (loss) are as follows:
|
| December 31, 2005 |
| |||||||
|
| Before tax |
| Tax |
| Net of tax |
| |||
|
| (in thousands) |
| |||||||
Unrealized losses on securities |
|
|
|
|
|
|
| |||
Unrealized holding losses arising during period |
| $ | (2,094 | ) | $ | 711 |
| $ | (1,383 | ) |
Minimum pension liability adjustment |
| 107 |
| (37 | ) | 70 |
| |||
Other comprehensive loss, net |
| $ | (1,987 | ) | $ | 674 |
| $ | (1,313 | ) |
|
| December 31, 2004 |
| |||||||
|
| Before tax |
| Tax |
| Net of tax |
| |||
|
| (in thousands) |
| |||||||
Unrealized gains on securities |
|
|
|
|
|
|
| |||
Unrealized holding gains arising during period |
| $ | 168 |
| $ | (57 | ) | $ | 111 |
|
Minimum pension liability adjustment |
| (107 | ) | 37 |
| (70 | ) | |||
Other comprehensive income, net |
| $ | 61 |
| $ | (20 | ) | $ | 41 |
|
|
| December 31, 2003 |
| |||||||
|
| Before tax |
| Tax |
| Net of tax |
| |||
|
| (in thousands) |
| |||||||
Unrealized losses on securities |
|
|
|
|
|
|
| |||
Unrealized holding (losses) arising during period |
| $ | (3,297 | ) | $ | 1,120 |
| $ | (2,177 | ) |
Reclassification adjustment for gains realized in net income |
| (208 | ) | 71 |
| (137 | ) | |||
Other comprehensive loss, net |
| $ | (3,505 | ) | $ | 1,191 |
| $ | (2,314 | ) |
14. Segment Reporting
The Company follows SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit.
29
15. Reclassifications
Certain prior year amounts have been reclassified to conform to the current period presentation.
NOTE B—CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of the following:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Cash and due from banks |
| $ | 3,684 |
| $ | 7,686 |
|
Interest-bearing deposits in other financial institutions |
| 137 |
| 214 |
| ||
|
| $ | 3,821 |
| $ | 7,900 |
|
NOTE C—INVESTMENT AND MORTGAGE-BACKED SECURITIES
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities at December 31, 2005 and 2004, are summarized as follows:
|
| December 31, 2005 |
| ||||||||||
|
| Amortized |
| Gross |
| Gross |
| Fair |
| ||||
|
| (in thousands) |
| ||||||||||
Investment securities held to maturity |
|
|
|
|
|
|
|
|
| ||||
State and political subdivisions |
| $ | 1,015 |
| $ | 21 |
| $ | — |
| $ | 1,036 |
|
Corporate debt securities |
| 3,675 |
| — |
| (4 | ) | 3,671 |
| ||||
|
| $ | 4,690 |
| $ | 21 |
| $ | (4 | ) | $ | 4,707 |
|
Investment securities available for sale |
|
|
|
|
|
|
|
|
| ||||
U.S. Government and federal agencies |
| $ | 5,982 |
| $ | — |
| $ | (102 | ) | $ | 5,880 |
|
Corporate debt securities |
| 4,002 |
| — |
| (44 | ) | 3,958 |
| ||||
State and political subdivisions |
| 20,844 |
| 64 |
| (345 | ) | 20,563 |
| ||||
|
| $ | 30,828 |
| $ | 64 |
| $ | (491 | ) | $ | 30,401 |
|
Mortgage-backed securities held to maturity |
|
|
|
|
|
|
|
|
| ||||
FHLMC certificates |
| $ | 3,161 |
| $ | 124 |
| $ | — |
| $ | 3,285 |
|
FNMA certificates |
| 3,969 |
| 55 |
| (76 | ) | 3,948 |
| ||||
GNMA certificates |
| 3,040 |
| 105 |
| — |
| 3,145 |
| ||||
Real estate mortgage investment conduit |
| 7 |
| — |
| — |
| 7 |
| ||||
|
| $ | 10,177 |
| $ | 284 |
| $ | (76 | ) | $ | 10,385 |
|
Mortgage-backed securities available for sale |
|
|
|
|
|
|
|
|
| ||||
FHLMC certificates |
| $ | 9,986 |
| $ | 3 |
| $ | (303 | ) | $ | 9,686 |
|
FNMA certificates |
| 12,594 |
| 1 |
| (422 | ) | 12,173 |
| ||||
Real estate mortgage investment conduit |
| 63,064 |
| — |
| (1,412 | ) | 61,652 |
| ||||
|
| $ | 85,644 |
| $ | 4 |
| $ | (2,137 | ) | $ | 83,511 |
|
30
|
| December 31, 2004 |
| ||||||||||
|
| Amortized |
| Gross |
| Gross |
| Fair |
| ||||
|
| (in thousands) |
| ||||||||||
Investment securities held to maturity |
|
|
|
|
|
|
|
|
| ||||
State and political subdivisions |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
|
U.S. Government and federal agencies |
| 1,326 |
| 69 |
| — |
| 1,395 |
| ||||
Corporate debt securities |
| 5,701 |
| 92 |
| — |
| 5,793 |
| ||||
|
| $ | 7,027 |
| $ | 161 |
| $ | — |
| $ | 7,188 |
|
Investment securities available for sale |
|
|
|
|
|
|
|
|
| ||||
U.S. Government and federal agencies |
| $ | 2,978 |
| $ | — |
| $ | (20 | ) | $ | 2,958 |
|
Corporate debt securities |
| 1,000 |
| — |
| (8 | ) | 992 |
| ||||
State and political subdivisions |
| 13,704 |
| 121 |
| (150 | ) | 13,675 |
| ||||
|
| $ | 17,682 |
| $ | 121 |
| $ | (178 | ) | $ | 17,625 |
|
Mortgage-backed securities held to maturity |
|
|
|
|
|
|
|
|
| ||||
FHLMC certificates |
| $ | 5,195 |
| $ | 322 |
| — |
| 5,517 |
| ||
FNMA certificates |
| 5,182 |
| 135 |
| (41 | ) | 5,276 |
| ||||
GNMA certificates |
| 4,516 |
| 230 |
| — |
| 4,746 |
| ||||
Real estate mortgage investment conduit |
| 7 |
| — |
| — |
| 7 |
| ||||
|
| $ | 14,900 |
| $ | 687 |
| $ | (41 | ) | $ | 15,546 |
|
Mortgage-backed securities available for sale |
|
|
|
|
|
|
|
|
| ||||
FHLMC certificates |
| $ | 6,635 |
| $ | 11 |
| $ | (32 | ) | $ | 6,614 |
|
FNMA certificates |
| 15,255 |
| 5 |
| (152 | ) | 15,108 |
| ||||
Real estate mortgage investment conduit |
| 82,129 |
| 218 |
| (459 | ) | 81,888 |
| ||||
|
| $ | 104,019 |
| $ | 234 |
| $ | (643 | ) | $ | 103,610 |
|
There were no sales of investments and mortgage-backed securities during the years ended December 31, 2005 and 2004.
