UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 #000-22537-01
NATIONAL PENN BANCSHARES, INC
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2215075
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(State or other jurisdiction of I.R.S. Employer Identification No.)
incorporation or organization)
19512
Philadelphia and Reading Avenues ----------
Boyertown, Pennsylvania (Zip Code)
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(Address of principal executive offices)
Registrant's telephone number, including area code: (610) 367-6001
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (without par value)
Preferred Stock Purchase Rights
Guarantee (7.85% Preferred Securities of NPB Capital Trust II)
7.85% Junior Subordinated Debentures
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No
---- ----
The aggregate market value of the voting and non-voting common equity of
the Registrant held by non-affiliates, based on the closing sale price as of
March 1, 2004, was $643,881,000.
As of March 1, 2004, the Registrant had 24,278,179 shares of Common
Stock outstanding.
Portions of the following documents are incorporated by reference: the
definitive Proxy Statement of the Registrant relating to the Registrant's Annual
Meeting of Shareholders to be held on April 26, 2004 -- Part III.
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NATIONAL PENN BANCSHARES, INC.
FORM 10-K
TABLE OF CONTENTS
Page
Part I
Item 1 Business........................................................................... 1
Item 2. Properties......................................................................... 20
Item 3. Legal Proceedings.................................................................. 20
Item 4. Submission of Matters to a Vote of Security Holders................................ 21
Item 4A. Executive Officers of the Registrant............................................... 21
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters................................................... 23
Item 6. Selected Financial Data............................................................ 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................... 46
Item 8. Financial Statements and Supplementary Data........................................ 47
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure................ 89
Item 9A. Controls and Procedures............................................................ 89
Part III
Item 10. Directors and Executive Officers of the Registrant................................. 89
Item 11. Executive Compensation............................................................. 89
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters................................................... 90
Item 13. Certain Relationships and Related Transactions..................................... 90
Item 14. Principal Accounting Fees and Services............................................. 90
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................... 91
Signatures............................................................................................. 98
PART I
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Item 1. BUSINESS.
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Overview
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National Penn Bancshares, Inc. ("National Penn" or "we") is a
Pennsylvania business corporation and a registered bank holding company
headquartered in Boyertown, Pennsylvania. Our address is Philadelphia and
Reading Avenues, Boyertown, Pennsylvania 19512 (Telephone number 610-367-6001).
National Penn was incorporated in January 1982. We provide a diversified
range of financial services, principally through our banking subsidiary,
National Penn Bank. In addition, we conduct business through various direct or
indirect, nonbank subsidiaries. These subsidiaries are engaged in activities
related to the business of banking.
o National Penn Bank is one of the largest commercial banks
headquartered in southeastern Pennsylvania. It operates 66 community
banking offices throughout nine counties in southeastern Pennsylvania.
o At December 31, 2003, National Penn had total assets of $3.513
billion, total loans and leases of $2.271 billion, total deposits of
$2.435 billion, and total shareholders' equity of $317.81 million.
o For the year ended December 31, 2003, we reported record net income of
$43.35 million compared to net income for the year ended December 31,
2002 of $36.23 million, an increase of 19.7%.
o As of December 31, 2003, we, together with our banking subsidiary,
National Penn Bank, had a reserve for loan and lease losses of $49.265
million, which represents 2.17% of total loans and leases outstanding
of $2.271 billion.
o At the end of 2003, we experienced our twenty-sixth consecutive year
of increased earnings and increased dividends.
o National Penn, together with National Penn Bank prior to formation of
the bank holding company, have paid cash dividends without
interruption for more than 128 years.
Market Area
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National Penn is headquartered in Boyertown, Berks County, Pennsylvania.
Boyertown is located in eastern Berks County, which strategically positions
National Penn between Philadelphia to the southeast, Allentown and Bethlehem to
the northeast, and Reading to the west.
We serve communities throughout southeastern Pennsylvania. Specifically,
we have a nine-county market area--Berks, Bucks, Chester, Delaware, Lancaster,
Lehigh, Montgomery, Northampton and Philadelphia. Within this geographic region,
there are four distinct market areas:
o the Reading/Berks County area, an area in which the service industry
is increasingly replacing the old-line manufacturing industry;
o the Allentown/Lehigh Valley area, consisting of Lehigh and Northampton
Counties, also an area in which a growing service industry is
replacing the old-line manufacturing industry;
o the five-county Philadelphia metropolitan area; consisting of
Philadelphia and its suburbs in Bucks, Chester, Delaware and
Montgomery Counties; and
o Lancaster County, an area with a significant agricultural economy.
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National Penn's largest presence is in the Reading/Berks County area,
where 17 of our 66 community offices are located.
Competition
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The banking and financial services industry is extremely competitive in
our market area. We face vigorous competition for customers, loans and deposits
from many companies, including:
o Commercial banks;
o Savings and loan associations;
o Finance companies;
o Credit unions;
o Trust companies;
o Mortgage companies;
o Money market mutual funds;
o Insurance companies; and
o Brokerage and investment firms.
Many of these competitors are significantly larger than National Penn;
have greater resources, lending limits and larger branch systems; offer a wider
array of banking services than National Penn; and are long-established in their
geographic markets (some of which have only been recently entered by National
Penn). See "General Development of Business" below.
In addition, some of these competitors are subject to a lesser degree of
regulation than that imposed on National Penn.
Many of these competitors have elected to become financial holding
companies under the Gramm-Leach-Bliley Act of 1999, including many of the
largest ones. Most probably, this development will further narrow the
differences and intensify competition among commercial banks, investment banks,
insurance firms and other financial services companies. See "Gramm-Leach-Bliley
Act" below.
Business Strategy
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We believe that as a result of consolidation in our marketplace, there
is a strong need for super community banks to serve small and middle market
customers. Our goal is to become the most highly regarded financial institution
in the markets we serve. We intend to accomplish this goal by combining the
sophisticated products and fee-based services of a major regional bank with the
personal attention, service and responsiveness of a community bank. We believe
this strategy results in greater profitability than a typical community bank.
The primary components of our business strategy are commercial banking, niche
marketing, development of fee income, consumer banking and enhanced customer
service.
Commercial Banking. Commercial banking has been our historic and ongoing
business focus. Our business customers tend to be small to middle market
customers with annual gross revenues generally between $1 million and $50
million who generally do not receive the attention of our larger, more
nationally focused competitors. Many of these customers require us to have an
acute understanding of their business in order for us to be able to customize
solutions to their financial requirements. We believe that this helps to
distinguish us from our competitors. We offer a wide range of products including
short-term loans for seasonal and working capital purposes, term loans secured
by
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real estate and other assets, loans for construction and expansion needs,
revolving credit plans and other commercial loans. As of December 31, 2003, our
commercial loan portfolio was $1.754 billion, which represents 77% of our total
loans outstanding.
Another important component of our commercial lending practice is our
emphasis on small businesses and their unique needs. In order to serve small
businesses better, National Penn Bank was named an "SBA Preferred/Express
Lender" by the U.S. Small Business Administration. Being a Preferred/Express
Lender authorizes us to underwrite and approve qualifying small business loans
without the prior approval of the Small Business Administration. During 2003,
National Penn Bank originated over $23.7 million of loans that qualified for
U.S. Small Business Administration guarantees. National Penn Bank was ranked as
the 71st largest SBA lender in the United States in the Coleman Report's listing
of the top 100 SBA 7(a) lenders for the year ended September 30, 2003.
Niche Marketing. An important component of our business strategy is the
development of business lines that give us higher margin opportunities. We are
continually assessing the markets within which we operate in order to identify
and seize upon opportunities where we believe a market segment is being
under-served. Once identified, we focus on customizing solutions that are
beneficial to the user and profitable to us.
An example is the creation of our Manufacturing Group in December 1999.
The Manufacturing Group is a unique lending group whose focus is on assisting
manufacturing firms in solving industry-specific challenges. The Manufacturing
Group is comprised of specialized teams of experienced bankers who have
industry-specific training or experience and can offer an array of resources to
time-challenged business owners through the Manufacturing Group's Solutions
NetworkTM- a database of National Penn professionals and other selected
third-party resource providers who assist with financial and non-financial
business challenges. At December 31, 2003, the Manufacturing Group managed
relationships with loans outstanding of approximately $121.0 million.
Another example is our International Banking Group. Through the
International Banking Group, we offer comprehensive trade finance products and
services to assist our business customers that are importing, exporting or
otherwise operating internationally. The International Banking Group has been in
operation since June 2001.
