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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 000-16931
UNITED NATIONAL BANCORP
(Exact name of registrant as specified in its charter)
New Jersey 22-2894827
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer identification No.)
incorporation or organization)
1130 Route 22 East, Bridgewater, New Jersey 08807-0010
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(908) 429-2200
----------------------------------------------------
(Registrant's telephone number, including area code)
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
[X] Yes [ ] No
As of November 1, 2003, there were 18,858,821 shares of common stock, $1.25 par
value, outstanding.
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UNITED NATIONAL BANCORP
FORM 10 - Q
INDEX
PAGE(S)
-------
PART I - FINANCIAL INFORMATION
ITEM 1 Consolidated Financial Statements and Notes to Consolidated Financial Statements............. 1-9
ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ....... 10-30
ITEM 3 Quantitative and Qualitative Disclosure About Market Risk.................................... 31
ITEM 4 Controls and Procedures...................................................................... 31
PART II - OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K............................................................. 32
SIGNATURES............................................................................................. 33
Part I - Financial Information
Item 1 - Financial Statements
UNITED NATIONAL BANCORP AND SUBSIDIARIES
Consolidated Balance Sheet
(In thousands, except share data)
(unaudited)
September 30, December 31,
2003 2002
------------- ------------
Assets
Cash and due from banks $ 61,437 $ 68,759
Short-term investments -- 40,826
Securities available for sale, at market value 820,118 827,976
Securities held to maturity (market value of $59,096 and $45,829 for 2003 and
2002, respectively) 58,769 45,260
Loans, net of unearned income 1,985,431 1,665,069
Less: allowance for loan losses 22,981 20,407
---------- ----------
Loans, net 1,962,450 1,644,662
Premises and equipment, net 32,510 35,673
Other real estate, net 1,463 570
Goodwill 79,663 79,663
Other intangible assets 16,354 18,713
Cash surrender value of life insurance policies 79,516 76,649
Other assets 37,248 28,948
---------- ----------
Total assets 3,149,528 2,867,699
========== ==========
Liabilities and stockholders' equity
Liabilities
Deposits
Demand 373,636 361,816
NOW Accounts 272,717 267,668
Money Market Accounts 327,162 172,103
Savings 501,989 498,417
Time 745,731 853,404
---------- ----------
Total deposits 2,221,235 2,153,408
Short-term borrowings 206,583 38,787
Other borrowings 431,631 376,565
Other liabilities 28,075 34,259
---------- ----------
Total liabilities 2,887,524 2,603,019
---------- ----------
Stockholders' equity
Preferred stock, authorized 1,000,000 shares in 2003 and 2002
None issued and outstanding -- --
Common stock, $1.25 par value,
Authorized shares - 25,000,000 in 2003 and 2002
Issued shares - 21,035,830 in 2003 and 20,937,783 in 2002
Outstanding shares - 18,855,607 in 2003 and 18,999,035 in 2002 26,295 26,172
Additional paid-in capital 239,175 237,002
Retained earnings 43,457 36,430
Treasury stock, at cost - 2,180,223 shares in 2003 and 1,938,223 shares in 2002 (46,023) (39,655)
Accumulated other comprehensive (loss) income (900) 4,731
---------- ----------
Total stockholders' equity 262,004 264,680
---------- ----------
Total liabilities and stockholders' equity $3,149,528 $2,867,699
========== ==========
See accompanying Notes to Consolidated Financial Statements.
1
UNITED NATIONAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
------- ------- -------- -------
Interest income
Interest and fees on loans $27,777 $23,556 $ 81,870 $65,147
Interest and dividends on securities available for sale:
Taxable 6,909 8,223 23,983 23,113
Tax-exempt 1,377 1,244 4,036 3,459
Interest and dividends on securities held to maturity:
Taxable 338 78 569 206
Tax-exempt 251 351 833 1,037
Interest on short-term investments 3 173 159 183
------- ------- -------- -------
Total interest income 36,655 33,625 111,450 93,145
------- ------- -------- -------
Interest expense
Interest on NOW accounts 201 366 826 942
Interest on money market accounts 689 415 1,740 785
Interest on savings deposits 732 1,699 2,962 3,825
Interest on time deposits 5,060 6,012 18,016 16,900
Interest on short-term borrowings 538 277 1,116 1,275
Interest on other borrowings 4,051 4,423 12,604 13,117
------- ------- -------- -------
Total interest expense 11,271 13,192 37,264 36,844
------- ------- -------- -------
Net interest income 25,384 20,433 74,186 56,301
Provision for loan losses 1,680 1,000 4,755 9,950
------- ------- -------- -------
Net interest income after provision for loan losses 23,704 19,433 69,431 46,351
------- ------- -------- -------
Non-interest income
Trust income 1,398 1,362 4,525 4,332
Service charges on deposit accounts 2,109 1,183 5,474 3,143
Other service charges, commissions and fees 1,009 763 3,203 2,542
Net gains from securities transactions 1,106 134 5,252 154
Income on corporate owned life insurance 948 1,150 2,867 2,809
Dissolution of joint venture -- -- -- 1,171
Gain on the disposition of credit card portfolio -- -- -- 920
Other income 1,463 732 2,777 1,929
------- ------- -------- -------
Total non-interest income 8,033 5,324 24,098 17,000
------- ------- -------- -------
Non-interest expense
Salaries, wages and employee benefits 10,298 8,493 31,642 23,679
Occupancy expense, net 2,148 1,598 7,051 4,441
Furniture and equipment expense 1,284 1,232 4,004 3,378
Data processing expense 1,066 1,310 2,992 3,889
Amortization of intangible assets 778 494 2,359 1,235
Merger related charges 6,824 1,068 6,824 1,847
Other expenses 5,615 3,455 15,236 10,409
------- ------- -------- -------
Total non-interest expense 28,013 17,650 70,108 48,878
------- ------- -------- -------
Income before provision for income taxes 3,724 7,107 23,421 14,473
Provision for income taxes 508 1,406 5,019 1,794
------- ------- -------- -------
Net income $ 3,216 $ 5,701 $ 18,402 $12,679
======= ======= ======== =======
Net income per common share:
Basic $ 0.17 $ 0.34 $ 0.97 $ 0.83
======= ======= ======== =======
Diluted $ 0.17 $ 0.34 $ 0.96 $ 0.82
======= ======= ======== =======
Weighted Average Shares Outstanding:
Basic 18,824 16,665 18,888 15,343
======= ======= ======== =======
Diluted 19,085 16,786 19,091 15,476
======= ======= ======== =======
See accompanying Notes to Consolidated Financial Statements.
2
UNITED NATIONAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In thousands, except per share data)
(unaudited)
Accumulated
Additional Other Total
Common Paid-In Retained Treasury Comprehensive Stockholders'
Stock Capital Earnings Stock Income (Loss) Equity
------- ---------- -------- -------- ------------- -------------
Balance - December 31, 2002 $26,172 $237,002 $ 36,430 $(39,655) $ 4,731 $264,680
Comprehensive income:
Net income -- -- 18,402 -- -- 18,402
Unrealized holding gains (losses)
on securities available for
sale arising during the
period, net of tax of $(1,743) -- -- -- -- (2,524) (2,524)
Less: reclassification
adjustment for gains included in
net income, net of tax of $(2,145) -- -- -- -- (3,107) (3,107)
--------
Total comprehensive income 12,771
Cash dividend declared
(0.60 per share) -- -- (11,286) -- -- (11,286)
Stock activity:
Exercise of stock options - 94,547
shares 119 1,731 -- -- -- 1,850
Treasury stock purchased - 242,000 -- -- -- (6,368) -- (6,368)
shares
Restricted - 3,500 shares 4 87 (89) 2
Stock-based compensation -- 355 -- -- -- 355
------- -------- -------- -------- ------- --------
Balance - September 30, 2003 26,295 239,175 43,457 (46,023) (900) 262,004
======= ======== ======== ======== ======= ========
See accompanying Notes to Consolidated Financial Statements.
3
UNITED NATIONAL BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
Nine Months Ended
September 30,
---------------------
2003 2002
--------- ---------
Operating activities
Net income $ 18,402 $ 12,679
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 5,736 3,770
Amortization of securities premiums, net 715 219
Provision for loan losses 4,755 9,950
Benefit for deferred income taxes (458) 2,461
Gain on disposition of premises and equipment (87) (1)
Impairment on securities -- 105
Gain from securities transactions (5,252) (154)
Net gain on the sale of loans (696) --
Net gain on the sale of credit cards -- (920)
Increase in life insurance (2,867) (2,809)
Increase in other assets (4,473) (7,568)
Decrease in other liabilities (5,639) (2,363)
Stock-based compensation 355 320
Restricted stock activity, net 2 24
--------- ---------
Net cash provided by operating activities 10,493 15,713
--------- ---------
Investing activities
Securities available for sale:
Proceeds from sales of securities 178,251 33,027
Proceeds from maturities of securities 357,400 112,939
Purchases of securities (532,626) (199,925)
Securities held to maturity:
Proceeds from maturities of securities 28,241 10,366
Purchases of securities (41,838) (14,934)
Purchase of corporate owned life insurance -- (1,728)
Redemption of corporate owned life insurance -- 138
Net increase in loans (364,503) (21,639)
Proceeds from the sale of loans 42,656 --
Proceeds from the sale of credit card business, net -- 14,495
Expenditures for premises and equipment (1,409) (2,461)
Proceeds from the sale of premises and equipment 1,195 2
Increase in other real estate, net (893) (419)
Cash and cash equivalents acquired in excess of cash paid from acquisition of Vista -- 71,591
--------- ---------
Net cash (used in) provided by investing activities (333,526) 1,452
--------- ---------
Financing activities
Net increase in demand and savings deposits 175,500 101,887
Net (decrease) increase in time deposits (107,673) 53,637
Net increase (decrease) in short-term borrowings 167,796 (116,738)
Advances on other borrowed funds 139,000 138,235
Repayments in other borrowed funds (83,934) (46,132)
Cash dividends on common stock (11,286) (9,683)
Proceeds from exercise of stock options 1,850 364
Treasury stock acquired, at cost (6,368) (7,480)
--------- ---------
Net cash provided by financing activities 274,885 114,090
--------- ---------
Net (decrease) increase in cash and cash equivalents (48,148) 131,255
Cash and cash equivalents at beginning of period 109,585 55,764
--------- ---------
Cash and cash equivalents at end of period $ 61,437 $ 187,019
========= =========
Supplemental disclosures of cash flow information
Cash paid during the period:
Interest $ 39,736 $ 38,802
Taxes paid 10,515 5,147
Transfer of loans to other real estate 1,024 148
Issuance of common stock for purchase accounting merger -- 109,685
========= =========
See accompanying Notes to Consolidated Financial Statements.
4
UNITED NATIONAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
Note 1. Basis of Presentation
The accompanying unaudited Consolidated Financial Statements included
herein have been prepared by United National Bancorp (the "Company"), in
accordance with accounting principles generally accepted in the United States of
America and pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements have been condensed or omitted pursuant to such rules and
regulations. These Consolidated Financial Statements should be read in
conjunction with the financial statements and the notes thereto included in the
Company's latest annual report on Form 10-K.