Gross realized gains were $725,000 for the year ended December 31, 2003. These gains resulted from the sale of investment and mortgage-backed securities of $22.6 million for the year ended December 31, 2003.
Gross realized losses were $517,000 for the year ended December 31, 2003. These losses resulted from the sale of investment and mortgage-backed securities of $72.4 million for the year ended December 31, 2003.
31
The amortized cost and fair value of investment and mortgage-backed securities, by contractual maturity, are shown below.
|
| December 31, 2005 |
| ||||||||||
|
| Available for sale |
| Held to maturity |
| ||||||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||
|
| (in thousands) |
| ||||||||||
Investment securities |
|
|
|
|
|
|
|
|
| ||||
Due in one year or less |
| $ | — |
| $ | — |
| $ | 3,675 |
| $ | 3,671 |
|
Due after one year through five years |
| 10,588 |
| 10,431 |
| 800 |
| 821 |
| ||||
Due after five years through 10 years |
| 7,634 |
| 7,572 |
| 215 |
| 215 |
| ||||
Due after 10 years |
| 12,606 |
| 12,398 |
| — |
| — |
| ||||
|
| 30,828 |
| 30,401 |
| 4,690 |
| 4,707 |
| ||||
Mortgage-backed securities |
| 85,644 |
| 83,511 |
| 10,177 |
| 10,385 |
| ||||
|
| $ | 116,472 |
| $ | 113,912 |
| $ | 14,867 |
| $ | 15,092 |
|
Investment securities having an aggregate amortized cost of approximately $3.0 million were pledged to secure public deposits at December 31, 2005 and 2004.
There were no securities held other than U.S. Government and agencies from a single issuer that represented more than 10% of stockholders’ equity at year end.
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been in a continuous unrealized loss position at December 31, 2005:
|
| Number |
| Less than 12 months |
| 12 months or longer |
| Total |
| ||||||||||||
Description of Securities |
| of |
| Fair Value |
| Unrealized |
| Fair Value |
| Unrealized |
| Fair value |
| Unrealized |
| ||||||
|
| (in thousands) |
| ||||||||||||||||||
U.S. Government and federal agencies |
| 2 |
| $ | 2,984 |
| $ | (14 | ) | $ | 2,897 |
| $ | (88 | ) | $ | 5,881 |
| $ | (102 | ) |
Corporate debt securities |
| 6 |
| 6,632 |
| (44 | ) | 997 |
| (4 | ) | 7,629 |
| (48 | ) | ||||||
State and political subdivisions |
| 20 |
| 11,061 |
| (155 | ) | 5,042 |
| (190 | ) | 16,103 |
| (345 | ) | ||||||
Mortgage-backed securities |
| 32 |
| 35,899 |
| (657 | ) | 49,199 |
| (1,556 | ) | 85,098 |
| (2,213 | ) | ||||||
Total temporarily impaired securities |
| 60 |
| $ | 56,576 |
| $ | (870 | ) | $ | 58,135 |
| $ | (1,838 | ) | $ | 114,711 |
| $ | (2,708 | ) |
The unrealized losses on investments in securities issued by the U. S. Treasury and Government agencies, U. S. Government sponsored agencies and agency mortgage-backed securities were caused by changes in market interest rates. The contractual terms and contractual cash flows of these securities do not permit the issuer to settle at a price less than the amortized cost of the investment. The Company has the ability and intent to hold these investments until a market price recovery or maturity. Accordingly, the Company has determined that the unrealized losses at December 31, 2005 are not considered other-than-temporary.
32
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been in a continuous unrealized loss position at December 31, 2004:
|
| Number |
| Less than 12 months |
| 12 months or longer |
| Total |
| ||||||||||||
Description of Securities |
| of |
| Fair Value |
| Unrealized |
| Fair Value |
| Unrealized |
| Fair value |
| Unrealized |
| ||||||
|
| (in thousands) |
| ||||||||||||||||||
U.S. Government and federal agencies |
| 1 |
| $ | — |
| $ | — |
| $ | 2,957 |
| $ | (20 | ) | $ | 2,957 |
| $ | (20 | ) |
Corporate debt securities |
| 1 |
| — |
| — |
| 993 |
| (8 | ) | 993 |
| (8 | ) | ||||||
State and political subdivisions |
| 7 |
| — |
| — |
| 5,092 |
| (150 | ) | 5,092 |
| (150 | ) | ||||||
Mortgage-backed securities |
| 25 |
| 22,901 |
| (130 | ) | 46,367 |
| (554 | ) | 69,268 |
| (684 | ) | ||||||
Total temporarily impaired securities |
| 34 |
| $ | 22,901 |
| $ | (130 | ) | $ | 55,409 |
| $ | (732 | ) | $ | 78,310 |
| $ | (862 | ) |
The Company has attributed interest rate fluctuations as the underlying factor causing the decline in fair value of these securities. The Company maintains the intent and ability to hold such securities until recovery or maturity at which point the market value of the security will no longer reflect impairment. Accordingly, it has been concluded that there are no securities that are other-than-temporarily impaired as of December 31, 2004.
NOTE D—LOANS RECEIVABLE
Loans receivable are summarized as follows:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
First mortgage loans (principally conventional) |
|
|
|
|
| ||
Secured by one-to-four family residences |
| $ | 289,746 |
| $ | 284,645 |
|
Secured by other non-residential properties |
| 89,489 |
| 83,559 |
| ||
Construction loans |
| 24,888 |
| 10,286 |
| ||
|
| 404,123 |
| 378,490 |
| ||
Net deferred loan origination costs and unamortized premiums |
| 504 |
| 700 |
| ||
Total first mortgage loans |
| 404,627 |
| 379,190 |
| ||
Other loans |
|
|
|
|
| ||
Commercial non-real estate |
| 48,471 |
| 30,543 |
| ||
Home equity and second mortgage |
| 37,479 |
| 29,522 |
| ||
Commercial leases |
| 186 |
| 857 |
| ||
Other |
| 2,836 |
| 4,384 |
| ||
|
| 88,972 |
| 65,306 |
| ||
Unamortized premiums |
| 1 |
| 6 |
| ||
Total other loans |
| 88,973 |
| 65,312 |
| ||
Less allowance for loan losses |
| (2,641 | ) | (2,307 | ) | ||
Total loans receivable |
| $ | 490,959 |
| $ | 442,195 |
|
33
Activity in the allowance for loan losses is summarized as follows:
|
| December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Balance at beginning of year |
| $ | 2,307 |
| $ | 2,111 |
| $ | 2,047 |
|
Provision charged to income |
| 540 |
| 600 |
| 330 |
| |||
Charge-offs, net |
| (206 | ) | (404 | ) | (266 | ) | |||
Balance at end of year |
| $ | 2,641 |
| $ | 2,307 |
| $ | 2,111 |
|
Non-performing loans, which include non-accrual loans for which the accrual of interest has been discontinued and loan balances past due over 90 days that are not on a non-accrual status but that management expects will eventually be paid in full, totaled approximately $1.6 million and $960,000 at December 31, 2005 and 2004, respectively. The Company has reviewed these loans and has determined there was no impairment at December 31, 2005 and 2004.