A third example is our Government Banking Group, formed in 2001, which
serves the unique banking needs of local government entities such as school
districts, municipalities and townships. At December 31, 2003, our Government
Banking Group deposits totaled $265.2 million.
Development of Fee Income. We have formed a number of specialized
investment, insurance and lending subsidiaries to develop fee income and to
serve specific markets.
We provide trust and investment management services through Investors
Trust Company, our trust company subsidiary. We also provide investment
management services through FirstService Capital, Inc. In total, Investors Trust
Company and FirstService Capital manage approximately $1.04 billion for over
2,300 individual and corporate customers.
We provide brokerage services through Penn Securities, Inc. and
insurance services through FirstService Insurance Agency, Inc. FirstService
Insurance Agency generated over $2.7 million in revenue in 2003 and serves over
4,700 customers. We conduct mortgage banking activities through Penn 1st
Financial Services, Inc. We offer commercial equipment leasing services through
National Penn Leasing Company. For the year ended December 31, 2003, our efforts
produced fee income of $41.3 million compared to $36.6 million for the year
ended December 31, 2002.
Consumer Banking. We offer a full range of deposit accounts, which
include demand, NOW, money market, certificates of deposit and other checking
and savings accounts. We also offer consumer loan products such as installment
loans, home equity loans, residential mortgage loans, multi-family loans,
educational loans and credit cards. In addition, we offer automated teller
services through an inter-bank automated teller system, safe deposit and night
depository facilities and internet banking services, including on-line bill
paying. We also offer a range of
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services to high net worth individuals through our Private Wealth Management
Group, which combines our Private Banking Group with the wealth management
services of Investors Trust Company and FirstService Capital.
Enhanced Customer Service. Our business strategy is supported by a
strong delivery system that places great emphasis on customer service. We have
segmented our market into divisions based primarily on geographic
considerations. Each division is managed by a division president who reports to
our chief delivery officer. Our chief delivery officer coordinates our sales and
servicing efforts in order to serve effectively our current customers and to
gain new customers. The purpose of this initiative is to better leverage our
centralized marketing and servicing efforts, thereby increasing sales of the
wide range of products and services that we offer. We believe that this
cross-functional approach leads to more responsive service for our customers
who, in turn, reward us with more of their total financial services needs.
General Development of Business
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National Penn Bank, then known as National Bank of Boyertown, was
originally chartered in 1874. National Bank of Boyertown converted to a holding
company structure in 1982 by forming National Penn Bancshares, Inc. as a parent
company to the bank. National Bank of Boyertown changed its name to National
Penn Bank in 1993 to reflect its growing market territory.
Since 1998, National Penn has grown significantly. Growth has been
generated both internally and through acquisitions and mergers that have either
"filled in" or extended our market reach. At December 31, 1998, National Penn
had $1.8 billion in net assets, and National Penn Bank conducted operations
through 50 community offices. At December 31, 2003, National Penn had $3.5
billion in net assets, and National Penn Bank conducted operations through 66
community offices.
The following highlights major developments in our business of the last
six years:
1998. In mid-year, we entered into an agreement to acquire Elverson
National Bank, a community bank headquartered in Elverson, Chester County,
Pennsylvania, with eight other community offices in Chester, Berks and Lancaster
Counties, Pennsylvania. This acquisition would substantially strengthen our
retail and commercial banking presence in Chester County. Penn Securities, Inc.
began operations as our full-service broker/dealer subsidiary, replacing a third
party vendor and augmenting our trust and asset management operations at
Investors Trust Company. We also formed the National Asian Bank division of
National Penn Bank to better serve the Asian business community in the Delaware
Valley and greater Philadelphia area.
1999. At the beginning of the year, we completed the acquisition of
Elverson National Bank, acquiring assets of $324.6 million. We then merged it
into National Penn Bank. In keeping with our strategy to increase fee-based
revenues, we began operations of our separate mortgage company, National Penn
Mortgage Company, now named Penn 1st Financial Services, Inc. Also, Investors
Trust Company formed its Private Wealth Management Group to provide
personalized, comprehensive service to individuals of substantial wealth.
National Penn Bank was named a "Preferred/Express Lender" by the U.S. Small
Business Administration.
2000. In February, as part of our niche marketing strategy, we entered
into an agreement to acquire Panasia Bank, a community bank headquartered in Ft.
Lee, New Jersey which, like our National Asian Bank Division at the time, was
focused on providing banking and other financial services to Asian-American
businesses and individuals. We completed this acquisition in mid-year; later in
the year, we converted Panasia's New Jersey state charter to a national bank
charter, which furthered the expansion of Panasia's business. At December 31,
2000, Panasia had four community offices in northern New Jersey and assets of
$128.7 million. In July, we entered into an agreement to acquire Community
Independent Bank, Inc. and its subsidiary, Bernville Bank, N.A. The acquisition
of Bernville Bank would further extend our retail operations into western Berks
County. Also during the year, National Penn Bank formed its Manufacturing Group,
a group of financial specialists dedicated to helping manufacturing firms
increase profits and solve industry-specific challenges.
2001. In January, we completed the acquisition of Community Independent
Bank, Inc. and then merged its subsidiary, Bernville Bank, N.A., into National
Penn Bank. In this transaction, National Penn Bank acquired four
4
community offices in western Berks County, with $103 million in assets. Later
during the year, we transferred the assets, liabilities and business of National
Penn Bank's National Asian Bank Division to Panasia Bank, N.A., creating a
larger unified entity better able to focus on serving the Asian-American
communities in northern New Jersey and southeastern Pennsylvania. Also during
the year, National Penn Bank formed the Government Banking Group to serve the
unique banking needs of local government entities such as school districts,
municipalities and townships, and the International Banking Group to help
companies enter global markets, increase their international sales and
profitability and reduce the various risks of their international operations.
2002. In early 2002, National Penn Bank began a unified branding
campaign emphasizing use of the "National Penn Bank" brand-name and phasing out
the use of historically-based divisional names other than those relating to our
most recent acquisitions. We also formed National Penn Leasing Company as a new
commercial equipment leasing company. In August, we raised capital by issuing
$63.25 million of 7.85% trust preferred securities. In September, we entered
into an agreement to acquire FirstService Bank, a community bank headquartered
in Doylestown, Bucks County, with seven community offices in Bucks and
Montgomery Counties. This acquisition would substantially strengthen our retail
and commercial banking presence in Bucks County, as well as strengthen our asset
management and insurance businesses. In October, we used a portion of the net
proceeds of the August trust preferred securities offering to redeem all $40.25
million of our 9% trust preferred securities issued in 1997. Late in the year,
we decided to re-focus all of our efforts on our core southeastern Pennsylvania
markets.
2003. In February, we completed the FirstService Bank acquisition,
acquiring assets of $367 million, by merging FirstService Bank into National
Penn Bank. This transaction substantially increased our presence in the Bucks
County marketplace. Given our decision to re-focus our efforts on our core
southeastern Pennsylvania markets, in February, we entered into an agreement to
sell our Panasia Bank, N.A. subsidiary to Woori America Bank for $34.5 million
in cash. This sale was completed in September. In April, in a market extending
acquisition, we entered into an agreement to acquire HomeTowne Heritage Bank, a
community bank with $165 million in assets and four community offices located in
Lancaster County. We acquired HomeTowne Heritage Bank in December and merged it
into National Penn Bank, strengthening our efforts to expand our business in the
Lancaster County market. In December, we entered into an agreement to acquire
Peoples First, Inc. and its banking subsidiary, The Peoples Bank of Oxford.
Peoples has assets of approximately $456 million, with eight community offices
in southern Chester County and Lancaster County and one community office in
Cecil County, Maryland. This acquisition would substantially strengthen our
market position in southern Chester County and Lancaster County and provide us
with an entry into Maryland. Subject to required regulatory approvals and
approval by Peoples First shareholders, we expect to complete this transaction
in second quarter 2004.
Lending
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Underwriting and Credit Administration
--------------------------------------
Our Board of Directors has established comprehensive lending practices.