In the opinion of the Company, all adjustments (consisting only of
normal recurring accruals), which are necessary for a fair presentation of the
operating results for the interim periods, have been included. The results of
operations for periods of less than a year are not necessarily indicative of
results for the full year.
Certain reclassifications have been made to the prior years' financial
statements to conform with the classifications used in 2003.
Note 2. Pending Acquisition
In August 2003, The PNC Financial Services Group, Inc. (PNC) and
United National Bancorp signed a definitive agreement for PNC to acquire United
National Bancorp for approximately $638 million in stock and cash. The
transaction, which is expected to close in January 2004, is subject to customary
closing conditions, including regulatory approvals and the approval of United
National Bancorp shareholders.
Note 3. Acquisition
On August 21, 2002, Vista Bancorp, Inc. ("Vista") was merged with and
into the Company with the Company being the surviving corporation (the "Vista
Merger") in a transaction accounted for under the purchase method of accounting.
Under the terms of the Vista Merger, the Company acquired all 5,350,637
outstanding shares of Vista in exchange for 4,695,184 shares of the Company's
Common Stock and $37,943,095 in cash.
Note 4. Comprehensive Income
Total comprehensive income amounted to the following for the periods
indicated (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2003 2002 2003 2002
------- ------ ------- -------
Net income $ 3,216 $5,701 $18,402 $12,679
Unrealized holding (losses) gains on securities available for
sale arising during the period, net of tax (benefit) expense of
$(3,307) and $3,003 in three months ended September 30, 2003
and 2002, respectively, and tax (benefit) expense of $(1,743)
and $7,931 in the nine months ended September30, 2003 and
2002, respectively (4,789) 4,349 (2,524) 11,484
Less: reclassification adjustment for gains included in net
income, net of tax (654) (79) (3,107) (91)
------- ------ ------- -------
Total comprehensive (loss) income $(2,227) $9,971 $12,771 $24,072
======= ====== ======= =======
5
Note 5. Net Income per Share
Basic net income per common share is computed by dividing net income
available to common stockholders by the weighted average number of shares
outstanding during each year.
Diluted net income per common share is computed by dividing net income
available to common stockholders by the weighted average number of shares
outstanding, as adjusted for the assumed exercise of common stock options, using
the treasury stock method.
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands, except per share data) ------------------ -----------------
2003 2002 2003 2002
------- ------- ------- -------
Net income $ 3,216 $ 5,701 $18,402 $12,679
======= ======= ======= =======
Basic weighted average common shares outstanding 18,824 16,665 18,888 15,343
Plus: dilutive stock options and awards 261 121 203 133
------- ------- ------- -------
Diluted weighted average common shares outstanding 19,085 16,786 19,091 15,476
======= ======= ======= =======
Net income per common share:
Basic $ 0.17 $ 0.34 $ 0.97 $ 0.83
Diluted $ 0.17 $ 0.34 $ 0.96 $ 0.82
======= ======= ======= =======
Note 6. Goodwill and Other Intangibles
On July 20, 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill
and Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested for impairment at least annually in accordance with the provisions of
SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and periodically reviewed for impairment. The Company
adopted SFAS No. 142 on January 1, 2002.
The Company recorded a core deposit intangible of $14.8 million in
connection with the Vista Merger during the third quarter of 2002. The core
deposit intangible has an estimated life of 10 years and during the three- and
nine-months ended September 30, 2003, the Company amortized $370,000 and
$1,112,000, respectively. The core deposit intangible will be periodically
reviewed for impairment. In addition, the Company recorded goodwill of $79.5
million in connection with the Vista Merger. The goodwill is tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
As of September 30, 2003, the Company tested the goodwill associated with the
Vista Merger and based on these assessments, Management concluded that such
asset did not require an impairment charge.
During the three- and nine-months ended September 30, 2003, the
Company recorded amortization of intangible assets acquired before July 1, 2001
of approximately $411,000 and $1,250,000, respectively which primarily
represented core deposit intangibles. The remaining amortization period of these
core deposit intangibles is approximately 1.8 years.
Note 7. Recent Accounting Pronouncements
FASB Interpretation No. 46, Consolidation of Variable Interest
Entities ("FIN 46") was issued in January 2003. FIN 46 applies immediately to
enterprises that hold a variable interest in variable interest entities created
after January 31, 2003. It applies in the first fiscal year or interim period
beginning after June 15, 2003 to enterprises that hold a variable interest in
variable interest entities created before February 1, 2003. FIN 46 applies to
public enterprises as of the beginning of the applicable interim or annual
period, and it applies to nonpublic enterprises no later than the end of the
applicable annual period. FIN 46 may be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated. FIN
46 provides guidance on the identification of entities controlled through means
other than voting rights. FIN 46 specifies how a business enterprise should
evaluate its interest in a variable interest entity to determine whether to
consolidate that entity. A variable interest entity must be consolidated by its
primary beneficiary if the entity does not effectively disperse risks among the
parties involved.
6
In its current form, FIN 46 may require the Company to de-consolidate
its investment in Mandatorily Redeemable Trust Preferred Securities of
Subsidiary Trusts in future financial statements. The potential de-consolidation
of subsidiary trusts of bank holding companies formed in connection with the
issuance of trust preferred securities appears to be an unintended consequence
of FIN 46. In July 2003, the Board of Governors of the Federal Reserve System
instructed bank holding companies to continue to include the trust preferred
securities in their Tier I capital for regulatory capital purposes until notice
is given to the contrary. There can be no assurance that the Federal Reserve
will continue to allow institutions to include trust preferred securities in
Tier I capital for regulatory capital purposes. As of September 30, 2003,
assuming the Company was not allowed to include the $30.0 million in trust
preferred securities issued by subsidiary trusts in Tier I capital due to the
call provisions, the Company would remain "well capitalized."
On October 9, 2003, the effective date was deferred until the end of
the first interim or annual period ending after December 15, 2003, for certain
interests held by a public entity in certain variable interest entities or
potential variable interest entities created before February 1, 2003. The
adoption of FIN 46 did not have a significant effect on the Company's
consolidated financial statements.
Statement of Financial Accounting Standards No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity," was issued in May 2003. Statement 150 requires instruments within its
scope to be classified as a liability (or, in some cases, as an asset).
Statement 150 is generally effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003 (i.e., July 1, 2003 for
calendar year entities). For financial instruments created before June 1, 2003
and still existing at the beginning of the interim period of adoption,
transition generally should be applied by reporting the cumulative effect of a
change in an accounting principle by initially measuring the financial
instruments at fair value or other measurement attributes of the Statement. The
adoption of Statement 150 did not have a significant effect on the Company's
consolidated financial statements.
Statement of Financial Accounting Standards No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," was issued on
April 30, 2003. The Statement amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement 133. This Statement is
effective for contracts entered into or modified after June 30, 2003. The
adoption of this Statement did not have a significant effect on the Company's
consolidated financial statements.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure, an amendment to FASB
Statement No. 123." SFAS No. 148 provides alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both interim
and annual financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
interim reporting requirements of SFAS No. 148 are effective for interim periods
beginning after December 31, 2002. In April 2003, the FASB announced that they
will propose an accounting standard requiring all companies to expense the value
of employee stock options based upon the fair value of options.
Effective December 31, 2002, the Company elected to adopt the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation", for stock-based employee compensation. All prior periods
presented have been restated to reflect the compensation cost that would have
been recognized had the recognition provisions of Statement 123 been applied to
all awards granted to employees after January 1, 1995.
Note 8. Lines of Business - Segment Reporting
For management purposes, the Company is divided into the following
lines of business: Retail Banking, Commercial Banking, Investments, and Trust
and Investment Services. Activities not included in these lines are reflected in
All Other.
Line of business information is based on accounting practices that
conform to and support the current management structure, and is not necessarily
comparable with similar information for any other financial institution.
Net income before taxes on a fully tax-equivalent basis includes
revenues and expenses directly associated with each line, plus allocations of
certain indirect revenues and expenses. Centrally provided corporate services
and general overhead are allocated in proportion to the contribution of each
business line to consolidated pretax income
7
prior to the inclusion of these costs. A matched maturity funds transfer method
is employed to assign a cost of funds to the earning assets of each business
line, as well as to a value of funds to the liabilities of each business line.
The provision for loan losses is allocated based on the historical net
charge-off ratio for each line of business.
The following tables present the results of operations on a
tax-equivalent basis, using a 35% Federal tax rate, and average balances by
reportable segment for the periods presented below (in thousands).