The Bank has no concentration of loans to borrowers engaged in similar activities that exceeded 10% of loans at December 31, 2005 and 2004. In the ordinary course of business, the Bank has granted loans to certain executive officers, directors and their related interests. Related party loans are made on substantially the same terms as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. The aggregate dollar amount of these loans was approximately $70,000 and $82,000 at December 31, 2005 and 2004, respectively. For the year ended December 31, 2005, principal repayments of approximately $12,000 were received. No new loans to related parties were issued during the year.
NOTE E—LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial position. The unpaid principal balances of these loans are summarized as follows:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Mortgage loan servicing portfolios |
|
|
|
|
| ||
FHLMC |
| $ | 1,182 |
| $ | 1,619 |
|
FNMA |
| 9,696 |
| 653 |
| ||
Other investors |
| 6,173 |
| 6,997 |
| ||
|
| $ | 17,051 |
| $ | 9,269 |
|
Custodial balances maintained in connection with the foregoing loan servicing totaled approximately $168,000 and $198,000 at December 31, 2005 and 2004, respectively. The net servicing revenue on mortgage loans serviced for others is immaterial for all periods presented. Mortgage servicing rights are reported as a component of other assets and were not material at December 31, 2005 and 2004.
34
NOTE F—PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
|
| Estimated |
| December 31, |
| ||||
|
| useful lives |
| 2005 |
| 2004 |
| ||
|
|
|
| (in thousands) |
| ||||
Buildings |
| 30 years |
| $ | 6,472 |
| $ | 6,063 |
|
Leasehold improvements |
| 5 years |
| 1,429 |
| 1,429 |
| ||
Furniture, fixtures and equipment |
| 3-7 years |
| 10,178 |
| 9,398 |
| ||
|
|
|
| 18,079 |
| 16,890 |
| ||
Less accumulated depreciation |
|
|
| 13,482 |
| 12,619 |
| ||
|
|
|
| 4,597 |
| 4,271 |
| ||
Land |
|
|
| 1,692 |
| 1,692 |
| ||
|
|
|
| $ | 6,289 |
| $ | 5,963 |
|
NOTE G—DEPOSITS
Deposits are summarized as follows:
|
| December 31, |
| ||||
Deposit type |
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Demand |
| $ | 37,138 |
| $ | 32,636 |
|
NOW |
| 52,319 |
| 54,887 |
| ||
Money Market |
| 79,666 |
| 42,496 |
| ||
Passbook savings |
| 151,725 |
| 182,945 |
| ||
Total demand, transaction and passbook deposits |
| 320,848 |
| 312,964 |
| ||
Certificates of deposit |
| 149,673 |
| 146,939 |
| ||
|
| $ | 470,521 |
| $ | 459,903 |
|
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was approximately $31.3 million and $26.6 million at December 31, 2005 and 2004, respectively. The Bank had no broker-originated certificates of deposit at December 31, 2005 and 2004.
At December 31, 2005, scheduled maturities of certificates of deposit are as follows:
Year ending December 31, |
| |||||||||||||||||||
2006 |
| 2007 |
| 2008 |
| 2009 |
| 2010 |
| Thereafter |
| Total |
| |||||||
(in thousands) |
| |||||||||||||||||||
$ | 92,402 |
| $ | 34,239 |
| $ | 7,009 |
| $ | 7,643 |
| $ | 7,766 |
| $ | 614 |
| $ | 149,673 |
|
Related party deposits are on substantially the same terms as for comparable transactions with unrelated persons. The aggregate dollar amount of these deposits was approximately $2.0 million and $1.4 million at December 31, 2005 and 2004, respectively.
35
NOTE H—ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
Advances from the Federal Home Loan Bank consist of the following:
|
| December 31, |
| ||||||||
|
| 2005 |
| 2004 |
| ||||||
Principal payments due during |
| Amount |
| Weighted |
| Amount |
| Weighted |
| ||
|
| (in thousands) |
|
|
| (in thousands) |
|
|
| ||
2005 |
| $ | — |
| — | % | 23,448 |
| 2.90 | % | |
2006 |
| 32,672 |
| 3.81 |
| 15,237 |
| 3.32 |
| ||
2007 |
| 22,050 |
| 3.73 |
| 15,750 |
| 3.32 |
| ||
2008 |
| 17,638 |
| 3.40 |
| 16,280 |
| 3.32 |
| ||
2009 |
| 34,566 |
| 3.84 |
| 28,147 |
| 3.60 |
| ||
2010 |
| 8,539 |
| 4.25 |
| 2,058 |
| 3.89 |
| ||
Thereafter |
| 5,795 |
| 4.20 |
| 1,827 |
| 3.94 |
| ||
|
| $ | 121,260 |
| 3.79 | % | $ | 102,747 |
| 3.32 | % |
The advances are collateralized by Federal Home Loan Bank stock and certain first mortgage loans and mortgage-backed securities. At December 31, 2005 principal payments due during 2006 included $16.2 million at a daily variable interest rate of 4.23%, pursuant to a line of credit agreement with the Federal Home Loan Bank. Unused lines of credit at the Federal Home Loan Bank were $13.8 million at December 31, 2005. The remaining long-term advances from the Federal Home Loan Bank are fixed rate.
NOTE I—BENEFIT PLANS
The Bank maintains a 401(k) profit-sharing plan for eligible employees. Participants may contribute up to 15% of pretax eligible compensation. The Bank makes matching discretionary contributions equal to 75% of the initial $1,000 deferral. Contributions to the 401(k) plan totaled $61,000, $65,000, and $58,000 in 2005, 2004 and 2003, respectively.
The Bank has a non-contributory defined benefit pension plan covering substantially all full-time employees meeting certain eligibility requirements. The benefits are based on each employee’s years of service and an average earnings formula. An employee becomes fully vested upon completion of five years of qualifying service. It is the policy of the Bank to fund the maximum amount allowable under the individual aggregate cost method to the extent deductible under existing federal income tax regulations.