Our policies require that loans meet sound underwriting criteria. A
Board-appointed committee (Executive Credit Committee) approves loan authority
for certain officers to be used individually or jointly and for various loan
committees of National Penn Bank. Any loan request for an amount exceeding
individual or joint approval levels must be approved by one of two credit
committees. The first committee (the Commercial Credit Committee) consists of
Wayne Weidner (National Penn Chairman and Chief Executive Officer), Glenn Moyer
(National Penn President and National Penn Bank CEO), Paul McGloin (Chief
Lending Officer), Garry Koch (Chief Credit Officer) and Hugh Marshall (Senior
Vice President and Regional Credit Officer). This committee considers commercial
business loan requests from $7.5 million up to $12.5 million and commercial real
estate loan requests from $5.0 million up to $10.0 million. The second committee
(the Executive Credit Committee) consists of Messrs. Weidner, Moyer, McGloin and
Koch, together with independent non-employee National Penn Bank directors John
H. Body, J. Ralph Borneman, Jr., C. Robert Roth and Stratton D. Yatron. This
committee considers commercial business loan requests in excess of $12.5 million
and commercial real estate loan requests in excess of $10.0 million. All loans
approved in excess of $10.0 million are reported to the National Penn Bank Board
of Directors.
National Penn Bank originates loans through direct solicitation of the
borrower, referral sources, through loan participations with other banks, loan
brokers, and purchases some leases through other financial institutions.
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As part of our credit administration process, we have an asset quality
review performed by an outside consultant. Their review consists of sampling the
commercial business and commercial real estate portfolio, reviewing individual
borrower files for adherence to policy and underwriting standards, proper loan
administration, and asset quality. National Penn Bank's Chairman, CEO and senior
lending personnel meet monthly to review delinquencies, non-performing assets,
classified assets and other relevant information to evaluate credit risk within
this portfolio. The results are reviewed by the Board of Directors monthly.
Loan Portfolio
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At December 31, 2003 and December 31, 2002, our portfolio was composed
of the following loan types.
Percentage of Percentage of
December 2003 Portfolio December 2002 Portfolio
------------- -------------- --------------- -------------
Commercial Real Estate
Commercial Properties $ 217,157,421 9.56% $ 186,744,867 10.46%
Residential Subdivision 153,475,505 6.76 89,360,567 5.01
Multifamily 67,489,263 2.97 74,225,618 4.16
Commercial Business Loans
Commercial Term Loans &
Mortgages 946,722,760 41.69 617,928,550 34.60
Lines of Credit 289,705,972 12.76 212,866,294 11.92
Leases 17,605,258 .78 673,103 .04
Consumer Loans
Residential Mortgages 229,995,051 10.13 244,230,930 13.68
Home Equity Loans 128,665,230 5.67 151,501,032 8.49
Home Equity Lines of Credit 157,457,671 6.93 131,650,876 7.37
Other Loans 62,425,588 2.75 76,225,478 4.27
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Total Loans $2,270,699,719 100.00% $1,785,407,315 100.00%
============== ==============
Commercial Lending
------------------
General - A majority of National Penn Bank's loan assets are loans to
business owners of many types. National Penn Bank makes commercial loans for
real estate development, equipment financing, account receivables and inventory
financing and other purposes as required by the broad spectrum of borrowers.
Commercial loans by their nature carry higher risk than loans to consumers. The
changes in commercial borrowers' financial condition and cash flow plus the
potential volatility in the value of collateral held makes commercial lending a
higher risk form of lending. Consequently, a greater percentage of National Penn
Bank's resources and the staff's time are devoted to monitoring this area of the
portfolio.
National Penn Bank's credit policies determine advance rates against
the different forms of collateral that can be pledged against commercial loans.
Typically, loans will be limited to 85% of real estate values, 75% of new
equipment, 80% against eligible accounts receivable and 50% or less against
finished inventory or raw material. Individual loan advance rates may be higher
or lower depending upon the financial strength of the borrower and/or the term
of the loan.
Below are different loan types and descriptions offered to National
Penn Bank's commercial loan customers.
Commercial Real Estate
----------------------
Commercial properties - These loans include both construction loans and
long-term loans financing commercial properties such as office buildings, retail
strip malls, and medical office buildings. All properties in this category are
non-owner occupied. Repayment of this kind of loan is dependent upon the resale
of or lease of the subject property. Loan terms range from one year to 20 years.
Interest rates can be either floating or fixed rates.
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Fixed rates are generally set for periods of three to seven years with either a
rate reset provision or a balloon payment.
Residential Subdivision - These loans are made to residential
subdivision developers for the building of residential properties
including roadways, the installation of utilities and the actual
construction of the one to four family houses. Repayment of this kind
of loan is dependent upon the sale of individual houses to consumers or
in some cases to other developers. Terms of the loan are generally for
one to two years, with an option to extend the loan for six months.
Interest rates are usually floating, generally based on the Wall Street
Journal prime rate plus an increment.
Multifamily - These loans provide the construction and/or long term
financing of greater than five unit residential properties that are for
lease. Loan terms are generally from one year to 20 years with some
loans amortizing over 25 years. Interest rates can be either floating
or fixed for three to 10 year periods. These loans are repaid from the
lease of the individual units.
Commercial Business Loans
-------------------------
Loans in this general category are made to proprietors, professionals,
partnerships and corporations. Repayment of this kind of loan generally comes
from the cash flow of the business. The assets financed are used within the
business for its ongoing operation.
Commercial Term Loans and Mortgages - These loans are typically used to
finance the equipment and the owner-occupied real estate needs of the
borrower. Terms will range from 3 to 25 years dependent upon the
economic life of the asset financed. Interest rates will be either
floating or fixed for periods up to 10 years. Many loans, although
written with extended amortizations, will actually require balloon
payments at 3, 5, or 10 years.
Commercial Lines of Credit - As of December 31, 2003, National Penn
Bank has lines of credit representing $757 million in commitments to
business owners. The lines finance short-term working capital needs of
the borrower including funds for accounts receivable, inventory,
short-term equipment needs and operating expenses. Lines of credit
allow the business owner to borrow, repay, and reborrow funds on an as
needed basis up to a pre-determined maximum level. Lines of credit are
typically committed for one year but may be granted for longer terms
based on the financial strength of the borrower and the collateral
provided. Typical collateral for a line of credit will consist of the
borrower's accounts receivable, inventory, machinery and equipment.
Sometimes the collateral will include the business real estate or the
business owner's personal residence. Repayment of the line is dependent
upon the ongoing success of the business and the conversions of assets,
such as accounts receivable and inventory, to cash. Interest rates are
usually floating and are generally based on Wall Street Journal Prime
rate, or the 30 day London InterBank Offered Rate (LIBOR).
National Penn Bank is a preferred lender as designated by the U.S.
Small Business Administration (SBA). As such, National Penn Bank
originates loans to business owners that qualify for a loan guaranty
issued by the SBA. The amount of the guaranty can range from 50% to 85%
of the loan amount dependent on the form of the loan. SBA guaranteed
loans may be used to finance equipment, owner-occupied business real
estate, accounts receivables and inventory. The term of SBA loans can
range from a few months up to 20 years dependent upon the purpose and
collateral offered. SBA regulations limit interest rates and terms.
In calendar year 2003, National Penn Bank originated $23.7 million SBA
guaranteed loans, up from $21.6 million originated in 2002.
Leasing - National Penn Bank makes lease financing available to
business customers through its wholly owned subsidiary, National Penn
Leasing Company (NPLC). NPLC provides leases for many types of
equipment, serving the manufacturing, service, transportation and
construction sectors. Leases are written at fixed rates for 3 to 7 year
terms based on the economic life of the underlying equipment. Leases
can be capital leases, operating leases, conditional sales contracts or
other lease structures dependent on the
7
financial condition and needs of the leasee as well as the type of
equipment involved. NPLC started business in December 2002 and by
December 31, 2003, had total leases outstanding of $17.6 million.
Consumer Lending
----------------
General - National Penn provides loans to consumers to finance personal
residences, automobiles, college tuition, home improvements and other personal
needs. Through its subsidiary, Penn 1st Financial Services, National Penn Bank
originates first lien residential mortgages throughout southeastern
Pennsylvania, New Jersey, Virginia, North Carolina and South Carolina. In 2003,
Penn 1st originated $411.7 million in residential mortgages and in 2002, $279.7
million. All of these residential mortgages are sold to secondary market
investors or held within National Penn Bank's investment or loan portfolios. At
year-end 2003, the residential mortgages held in the National Penn Bank's loan
portfolio totaled $230.0 million compared to $244.2 million as of December 31,
2002. The bulk of the mortgage banking originations occurred in the first half
of 2003, and National Penn Bank securitized $123.8 million in 2003, which
accounts for the decrease in mortgage banking income.