Trust and
Results of Operations for the Three Retail Commercial Investment
Months Ended September 30, 2003 Banking Banking Investments Services All Other Consolidated
---------- ---------- ----------- ---------- --------- ------------
Interest income (tax-equivalent basis) $ 15,631 $ 12,197 $ 9,911 $ -- $ -- $ 37,739
Interest expense 6,648 -- 4,623 -- -- 11,271
Funds transfer pricing allocation 12,258 (7,947) (3,954) -- (357) --
---------- --------- --------- ------ -------- ----------
Net interest income (loss) 21,241 4,250 1,334 -- (357) 26,468
Provision for loan losses 1,692 (12) -- -- -- 1,680
---------- --------- --------- ------ -------- ----------
Net interest income (loss) after
provision for loan losses 19,549 4,262 1,334 -- (357) 24,788
Non-interest income 3,403 646 2,205 1,759 20 8,033
Non-interest expense 15,175 2,916 1,705 1,319 6,898 28,013
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes (tax-
equivalent basis) 7,777 1,992 1,834 440 (7,235) 4,808
Tax-equivalent adjustment -- (51) (1,033) -- -- (1,084)
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes $ 7,777 $ 1,941 $ 801 $ 440 $ (7,235) $ 3,724
---------- --------- --------- ------ -------- ----------
Average balances:
Gross funds provided $2,173,655 $ -- $ 609,450 $ -- $309,081 $3,092,186
Funds used:
Interest-earning assets 1,110,300 832,525 838,022 -- -- 2,780,847
Non-interest-earning assets 85,610 13,509 78,974 500 132,746 311,339
---------- --------- --------- ------ -------- ----------
Net funds provided (used) $ 977,745 $(846,034) $(307,546) $ (500) $176,335 $ --
---------- --------- --------- ------ -------- ----------
Trust and
Results of Operations for the Three Retail Commercial Investment
Months Ended September 30, 2002 Banking Banking Investments Services All Other Consolidated
---------- ---------- ----------- ---------- --------- ------------
Interest income (tax-equivalent basis) $ 11,689 $ 11,900 $ 10,927 $ -- $ -- $ 34,516
Interest expense 8,461 -- 4,731 -- -- 13,192
Funds transfer pricing allocation 12,142 (7,947) (4,180) -- (15) --
---------- --------- --------- ------ -------- ----------
Net interest income (loss) 15,370 3,953 2,016 -- (15) 21,324
Provision for loan losses 318 682 -- -- -- 1,000
---------- --------- --------- ------ -------- ----------
Net interest income (loss) after
provision for loan losses 15,052 3,271 2,016 -- (15) 20,324
Non-interest income 1,733 477 1,394 1,625 95 5,324
Non-interest expense 11,472 2,322 1,368 1,303 1,185 17,650
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes (tax-
equivalent basis) 5,313 1,426 2,042 322 (1,105) 7,998
Tax-equivalent adjustment -- (32) (859) -- -- (891)
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes $ 5,313 $ 1,394 $ 1,183 $ 322 $ (1,105) $ 7,107
---------- --------- --------- ------ -------- ----------
Average balances:
Gross funds provided $1,713,203 $ -- $ 383,107 $ -- $262,087 $2,358,397
Funds used:
Interest-earning assets 687,974 716,234 738,465 -- -- 2,142,673
Non-interest-earning assets 13,572 4,098 67,215 -- 130,839 215,724
---------- --------- --------- ------ -------- ----------
Net funds provided (used) $1,011,657 $(720,332) $(422,573) $ -- $131,248 $ --
---------- --------- --------- ------ -------- ----------
8
Trust and
Results of Operations for the Nine Retail Commercial Investment
Months Ended September 30, 2003 Banking Banking Investments Services All Other Consolidated
---------- ---------- ----------- ---------- --------- ------------
Interest income (tax-equivalent basis) $ 45,677 $ 36,334 $ 32,694 $ -- $ -- $ 114,705
Interest expense 23,464 -- 13,800 -- -- 37,264
Funds transfer pricing allocation 38,120 (23,665) (13,610) -- (845) --
---------- --------- --------- ------ -------- ----------
Net interest income (loss) 60,333 12,669 5,284 -- (845) 77,441
Provision for loan losses 2,948 1,807 -- -- -- 4,755
---------- --------- --------- ------ -------- ----------
Net interest income (loss) after
Provision for loan losses 57,385 10,862 5,284 -- (845) 72,686
Non-interest income 8,225 1,576 8,556 5,616 125 24,098
Non-interest expense 44,417 7,850 6,635 4,205 7,001 70,108
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes (tax-
equivalent basis) 21,193 4,588 7,205 1,411 (7,721) 26,676
Tax-equivalent adjustment -- (141) (3,114) -- -- (3,255)
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes $ 21,193 $ 4,447 $ 4,091 $1,411 $ (7,721) $ 23,421
---------- --------- --------- ------ -------- ----------
Average balances:
Gross funds provided $2,163,325 $ -- $ 514,869 $ -- $315,623 $2,993,817
Funds used:
Interest-earning assets 1,024,383 794,207 856,542 -- -- 2,675,132
Non-interest-earning assets 84,196 13,509 78,008 500 142,472 318,685
---------- --------- --------- ------ -------- ----------
Net funds provided (used) $1,054,746 $(807,716) $(419,681) $ (500) $173,151 $ --
---------- --------- --------- ------ -------- ----------
Trust and
Results of Operations for the Nine Retail Commercial Investment
Months Ended September 30, 2002 Banking Banking Investments Services All Other Consolidated
---------- ---------- ----------- ---------- --------- ------------
Interest income (tax-equivalent basis) $ 32,222 $ 33,006 $ 30,419 $ -- $ -- $ 95,647
Interest expense 22,270 -- 14,574 -- -- 36,844
Funds transfer pricing allocation 26,915 (21,812) (11,061) -- 5,958 --
---------- --------- --------- ------ -------- ----------
Net interest income 36,867 11,194 4,784 -- 5,958 58,803
Provision for loan losses 565 9,385 -- -- -- 9,950
---------- --------- --------- ------ -------- ----------
Net interest income after
provision for loan losses 36,302 1,809 4,784 -- 5,958 48,853
Non-interest income 6,096 1,243 3,281 5,058 1,322 17,000
Non-interest expense 33,150 6,035 3,576 3,933 2,184 48,878
---------- --------- --------- ------ -------- ----------
Net income before taxes (tax-
equivalent basis) 9,248 (2,983) 4,489 1,125 5,096 16,975
Tax-equivalent adjustment -- (81) (2,421) -- -- (2,502)
---------- --------- --------- ------ -------- ----------
Net income (loss) before taxes $ 9,248 $ (3,064) $ 2,068 $1,125 $ 5,096 $ 14,473
---------- --------- --------- ------ -------- ----------
Average balances:
Gross funds provided $1,505,437 $ -- $ 405,301 $ -- $215,361 $2,126,099
Funds used:
Interest-earning assets 625,874 673,012 646,633 -- -- 1,945,519
Non-interest-earning assets 12,638 3,190 61,261 -- 103,491 180,580
---------- --------- --------- ------ -------- ----------
Net funds provided (used) $ 866,925 $(676,202) $(302,593) $ -- $111,870 $ --
---------- --------- --------- ------ -------- ----------
9
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is an analysis of the financial condition and
results of operations of the Company for the three- and nine-months ended
September 30, 2003 and 2002, and should be read in conjunction with the related
financial statements and accompanying notes presented elsewhere herein. Results
of operations for the three- and nine-month periods ended September 30, 2003 are
not necessarily indicative of results to be attained for any other period.
FORWARD-LOOKING STATEMENTS
The discussion contains forward-looking statements within the meaning
of The Private Securities Litigation Reform Act of 1995. Such statements are not
historical facts and include expressions about our confidence and strategies and
our expectations about earnings, opportunities, and market conditions. These
statements may be identified by such forward-looking terminology as "expect",
"believe", "anticipate", "optimistic", or by expressions of confidence such as
"for the coming months", "consistent", "continue", "strong", "superior" or
similar statements or variations of such terms. Such forward-looking statements
involve certain risks and uncertainties. These include, but are not limited to,
expected benefits, cost savings and other benefits from the Vista acquisition or
other planned programs not being realized or not being realized within the
expected time frame; income or revenues from the Vista acquisition or other
planned programs being lower than expected or operating costs higher;
efficiencies of our operations not improving as a result of certain cost cutting
measures, competitive pressures in the banking or financial services industries
increasing significantly; business disruption related to program implementation
or methodologies; weakening of economic conditions in New Jersey or
Pennsylvania; changes in legal, regulatory and tax structures; and unanticipated
occurrences delaying planned programs or initiatives or increasing their costs
or decreasing their benefits. Actual results may differ materially from such
forward-looking statements. The Company does not assume any obligation for
updating any such forward-looking statements at any time.
PENDING MERGER
In August 2003, The PNC Financial Services Group, Inc. (PNC) and
United National Bancorp signed a definitive agreement for PNC to acquire United
National Bancorp for approximately $638 million in stock and cash. The
transaction, which is expected to close in January 2004, is subject to customary
closing conditions, including regulatory approvals and the approval of United
National Bancorp shareholders. Under the definitive agreement, the Company has
agreed among other things, to refrain from taking certain actions pending the
completion of the merger and subject to certain exceptions, including the
reasonable consent of PNC.
VISTA MERGER
On August 21, 2002, the Company acquired Vista Bancorp, Inc. ("Vista")
in a transaction accounted for under the purchase method of accounting (the
"Vista Merger"). Under the terms of the Vista Merger, the Company acquired all
5,350,637 outstanding shares of Vista in exchange for 4,695,184 shares of the
Company's Common Stock and $37,943,095 in cash.
Based on its unaudited financial statement at June 30, 2002, Vista had
total assets of $713 million, deposits of $600 million and stockholders' equity
of $66 million. Vista was headquartered in Phillipsburg, New Jersey and operated
16 banking offices in western New Jersey and eastern Pennsylvania.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" is based upon the Company's Consolidated Financial
Statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. Certain information and note
disclosures usually included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America have
been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission for the preparation of the Form 10-Q. The
preparation of these financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses. Some accounting policies have a significant impact on amounts
reported in these financial statements. A summary of significant accounting
policies and a description of accounting policies that are considered critical
may be found in the Company's Annual Report on Form 10-K, filed on March 20,
2003, in the Notes to the Consolidated Financial Statements and the Critical
Accounting Policies and Estimates section.
10
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Earnings Summary
Basic and diluted net income per common share were both negatively
impacted by the recognition of merger related charges in all periods presented.
In 2003, the Company recognized merger related charges associated with the
pending merger with PNC, while in 2002 the merger related charges were
associated with the Vista acquisition.
Three Months Ended
September 30,
(In thousands, except per share data) ------------------
2003 2002
------- -------
Net income, GAAP basis $ 3,216 $ 5,701
Adjustment for merger charges, net of tax 4,612 632
------- -------
Net income, adjusted $ 7,828 $ 6,333
======= =======
Basic weighted average common shares outstanding 18,824 16,665
Plus: dilutive stock options and awards 261 121
------- -------
Diluted weighted average common shares outstanding 19,085 16,786
======= =======
Net income per common share, adjusted (non-GAAP basis):
Basic $ 0.42 $ 0.38
Diluted $ 0.41 $ 0.38
======= =======
The above adjustments to net income were made to reflect core
operating earnings, in an effort to present a better picture of the Company's
continuing operations.
The Company reported net income for the third quarter of 2003 of $3.2
million or $0.17 per diluted share after the recognition of $4.6 million, or
$0.24 per diluted share, in after-tax merger charges incurred during this
quarter. Net income for the third quarter of 2003 declined 44% from the $5.7
million reported in the third quarter of 2002, while net income per diluted
share fell 50% from the $0.34 for the same comparison. The decrease in earnings
per share from the prior year period resulted primarily from the recognition of
$6.8 million in merger related charges offset in part by increased gains on
securities sold. Adjusting third quarter net income in both 2003 and 2002 for
after-tax merger charges, net income amounted to $7.8 million for the third
quarter of 2003, an increase of 24% from the adjusted net income of $6.3 million
in the third quarter of 2002. Adjusted net income per diluted share was $0.41 in
the third quarter of 2003 compared to $0.38 in the same quarter of last year,
representing an 8% increase.
The return on average assets was 0.41% and 0.96% for the third quarter
of 2003 and 2002, respectively, while the return on average stockholders' equity
was 4.85% and 10.95% for the third quarter of 2003 and 2002, respectively. The
higher merger related charges recorded in the third quarter of 2003 adversely
affected the return on average assets and the return on average stockholders'
equity for this period. The adjusted return on average assets was 1.00% and
1.07% for the third quarter of 2003 and 2002, respectively, while the adjusted
return on average stockholders' equity was 11.80% and 12.16% for the third
quarter of 2003 and 2002, respectively.
Net Interest Income
The Company's most significant revenue source is net interest income,
which represents the difference between interest earned on assets and interest
paid to depositors and other creditors. A portion of the Company's total
interest income is derived from investments that are exempt from Federal
taxation. Due to the "tax-free" nature of these investments, the amount of
pretax income realized from them is less than the amount of pretax income
realizable from comparable investments subject to Federal taxation. For purposes
of the following discussion, interest exempt from Federal taxation has been
adjusted to a fully tax-equivalent basis assuming a statutory tax rate of 35%
for both the third quarter of 2003 and 2002. This was accomplished by adjusting
this income upward to make it equivalent to the level of taxable income required
to earn the same amount after taxes.