36
The following tables set forth the projected benefit obligation, funded status of the defined benefit pension plan and the amounts reflected in the consolidated statements of financial position, and fair value of assets of the plan.
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Reconciliation of Projected Benefit Obligation |
|
|
|
|
| ||
Benefit obligation at beginning of year |
| $ | 3,382 |
| $ | 3,028 |
|
Service cost |
| 314 |
| 230 |
| ||
Interest cost |
| 211 |
| 190 |
| ||
Plan amendments |
| — |
| — |
| ||
Actuarial loss |
| 122 |
| 304 |
| ||
Benefits paid |
| (408 | ) | (370 | ) | ||
Benefits obligation at end of year |
| $ | 3,621 |
| $ | 3,382 |
|
|
|
|
|
|
| ||
Reconciliation of Fair Value of Assets |
|
|
|
|
| ||
Fair value of plan assets at beginning of year |
| $ | 2,490 |
| $ | 2,768 |
|
Actual return on plan assets |
| 77 |
| 62 |
| ||
Employer contribution |
| 1,015 |
| 30 |
| ||
Benefits paid |
| (408 | ) | (370 | ) | ||
Fair value of plan assets at end of year |
| $ | 3,174 |
| $ | 2,490 |
|
|
|
|
|
|
| ||
Reconciliation of Funded Status |
|
|
|
|
| ||
Funded status |
| $ | (447 | ) | $ | (892 | ) |
Unrecognized transition obligation |
| — |
| — |
| ||
Unrecognized net actuarial loss |
| 1,162 |
| 954 |
| ||
Unrecognized prior service cost |
| 156 |
| 219 |
| ||
Prepaid benefit cost at end of year |
| $ | 871 |
| $ | 281 |
|
The accumulated benefit obligation at December 31, 2005 and 2004 was $3,079,000 and $2,816,000 respectively.
Employer contributions and benefits paid in the above table include only those amounts contributed directly to, or paid directly from, Plan assets. The expected employer contribution for 2006 is $1.0 million.
|
| 2005 |
| 2004 |
|
Weighted-average assumptions used to determine benefit obligations, end of year |
|
|
|
|
|
Discount rate |
| 5.75 | % | 6.00 | % |
Rate of compensation increase |
| 4.00 |
| 4.00 |
|
37
|
| 2005 |
| 2004 |
| 2003 |
| |||
Components of net periodic benefit cost |
|
|
|
|
|
|
| |||
Service cost |
| $ | 314 |
| $ | 230 |
| $ | 191 |
|
Interest cost |
| 211 |
| 190 |
| 185 |
| |||
Expected return on plan assets |
| (205 | ) | (210 | ) | (217 | ) | |||
Amortization of prior service cost |
| 63 |
| 63 |
| 63 |
| |||
Amortization of transition obligation (asset) |
| — |
| 4 |
| 4 |
| |||
Recognized net actuarial (gain) loss |
| 42 |
| 24 |
| 13 |
| |||
Net periodic benefit cost |
| $ | 425 |
| $ | 301 |
| $ | 239 |
|
|
| 2005 |
| 2004 |
| 2003 |
|
Weighted-average assumptions used to determine net benefit costs as of December 31 |
|
|
|
|
|
|
|
Discount rate |
| 6.00 | % | 6.25 | % | 6.75 | % |
Expected return on plan assets |
| 8.00 |
| 8.00 |
| 8.00 |
|
Rate of compensation increase |
| 4.00 |
| 4.00 |
| 4.00 |
|
The expected rate of return was determined by applying the average rates of return over the past ten years on the assets which the Plan is currently invested.
Estimated future benefits payments are as follows:
|
| (in thousands) |
| |
2006 |
| $ | 324 |
|
2007 |
| 49 |
| |
2008 |
| 65 |
| |
2009 |
| 89 |
| |
2001 |
| 88 |
| |
2011-2015 |
| 689 |
| |
The Plan’s weighted-average asset allocations by asset category is as follows:
|
| Percentage of Plan Assets |
| ||
|
| 2005 |
| 2004 |
|
Asset Category |
|
|
|
|
|
Equity securities |
| 64 | % | 57 | % |
Debt securities |
| 27 |
| 26 |
|
Other |
| 9 |
| 17 |
|
Total |
| 100 | % | 100 | % |
Trustees of the Plan are responsible for defining and implementing the investment objectives and policies for the Plan’s assets. Assets are invested in accordance with sound investment practices that
38
emphasize long-term investment fundamentals that closely match the demographics of the plan’s participants. The Plan’s goal is to earn long-term returns that match or exceed the benefit obligations of the Plan through a well-diversified portfolio structure. The Plan’s return objectives and risk parameters are managed through a diversified mix of assets. The asset mix and investment strategy are reviewed on a quarterly basis and rebalanced when necessary. The asset allocation for the Plan is targeted at 60% equity securities and 40% debt securities.
The Company also maintains the following benefit plans:
1. Employee Stock Ownership Plan
The Company has an internally leveraged ESOP for eligible employees who have completed six months of service with the Company or its subsidiaries. The ESOP borrowed $4.2 million from the Company in 1996 to purchase 423,200 newly issued shares of common stock. The Company makes discretionary contributions to the ESOP in order to service the ESOP’s debt. Any dividends received by the ESOP will be used to pay debt service. The ESOP shares are pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to qualifying employees based on the proportion of debt service paid in the year. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the allocated shares are included in outstanding shares for earnings per share computations. ESOP compensation expense was $387,000, $431,000 and $523,000 in 2005, 2004 and 2003, respectively.