Throughout its nine county southeastern Pennsylvania market, National
Penn Bank provides home equity loans, home equity lines of credit and other
consumer loans through its community offices and Private Banking division. The
majority of National Penn Bank's consumer loans are secured by the borrower's
residential real estate in either a first or second lien position. National Penn
Bank requires a loan to value ratio of not greater than 80% on this portfolio
with some exceptions based on the borrower's financial strength. National Penn
Bank originates all of its home equity loans and home equity lines of credit
directly with its customers. National Penn Bank does have a small indirect loan
portfolio in which the transactions are initiated through a third party,
generally an auto dealer or equipment vendor, and subsequently funded by
National Penn Bank. This "indirect" loan portfolio had total loans outstanding
at December 31, 2003, of $3.2 million.
Investment Policies and Strategies
- ----------------------------------
The investment portfolio consists of two parts: the National Penn Bank
portfolio and the National Penn Investment Company portfolio. The Bank portfolio
totaled $896.3 million and $614.7 million at December 31, 2003 and December 31,
2002, respectively. The investment company portfolio was $35.1 million at
December 31, 2003 and $33.4 million at December 31, 2002, respectively.
Investor's Trust Company and Penn Securities, Inc. have small investment
portfolios totaling $2.9 million as a vehicle to invest their capital.
National Penn Bank's investment portfolio consists primarily of Agency
and Municipal bonds. The Agency bonds include debentures as well as
mortgage-backed securities issued by GNMA, FNMA and FHLMC. Agency and municipal
bonds carry low risk-based capital requirements. The primary purpose of the bank
investment portfolio is to provide a secondary source of liquidity, and the
secondary purpose is to provide a source of income. With liquidity as the
primary focus, we concentrate on buying high quality, highly marketable
securities. We also construct the portfolio to provide a steady cash flow
stream. Virtually all of the bank's investment portfolio supports our funding
pledging needs. In addition to the factors discussed, we follow a strategy of
shortening the duration of the bank portfolio when rates are low and lengthening
the duration of the investment portfolio when rates are high. With rates
dropping the past two years, we have shortened the duration of the portfolio,
generally buying only securities with a maximum term of five years. However, we
still have bonds in the investment portfolio that we purchased in the late
1980's when rates were much higher. At that time, we purchased bonds with final
maturities as long as 20 years. Whether we are buying shorter-term securities
during low rate cycles, or longer-term securities during times of higher rates,
we always consider the impact of the investment portfolio in the Company's
overall interest rate risk position. We therefore might adjust this strategy,
due to our need to remain consistent with our interest rate risk corporate
guidelines.
In 2002 and 2003, we pooled our own production of ten and fifteen year
fixed rate mortgage loans and converted the loans to FHLMC securities in order
to transfer assets to the investment portfolio. This is a more price-efficient
way to add mortgage-backed securities to our portfolio as compared to purchasing
mortgage-backed securities in the secondary market. These loans, when
securitized, are more liquid and also support our deposit pledging needs.
The investment company's portfolio consists primarily of investments in
other commercial banks. These investments are in the form of common stock or
trust preferred securities. The primary purpose of this portfolio is to generate
income, including both current income in the form of interest and dividends, as
well as long-term capital gains.
8
The common stock is readily marketable, but there is not an active secondary
market in the trust preferred securities. Our strategy in the trust preferred
portfolio is to invest in other banks where we can understand the financial
performance and risks involved, while enjoying a higher return. These
investments require the same risk-based capital as commercial loans, but the
overall dollar amount of this portfolio, at $29.0 million, is small so the
impact on capital is not material.
Operating Segments
- ------------------
National Penn has one reportable segment, Community Banking (consisting
of National Penn Bank), and certain other non-reportable segments, as described
in Note 21 of the Notes to Consolidated Financial Statements included at Item 8
of this Report. Note 21 includes segment information on revenue, assets and
income, and is incorporated by reference in this Item 1.
Products and Services with Reputation Risk
- ------------------------------------------
National Penn and its subsidiaries offer a diverse range of financial
and banking products and services. In the event one or more customers and/or
governmental agencies becomes dissatisfied or objects to any product or service
offered by National Penn or any of its subsidiaries, negative publicity with
respect to any such product or service, whether legally justified or not, could
have a negative impact on National Penn's reputation. The discontinuance of any
product or service, whether or not any customer or governmental agency has
challenged any such product or service, could have a negative impact on National
Penn's reputation.
Other Bank Investments
- ----------------------
National Penn owns, indirectly through National Penn Investment Company,
approximately 22% of The Pennsylvania State Banking Company, a Pennsylvania bank
holding company headquartered in Camp Hill, Pennsylvania. Its subsidiary,
Pennsylvania State Bank, began operations as a bank in May 1989. For financial
reporting purposes, we account for our investment in this company using the
equity method of accounting.
Future Acquisitions
- -------------------
Our acquisition strategy consists of identifying financial institutions
with business philosophies that are similar to ours, which operate in strong
markets that are geographically compatible with our operations, and which can be
acquired at an acceptable cost. In evaluating acquisition opportunities, we
generally consider potential revenue enhancements and operating efficiencies,
asset quality, interest rate risk, and management capabilities. Other than the
pending acquisition of Peoples First, Inc. and its subsidiary, The Peoples Bank
of Oxford discussed above, we currently have no formal commitments with respect
to future acquisitions, although discussions with acquisition candidates take
place frequently.
Concentrations, Seasonality
- ---------------------------
We do not have any portion of our businesses dependent on a single or
limited number of customers, the loss of which would have a material adverse
effect on our business. No substantial portion of loans or investments are
concentrated within a single industry or group of related industries, although a
significant amount of loans are secured by real estate located in southeastern
Pennsylvania. Our businesses are not seasonal in nature.
Environmental Compliance
- ------------------------
Our compliance with federal, state and local environmental protection
laws had no material effect on capital expenditures, earnings or our competitive
position in 2003, and is not expected to have a material effect on such
expenditures, earnings or competitive position in 2004.
Employees
- ---------
At December 31, 2003, National Penn and its subsidiaries had 1,074 full-
and part-time employees.
9
Website Availability of Reports
- -------------------------------
We maintain a website at: www.nationalpennbancshares.com. We make our
Forms 10-K, 10-Q and 8-K (and amendments to each) available on this website free
of charge at the same time as those reports are filed with the SEC (or as soon
as reasonably practicable following that filing).
Supervision and Regulation
- --------------------------
Bank holding companies and banks operate in a highly regulated
environment and are regularly examined by Federal and state regulatory
authorities.
The following discussion concerns various Federal and state laws and
regulations and the potential impact of such laws and regulations on National
Penn and its subsidiaries.
To the extent that the following information describes statutory or
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory or regulatory provisions themselves. Proposals to change
laws and regulations are frequently introduced in Congress, the state
legislatures, and before the various bank regulatory agencies. National Penn
cannot determine the likelihood or timing of any such proposals or legislation
or the impact they may have on National Penn and its subsidiaries. A change in
law, regulations or regulatory policy may have a material effect on the business
of National Penn and its subsidiaries.
Bank Holding Company Regulation
- -------------------------------
National Penn is registered as a bank holding company and is subject to
the regulations of the Board of Governors of the Federal Reserve System (the
"Federal Reserve") under the Bank Holding Company Act of 1956 ("BHCA").
The Gramm-Leach-Bliley Act of 1999 ("GLBA") established a new kind of
bank holding company called a "financial holding company". Although National
Penn believes that it is eligible to do so, National Penn has not elected to
become a "financial holding company." See "Gramm-Leach-Bliley Act".
Bank holding companies are required to file periodic reports with and
are subject to examination by the Federal Reserve. The Federal Reserve's
regulations require a bank holding company to serve as a source of financial and
managerial strength to its subsidiary banks. As a result, the Federal Reserve,
pursuant to its "source of strength" regulations, may require National Penn to
commit its resources to provide adequate capital funds to National Penn Bank
during periods of financial stress or adversity. This support may be required at
times when National Penn is unable to provide such support.
Under the Federal Deposit Insurance Act ("FDIA"), a bank holding company
is required to guarantee the compliance of any insured depository institution
subsidiary that may become "undercapitalized" (as defined by regulations) with
the terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency, up to specified limits.
Under the BHCA, the Federal Reserve has the authority to require a bank
holding company to terminate any activity or relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
to the financial soundness and stability of any bank subsidiary of the bank
holding company.
The BHCA prohibits National Penn from acquiring direct or indirect
control of more than 5% of the outstanding shares of any class of voting stock
or substantially all of the assets of any bank, or merging or consolidating with
another bank holding company, without prior approval of the Federal Reserve.