11
A summary of net interest income on a tax-equivalent basis for the
third quarter of 2003 and 2002 is presented in the following table (in
thousands):
Three Months Ended
September 30, 2003 Over (Under) 2002
------------------ ----------------------
2003 2002 Amount Percent
------- ------- ------- -------
Interest income (tax-equivalent basis) $37,739 $34,516 $ 3,223 9.3%
Interest expense 11,271 13,192 (1,921) (14.6)
------- ------- -------
Net interest income (tax-equivalent basis) 26,468 21,324 5,144 24.1
Tax-equivalent adjustment (1,084) (891) (193) 21.7
------- ------- -------
Net interest income $25,384 $20,433 $ 4,951 24.2%
======= ======= ======= =====
For the third quarter of 2003, tax-equivalent net interest income
increased 24% to $26.5 million from $21.3 million in the third quarter of 2002.
This growth resulted from an increase of $638.2 million in average
interest-earning assets primarily related to the acquisition of Vista during the
third quarter of 2002, which was accounted for using the purchase method of
accounting. The remainder of the increase in average earnings assets was due to
growth in residential mortgage and consumer loans and investment securities. A
17 basis-point narrowing in the net interest margin in the third quarter of 2003
from the same quarter of 2002 served to limit the growth in net interest income.
The net interest margin for the third quarter of 2003 declined to
3.80% from 3.97% in the third quarter of 2002, despite a five basis-point
widening in the net interest spread. This 17 basis point narrowing was adversely
affected by the elimination of the third quarter dividend on the Federal Home
Loan Bank of New York (the "FHLBNY") stock held by the Bank, which reduced net
interest income by $221,000 and effected the quarterly net interest margin by
three basis points. Additionally, a reduced contribution of net
non-interest-bearing funds resulting from the lower 2003 interest rate
environment as well as a decline in the proportion of net non-interest-bearing
funds to total sources of funds principally due to the Vista Merger contributed
to the reduction in the net interest margin.
Average interest-earning assets grew $638.2 million or 30% in the
third quarter of 2003 from the same quarter in 2002 as average loans and
securities increased, offset by a reduction in short-term investments. Average
loans increased $534.8 million or 38% during the third quarter of 2003 compared
to the same quarter in 2002, primarily from loans added in the Vista Merger.
Average securities rose $139.0 million or 20% in the third quarter of 2003 from
the prior year, also due to the Vista Merger. Average short-term investments
decreased $35.6 million to $1.2 million in the third quarter of 2003 from the
prior year quarter. Excluding the impact of the Vista Merger, average loans
increased $283.0 million or 23% and average securities increased $27.8 million
or 4%.
Average deposits grew $473.3 million or 27% in the third quarter of
2003 from the same quarter last year. Excluding the effect of the Vista Merger,
average total deposits for the third quarter of 2003 increased $98.2 million or
7% from the third quarter of 2002. The increase in average deposits in the third
quarter of 2003 over the same quarter of 2002 excluding the impact of the Vista
Merger was largely attributable to a $32.5 million or 12% growth in average
demand deposits and a $121.9 million or 19% growth in average savings deposits,
which includes NOW and money market accounts. Time deposits, excluding the
impact of the Vista Merger, decreased $56.2 million or 10%. The Company
increased its short-term borrowings by $129.6 million due to the aforementioned
growth in average loans. Average other borrowings, which consist of debt having
an original maturity of one year or more, increased $86.7 million or 27% during
the third quarter of 2003 from the prior year quarter. The increase in average
other borrowings was principally due to the impact of Vista Merger and liability
extensions made to reduce the liability sensitivity of the Bank and higher
amortizing advances from the Federal Home Loan Bank of New York that were used
to match fund certain fixed-rate loans.
12
Average Consolidated Balance Sheet, Net Interest Income and Net Interest Margin
(Tax-Equivalent Basis)
Three Months Ended
-----------------------------------------------------------------
September 30, 2003 September 30, 2002
------------------------------- -------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate
---------- -------- ------- ---------- -------- -------
Assets:
Short-term investments $ 1,249 $ 3 0.92% $ 36,871 $ 173 1.84%
Securities available for sale: (1)(2)
Taxable 644,283 7,093 4.40 534,264 8,223 6.16
Non-taxable 131,823 2,091 6.34 116,306 1,914 6.58
Securities held to maturity: (2)
Taxable 35,452 338 3.81 7,964 78 3.91
Non-taxable 25,215 386 6.12 39,274 540 5.50
---------- ------- ---- ---------- ------- ----
Total securities 836,773 9,908 4.74 697,808 10,755 6.16
---------- ------- ---- ---------- ------- ----
Loans: (2)(3)
Commercial 427,171 5,453 5.07 338,354 4,725 5.54
Real estate - commercial 465,743 7,746 6.60 418,455 7,845 7.34
Real estate - residential 586,086 7,740 5.28 310,881 5,086 6.54
Consumer 463,825 6,889 5.89 340,304 5,932 6.92
---------- ------- ---- ---------- ------- ----
Total loans 1,942,825 27,828 5.69 1,407,994 23,588 6.63
---------- ------- ---- ---------- ------- ----
Total interest-earning assets 2,780,847 37,739 5.40 2,142,673 34,516 6.40
---------- ------- ---- ---------- ------- ----
Allowance for loan losses (22,534) (18,091)
Cash and due from banks 64,109 56,341
Intangible assets 96,465 41,902
Net unrealized gain - AFS 4,893 13,891
---------- ----------
Other assets 168,406 121,681
---------- ----------
Total assets $3,092,186 $2,358,397
========== ==========
Liabilities and stockholders' equity:
Now accounts $ 283,930 201 0.28 $ 198,720 366 0.73
Money market accounts 253,273 689 1.08 113,383 415 1.45
Savings deposits 507,348 732 0.57 443,833 1,699 1.52
Time deposits 767,184 5,060 2.62 659,897 6,012 3.61
---------- ------- ---- ---------- ------- ----
Total interest-bearing deposits 1,811,735 6,682 1.46 1,415,833 8,492 2.38
Short-term borrowings 192,925 538 1.11 63,302 277 1.74
Other borrowed funds 411,525 4,051 3.92 324,789 4,423 5.42
---------- ------- ---- ---------- ------- ----
Total interest-bearing liabilities 2,416,185 11,271 1.85 1,803,924 13,192 2.90
---------- ------- ---- ---------- ------- ----
Non-interest-bearing liabilities 386,886 309,464
Other liabilities 25,970 38,446
Stockholders' equity 263,145 206,563
---------- ----------
Total liabilities and stockholders' equity $3,092,186 $2,358,397
========== ==========
Net interest income (tax-equivalent basis) 26,468 21,324
Less: Tax-equivalent adjustment 1,084 891
------- -------
Net interest income $25,384 $20,433
======= =======
Net interest spread 3.55 3.50
Effect of net non-interest-bearing funds 0.25 0.47
---- ----
Net interest margin (4) 3.80% 3.97%
==== ====
- ----------
(1) Securities available for sale are stated at amortized cost.
(2) Interest income is presented on a tax-equivalent basis using a 35% Federal
tax rate.
(3) Average loan balances and yields include non-accruing loans. Loan fees are
included in the interest amounts and are not material.
(4) Net interest income on a tax-equivalent basis as a percentage of total
average interest-earning assets.
13
Provision for Loan Losses
The provision for loan losses represents Management's estimate of the
amount necessary to be charged to operations to bring the allowance for loan
losses to a level that is considered adequate in relation to the risk of losses
inherent in the loan portfolio. Actual loan losses, net of recoveries, serve to
reduce the allowance.
The loan loss provision amounted to $1.7 million in the third quarter
of 2003, representing a $0.7 million increase from the same quarter of 2002
provision of $1.0 million. This increase was due primarily to the growth
experienced in residential, commercial and consumer loans.
Non-Interest Income
Non-interest income has become an increasingly important source of
revenue for the Company. The major components of non-interest income are
presented below (in thousands).
Three Months Ended
September 30, 2003 Over (Under) 2002
------------------ ----------------------
2003 2002 Amount Percent
------ ------ ------ -------
Trust income $1,398 $1,362 $ 36 2.6%
Service charges on deposit accounts 2,109 1,183 926 78.3
Other service charges, commissions and fees 1,009 763 246 32.2
Net gains from securities transactions 1,106 134 972 725.4
Income on life insurance 948 1,150 (202) (17.6)
Other income 1,463 732 731 99.9
------ ------ ------
Total non-interest income $8,033 $5,324 $2,709 50.9%
====== ====== ====== =====
Non-interest income amounted to $8.0 million in the third quarter of
2003, an increase of 51% from the $5.3 million earned in the prior year quarter.
This increase was due primarily to the realization of $1.1 million in gains on
securities transactions in the third quarter of 2003 resulting from the sale of
certain equity securities. Additionally, increased deposit services fee income,
higher gains on the sale of residential mortgage and SBA loans and the effect of
the Vista Merger also helped contribute to the rise in non-interest income.
14
Non-Interest Expense
The Company closely monitors non-interest expense growth. The
following table presents an analysis of the major categories of non-interest
expenses (in thousands):
Three Months Ended
September 30, 2003 Over (Under) 2002
------------------ ----------------------
2003 2002 Amount Percent
------- ------- ------- -------
Salaries, wages and employee benefits $10,298 $ 8,493 $ 1,805 21.3%
Occupancy expense, net 2,148 1,598 550 34.4
Furniture and equipment expense 1,284 1,232 52 4.2
Data processing expense 1,066 1,310 (244) (18.6)
Amortization of intangible assets 778 494 284 57.5
Merger related charges 6,824 1,068 5,756 539.0
Other expenses:
Legal and other professional service expense 1,003 799 204 25.5
Marketing and shareholder communications expense 893 629 264 42.0
Telecommunication expense 389 414 (25) (6.0)
Loan origination/collection expense 581 366 215 58.7
Credit card expense -- 29 (29) (100.0)
All other 2,749 1,218 1,531 125.7
------- ------- -------
Total other expenses 5,615 3,455 2,160 62.5
------- ------- -------
Total non-interest expense $28,013 $17,650 $10,363 58.7%
======= ======= ======= ======
Non-interest expense amounted to $28 million in the third quarter of
2003, an increase of $10.4 million or 59% over the $17.7 million incurred in the
same quarter of 2002. The increase over the third quarter of 2002 was primarily
due to the recognition of $6.8 million in merger related expenses incurred in
connection with the pending merger with PNC, the impact of the Vista Merger,
higher pension and healthcare costs and the recognition of $0.9 million in
interest penalties on the prepayment of certain long-term FHLB borrowings.
Partly offsetting these expense increases were declines in data processing
expense related to the in-house processing of checks and lower credit card
expense resulting from the sale of this portfolio. In addition, the Company
incurred $1.1 million in integration costs in the third quarter of 2002 related
to the Vista Merger.
The Company adopted the fair value based method to recognize
compensation expense on all of its outstanding stock option awards in the fourth
quarter of 2002, in accordance with the provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," as amended by SFAS No. 148, which permits
retroactive restatement. Accordingly, the Company increased its employee benefit
expense in its prior period.
Income Taxes
The provision for income taxes amounted to $0.5 million in the third
quarter of 2003 compared to $1.4 million recognized in the third quarter of
2002. The decrease in the income tax provision was due to a reduction in income
before provision for income taxes. The decline in the effective tax rate from
20% in 2002 to 14% in 2003 was largely due to an increase in the proportion of
tax-exempt income to income before provision for income taxes.