|
| 2005 |
| 2004 |
| ||
Allocated shares |
| 165,000 |
| 158,300 |
| ||
Unreleased shares |
| 184,000 |
| 200,700 |
| ||
|
|
|
|
|
| ||
Total ESOP shares |
| 349,000 |
| 359,000 |
| ||
|
|
|
|
|
| ||
Fair value of unreleased shares (in thousands) |
| $ | 5,235 |
| $ | 6,422 |
|
2. Stock Compensation Plans
A summary of the status of the Company’s fixed stock option plans as of December 31, 2005, and changes for each of the years in the three-year period then ended is as follows:
|
| 2005 |
| 2004 |
| 2003 |
| |||||||||
|
| Number |
| Weighted |
| Number |
| Weighted |
| Number |
| Weighted |
| |||
Outstanding at beginning of year |
| 283,072 |
| $ | 19.09 |
| 585,714 |
| $ | 15.40 |
| 658,973 |
| $ | 14.11 |
|
Options granted |
| 160,500 |
| 28.46 |
| — |
| — |
| 40,248 |
| 32.42 |
| |||
Options exercised |
| (49,975 | ) | 16.01 |
| (294,925 | ) | 11.56 |
| (92,902 | ) | 12.34 |
| |||
Options forfeited |
| (8,749 | ) | 28.40 |
| (7,717 | ) | 26.75 |
| (20,605 | ) | 21.09 |
| |||
Outstanding at end of year |
| 384,848 |
| $ | 23.18 |
| 283,072 |
| $ | 19.09 |
| 585,714 |
| $ | 15.40 |
|
39
The following table summarizes information about stock options outstanding at December 31, 2005:
|
| Options outstanding |
| Options exercisable |
| ||||||||
Range of exercise prices |
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| ||
$13.25-19.88 |
| 154,743 |
| 1.58 years |
| $ | 15.81 |
| 154,743 |
| $ | 15.81 |
|
$19.89-29.84 |
| 205,284 |
| 5.50 years |
| 27.41 |
| 31,455 |
| 23.40 |
| ||
$29.85-34.14 |
| 24,821 |
| 7.97 years |
| 34.14 |
| 9.928 |
| 34.14 |
| ||
|
| 384,848 |
| 4.08 years |
| $ | 23.18 |
| 196,126 |
| $ | 17.96 |
|
The Company granted 39,000 shares of stock in December 2005 which will vest over a three-year period. As a result, the Company recognized $15,000 of compensation expense based on the market value of the stock on the date of the grant and the vesting period. There were no stock grants in 2004 and 2003.
NOTE J—INCOME TAXES
The components of income tax expense (benefit) are summarized as follows:
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Federal |
|
|
|
|
|
|
| |||
Current |
| $ | 1,753 |
| $ | 508 |
| $ | (4,364 | ) |
Charge in lieu of income tax relating to stock compensation |
| 144 |
| 1,616 |
| 379 |
| |||
Deferred |
| 403 |
| 343 |
| 596 |
| |||
|
| 2,300 |
| 2,467 |
| (3,389 | ) | |||
|
|
|
|
|
|
|
| |||
State and local—current |
| — |
| — |
| 5 |
| |||
Income tax provision |
| $ | 2,300 |
| $ | 2,467 |
| $ | (3,384 | ) |
The Company’s effective income tax rate was different than the statutory federal income tax rate as follows:
|
| Year ended December 31, |
| ||||
|
| 2005 |
| 2004 |
| 2003 |
|
Statutory federal income tax (benefit) |
| 34.0 | % | 34.0 | % | (34.0 | )% |
Increase (decrease) resulting from |
|
|
|
|
|
|
|
Tax-exempt income |
| (5.7 | ) | (3.7 | ) | (2.6 | ) |
State tax, net of federal benefit |
| (0.0 | ) | (0.0 | ) | (0.0 | ) |
Other |
| (1.1 | ) | (3.0 | ) | (0.1 | ) |
|
| 27.2 | % | 27.3 | % | (36.7 | )% |
40
Deferred taxes are included in the accompanying consolidated statements of financial position at December 31, 2005 and 2004, for the estimated future tax effects of differences between the financial statement and federal income tax bases of assets and liabilities according to the provisions of currently enacted tax laws. No valuation allowance was recorded against deferred tax assets at December 31, 2005 and 2004. The Company’s net deferred tax asset at December 31, 2005 and 2004, was composed of the following:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Deferred tax assets |
|
|
|
|
| ||
Deferred compensation |
| $ | 208 |
| $ | 277 |
|
Allowance for loan losses, net |
| 885 |
| 784 |
| ||
Unrealized loss on securities available for sale |
| 869 |
| 158 |
| ||
Minimum pension liability adjustment |
| — |
| 37 |
| ||
Other |
| 51 |
| 9 |
| ||
|
| 2,013 |
| 1,265 |
| ||
Deferred tax liabilities |
|
|
|
|
| ||
Accrued pension expense |
| 504 |
| 399 |
| ||
Prepaid expenses |
| 43 |
| 51 |
| ||
Deferred loan costs |
| 472 |
| 391 |
| ||
Amortization of goodwill |
| 263 |
| 93 |
| ||
Other |
| 419 |
| 290 |
| ||
|
| 1,701 |
| 1,224 |
| ||
Net deferred tax asset |
| $ | 312 |
| $ | 41 |
|
Prior to 2004 the Company filed its income tax returns on the basis of a fiscal tax year ending June 30. Effective July 1, 2005, the Company changed the tax year end to coincide with the fiscal reporting period end of December 31.
The Bank is not required to recapture approximately $5.7 million of its tax bad debt reserve, attributable to bad debt deductions taken by it prior to 1988, as long as the Bank continues to operate as a bank under federal tax law and does not use the reserve for any other purpose. In accordance with SFAS No. 109, the Bank has not recorded any deferred tax liability on this portion of its tax bad debt reserve. The tax that would be paid were the Bank ultimately required to recapture that portion of the reserve would amount to approximately $1.9 million.
41
NOTE K—REGULATORY MATTERS
The Bank is subject to minimum regulatory capital standards promulgated by the Office of Thrift Supervision (OTS). Failure to meet minimum capital requirements can initiate certain mandatory—and possible additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Such minimum capital standards generally require the maintenance of regulatory capital sufficient to meet each of three tests, hereinafter described as the tangible capital requirement, the core capital requirement and the risk-based capital requirement. The tangible capital requirement provides for minimum tangible capital (defined as stockholders’ equity less all intangible assets) equal to 1.5% of adjusted total assets. The core capital requirement provides for minimum core capital (tangible capital plus certain forms of supervisory goodwill and other qualifying intangible assets) equal to 4% of adjusted total assets at December 31, 2005. The risk-based capital requirement provides for minimum core capital (tangible capital plus certain forms of supervisory goodwill and other qualifying intangible assets) adjusted for the general valuation allowances equal to 8% of total assets classified in one of four risk-weighted categories at December 31, 2005.