Such a transaction may also require approval of the Pennsylvania Department of
Banking. Pennsylvania law permits Pennsylvania bank holding companies to control
an unlimited number of banks.
10
Additionally, the BHCA prohibits National Penn from engaging in or from
acquiring ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a nonbanking business unless
such business is determined by the Federal Reserve, by regulation or by order,
to be so "closely related to banking" as to be a "proper incident" thereto. The
BHCA does not place territorial restrictions on the activities of such
nonbanking-related businesses.
The Federal Reserve's regulations concerning permissible nonbanking
activities for National Penn (a bank holding company that, at present, is not a
"financial holding company") provide fourteen categories of functionally related
activities that are permissible nonbanking activities. These are:
o Extending credit and servicing loans.
o Certain activities related to extending credit.
o Leasing personal or real property under certain conditions.
o Operating nonbank depository institutions, including savings
associations.
o Trust company functions.
o Certain financial and investment advisory activities.
o Certain agency transactional services for customer investments,
including securities brokerage activities.
o Certain investment transactions as principal.
o Management consulting and counseling activities.
o Certain support services, such as courier and printing services.
o Certain insurance agency and underwriting activities.
o Community development activities.
o Issuance and sale of money orders, savings bonds, and traveler's
checks.
o Certain data processing services.
Depending on the circumstances, Federal Reserve approval may be required
before National Penn or its nonbank subsidiaries may begin to engage in any such
activity and before any such business may be acquired.
A bank holding company that is eligible and makes an effective election
under GLBA to be a "financial holding company" may engage in any type of
financial activity. See "Gramm-Leach-Bliley Act".
Dividend Restrictions
---------------------
National Penn is a legal entity separate and distinct from National Penn
Bank and National Penn's other direct and indirect nonbank subsidiaries.
National Penn's revenues (on a parent company only basis) result almost
entirely from dividends paid to National Penn by its subsidiaries. The right of
National Penn, and consequently the right of creditors and shareholders of
National Penn, to participate in any distribution of the assets or earnings of
any subsidiary through the payment of such dividends or otherwise is necessarily
subject to the prior claims of creditors of the subsidiary (including
depositors, in the case of National Penn Bank), except to the extent that claims
of National Penn in its capacity as a creditor may be recognized.
11
Federal and state laws regulate the payment of dividends by National
Penn's subsidiaries. See "Supervision and Regulation - Regulation of National
Penn Bank".
Further, it is the policy of the Federal Reserve that bank holding
companies should pay dividends only out of current earnings. Federal banking
regulators also have the authority to prohibit banks and bank holding companies
from paying a dividend if they should deem such payment to be an unsafe or
unsound practice.
Capital Adequacy
----------------
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines.
The required minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) is 8%. At least half of total capital must be "Tier 1 capital". Tier 1
capital consists principally of common shareholders' equity, retained earnings,
a limited amount of qualifying perpetual preferred stock and minority interests
in the equity accounts of consolidated subsidiaries, less goodwill and certain
intangible assets. The remainder of total capital may consist of mandatory
convertible debt securities and a limited amount of subordinated debt,
qualifying preferred stock and loan loss allowance ("Tier 2 capital"). At
December 31, 2003, National Penn's Tier 1 capital and total (Tier 1 and Tier 2
combined) capital ratios were 9.74% and 11.0%, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve
requires a bank holding company to maintain a minimum "leverage ratio". This
requires a minimum level of Tier 1 capital (as determined under the risk-based
capital rules) to average total consolidated assets of 3% for those bank holding
companies that have the highest regulatory examination ratings and are not
contemplating or experiencing significant growth or expansion. The Federal
Reserve expects all other bank holding companies to maintain a ratio of at least
1% to 2% above the stated minimum. At December 31, 2003, National Penn's
leverage ratio was 7.84%.
The Federal Reserve has also indicated that it will consider a "tangible
Tier 1 capital leverage ratio" (deducting all intangibles) and other indicators
of capital strength in evaluating proposals for expansion or new activities. The
Federal Reserve has not advised National Penn of any specific minimum leverage
ratio applicable to National Penn.
Pursuant to the "prompt corrective action" provisions of the FDIA, the
federal banking agencies have specified, by regulation, the levels at which an
insured institution is considered "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", or "critically
undercapitalized."
Under these regulations, an institution is considered "well capitalized"
if it satisfies each of the following requirements:
o It has a total risk-based capital ratio of 10% or more
o It has a Tier 1 risk-based capital ratio of 6% or more
o It has a leverage ratio of 5% or more.
o It is not subject to any order or written directive to meet and
maintain a specific capital level.
At December 31, 2003, National Penn Bank qualified as "well capitalized"
under these regulatory standards. See Note 19 of the Notes to Consolidated
Financial Statements included at Item 8 of this Report.
FDIC Insurance Assessments
--------------------------
National Penn Bank is subject to deposit insurance assessments by the
Federal Deposit Insurance Corporation ("FDIC"). These assessments fund both the
Bank Insurance Fund ("BIF") for banks and the Savings Association Insurance Fund
("SAIF") for savings associations. They are based on the risk classification of
the depository institutions. National Penn Bank was not subject to any regular
insurance assessments by the FDIC in 2003. Under
12
current FDIC practices, National Penn Bank does not expect to be required to pay
regular insurance assessments to the FDIC in 2004.
In 1996, the SAIF was recapitalized. As part of the recapitalization,
both BIF-insured deposits and SAIF-insured deposits are now assessed to fund
debt service on the Federal government's related bond payments. The current
annualized rate established by the FDIC for both BIF-insured deposits and
SAIF-insured deposits is $.017 per $100 of deposits. These bonds mature in 2017.
Regulation of National Penn Bank
- --------------------------------
The operations of National Penn Bank are subject to Federal and state
statutes applicable to banks chartered under the banking laws of the United
States, to members of the Federal Reserve System, and to banks whose deposits
are insured by the FDIC. These operations are also subject to regulations of the
Office of the Comptroller of the Currency ("OCC"), the Federal Reserve, and the
FDIC.
The OCC, which has primary supervisory authority over National Penn
Bank, regularly examines banks in such areas as reserves, loans, investments,
management practices and other aspects of operations. These examinations are
designed for the protection of depositors rather than National Penn's
shareholders. The bank must furnish annual and quarterly reports to the OCC,
which has the legal authority to prevent a national bank from engaging in an
unsafe or unsound practice in conducting its business.
Federal and state banking laws and regulations govern, among other
things, the scope of a bank's business, the investments a bank may make, the
reserves against deposits a bank must maintain, the types and terms of loans a
bank may make and the collateral it may take, the activities of a bank with
respect to mergers and consolidations, and the establishment of branches.
Pennsylvania law permits statewide branching.
Under the National Bank Act, National Penn Bank is required to obtain
the prior approval of the OCC for the payment of dividends if the total of all
dividends declared by it in one year would exceed its net profits for the
current year plus its retained net profits for the two preceding years, less any
required transfers to surplus. In addition, the bank may only pay dividends to
the extent that its retained net profits (including the portion transferred to
surplus) exceed statutory bad debts. Under the FDIA, the bank is prohibited from
paying any dividends, making other distributions or paying any management fees
if, after such payment, it would fail to satisfy its minimum capital
requirements.
As a subsidiary bank of a bank holding company, National Penn Bank is
subject to certain restrictions imposed by the Federal Reserve Act on extensions
of credit to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries, and
on taking such stock or securities as collateral for loans.
The Federal Reserve Act and Federal Reserve regulations also place
certain limitations and reporting requirements on extensions of credit by a bank
to the principal shareholders of its parent holding company, among others, and
to related interests of such principal shareholders. In addition, such
legislation and regulations may affect the terms upon which any person becoming
a principal shareholder of a holding company may obtain credit from banks with
which the subsidiary bank maintains a correspondent relationship.
Regulation of Other Subsidiaries
- --------------------------------
National Penn's direct nonbank subsidiaries are subject to regulation by
the Federal Reserve and, in the case of Investors Trust Company, the
Pennsylvania Department of Banking.
National Penn Bank's direct nonbank subsidiaries are subject to
regulation by the OCC. In addition, Penn Securities, Inc., as a broker-dealer
and investment advisory firm, is regulated by the Securities and Exchange
Commission, various state securities regulators and the National Association of
Securities Dealers, Inc. National Penn Bank's insurance agency subsidiaries are
each also subject to regulation by the Pennsylvania Insurance Department. In
addition to regulation by the OCC, FirstService Capital, Inc., an investment
advisory firm, is subject to regulation by the SEC, various state securities
regulators and the NASD.