LINES OF BUSINESS - SEGMENT REPORTING
For management purposes, the Company is segmented into the following
lines of business: Retail Banking, Commercial Banking, Investments, and Trust
and Investment Services. Activities not included in these lines are reflected in
All Other. Summary financial information for the lines of business is presented
in "Note 8. Lines of Business - Segment Reporting" of this report.
Line of business information is based on accounting practices that
conform to and support the current management structure, and is not necessarily
comparable with similar information for any other financial institution.
15
Net income (loss) before taxes includes revenues and expenses directly
associated with each line, plus allocations of certain indirect revenues and
expenses. Centrally provided corporate services and general overhead are
allocated in proportion to the contribution of each business line to
consolidated pretax income prior to the inclusion of these costs. A matched
maturity funds transfer method is employed to assign a cost of funds to the
earning assets of each business line, as well as to assign an earnings credit to
the liabilities of each business line. The provision for loan losses is
allocated based on the historical net charge-off ratio for each line of
business.
Retail Banking
Retail Banking meets the needs of individuals and small businesses.
This segment includes loans secured by one-to-four family residential
properties, construction financing, loans to individuals for household, family
and other personal expenditures, and lease financing. In addition, this segment
includes the branch network. Income before taxes for this segment, in the third
quarter of 2003, increased $2.5 million from the third quarter of 2002 due to
increases of $5.9 million in net interest income and $1.7 million in
non-interest income. This was offset by increases in non-interest expense of
$3.7 million and the allocation of the provision for loan losses of $1.4
million. The higher net interest income was primarily related to increased
average residential mortgage and consumer loans and wider-spread average core
deposits when compared to the third quarter of 2002. Increased deposit services
fee income and the effect of the Vista Merger contributed to the rise in
non-interest income. The increase in non-interest expense was mainly due to the
Vista Merger, and the increase in the loan loss provision was due primarily to
the Vista Merger and increased loan volume.
Commercial Banking
Commercial Banking provides term loans, demand secured loans, Small
Business Administration ("SBA") financing, floor plan loans and financing for
commercial and construction lending and commercial credit to middle-market
businesses. It also includes the operations of United Commercial Capital Group,
which provides non-traditional real estate and commercial financings. Pretax
results for the third quarter of 2003 increased $0.5 million from the third
quarter of 2002 primarily due to an increase in tax-equivalent net interest
income of $0.3 million and a $0.7 million decrease in the loan loss provision
allocation. The increase in tax-equivalent net interest income in the third
quarter of 2003 was due to increased average commercial and real estate
construction loans, and the decrease in the loan loss provision for the current
quarter was related primarily to the continued improvement in asset quality. In
addition, non-interest expense increased $0.6 million due to the Vista Merger.
Investments
The Investments segment is comprised of the Company's securities
portfolio, which includes U.S. Treasury and Federal Agency securities,
tax-exempt securities, mortgage-backed securities, corporate debt securities,
equity securities and short-term investments. Pretax income for the third
quarter of 2003 decreased $0.4 million from the third quarter of 2002 due to a
$0.7 million decrease in tax-equivalent net interest income and an increase in
non-interest expense of $0.3 million. This was offset by a $0.8 million increase
in non-interest income due to securities gains. The decrease in tax-equivalent
net interest income was largely due to narrower spreads on mortgage-backed
securities, and the increase in non-interest expense was due to a larger
allocation of corporate overhead.
Trust and Investment Services
The Trust and Investment Services segment derives revenue in the form
of fees generated for the services provided. The major sources of fee income are
generated from a full range of fiduciary services, ranging from mutual funds to
personal trust, investment advice and employee benefits plans. Also included are
fees generated from the financial services area, which provides uninsured
financial products, including the sale of annuities, insurance and mutual funds.
In the third quarter of 2003, income before taxes for this segment increased
$0.1 million from the third quarter of 2002 due to an increase in fees for trust
services.
All Other
The All Other segment primarily includes the impact of stockholders'
equity and the allowance for loan losses, as well as funds transfer-pricing
offsets. Additionally, certain revenues and expenses that are not considered
allocable to a line of business are reflected in this segment. Net loss before
taxes in the third quarter of 2003 for this segment increased $6.1 million when
compared to the third quarter of 2002. This was due primarily to the recognition
of $6.8 million in merger related expenses incurred in connection with the
pending merger with PNC.
16
The following table shows the percentage contribution of the various
lines of business to consolidated income before taxes:
Three Months Ended
September 30,
------------------
2003 2002
------ ------
Retail banking 208.8% 74.8%
Commercial banking 52.1 19.6
Investments 21.5 16.7
Trust and investment services 11.8 4.5
All other (194.2) (15.6)
------ -----
Total consolidated 100.0% 100.0%
====== =====
17
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Earnings Summary
Basic and diluted net income per common share were both negatively
impacted by the recognition of merger related charges in all periods presented.
In 2003, the Company recognized merger related charges associated with the
pending merger with PNC, while in 2002 the merger related charges were
associated with the Vista acquisition.
Nine Months Ended
September 30,
(In thousands, except per share data) -----------------
2003 2002
------- -------
Net income, GAAP basis $18,402 $12,679
Adjustment for merger charges, net of tax 4,612 1,093
------- -------
Net income, adjusted $23,014 $13,772
======= =======
Basic weighted average common shares outstanding 18,888 15,343
Plus: dilutive stock options and awards 203 133
------- -------
Diluted weighted average common shares outstanding 19,091 15,476
======= =======
Net income per common share, adjusted (non-GAAP basis):
Basic $ 1.22 $ 0.90
Diluted $ 1.21 $ 0.89
======= =======
The above adjustments to net income were made to reflect core
operating earnings, in an effort to present a better picture of the Company's
continuing operations.
The Company reported net income for the nine months ended September
30, 2003 of $18.4 million, up 45% from the $12.7 million earned in the same
period of the prior year. Diluted per share earnings were $0.96 in the nine
months ended September 30, 2003, up 17% over the $0.82 recorded for the nine
months ended September 30, 2002. The increase in earnings per share over the
prior year period resulted primarily from a decreased loan loss provision
compared to the prior year period, an increase in gains on securities
transactions and the impact of the Vista Merger partially offset by an increase
in merger related charges. The substantial decrease in the loan loss provision
for the current year period was related primarily to one large credit that was
placed on non-accrual in the second quarter of 2002 and the continued
improvement in asset quality. In the second quarter of 2002, the Company
recorded a $2.8 million charge-off on a $5.3 million loan participation to
Suprema Specialties, a company that declared bankruptcy during the first quarter
of 2002, and recorded a $2.4 million charge-off related to a loan to an
insurance premium financing company that was placed on non-accrual during the
second quarter of 2002. The gains on securities transactions largely resulted
from the sale of mortgage-backed securities to take advantage of current market
conditions and the opportunity to reinvest the proceeds, expecting that
otherwise these securities would have been prepaid in the near term at par
value. During September 2003, the Company incurred $6.8 million in merger
related charges in connection with the pending PNC merger as compared to $1.8
million in merger charges associated with the Vista acquisition incurred in
2002.
Adjusting the nine months net income in both 2003 and 2002 for
after-tax merger charges, net income amounted to $23.0 million for the nine
months ended September 30, 2003, an increase of $9.2 million or 67% from the
adjusted net income of $13.7 million in same period of 2002. Adjusted net income
per diluted share was $1.21 in the nine months ended September 30, 2003 compared
to $0.89 in the same period of the prior year, representing a 36% increase.
The return on average assets was 0.82% and 0.80% for the nine months
ended September 30, 2003 and 2002, respectively, while the return on average
stockholders' equity was 9.24% and 9.76% for the nine months ended September 30,
2003 and 2002, respectively. Both the returns on average assets and on average
stockholders' equity were adversely affected by the recognition of $4.6 million
in after-tax merger charges in the third quarter of 2003 and $0.6 million in
after-tax merger charges in the third quarter of 2002. If the effect of these
merger charges after taxes is excluded, the adjusted return on average assets
would be 1.03% and 0.87% for the nine months ended September 30, 2003 and 2002,
respectively, while the return on average stockholders' equity would be 11.55%
and 10.61% for the nine months ended September 30, 2003 and 2002, respectively.
18
Net Interest Income
A summary of net interest income on a tax-equivalent basis for the
nine months ended September 30, 2003 and 2002 is presented in the following
table (in thousands):
Nine Months Ended
September 30, 2003 Over (Under) 2002
------------------ ----------------------
2003 2002 Amount Percent
-------- ------- ------- -------
Interest income (tax-equivalent basis) $114,705 $95,647 $19,058 19.93%
Interest expense 37,264 36,844 420 1.14
-------- ------- -------
Net interest income 77,441 58,803 18,638 31.70
Tax-equivalent adjustment (3,255) (2,502) (753) 30.10
-------- ------- -------
Net interest income $ 74,186 $56,301 $17,885 31.77%
======== ======= ======= =====
For the 2003 period, tax-equivalent net interest income increased 32%
to $77.4 million from $58.8 million in the prior year period. This growth was
primarily due to the impact of the Vista Merger, growth in residential mortgage
and consumer loans and investment securities. A 17 basis-point narrowing in the
net interest margin during the first nine months of this year from the same
period of last year partially offset the favorable effect of the increase in
average interest-earning assets.
The net interest margin narrowed by 17 basis points for the nine
months ended September 30, 2003 to 3.86% from 4.03% in the prior year period,
despite a five basis-point widening in the net interest spread during these
periods. The favorable effect of the improvement in spread was offset by a
reduced contribution of net non-interest-bearing funds resulting from the lower
2003 interest rate environment and a decline in the proportion of net
non-interest-bearing funds to total sources of funds resulting from the Vista
Merger. The average rate earned on interest-earning assets declined 82
basis-points to 5.72% while the average rate paid on interest-bearing
liabilities declined 87 basis points to 2.14%.
Average interest-earning assets grew $729.6 million or 38% in the nine
months ended September 30, 2003 compared to the same period of the prior year,
as average loans, securities and short-term investments all increased. The
decline in the average rate on interest-earning assets of 82 basis points was
largely attributable to a sharp rise in prepayments on mortgage-related assets
due to a 75 basis-point decline in the prime rate and in other short-term
interest rates. Average loans increased $516.6 million or 40% during the nine
months ended September 30, 2003 compared to the same period in 2002 primarily
due to the Vista Merger coupled with strong loan growth experienced during the
second and third quarters of 2003. Average securities rose $209.0 million or 33%
in the first nine months of 2003 from the same period of the prior year, which
was also due to the Vista Merger. Average short-term investments increased $4.0
million to $17.2 million in the nine months ended September 30, 2003 from $13.1
million in the same period of 2002. Excluding the impact of the Vista Merger,
average loans increased $157.4 million or 13% and average securities increased
$50.4 million or 8%.