As of December 31, 2005, management believes that the Bank met all capital adequacy requirements to which it was subject.
|
| Regulatory capital |
| |||||||||||||
|
| Tangible |
| Core |
| Risk-based |
| |||||||||
|
| Capital |
| Percent |
| Capital |
| Percent |
| Capital |
| Percent |
| |||
|
| (in thousands) |
| |||||||||||||
Capital under generally accepted accounting principles |
| $ | 57,421 |
| 8.69 | % | $ | 57,421 |
| 8.69 | % | $ | 57,421 |
| 14.90 | % |
Unrealized loss on certain available-for-sale securities |
| 1,689 |
| 0.25 |
| 1,689 |
| 0.25 |
| 1,689 |
| 0.44 |
| |||
Goodwill and other intangible assets |
| (3,774 | ) | (0.57 | ) | (3,774 | ) | (0.57 | ) | (3,774 | ) | (0.98 | ) | |||
Additional capital items |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
General valuation allowances—limited |
| — |
| — |
| — |
| — |
| 2,641 |
| 0.68 |
| |||
Regulatory capital computed |
| 55,336 |
| 8.37 |
| 55,336 |
| 8.37 |
| 57,977 |
| 15.04 |
| |||
Minimum capital requirement |
| 9,913 |
| 1.50 |
| 26,434 |
| 4.00 |
| 30,834 |
| 8.00 |
| |||
Regulatory capital—excess |
| $ | 45,423 |
| 6.87 | % | $ | 28,902 |
| 4.37 | % | $ | 27,143 |
| 7.04 | % |
42
|
| Regulatory capital |
| |||||||||||||
|
| Tangible |
| Core |
| Risk-based |
| |||||||||
|
| Capital |
| Percent |
| Capital |
| Percent |
| Capital |
| Percent |
| |||
|
| (in thousands) |
| |||||||||||||
Capital under generally accepted accounting principles |
| $ | 55,143 |
| 8.81 | % | $ | 55,143 |
| 8.81 | % | $ | 55,143 |
| 16.30 | % |
Unrealized loss on certain available-for-sale securities |
| 307 |
| 0.04 |
| 307 |
| 0.04 |
| 307 |
| 0.09 |
| |||
Goodwill and other intangible assets |
| (4,537 | ) | (0.72 | ) | (4,537 | ) | (0.72 | ) | (4,537 | ) | (1.34 | ) | |||
Additional capital items |
|
|
|
|
|
|
|
|
|
|
|
|
| |||
General valuation allowances—limited |
| — |
| — |
| — |
| — |
| 2,104 |
| 0.62 |
| |||
Regulatory capital computed |
| 50,913 |
| 8.13 |
| 50,913 |
| 8.13 |
| 53,017 |
| 15.67 |
| |||
Minimum capital requirement |
| 9,390 |
| 1.50 |
| 25,041 |
| 4.00 |
| 27,060 |
| 8.00 |
| |||
Regulatory capital—excess |
| $ | 41,523 |
| 6.63 | % | $ | 25,872 |
| 4.13 | % | $ | 25,957 |
| 7.67 | % |
At December 31, 2005, the Bank met all regulatory requirements for classification as a “well-capitalized” institution. A “well-capitalized” institution must have risk-based capital of 10% and core capital of 5%. The Bank’s capital exceeded the minimum required amounts for classification as a “well-capitalized” institution. There are no conditions or events that have occurred that management believes have changed the Bank’s classification as a “well-capitalized” institution.
The Bank maintains a liquidation account for the benefit of eligible savings account holders who maintained deposit accounts in the Bank after the Bank converted to a stock form of ownership. The Bank may not declare or pay a cash dividend on or repurchase any of its common shares if the effect thereof would cause the Bank’s stockholders’ equity to be reduced below either the amount required for the liquidation account or the regulatory capital requirements for insured institutions.
NOTE L—FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are primarily commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become receivable or payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial position. The contract or notional amounts of those instruments reflect the extent of the Bank’s involvement in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Unless noted otherwise, the Company requires collateral to support financial instruments with credit risk.
43
Financial instruments, the contract amounts of which represent credit risk, are as follows:
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
Commitments to extend credit |
| $ | 69,822 |
| $ | 73,330 |
|
Standby letters of credit |
| 2,220 |
| 1,201 |
| ||
Loans sold with recourse |
| 74 |
| 109 |
| ||
|
| $ | 72,116 |
| $ | 74,640 |
|
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held generally includes residential and or commercial real estate.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
NOTE M—COMMITMENTS AND CONTINGENCIES
The Bank had optional commitments of $1,085,000 and $1,069,000 to sell mortgage loans to investors at December 31, 2005 and 2004 respectively.
The Bank leases branch facilities and office space for periods ranging up to ten years. These leases are classified as operating leases and contain options to renew for additional periods. Rental expense was approximately $420,000, $359,000, and $304,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
The minimum annual rental commitments of the Bank under all non-cancelable leases with terms of one year or more are as follows:
Year ending December 31, |
| (in thousands) |
| |
2006 |
| $ | 401 |
|
2007 |
| 344 |
| |
2008 |
| 255 |
| |
2009 |
| 179 |
| |
2010 |
| 100 |
| |
Thereafter |
| 445 |
| |
|
| $ | 1,724 |
|
The Company has agreements with certain key executives that provide severance pay benefits if there is a change in control of the Company. The agreements will continue in effect until terminated or not
44
renewed by the Company or key executives. Upon a change in control, the Company shall make a lump-sum payment or continue to pay the key executives’ salaries per the agreements, and reimburse the executive for certain benefits for one year. The maximum contingent liability under the agreements at December 31, 2005 was approximately $1,691,000.
From time to time, the Company and its subsidiaries are parties to routine litigation that arises in the normal course of business. In the opinion of management, the resolution of these lawsuits would not have a material adverse effect on the Company’s consolidated financial position or results of operations.
NOTE N—SIGNIFICANT CONCENTRATIONS OF CREDIT RISK
The Bank is principally engaged in originating and investing in one-to-four family residential real estate and commercial real estate loans in eastern Pennsylvania and New Jersey. The Bank offers both fixed and adjustable rates of interest on these loans that have amortization terms ranging to 30 years. The loans are generally originated or purchased on the basis of an 80% loan-to-value ratio, which has historically provided the Bank with more than adequate collateral coverage in the event of default. Nevertheless, the Bank, as with any lending institution, is subject to the risk that residential real estate values in the primary lending area will deteriorate, thereby potentially impairing underlying collateral values. However, management believes that residential and commercial real estate values are presently stable in its primary lending area and that loan loss allowances have been provided for in amounts commensurate with its current perception of the foregoing risks in the portfolio.
NOTE O—FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires all entities to disclose the estimated fair value of their assets and liabilities considered to be financial instruments. For the Bank, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity or available for sale and to not engage in trading or significant sales activities. Therefore, the Company and the Bank use significant estimations and present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. In addition, there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.
Fair values have been estimated using data which management considered the best available, as generally provided by estimation methodologies deemed suitable for the pertinent category of financial instrument. The estimation methodologies, resulting fair values and recorded carrying amounts are as follows:
Fair value of loans and deposits with floating interest rates is generally presumed to approximate the recorded carrying amounts.