13
Monetary and Fiscal Policies
- ----------------------------
The financial services industry, including National Penn and National
Penn Bank, is affected by the monetary and fiscal policies of government
agencies, including the Federal Reserve. Through open market securities
transactions and changes in its discount rate and reserve requirements, the
Federal Reserve exerts considerable influence over the cost and availability of
funds for lending and investment.
Gramm-Leach-Bliley Act
- ----------------------
The Gramm-Leach-Bliley Act of 1999 ("GLBA"):
o Repealed various provisions of the Glass Steagall Act to permit
commercial banks to affiliate with investment banks (securities
firms).
o Amended the BHCA to permit qualifying bank holding companies to engage
in any type of financial activity.
o Permits subsidiaries of national banks now to engage in a broad range
of financial activities that are not permitted for national banks
themselves.
The result is that banking companies are generally able to offer a wider
range of financial products and services and are more readily able to combine
with other types of financial companies, such as securities and insurance
companies.
GLBA created a new kind of bank holding company called a "financial
holding company" (an "FHC"). An FHC is authorized to engage in any activity that
is "financial in nature or incidental to financial activities" and any activity
that the Federal Reserve determines is "complementary to financial activities"
and does not pose undue risks to the financial system. Among other things,
"financial in nature" activities include securities underwriting and dealing,
insurance underwriting and sales, and certain merchant banking activities.
A bank holding company qualifies to become an FHC if each of its
depository institution subsidiaries is "well capitalized", "well managed", and
CRA-rated "satisfactory" or better. A qualifying bank holding company becomes an
FHC by filing with the Federal Reserve an election to become an FHC.
If an FHC at any time fails to remain "well capitalized" or "well
managed", the consequences can be severe. Such an FHC must enter into a written
agreement with the Federal Reserve to restore compliance. If compliance is not
restored within 180 days, the Federal Reserve can require the FHC to cease all
its newly authorized activities or even to divest itself of its depository
institutions. A failure to maintain a CRA rating of "satisfactory" will not
jeopardize any then existing newly authorized activities; rather, the FHC cannot
engage in any additional newly authorized activities until a "satisfactory" CRA
rating is restored.
In addition to activities otherwise permitted by law and regulation for
bank holding companies, an FHC may engage in virtually any other kind of
financial activity. Under limited circumstances, an FHC may even be authorized
to engage in certain non-financial activities. These include:
o Securities underwriting and dealing.
o Insurance underwriting and sales.
o Merchant banking activities.
o Activities determined by the Federal Reserve to be "financial in
nature" and incidental activities.
o "Complementary" financial activities, as determined by the Federal
Reserve.
14
Bank holding companies that do not qualify to become, or do not elect to
become FHCs are limited in their activities to the activities permitted by law
and regulation on March 11, 2000, the effective date of that portion of GLBA.
Although National Penn believes that it is eligible to do so, National Penn has
not elected to become a "financial holding company." National Penn has, instead,
continued to utilize the continuing authority of national banks to create
"operating subsidiaries" to expand its business products and services.
GLBA also authorizes national banks to create "financial subsidiaries".
This is in addition to the present authority of national banks to create
"operating subsidiaries". A "financial subsidiary" is a direct subsidiary of a
national bank that satisfies the same conditions as an FHC, plus certain other
conditions, and is approved in advance by the OCC. A "financial subsidiary" can
engage in most, but not all, of the newly authorized activities. National Penn
Bank has not created any "financial subsidiaries".
In addition, GLBA includes significant provisions relating to the
privacy of consumer and customer information. These provisions apply to any
company "the business of which" is engaging in activities permitted for an FHC,
even if it is not itself an FHC. Thus, they apply to National Penn. Basically,
GLBA requires a financial institution to: adopt and disclose its privacy policy;
give consumers and customers the right to "opt out" of disclosures to
non-affiliated third parties; not disclose any account information to
non-affiliated third party marketers; and follow regulatory standards to protect
the security and confidentiality of consumer and customer information.
Although the long-range effects of GLBA cannot be predicted, most
probably it will further narrow the differences and intensify competition among
commercial banks, investment banks, insurance firms and other financial services
companies.
Interest Rate Swaps
- -------------------
National Penn uses interest rate swap agreements for interest rate risk
management. No derivative financial instruments are held for trading purposes.
The contract or notional amounts of the swap agreements do not represent
exposure to credit loss. Potential credit risk on these contracts arises from
the counterparty's inability to meet the terms of the agreement. Management
considers the credit risk of these agreements to be minimal and manages this
risk through routine review of the counterparty's financial ratings.
Information about the amounts of interest rate swaps is set forth in
Notes 1 and 17 of the Notes to Consolidated Financial Statements included at
Item 8 of this Report. In 2003, interest rate swaps had the effect of increasing
National Penn's net interest income by $1.48 million from what would have been
realized had National Penn Bank not entered into the swap agreements.
Critical Accounting Policies, Judgments and Estimates
- -----------------------------------------------------
The accounting and reporting policies of National Penn conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. Critical accounting
policies, judgments and estimates relate to loans, the allowance for loan losses
and goodwill and intangibles. These policies significantly affect the
determination of National Penn's financial position, results of operations and
cash flows, and are summarized in Note 1 (Summary of Significant Accounting
Policies) of the Notes to Consolidated Financial Statements and discussed in the
section captioned "Critical Accounting Policies, Judgments and Estimates" of
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included in Items 7 and 8 of this Report, each of which is
incorporated herein by reference.
Recent Accounting Pronouncement
- -------------------------------
Off Balance Sheet Commitments
-----------------------------
The Company adopted FIN 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of Indebtedness of
Others, on January 1, 2003. FIN 45 requires a guarantor entity, at the inception
of a guarantee covered by the measurement provisions of the interpretation, to
record a liability for the
15
fair value of the obligation undertaken in issuing the guarantee. The Company
issues financial and performance letters of credit. Financial letters of credit
require the Company to make payment if the customer's financial condition
deteriorates, as defined in the agreements. Performance letters of credit
require the Company to make payments if the customer fails to perform identified
non-financial contractual obligations. The Company previously did not record an
initial liability when guaranteeing obligations unless it became probable that
the Company would have to perform under the guarantee. FIN 45 applies
prospectively to guarantees the Company issues or modifies subsequent to
December 31, 2002.
The Company defines the initial fair value of these letters of credit
as the fee received from the customer. The maximum potential undiscounted amount
of future payments on these letters of credit as of December 31, 2003 is $54.5
million and they expire through 2008. The amounts due under these letters of
credit would be reduced by any proceeds that the Company would be able to obtain
in liquidating the collateral for these loans. The adoption of FIN 45 did not
have a material impact on the Company's consolidated financial position or
results of operations.
Acquired Loans
--------------
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows expected at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. Management is currently evaluating the provisions of SOP 03-3.
Variable Interest Entities
--------------------------
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application of
Accounting Research Bulletin 51, Consolidated Financial Statements, to certain
entities in which voting rights are not effective in identifying the investor
with the controlling financial interest. An entity is subject to consolidation
under FIN 46 if the investors either do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support, are unable to direct the entity's activities, or are not exposed to the
entity's losses or entitled to its residual returns ("variable interest
entities"). Variable interest entities within the scope of FIN 46 will be
required to be consolidated by their primary beneficiary. The primary
beneficiary of a variable interest entity is determined to be the party that
absorbs a majority of the entity's expected losses, receives a majority of its
expected returns, or both.
Management has determined that NPB Capital Trust II qualifies as a
variable interest entity under FIN 46. NPB Capital Trust II issued mandatorily
redeemable preferred stock to investors and loaned the proceeds to the Company.