Average deposits grew $665.7 million or 44% in the nine months ended
September 30, 2003 from the same period last year. Average deposits for 2003
contained approximately $616.2 million in deposits resulting from the Vista
Merger. Excluding the effect of the Vista Merger, average total deposits for the
current period of 2003 increased $130.7 million or 9% from the same period of
2002. The increase in average deposits in the nine month period of 2003 over the
prior year period excluding the impact of the Vista Merger was largely
attributable to an $25.0 million or 9% growth in average demand deposits and a
$123.6 million or 21% growth in average savings deposits, which includes NOW and
money market accounts. Time deposits, excluding the impact of the Vista Merger,
decreased $17.9 million or 3%. The Company increased its short-term borrowings
by $39.1 million or 45% due to the effect of the Vista Merger as well as to the
aforementioned growth in average loans and securities. Average other borrowings,
which consist of debt having an original maturity of one year or more, increased
$69.5 million or 22% during the nine months of 2003 from the same period last
year. The increase in average other borrowings was principally due to the impact
of the Vista Merger and liability extensions made to reduce the liability
sensitivity of the Bank and higher amortizing advances from the Federal Home
Loan Bank of New York that were used to match fund certain fixed-rate loans.
19
Average Consolidated Balance Sheet, Net Interest Income and Net Interest Margin
(Tax-Equivalent Basis)
Nine Months Ended
-----------------------------------------------------------------
September 30, 2003 September 30, 2002
------------------------------- -------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate
---------- -------- ------- ---------- -------- -------
Assets:
Short-term investments $ 17,178 $ 159 1.24% $ 13,125 $ 183 1.84%
Securities available for sale: (1)(2)
Taxable 661,668 24,527 4.94 480,770 23,113 6.41
Non-taxable 129,613 6,158 6.33 105,605 5,322 6.72
Securities held to maturity: (2)
Taxable 19,929 569 3.81 6,831 206 4.03
Non-taxable 28,154 1,281 6.07 37,176 1,595 5.72
---------- -------- ---- ---------- -------- ----
Total securities 839,364 32,535 5.17 630,382 30,236 6.40
---------- -------- ---- ---------- -------- ----
Loans: (2)(3)
Commercial 390,613 15,470 5.29 325,626 13,469 5.53
Real estate - commercial 466,781 23,995 6.87 378,441 21,074 7.34
Real estate - residential 532,046 22,420 5.62 282,827 13,912 6.56
Consumer 429,150 20,126 6.27 315,118 16,773 7.12
---------- -------- ---- ---------- -------- ----
Total loans 1,818,590 82,011 6.02 1,302,012 65,228 6.66
---------- -------- ---- ---------- -------- ----
Total interest-earning assets 2,675,132 114,705 5.72 1,945,519 95,647 6.54
---------- -------- ---- ---------- -------- ----
Allowance for loan losses (21,771) (15,741)
Cash and due from banks 65,402 48,693
Intangible assets 97,260 17,345
Net unrealized gain - AFS 13,078 7,375
---------- ----------
Other assets 164,716 122,908
---------- ----------
Total assets $2,993,817 $2,126,099
========== ==========
Liabilities and stockholders' equity:
Now accounts $ 282,221 826 0.39 $ 170,842 942 0.74
Money market accounts 204,996 1,740 1.13 89,140 785 1.18
Savings deposits 507,554 2,962 0.78 373,502 3,825 1.37
Time deposits 818,057 18,016 2.94 602,710 16,900 3.75
---------- -------- ---- ---------- -------- ----
Total interest-bearing deposits 1,812,828 23,544 1.73 1,236,194 22,452 2.43
Short-term borrowings 126,898 1,116 1.18 87,815 1,275 1.94
Other borrowed funds 382,028 12,604 4.40 312,525 13,117 5.61
---------- -------- ---- ---------- -------- ----
Total interest-bearing liabilities 2,321,754 37,264 2.14 1,636,534 36,844 3.01
---------- -------- ---- ---------- -------- ----
Non-interest-bearing liabilities 375,626 286,567
Other liabilities 30,132 29,397
Stockholders' equity 266,305 173,601
---------- ----------
Total liabilities and stockholders' equity $2,993,817 $2,126,099
========== ==========
Net interest income (tax-equivalent basis) 77,441 58,803
Tax-equivalent adjustment (3,255) (2,502)
-------- --------
Net interest income $ 74,186 $ 56,301
======== ========
Net interest spread 3.58 3.53
Effect of net non-interest-bearing funds 0.28 0.50
---- ----
Net interest margin (4) 3.86% 4.03%
==== ====
- ----------
(1) Securities available for sale are stated at amortized cost.
(2) Interest income is presented on a tax-equivalent basis using a 35% Federal
tax rate.
(3) Average loan balances and yields include non-accruing loans. Loan fees are
included in the interest amounts and are not material.
(4) Net interest income on a tax-equivalent basis as a percentage of total
average interest-earning assets.
20
Provision for Loan Losses
The provision for loan losses represents Management's estimate of the
amount necessary to be charged to operations to bring the allowance for loan
losses to a level that is considered adequate in relation to the risk of losses
inherent in the loan portfolio. Actual loan losses, net of recoveries, serve to
reduce the allowance.
The loan loss provision amounted to $4.8 million in the nine months
ended September 30, 2003, representing a $5.2 million decrease from the same
period of 2002. The substantial decrease in the loan loss provision for the nine
months was related primarily to two credits that were placed on non-accrual in
the first and second quarters of 2002 and the continued improvement in asset
quality.
Non-Interest Income
Non-interest income has become an increasingly important source of
revenue for the Company. The major components of non-interest income are
presented below (in thousands).
Nine Months Ended
September 30, 2003 Over (Under) 2002
----------------- ----------------------
2003 2002 Amount Percent
------- ------- ------ -------
Trust income $ 4,525 $ 4,332 $ 193 4.5%
Service charges on deposit accounts 5,474 3,143 2,331 74.2
Other service charges, commissions and fees 3,203 2,542 661 26.0
Net gains from securities transactions 5,252 154 5,098 NM
Income on life insurance 2,867 2,809 58 2.1
Dissolution of joint venture -- 1,171 (1,171) (100.0)
Gain on the disposition of credit card portfolio -- 920 (920) (100.0)
Other income 2,777 1,929 848 44.0
------- ------- ------
Total non-interest income $24,098 $17,000 $7,098 41.8%
======= ======= ====== ======
- ----------
NM - Not meaningful.
Non-interest income increased 42% to $24.1 million for the nine months
ended September 30, 2003 from the $17.0 million earned in the same period of
2002. The increase from the prior year period was attributable to the
realization of $5.3 million in gains on securities transactions during the nine
months ended September 30, 2003, higher service charges on deposit accounts,
higher gains on the sale of residential mortgages and SBA loans and the impact
of the Vista Merger, partly offset by a $1.2 million recovery on the dissolution
of a joint venture in the first quarter of 2002 and the aforementioned gain
recognized from the sale of the credit card portfolio in the second quarter of
2002. The Company sold $152 million in available for sale mortgage-backed
securities during the nine months ended September 30, 2003 in an effort to
realize gains and reinvest the proceeds, expecting that otherwise these
securities would be prepaid in the near term at par value. Typically, such
prepayments have an adverse effect on the yields on average loans and securities
and, accordingly, on net interest income.
21
Non-Interest Expense
The Company closely monitors non-interest expense growth. The
following table presents an analysis of the major categories of non-interest
expenses (in thousands):
Nine Months Ended
September 30, 2003 Over (Under) 2002
----------------- ----------------------
2003 2002 Amount Percent
------- ------- ------- -------
Salaries, wages and employee benefits $31,642 $23,679 $ 7,963 33.6%
Occupancy expense, net 7,051 4,441 2,610 58.8
Furniture and equipment expense 4,004 3,378 626 18.5
Data processing expense 2,992 3,889 (897) (23.1)
Amortization of intangible assets 2,359 1,235 1,124 91.0
Merger related charges 6,824 1,847 4,977 269.5
Other expenses:
Legal and other professional service expense 3,042 2,502 540 21.6
Marketing and shareholder communications expense 3,329 2,057 1,272 61.8
Telecommunication expense 1,300 1,062 238 22.4
Loan origination/collection expense 1,344 822 522 63.5
Credit card expense -- 601 (601) (100.0)
All other 6,221 3,365 2,856 84.9
------- ------- -------
Total other expenses 15,236 10,409 4,827 46.4
------- ------- -------
Total non-interest expense $70,108 $48,878 $21,230 43.4%
======= ======= ======= ======
Non-interest expense increased 43% to $70.1 million in the nine months
ended September 30, 2003 over the $48.9 million incurred in the same period of
2002. The same factors noted in the comparison of the third quarter 2003
expenses to those of the same period in 2002 also contributed to the nine months
expense variance, as well as increased snow removal/parking lot maintenance
costs of $0.7 million, higher proxy solicitation expenses and costs relating to
the settlement of a lawsuit, which amounted to $0.5 million.
The Company adopted the fair value based method to recognize
compensation expense on all of its outstanding stock option awards in the fourth
quarter of 2002, in accordance with the provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," as amended by SFAS No. 148, which permits
retroactive restatement. Accordingly, the Company increased its employee benefit
expense in its prior period.
Income Taxes
The provision for income taxes amounted to $5.0 million in the nine
months ended September 30, 2003 from the $1.8 million incurred in the same
period of the prior year. The increase in the income tax provision was due to a
62% increase in income before provision for income taxes. The increase in the
effective tax rate from 12% in 2002 to 21% in 2003 was largely due to a decline
in the proportion of tax-exempt income to income before provision for income
taxes.
LINES OF BUSINESS - SEGMENT REPORTING
For management purposes, the Company is segmented into the following
lines of business: Retail Banking, Commercial Banking, Investments, and Trust
and Investment Services. Activities not included in these lines are reflected in
All Other. Summary financial information for the lines of business is presented
in "Note 8. Lines of Business - Segment Reporting" of this report.
Line of business information is based on accounting practices that
conform to and support the current management structure, and is not necessarily
comparable with similar information for any other financial institution.
Net income (loss) before taxes includes revenues and expenses directly
associated with each line, plus allocations of certain indirect revenues and
expenses. Centrally provided corporate services and general overhead are
allocated in proportion to the contribution of each business line to
consolidated pretax income prior to the inclusion of these costs. A matched
maturity funds transfer method is employed to assign a cost of funds to the
22
earning assets of each business line, as well as to a value of funds to the
liabilities of each business line. The provision for loan losses is allocated
based on the historical net charge-off ratio for each line of business.
Retail Banking
Net income before taxes for this segment in the nine months ended
September 30, 2003 increased $11.9 million from the same period in 2002 due to
increases of $23.5 million in net interest income and $2.1 million in
non-interest income. This was offset by increases in non-interest expense of
$11.3 million and an increase in the allocation of the provision for loan losses
of $2.4 million. The higher net interest income was primarily related to
increased average residential mortgage and consumer loans and wider-spread
average core deposits when compared to the first nine months of 2002. The
increase in non-interest income was due to higher service charges on deposit
accounts and the Vista Merger, and the increase in non-interest expense was
mainly due to the Vista Merger. The increase in the loan loss provision was due
primarily to the Vista Merger and increased loan volume.