45
Fair value of financial instruments actively traded in a secondary market has been estimated using quoted market prices.
|
| December 31, |
| ||||||||||
|
| 2005 |
| 2004 |
| ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying |
| ||||
|
| (in thousands) |
| ||||||||||
Cash and cash equivalents |
| $ | 3,821 |
| $ | 3,821 |
| $ | 7,900 |
| $ | 7,900 |
|
Investment securities |
| 35,108 |
| 35,091 |
| 24,813 |
| 24,652 |
| ||||
Mortgage-backed securities |
| 93,896 |
| 93,688 |
| 119,156 |
| 118,510 |
| ||||
The fair value of financial instruments with stated maturities has been estimated using the present value of cash flows, discounted at rates approximating current market rates for similar assets and liabilities.
|
| December 31, |
| ||||||||||
|
| 2005 |
| 2004 |
| ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying |
| ||||
|
| (in thousands) |
| ||||||||||
Assets |
|
|
|
|
|
|
|
|
| ||||
Certificates of deposit |
| $ | 40 |
| $ | 40 |
| $ | 38 |
| $ | 38 |
|
Liabilities |
|
|
|
|
|
|
|
|
| ||||
Deposits with stated maturities |
| 147,561 |
| 149,673 |
| 145,933 |
| 146,939 |
| ||||
Borrowings with stated maturities |
| 118,352 |
| 121,260 |
| 101,504 |
| 102,747 |
| ||||
The fair value of financial instrument liabilities with no stated maturities is generally presumed to approximate the carrying amount (the amount payable on demand).
|
| December 31, |
| ||||||||||
|
| 2005 |
| 2004 |
| ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying |
| ||||
|
| (in thousands) |
| ||||||||||
Deposits with no stated maturities |
| $ | 320,848 |
| $ | 320,848 |
| $ | 312,964 |
| $ | 312,964 |
|
The fair value of the net loan portfolio has been estimated using the present value of cash flows, discounted at the approximate current market rates, and giving consideration to estimated prepayment risk and credit loss factors.
|
| December 31, |
| ||||||||||
|
| 2005 |
| 2004 |
| ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying |
| ||||
|
| (in thousands) |
| ||||||||||
Net loans |
| $ | 486,214 |
| $ | 490,959 |
| $ | 445,457 |
| $ | 442,195 |
|
46
The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are immaterial.
The Bank’s remaining assets and liabilities are not considered financial instruments. No disclosure of the relationship value of the Bank’s deposits is required by SFAS No. 107.
NOTE P—SERVICE FEES, CHARGES AND OTHER OPERATING INCOME AND OTHER OPERATING EXPENSE
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Service fees, charges and other operating income |
|
|
|
|
|
|
| |||
Loan servicing fees |
| $ | 363 |
| $ | 331 |
| $ | 358 |
|
Late charge income |
| 83 |
| 90 |
| 100 |
| |||
Deposit service charges |
| 1,061 |
| 1,092 |
| 923 |
| |||
Bank-owned life insurance value increase |
| 501 |
| 525 |
| 553 |
| |||
Other income |
| 562 |
| 562 |
| 438 |
| |||
|
| $ | 2,570 |
| $ | 2,600 |
| $ | 2,372 |
|
Other operating expense |
|
|
|
|
|
|
| |||
Insurance and surety bond |
| $ | 193 |
| $ | 190 |
| $ | 180 |
|
Office supplies |
| 221 |
| 220 |
| 234 |
| |||
Loan expense |
| 337 |
| 444 |
| 491 |
| |||
MAC expense |
| 328 |
| 315 |
| 307 |
| |||
Postage |
| 272 |
| 237 |
| 299 |
| |||
Telephone |
| 306 |
| 273 |
| 283 |
| |||
Supervisory examination fees |
| 138 |
| 130 |
| 147 |
| |||
Other expenses |
| 698 |
| 738 |
| 906 |
| |||
|
| $ | 2,493 |
| $ | 2,547 |
| $ | 2,847 |
|
47
The following tables set forth the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (dollars in thousands, except per share data):
|
| Year ended December 31, 2005 |
| ||||||
|
| Income |
| Weighted |
| Per share |
| ||
Basic earnings per share |
|
|
|
|
|
|
| ||
Income available to common stockholders |
| $ | 6,153 |
| 2,736,945 |
| $ | 2.25 |
|
Effect of dilutive securities |
|
|
|
|
|
|
| ||
Stock compensation plans |
| — |
| 61,226 |
| (0.05 | ) | ||
|
|
|
|
|
|
|
| ||
Diluted earnings per share |
|
|
|
|
|
|
| ||
Income available to common stockholders plus effect of dilutive securities |
| $ | 6,153 |
| 2,798,171 |
| $ | 2.20 |
|
There were options to purchase 170,321 shares of common stock at a range of $28.48 to $34.14 per share which were outstanding during 2005 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.
|
| Year ended December 31, 2004 |
| ||||||
|
| Income |
| Weighted |
| Per share |
| ||
Basic earnings per share |
|
|
|
|
|
|
| ||
Income available to common stockholders |
| $ | 6,567 |
| 2,686,732 |
| $ | 2.44 |
|
Effect of dilutive securities |
|
|
|
|
|
|
| ||
Stock compensation plans |
| — |
| 126,173 |
| (0.11 | ) | ||
|
|
|
|
|
|
|
| ||
Diluted earnings per share |
|
|
|
|
|
|
| ||
Income available to common stockholders plus effect of dilutive securities |
| $ | 6,567 |
| 2,812,905 |
| $ | 2.33 |
|
48
There were options to purchase 30,029 shares of common stock at a price of $34.14 per share which were outstanding during 2004 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.
|
| Year ended December 31, 2003 |
| ||||||
|
| Income |
| Weighted |
| Per share |
| ||
Basic earnings (loss) per share |
|
|
|
|
|
|
| ||
Loss available to common stockholders |
| $ | (5,834 | ) | 2,541,677 |
| $ | (2.30 | ) |
Effect of dilutive securities |
|
|
|
|
|
|
| ||
Stock compensation plans |
| — |
| — |
| — |
| ||
Diluted earnings (loss) per share |
|
|
|
|
|
|
| ||
Income available to common stockholders plus effect of dilutive securities |
| $ | (5,834 | ) | 2,541,677 |
| $ | (2.30 | ) |
Due to the net loss in 2003, the effect of stock options on diluted loss per share was not included due to the anti-dilutive impact of such items on the calculation.