NPB Capital Trust II holds, as its sole asset, subordinated debentures issued by
the Company in 2002. NPB Capital Trust II is currently included in the Company's
consolidated balance sheet and statements of income. The Company has evaluated
the impact of FIN 46 and concluded it should continue to consolidate NPB Trust
II as of December 31, 2003, in part due to its ability to call the preferred
stock prior to the mandatory redemption date and thereby benefit from a decline
in required dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to certain
variable interest entities by March 31, 2004. The Company plans to adopt the
provisions under the revised interpretation in the first quarter of 2004. FIN
46(R) will require NPB to deconsolidate NPB Capital Trust II as of March 31,
2004. FIN 46(R) precludes consideration of the call option embedded in the trust
preferred securities when determining if the Company has the right to a majority
of NPB Capital Trust II's expected residual returns. Accordingly, the Company
will deconsolidate NPB Capital Trust II at the end of the first quarter, which
will result in an increase in outstanding debt by $2.71 million. The banking
regulatory agencies have not issued any guidance that would change the
regulatory capital treatment for the trust-preferred securities issued by NPB
Capital Trust II based on the adoption of FIN 46(R). However, as additional
interpretations from the banking
16
regulators related to entities such as NPB Capital Trust II become available,
management will reevaluate its potential impact to its Tier I capital
calculation under such interpretations.
Amendment to SFAS 133 on Derivative Instruments and Hedging Activities
----------------------------------------------------------------------
The Company adopted Statement of Financial Accounting Standard 149 (SFAS
No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, on July 1, 2003. SFAS No. 149 clarifies or amends SFAS No. 133 for
implementation issues raised by constituents or includes the conclusions reached
by the FASB on certain FASB Staff Implementation Issues. Statement 149 also
amends paragraph SFAS No. 133 to require a lender to account for loan
commitments related to mortgage loans that will be held for sale as derivatives.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003. The Company periodically enters into commitments with its customers, which
it intends to sell in the future. The adoption of SFAS No. 149 did not have a
material impact on the Company's financial position or results of operations.
Financial Instruments with Characteristics of Both Liabilities and Equity
-------------------------------------------------------------------------
The FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, on May 15,
2003. SFAS No. 150 changes the classification in the statement of financial
position of certain common financial instruments from either equity or mezzanine
presentation to liabilities and requires an issuer of those financial statements
to recognize changes in fair value or redemption amount, as applicable, in
earnings. SFAS No. 150 is effective for public companies for financial
instruments entered into or modified after May 31, 2003 and is effective at the
beginning of the first interim period beginning after June 15, 2003. Management
has not entered into any financial instruments that would qualify under SFAS No.
150. The Company currently classifies its Guaranteed Preferred Beneficial
Interest in the Company's Subordinated Debt as a liability. As a result,
management does not anticipate the adoption of SFAS No. 150 will have a material
impact on the Company's financial position or results of operations.
Other than Temporary Impairment and Its Application to Certain Investments
--------------------------------------------------------------------------
The Company adopted EITF 03-1, The Meaning of Other than Temporary
Impairment and Its Application to Certain Investments, as of December 31, 2003.
EITF 03-1 includes quantitative and qualitative disclosures for investment
securities accounted for under FAS 115, Accounting for Certain Investments in
Debt and Equity Securities, that have an unrealized loss and are considered
impaired at December 31, 2003, but the Company has not recorded an
other-than-temporary impairment, as defined by SFAS No. 115. The disclosure
provisions under EITF 03-1 are required for financial statements for years
ending after December 15, 2003 and are included in these financial statements.
Forward-Looking Statements
- --------------------------
From time to time, National Penn or its representatives make written or
oral statements that may include "forward-looking statements" with respect to
its:
o Financial condition.
o Results of operations.
o Asset quality.
o Product, geographic and other business expansion plans and activities.
o Investments in new subsidiaries and other companies.
o Capital expenditures, including investments in technology.
17
o Pending or completed mergers with or acquisitions of financial or
non-financial companies or their assets, loans, deposits and branches,
and the revenue enhancements, cost savings and other benefits
anticipated in those transactions.
o Pending or completed sales of businesses or assets, and the benefits
anticipated in those transactions.
o Other matters.
Many of these statements can be identified by looking for words such as
"believes", "expects", "anticipates", "estimates", "projects" or similar words
or expressions.
These forward-looking statements involve substantial risks and
uncertainties. There are many factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements. These
factors include, among other things, the following possibilities:
o National Penn's unified branding campaign and other marketing
initiatives may be less effective than expected in building name
recognition and greater customer awareness of National Penn's products
and services. Use of non-National Penn brands may be
counter-productive.
o National Penn may be unable to differentiate itself from its
competitors by a higher level of customer service, as intended by its
business strategy.
o Expansion of National Penn's products and services offerings may take
longer, and may meet with more effective competitive resistance from
others already offering such products and services, than expected.
o New product development by new and existing competitors may be more
effective, and take place more quickly, than expected.
o Competitors with substantially greater resources may enter product
market, geographic or other niches currently served by National Penn.
o Geographic expansion may be more difficult, take longer, and present
more operational and management risks and challenges, than expected.
o Business development in newly entered geographic areas, including
those entered by mergers and acquisitions, may be more difficult, and
take longer, than expected.
o Competitive pressures may increase significantly and have an adverse
effect on National Penn's pricing, spending, third-party relationships
and revenues.
o Customers may substitute competitors' products and services for
National Penn's products and services, due to price advantage,
technological advantages, or otherwise.
o National Penn may be less effective in cross-selling its various
products and services, and in utilizing alternative delivery systems
such as the Internet, than expected.
o Projected business increases following new product development,
geographic expansion, and productivity and investment initiatives, may
be lower than expected, and recovery of associated costs may take
longer than expected.
o National Penn may be unable to retain key executives and other key
personnel due to intense competition for such persons or otherwise.
18
o Increasing interest rates may increase funding costs and reduce
interest margins, and may adversely affect business volumes, including
mortgage origination levels.
o Growth and profitability of National Penn's non-interest income or fee
income may be less than expected, including income from mortgage
banking activities.
o General economic or business conditions, either nationally or in the
regions in which National Penn will be doing business, may be less
favorable than expected, resulting in, among other things, a
deterioration in credit quality or a reduced demand for credit,
including the resultant effect on National Penn's loan portfolio and
allowance for loan losses.
o Expected synergies and cost savings from mergers and acquisitions may
not be fully realized or realized as quickly as expected.
o Revenues and loan growth following mergers and acquisitions, may be
lower than expected.
o Loan losses, deposit attrition, operating costs, customer and key
employee losses, and business disruption following mergers and
acquisitions may be greater than expected.
o Business opportunities and strategies potentially available to
National Penn after mergers and acquisitions may not be successfully
or fully acted upon.
o Costs, difficulties or delays related to the integration of businesses
of acquired companies with National Penn's business may be greater or
take longer than expected.
o Technological changes may be harder to make or more expensive than
expected or present unanticipated operational issues.
o Recent and proposed legislative or regulatory changes, including
changes in accounting rules and practices, and customer privacy and
data protection requirements, and intensified regulatory scrutiny of
the financial services industry in general, may adversely affect
National Penn's costs and business.
o Market volatility may continue in the securities markets, with an
adverse effect on National Penn's securities and asset management
activities.
o There may be unanticipated regulatory rulings or developments.
o Changes in consumer spending and savings habits could adversely affect
National Penn's business.
o Negative publicity with respect to any National Penn product or
service, whether legally justified or not, could adversely affect
National Penn's reputation and business.
o Various domestic or international military or terrorist activities or
conflicts may have a negative impact on National Penn's business as
well as the foregoing and other risks.
o National Penn may be unable to successfully manage the foregoing and
other risks and to achieve its current short-term and long-term
business plans and objectives.
Because such statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by such
statements. National Penn cautions shareholders not to place undue reliance on
such statements.
All written or oral forward-looking statements attributable to National
Penn or any person acting on its behalf made after the date of this Report are
expressly qualified in their entirety by the cautionary statements contained in
this Report. National Penn does not undertake any obligation to release publicly
any revisions to such
19
forward-looking statements to reflect events or circumstances after the date of
this Report or to reflect the occurrence of unanticipated events.
Statistical Disclosures - Management's Discussion and Analysis
- --------------------------------------------------------------
The following statistical disclosures are included in Item 7 of this
Report, Management's Discussion and Analysis of Financial Condition and Results
of Operations, and are incorporated by reference in this Item 1:
o Interest Rate Sensitivity Analysis.
o Interest Income and Expense, Volume and Rate Analysis.
o Average Balances, Average Rates, and Interest Rate Spread.
o Investment Portfolio.
o Loan Maturity and Interest Rate Sensitivity.
o Loan Portfolio.
o Risk Elements - Loans.
o Allowance for Loan Losses.
o Deposits.
o Short-Term Borrowings.
o Return on Equity and Assets; Dividend Payout Ratio.
Item 2. PROPERTIES.