Commercial Banking
Pretax results for the nine months ended September 30, 2003 increased
$7.5 million from the same period in 2002 primarily due to a $7.6 million
decrease in the loan loss provision allocation. The substantial decrease in the
loan loss provision for the current year was related primarily to two credits
that were placed on non-accrual in the first and second quarters of 2002 and the
continued improvement in asset quality. Tax-equivalent net interest income
increased $1.5 million in the nine months ended September 30, 2003 due to
increased average commercial and real estate construction loans. In addition,
non-interest expense increased $1.8 million due primarily to the Vista Merger.
Investments
Pretax income for the nine months ended September 30, 2003 increased
$2.0 million over the same period in 2002 due to a $0.5 million increase in
tax-equivalent net interest income and a $5.3 million increase in non-interest
income, offset by a $3.1 million increase in non-interest expense. The increase
in tax-equivalent net interest income was largely due to a 32% growth in average
investment securities partially offset by a narrower spread, while the increase
in non-interest income was due to the realization of $5.3 million of investment
securities gains. The increase in non-interest expense was due to a larger
allocation of corporate overhead due to the increased pretax income.
Trust and Investment Services
In the nine months ended September 30, 2003, income before taxes for
this segment increased $0.3 million from the same period in 2002. Fees for trust
services increased $0.6 million, which was offset by a $0.3 million increase in
non-interest expense.
All Other
Net loss before taxes in the nine months ended September 30, 2003 for
this segment was $7.7 million as compared to net income before taxes of $5.1
million for the same period in 2002. This was due primarily to a $6.8 million
decline in net interest income related to a higher funds credit assigned to
non-maturity core deposits in Retail Banking in the first nine months of 2003
due to longer expected life of these deposits and lower relative funding costs
charged on mortgage-related assets in the Retail Banking and Investments
segments. In addition, non-interest income decreased $1.2 million from the first
nine months of 2002 due to a $1.2 million recovery from the dissolution of the
UFS joint venture recorded in 2002. Also, non-interest expense was $4.8 million
higher in the nine months ended September 30, 2003 compared to the same period
of 2002 due primarily to the recognition of $6.8 million in merger related
expenses incurred in connection with the pending merger with PNC.
23
The following table shows the percentage contribution of the various
lines of business to consolidated income before taxes:
Nine Months Ended
September 30,
-----------------
2003 2002
------- -------
Retail banking 90.5% 63.9%
Commercial banking 19.0 (21.2)
Investments 17.5 14.3
Trust and investment services 6.0 7.8
All other (33.0) 35.2
----- -----
Total consolidated 100.0% 100.0%
===== =====
24
FINANCIAL CONDITION
Loan Portfolio
An analysis of loans outstanding, net of unearned income, is presented
in the following table (in thousands):
September 30, December 31,
2003 2002
------------- ------------
Commercial mortgage $ 370,474 $ 399,826
Residential mortgage 610,375 447,940
Construction 75,080 81,808
Commercial 434,259 339,635
Consumer 495,243 395,860
---------- ----------
Total $1,985,431 $1,665,069
========== ==========
At September 30, 2003, total loans increased $320.4 million or 19%
from year-end 2002, which represents an annual growth rate of 26%, despite the
sale of $42.0 million in residential loans. The Company achieved strong growth
in residential, commercial and consumer loans, which increased $162.4 million,
$94.6 million and $99.4 million, respectively. On an annualized basis, this
represents growth of 48%, 37% and 33%, respectively. Activity in the commercial
mortgage portfolio, which declined $29.2 million from year-end 2002, had been
affected in part by the economic conditions in the New Jersey and Pennsylvania
markets.
Asset Quality
Lending policies are formulated by the Company's Senior Lending
Officer and reviewed and approved by the Board of Directors of the Company and
the Bank. Loan approval requirements are dictated by the policies for the
respective loan areas of the Bank, which are based on, but not limited to,
reputation of the customer, collateral securing the loan, capital, ability to
repay, and current economic conditions. Individual approval limits for each of
the Bank's loan officers have been reviewed and reset, as appropriate. However,
authority for approval of credits between $1.5 million and $15 million, is still
retained by the Bank's Management Loan Committee, consisting of the Bank's Chief
Executive Officer, President, Chief Operating Officer and Senior Lending
Officer, Executive Vice President Commercial and Consumer Lending, Executive
Vice President Real Estate Lending, Senior Vice President and Commercial Real
Estate Department Head, the Senior Credit Officer and on a revolving basis one
of the three Commercial Loan Department Heads, as appropriate. Additionally, the
Executive Committee of the Board of Directors of the Company and the Bank
approve credit extensions exceeding $15 million.
Loan officers are required to identify potentially deteriorating loan
situations through a self-reporting system. The Bank maintains a risk rating
system for all commercial, construction and commercial real estate loans. Each
of these loans is evaluated and given a rating upon origination. Subsequently,
these loans are monitored on a regular basis and rating revisions are made, as
appropriate. Each month, the Bank's lending staff reviews delinquent loans for
all loan portfolios with the Credit Quality Committee of the Bank, consisting of
the same management group as the Bank's Management Loan Committee as well as
other lending department heads, and the Executive Committee of the Board of
Directors of the Company and the Bank. These processes allow for implementation
of a strategy to react in the early stage of a potential credit concern.
The Company's independent loan review function is an integral part of
its overall loan administration. The Bank has engaged an independent consultant
to perform the loan review function. The independent consultant is responsible
for the evaluation of credit extensions with respect to quality, documentation
and risk criteria. The consultant's direct reporting line to the Audit Committee
of the Board of Directors of the Bank is intended to maintain its independence
and to provide assurance that troubled loan situations will be identified and
proper procedures followed to establish corrective measures. The loan review and
the self-reporting and risk rating systems are designed to provide the Company
with an early warning mechanism to detect loans to customers with deteriorating
financial conditions or loans that may represent potentially troubled
situations. In addition, the Company's internal audit department reviews loan
documentation and collateral as part of its regular audit procedures.
25
Non-Performing Assets
The Company defines non-performing assets as non-accrual loans,
impaired loans, loans past due 90 days or more and still accruing, other real
estate owned and other assets owned. At September 30, 2003, non-performing
assets totaled $18.4 million or 0.58% of total assets compared to $16.3 million
or 0.57% of total assets at December 31, 2002.
Non-performing loans at September 30, 2003 were $16.9 million or 0.85%
of total loans, compared to $15.7 million or 0.95% of total loans at December
31, 2002.
At September 30, 2003, the Company's holdings in other real estate
owned amounted to $1.5 million compared to $570,000 at December 31, 2002.
Foreclosures will continue to result in assets migrating from non-performing
loans to other real estate owned. It is the Company's intent to actively
negotiate and dispose of these properties at fair market values, which are
considered reasonable under the circumstances. In the nine months ended
September 30, 2003, the Company recognized $52,000 in net recoveries relating to
these properties compared to $62,000 in net costs during the same period of
2002. Other assets owned amounted to $56,000 at September 30, 2003 compared to
$30,000 at December 31, 2002.
The following table provides an analysis of non-performing assets as
of the periods indicated (in thousands):
December 31,
September 30, ----------------------------------
2003 2002 2001 2000 1999
------------- ------- ------ ------ ------
Non-accrual loans (1) $11,983 $14,029 $4,373 $5,619 $4,382
Loans past due 90 days or more (2) 4,874 1,720 2,064 1,118 3,732
------- ------- ------ ------ ------
Total non-performing loans 16,857 15,749 6,437 6,737 8,114
Other real estate owned (OREO)(3) 1,463 570 127 165 56
Other assets owned (OAO)(4) 56 30 64 28 53
------- ------- ------ ------ ------
Non-performing assets $18,376 $16,349 $6,628 $6,930 $8,223
======= ======= ====== ====== ======
Troubled debt restructurings $ -- $ 12 $ -- $ 14 $ 28
======= ======= ====== ====== ======
Non-performing loans as a % of:
Loans 0.85% 0.95% 0.52% 0.52% 0.64%
Total assets 0.54 0.55 0.33 0.32 0.39
Non-performing assets as a % of:
Loans, OREO and OAO 0.92 0.98 0.54 0.54 0.65
Total assets 0.58 0.57 0.34 0.33 0.39
- ----------
(1) Generally represents those loans on which Management has determined that
borrowers may be unable to meet contractual principal and/or interest
obligations or where interest or principal is past due for a period of 90
days or more (except when such loans are both well-secured and in the
process of collection). When loans are placed on non-accrual status, all
accrued but unpaid interest is reversed.
(2) Represents loans on which payments of interest and/or principal are
contractually past due 90 days or more, but are currently accruing interest
at the previously negotiated rates, based on a determination that such
loans are both well-secured and in the process of collection.
(3) Consists of real estate acquired through foreclosure.
(4) Consists of assets, other than real estate acquired through repossession,
forfeiture or abandonment.
26
Loan Loss Experience
The following table presents an analysis of the allowance for loan
losses, including charge-offs and recoveries for the periods indicated.
December 31,
September 30, -------------------------------------
2003 2002 2001 2000 1999
------------- ------- ------- ------- -------
Beginning balance $20,407 $12,478 $12,419 $10,386 $11,174
Charge-offs (2,565) (9,985) (3,770) (3,745) (4,787)
Recoveries 384 640 1,068 1,048 967
------- ------- ------- ------- -------
Net charge-offs (2,181) (9,345) (2,702) (2,697) (3,820)
Provision for loan losses 4,755 11,150 2,761 4,730 3,825
Addition related to vista merger -- 6,124 -- -- --
Reduction related to loan sale -- -- -- -- (793)
------- ------- ------- ------- -------
Ending balance $22,981 $20,407 $12,478 $12,419 $10,386
======= ======= ======= ======= =======
Net charge-offs as a % of
Average loans 0.16%(1) 0.67% 0.22% 0.21% 0.34%
Allowance for loans losses as a % of:
Loans 1.16 1.23 1.01 0.96 0.82
Non-performing loans 136.33 129.58 193.85 184.34 128.00
- ----------
(1) Annualized basis.
Asset/Liability Management
The Company's asset/liability management activities are intended to
ensure adequate liquidity and to protect net interest revenue from the effect of
adverse movements in the level of interest rates and the shape of the interest
rate yield curve. The Asset/Liability Management Committee (the "ALCO") is
responsible for monitoring the Company's liquidity and interest rate risk
positions. The ALCO meets regularly to assess the Company's current and
prospective risk exposure and to establish strategies to achieve net interest
margin objectives. Both on-balance sheet and off-balance sheet (e.g., interest
rate swap agreements) techniques are used to implement ALCO strategies.
ALCO monitors and manages interest rate sensitivity through simulation
and market value of equity analyses in order to avoid unacceptable earnings
fluctuations due to interest rate changes. The Company's simulation model
includes certain management assumptions based upon past experience and the
expected behavior of customers during various interest rate scenarios. The
assumptions include principal prepayments for various loan and security products
and classifying the non-maturity deposit balances by degree of interest rate
sensitivity.
Management believes that the simulation of net interest income in
different interest rate environments provides a meaningful and dynamic measure
of interest rate risk. Income simulation analysis captures not only the
potential of all assets and liabilities to mature or reprice, but the
probability that such would occur. Income simulation also permits management to
assess the probable effects on the balance sheet not only of changes in interest
rates, but also of proposed strategies for responding to them.