NOTE R—SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATE (UNAUDITED)
|
| Three months ended |
| ||||||||||
|
| Dec. 31, |
| Sept. 30, |
| June 30, |
| March 31, |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
Total interest income |
| $ | 8,927 |
| $ | 8,570 |
| $ | 8,371 |
| $ | 8,097 |
|
Total interest expense |
| 3,281 |
| 2,987 |
| 2,797 |
| 2,467 |
| ||||
Net interest income |
| 5,646 |
| 5,583 |
| 5,574 |
| 5,630 |
| ||||
Provision for possible loan losses |
| 90 |
| 150 |
| 150 |
| 150 |
| ||||
Net interest income after provision |
| 5,556 |
| 5,433 |
| 5,424 |
| 5,480 |
| ||||
Other income |
| 647 |
| 742 |
| 677 |
| 662 |
| ||||
Other expenses |
| 4,010 |
| 4,084 |
| 3,943 |
| 4,131 |
| ||||
Income before income taxes |
| 2,193 |
| 2,091 |
| 2,158 |
| 2,011 |
| ||||
Income taxes |
| 666 |
| 546 |
| 553 |
| 535 |
| ||||
Net income |
| $ | 1,527 |
| $ | 1,545 |
| $ | 1,605 |
| $ | 1,476 |
|
Earnings per share—basic |
| $ | 0.56 |
| $ | 0.57 |
| $ | 0.59 |
| $ | 0.54 |
|
Earnings per share—assuming dilution |
| $ | 0.55 |
| $ | 0.55 |
| $ | 0.57 |
| $ | 0.52 |
|
49
|
| Three months ended |
| ||||||||||
|
| Dec. 31, |
| Sept. 30, |
| June 30, |
| March 31, |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
Total interest income |
| $ | 7,848 |
| $ | 7,868 |
| $ | 7,775 |
| $ | 7,730 |
|
Total interest expense |
| 2,349 |
| 2,214 |
| 2,151 |
| 2,152 |
| ||||
Net interest income |
| 5,499 |
| 5,654 |
| 5,624 |
| 5,578 |
| ||||
Provision for possible loan losses |
| 150 |
| 150 |
| 150 |
| 150 |
| ||||
Net interest income after provision |
| 5,349 |
| 5,504 |
| 5,474 |
| 5,428 |
| ||||
Other income |
| 623 |
| 595 |
| 681 |
| 709 |
| ||||
Other expenses |
| 3,800 |
| 3,743 |
| 3,869 |
| 3,917 |
| ||||
Income before income taxes |
| 2,172 |
| 2,356 |
| 2,286 |
| 2,220 |
| ||||
Income tax expense |
| 584 |
| 642 |
| 630 |
| 611 |
| ||||
Net income |
| $ | 1,588 |
| $ | 1,714 |
| $ | 1,656 |
| $ | 1,609 |
|
Earnings per share—basic |
| $ | 0.58 |
| $ | 0.64 |
| $ | 0.62 |
| $ | 0.61 |
|
Earnings per share—assuming dilution |
| $ | 0.56 |
| $ | 0.61 |
| $ | 0.58 |
| $ | 0.57 |
|
50
NOTE S—CONDENSED FINANCIAL INFORMATION—PARENT COMPANY ONLY
Condensed financial information for TF Financial Corporation (parent company only) follows:
BALANCE SHEET
|
| December 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
|
| (in thousands) |
| ||||
ASSETS |
|
|
|
|
| ||
Cash |
| $ | 3,452 |
| $ | 4,630 |
|
Certificates of deposit—other institutions |
| 40 |
| 38 |
| ||
Investment in Third Federal |
| 55,611 |
| 53,054 |
| ||
Investment in TF Investments |
| 2,392 |
| 2,347 |
| ||
Investment in Penns Trail Development |
| 991 |
| 1,001 |
| ||
Other assets |
| 240 |
| 121 |
| ||
Total assets |
| $ | 62,726 |
| $ | 61,191 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| ||
|
|
|
|
|
| ||
Total liabilities |
| $ | 78 |
| $ | 36 |
|
Stockholders’ equity |
| 62,648 |
| 61,155 |
| ||
Total liabilities and stockholders’ equity |
| $ | 62,726 |
| $ | 61,191 |
|
STATEMENT OF OPERATIONS
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
INCOME |
|
|
|
|
|
|
| |||
Equity in earnings (loss) of subsidiaries |
| $ | 6,510 |
| $ | 6,906 |
| $ | (5,556 | ) |
Interest and dividend income |
| 72 |
| 74 |
| 99 |
| |||
Total income (loss) |
| 6,582 |
| 6,980 |
| (5,457 | ) | |||
|
|
|
|
|
|
|
| |||
EXPENSES |
|
|
|
|
|
|
| |||
Other |
| 429 |
| 413 |
| 377 |
| |||
Total expenses |
| 429 |
| 413 |
| 377 |
| |||
NET INCOME (LOSS) |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) |
51
STATEMENT OF CASH FLOWS
|
| Year ended December 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
| (in thousands) |
| |||||||
Cash flows from operating activities |
|
|
|
|
|
|
| |||
Net income (loss) |
| $ | 6,153 |
| $ | 6,567 |
| $ | (5,834 | ) |
Adjustments to reconcile net income to net cash provided by (used in) operating activities |
|
|
|
|
|
|
| |||
Equity in (earnings) loss of subsidiaries |
| (6,510 | ) | (6,906 | ) | 5,556 |
| |||
Net change in assets and liabilities |
| (74 | ) | 357 |
| (147 | ) | |||
Net cash provided by (used in) operating activities |
| (431 | ) | 18 |
| (425 | ) | |||
|
|
|
|
|
|
|
| |||
Cash flows from investing activities |
|
|
|
|
|
|
| |||
Capital distribution from subsidiaries |
| 3,255 |
| 2,622 |
| — |
| |||
(Purchase) and maturities of certificates of deposit in other financial institutions, net |
| (2 | ) | 117 |
| 65 |
| |||
Net cash provided by investing activities |
| 3,253 |
| 2,739 |
| 65 |
| |||
Cash flows from financing activities |
|
|
|
|
|
|
| |||
Cash dividends paid to stockholders |
| (1,971 | ) | (1,765 | ) | (1,518 | ) | |||
Treasury stock acquired |
| (2,830 | ) | (4,725 | ) | — |
| |||
Exercise of stock options |
| 801 |
| 3,410 |
| 1,148 |
| |||
Net cash used in financing activities |
| (4,000 | ) | (3,080 | ) | (370 | ) | |||
NET DECREASE IN CASH |
| (1,178 | ) | (323 | ) | (730 | ) | |||
|
|
|
|
|
|
|
| |||
Cash at beginning of year |
| 4,630 |
| 4,953 |
| 5,683 |
| |||
Cash at end of year |
| $ | 3,452 |
| $ | 4,630 |
| $ | 4,953 |
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information |
| $ | — |
| $ | — |
| $ | — |
|
52
BOARD OF DIRECTORS AND EXECUTIVE OFFICERS
TF Financial Corporation
Board of Directors
Robert N. Dusek
Chairman of the Board
Carl F. Gregory
Dennis L. McCartney
George A. Olsen
John R. Stranford
Albert M. Tantala
Executive Officers
Kent C. Lufkin
President and Chief Executive Officer
Dennis R. Stewart
Executive Vice President and Chief Financial Officer
Lorraine A. Wolf
Corporate Secretary
53