The Company's income simulation model analyzes interest rate
sensitivity by projecting net interest income over the next 24 months in a flat
rate scenario versus net interest income in alternative interest rate scenarios.
Management reviews and refines its interest rate risk management process in
response to the changing economic climate. The model incorporates management
assumptions regarding the level of interest rate or balance changes on
non-maturity deposit products, such as NOW, savings, money market and demand
deposit accounts, for a given level of market rate changes. These assumptions
incorporate historical analysis and future expected customer behavior patterns.
Interest rate caps and floors are included, if applicable. Changes in prepayment
behaviors of mortgage-based products for both loans and securities in each rate
environment are also captured. Additionally, the impact of planned growth and
anticipated new business activities are factored into the model.
27
Currently, the Company's earnings simulation model employs a 400 basis
point differential in rates (i.e., the difference between a rising rate
projection and a declining rate projection) during the first year, in even
monthly increments, with rates held constant in the second year. The Company's
ALCO policy has established that interest income sensitivity will be considered
acceptable if the change in net interest income in the above interest rate
scenario is within 10% of net interest income from the flat rate scenario in the
first year and over a two-year timeframe. At September 30, 2003, the Company's
income simulation model indicates an acceptable level of interest rate risk and
is materially consistent with the year-end disclosure.
Liquidity and Funding
Liquidity management involves the Company's ability to maintain
prudent amounts of liquid assets in its portfolio in order to meet the borrowing
needs and deposit withdrawal requirements of customers and to support asset
growth. Current and future liquidity needs are reviewed by ALCO to determine the
appropriate asset/liability mix.
The ALCO analysis includes an examination of the maturity and
potential volatility characteristics of the Company's liabilities. Funding
sources available to the Company include retail and commercial deposits,
purchased liabilities and stockholders' equity. During 2002 and into 2003, the
Company was able to reduce its reliance on short-term borrowings or other
"purchased" funds to satisfy liquidity requirements through the growth in core
deposits and the impact of the Vista Merger. Consequently, the sum of average
large-denomination municipal certificates of deposit and average short-term
borrowings for the nine months ended September 30, 2003 was $143.9 million or
only 6.8% of average total assets.
Additionally, asset liquidity is provided by short-term investments
and the marketability of securities available for sale. Short-term investments
averaged $17.2 million in the nine months ended September 30, 2003 while
securities available for sale at market value averaged $804.4 million in the
same period of 2003. The Company did not maintain any short-term investments at
September 30, 2003, while securities available for sale at market value amounted
to $820.1 million at September 30, 2003.
The Company intends to hold its investment securities for the
foreseeable future. However, the level and composition of the portfolio may
change as a result of maturities and purchases undertaken as part of the
asset/liability management process. Unexpected changes in the financial
environment are likely to affect the Company's interest rate risk, liquidity
position and the potential return on the portfolio. Additionally, the Company
may also purchase and sell those securities that are available for sale in order
to address these changes. Overall balance sheet size and capital adequacy are
considered in determining the appropriate level for the portfolio. When economic
factors cause changes in the balance sheet or when the Company reassesses its
interest rate risk, liquidity or capital position, strategic changes may be made
in both the securities held to maturity and securities available for sale
portfolios based on opportunities to enhance the ongoing total return of the
balance sheet.
28
The following table sets forth the market value of securities
available for sale at September 30, 2003 and at December 31, 2002 (in thousands)
September 30, December 31,
2003 2002
------------- ------------
Debt Securities:
U.S. Treasury securities $ 8,034 $ 3,174
Federal agency obligations 11,600 13,561
State and municipal securities 136,210 134,629
Mortgage-backed securities 523,486 546,733
Corporate debt securities 110,204 106,603
-------- --------
Total debt securities 789,534 804,700
-------- --------
Equity securities:
Marketable equity securities 1,816 4,259
Federal Reserve Bank and Federal Home Loan Bank Stock 28,768 19,017
-------- --------
Total equity securities 30,584 23,276
-------- --------
Total securities available for sale $820,118 $827,976
======== ========
The following table sets forth the amortized costs of securities held
to maturity at September 30, 2003 and at December 31, 2002.
September 30, December 31,
2003 2002
------------- ------------
Debt Securities:
U.S. Treasury securities $ 999 $ 3,048
State and municipal securities 25,796 39,134
Mortgage-backed securities 31,749 831
Corporate debt securities -- 1,997
Foreign government securities 225 250
------- -------
Total securities held to maturity $58,769 $45,260
======= =======
Asset liquidity is represented by the ease with which assets can be
converted into cash. This liquidity is provided by marketable equity securities
and debt securities with maturity dates, assuming prepayments, of one year or
less, which totaled $294.3 million at September 30, 2003. Included within this
figure are marketable equity securities amounting to $1.0 million. Debt
securities consist primarily of U.S. Treasury securities, Federal agency
obligations, mortgage-backed securities and state and municipal securities. All
securities held by the Company are believed to be readily marketable. As of
September 30, 2003, debt securities scheduled to mature within one year based
upon estimated cash flows, amounted to $293.3 million and represented 37% of the
total debt securities portfolio. Approximately 82% of the entire debt portfolio
is projected to mature or reprice within five years, based upon estimated cash
flows. There was no security issue held which represented more than 10% of the
Company's stockholders' equity. Additional liquidity is derived from scheduled
loan and investment payments of principal and interest, as well as prepayments
received.
Capital Adequacy
The Company strives to maintain a strong capital position. Capital
adequacy is monitored in relation to the size, composition and quality of its
asset base and with consideration given to regulatory guidelines and
requirements, as well as industry standards. Management seeks to maintain a
capital structure that will support anticipated asset growth and provide for
favorable access to the capital markets.
At September 30, 2003, total stockholders' equity was $262.0 million,
a decrease of $2.7 million from year-end 2002. During the nine months ended
September 30, 2003, the Company generated net retained earnings of $7.1 million.
These increases were partially offset by a reduction of $6.4 million resulting
from the Company's purchases under its stock repurchase program of 242,000
shares to be held in Treasury at an average price of $26.31
29
per share and a decline of $5.6 million in the market value of the Company's
available for sale securities portfolio from December 31, 2002 to September 30,
2003.
The following reflects the Company's capital ratios as of
September 30, 2003 and December 31, 2002 in accordance with current regulatory
guidelines (dollars in thousands):
September 30, 2003 December 31, 2002
------------------ -----------------
Amount Ratio Amount Ratio
-------- ----- -------- -----
Risk-Based Capital Ratios:
Tier I Capital
Actual $212,981 9.54% $208,429 10.34%
Regulatory Minimum Requirement 89,307 4.00 80,602 4.00
For Classification as Well Capitalized 133,960 6.00 120,903 6.00
Combined Tier I and Tier II Capital
Actual 235,962 10.57 228,836 11.36
Regulatory Minimum Requirement 178,614 8.00 161,204 8.00
For Classification as Well Capitalized 223,267 10.00 201,505 10.00
Leverage Ratio:
Actual 212,981 7.07 208,429 7.40
Regulatory Minimum Requirement 120,512 4.00 112,603 4.00
For Classification as Well Capitalized 150,640 5.00 140,754 5.00
The Company's risk based capital ratios (Tier I Capital and Combined
Tier I and Tier II Capital) and Tier I leverage ratio continue to exceed the
minimum requirements set forth by the Company's regulators to be considered well
capitalized.
Common Stock and Dividends
The Company's Common Stock is traded in the over-the-counter market on
the NASDAQ Stock Market. The market price of its common shares increased during
the nine months ended September 30, 2003 reaching a high of $33.77 near the end
of the third quarter. The Company's Common Stock price was $33.21 at September
30, 2003, compared to $23.05 at December 31, 2002. Book value per common share
was $13.90 per share at September 30, 2003. The Company's per share market price
to book value was 239% from 165% at the end of 2002.
The Company has paid cash dividends for 61 consecutive quarters since
it commenced operations in 1988. While the Company presently expects to continue
to pay dividends, no assurance can be given that dividends will be paid in the
future since the declaration and payment of such dividends will be based on a
number of factors considered by the Board of Directors, including current and
prospective earnings, anticipated asset growth, the Company's capital position
and the economic outlook. Future dividends will also depend on, among other
things, the earnings and financial condition of the Bank, its need for funds and
applicable governmental policies and regulations. Any deferral of payments due
to the trust preferred securities would prevent the Company from paying
dividends until the deferred amounts are paid. Pending completion of the merger
with PNC and subject to certain exceptions, including the reasonable consent of
PNC, the Company agreed, and agreed to cause any of its subsidiaries, to refrain
from declaring or paying any dividends or distributing on any shares of its
stock, except for cash dividends on (1) the Company's Common Stock at a regular
quarterly rate not to exceed $0.20 per share and (2) certain other Company
securities.
30
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
Information pertaining to this item can be found in the section
"Asset/Liability Management" in Item 2 of this report.
Item 4 - Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer,
with the assistance of other members of the Company's management, have evaluated
the effectiveness of the Company's disclosure controls and procedures as of the
end of the period covered by this Quarterly Report on Form 10-Q. Based on such
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
have concluded that the Company's disclosure controls and procedures are
effective.
The Company's Chief Executive Officer and Chief Financial Officer have
also concluded that there have not been any changes in the Company's internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
31
Part II - Other Information
Item 6 - Exhibits and Reports on Form 8-K
Exhibit List
(1(b)) Agreement and Plan of Merger dated August 21, 2003 among the
Registrant, the PNC Financial Services Group, Inc. and PNC
Bancorp Inc.*
(3) By-laws of the Company, as amended through August 21, 2003.
(31.1) Certification of Chairman of the Board, President and Chief
Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(31.2) Certification of Vice President and Treasurer (Principal
Financial Officer) Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(32) Certification of the Chairman of the Board, President and CEO and
certification of the Vice President and Treasurer pursuant to
Section 302 of Sarbanes-Oxley Act of 2002.
- ----------
* Incorporated by Reference to the Registrant's Current Report on Form
8-K filed September 4, 2003
Reports on Form 8-K
A Form 8-K was filed on July 16, 2003, under Item 7
"Financial Statements and Exhibits" and Item 9 "Regulation FD
Disclosure." The Company's press release dated July 16, 2003, United
National Bancorp Reports Increased Second Quarter Earnings.
A Form 8-K was filed on September 4, 2003, under Item 1(b)
"Changes of Control of Registrant", Item 7 "Financial Statements and
Exhibits" and Item 9 "Regulation FD Disclosure." The Company's press
release dated August 21, 2003, PNC Financial Services Group and United
National Bancorp Announces the Definitive Agreement for PNC Financial
Services Group to Acquire United National Bancorp.
A Form 8-K was filed on September 18, 2003, under Item 5
"Other Information." The Company's press release dated September 17,
2003, United National Bancorp Declares Cash Dividend.
32
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned hereunto duly authorized.
UNITED NATIONAL BANCORP
(Registrant)
Dated: November 13, 2003 By: /s/ Thomas C. Gregor
-------------------------------------------
Thomas C. Gregor
Chairman, President and CEO
Dated: November 13, 2003 By: /s/ Alfred J. Soles
-------------------------------------------
Alfred J. Soles
Senior Vice President & Chief Financial Officer
(Principal Financial Officer)
33