- --------------------
National Penn does not own or lease any property. As of December 31,
2003, National Penn Bank owns 45 properties in fee and leases 42 other
properties; and National Penn's other direct and indirect subsidiaries lease 5
properties. The properties owned in fee are not subject to any major liens,
encumbrances, or collateral assignments.
The principal office of National Penn and National Penn Bank is owned in
fee and located at Philadelphia and Reading Avenues, Boyertown, Pennsylvania
19512.
National Penn Bank presently has 66 community offices located in the
following Pennsylvania counties: Berks, Bucks, Chester, Delaware, Lancaster,
Lehigh, Montgomery, Northampton, and Philadelphia. In addition to these offices,
National Penn Bank presently owns or leases 64 automated teller machines located
throughout the nine-county area, all of which are located at bank office
locations except for 9 that are "free-standing" (not located at an office).
Item 3. LEGAL PROCEEDINGS.
- ---------------------------
Various actions and proceedings are presently pending to which
National Penn or one or more of its subsidiaries is a party. These actions and
proceedings arise out of routine operations and, in management's opinion, will
not have a material adverse effect on National Penn's consolidated financial
position.
20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- -------------------------------------------------------------
None.
Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
- -----------------------------------------------
The principal executive officers of National Penn are as follows:
Principal Business Occupation
Name Age During the Past Five Years
- ---- --- ----------------------------------------
Wayne R. Weidner 61 Chairman and Chief Executive Officer of National Penn.
Chairman, President and Chief Executive Officer of National Penn from
January 2002 until December 2003. President and Chief Executive
Officer of National Penn in 2001, and President from 1998 to 2000.
Also, Chairman of National Penn Bank.
Glenn E. Moyer 53 President of National Penn and Chief Executive Officer of National Penn Bank since
December 2003. Executive Vice President of National Penn since April 2001 and President and
Chief Operating Officer of National Penn Bank since January 2001. Executive Vice President
and Chief Lending Officer of National Penn Bank and President of National Penn Bank's
Elverson Division from January 1999 to January 2001. Prior to that, he was President, Chief
Executive Officer and a director of Elverson National Bank.
Bruce G. Kilroy 54 Group Executive Vice President and Chief Delivery Officer of National Penn Bank since
January 2001. President of National Penn Bank's Lehigh Valley Division from February 1997 to
January 2001.
Garry D. Koch 49 Group Executive Vice President and Chief Credit Officer of National Penn Bank since
January 2001. Executive Vice President of National Penn Bank from September 1997 to January
2001.
Paul W. McGloin 56 Group Executive Vice President and Chief Lending Officer of National Penn Bank since
January 2002. Executive Vice President of National Penn Bank from March 2001 to January 2002.
President of National Penn Bank's Main Line/Chestnut Hill/Philadelphia Division since March
2001. Prior thereto, Managing Director, Capital Markets, of First Union National Bank.
Sharon L. Weaver 56 Group Executive Vice President, Human Resources/Branch Administration/Retail
Banking/Marketing of National Penn Bank since January 2001. Executive Vice
President of National Penn Bank from April 1998 to January 2001.
Sandra L. Spayd 60 Secretary and Corporate Governance Officer of National Penn. Group Executive Vice
President and Corporate Secretary of National Penn Bank since January 2004. Executive Vice
President and Corporate Secretary of National Penn Bank from January 2002 to January 2004.
Senior Vice President and Corporate Secretary of National Penn Bank prior to January 2002.
21
Gary L. Rhoads 49 Treasurer and Chief Financial Officer of National Penn. Group Executive Vice President and
Chief Financial Officer of National Penn Bank since January 2001. Executive Vice President,
Controller and Cashier of National Penn Bank prior to January 2001.
Michael R. Reinhard 46 Group Executive Vice President of National Penn Bank since January 2004. Executive Vice
President of National Penn Bank from January 2002 to January 2004. Senior Vice President of
National Penn Bank prior to January 2002.
Executive officers of National Penn are elected by the Board of
Directors and serve at the pleasure of the Board. Executive Officers of National
Penn Bank are appointed by the Board of Directors of National Penn Bank and
serve until they resign, retire, become disqualified, or are removed by the
Board.
22
PART II
-------
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- -------------------------------------------------------------------------
MATTERS.
--------
National Penn's common stock currently trades on the Nasdaq National
Market tier of The Nasdaq Stock Market under the symbol: "NPBC".
The following table reflects the high and low closing sale prices
reported for National Penn's common stock, and the cash dividends declared on
National Penn's common stock, for the periods indicated, after giving
retroactive effect to a 5% stock dividend paid on September 30, 2003 and
December 27, 2002.
MARKET VALUE OF COMMON STOCK
2003
------------------
High Low
---- ----
lst Quarter $26.03 $22.13
2nd Quarter 28.89 26.10
3rd Quarter 29.66 25.76
4th Quarter 34.20 28.10
2002
------------------
High Low
---- ----
lst Quarter $22.29 $20.10
2nd Quarter 25.40 22.04
3rd Quarter 26.00 21.00
4th Quarter 26.02 20.76
CASH DIVIDENDS DECLARED ON COMMON STOCK
2003 2002
---- ----
1st Quarter $.21 $.20
2nd Quarter .22 .20
3rd Quarter .22 .20
4th Quarter .24 .21
The Trust Preferred Securities of NPB Capital Trust II are reported on
Nasdaq's National Market under the symbol "NPBCO". These securities have a par
value of $25 and the preferred dividend is 7.85%.
23
Item 6. SELECTED FINANCIAL DATA
Five-Year Statistical Summary
- -----------------------------
(Dollars in thousands, except per share data)
Year Ended 2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
BALANCE SHEET (1)
Total assets $3,512,574 $2,858,262 $2,727,482 $2,615,447 $2,351,968
Total deposits 2,435,296 1,925,964 1,931,350 1,801,797 1,683,850
Loans and leases, net (2) 2,221,434 1,744,829 1,736,370 1,725,100 1,622,140
Total investment securities 934,375 650,930 597,687 563,980 529,411
Total shareholders' equity 317,813 222,360 195,682 183,216 154,938
Book value per share (3) 13.09 10.23 8.91 8.34 7.08
Percent shareholders' equity to assets 9.05% 7.78% 7.17% 7.01% 6.59%
Trust and other assets under management 1,038,756 778,246 843,755 905,682 834,585
EARNINGS (1), (4)
Total interest income $165,648 $163,178 $180,748 $188,588 $172,223
Total interest expense 51,099 61,098 90,330 102,326 86,765
---------- ---------- ---------- ---------- ----------
Net interest income 114,549 102,080 90,418 86,262 85,458
Provision for loan and lease losses 9,371 13,585 8,450 7,310 6,570
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for loan and lease losses 105,178 88,495 81,968 78,952 78,888
Other income 41,285 36,550 32,186 26,603 24,037
Other expenses 103,033 82,268 74,433 73,088 69,458
---------- ---------- ---------- ---------- ----------
Income before income taxes 43,430 42,777 39,721 32,467 33,467
Income taxes 8,697 8,603 7,756 5,236 5,816
---------- ---------- ---------- ---------- ----------
Net income from continuing operations 34,733 34,174 31,965 27,231 27,651
Net income from discontinued operations 8,621 2,060 769 557 -
---------- ---------- ---------- ---------- ----------
Net income $43,354 $36,234 $32,734 $27,788 $27,651
========== ========== ========== ========== ==========
Cash dividends paid $21,234 $17,664 $16,519 $14,538 $13,595
Dividend payout ratio 48.98% 48.75% 50.46% 52.32% 49.17%
Return on average assets 1.34% 1.30% 1.25% 1.13% 1.21%
Return on average shareholders' equity 16.2% 17.4% 16.8% 17.3% 17.2%
PER SHARE DATA (3)
Basic earnings $1.82 $1.66 $1.49 $1.27 $1.26
Diluted earnings $1.78 $1.64 $1.47 $1.26 $1.24
Dividends paid in cash 0.89 0.81 0.75 0.67 0.62
Dividends paid in stock 5% 5% 3% 5% 5%
SHAREHOLDERS AND STAFF
Average shares outstanding - basic* 23,813,291 21,816,702 22,033,623 21,849,503 21,963,159
Average shares outstanding - diluted* 24,411,023 22,102,969 22,295,826 22,085,583 22,302,066
Shareholders 3,684 3,346 3,338 3,115 3,110
Staff--Full-time equivalents 940 840 783 786 715
<FN>
(1) Balances have been restated for the sale of Panasia Bank, N.A. which
is being presented as discontinued operations.
(2) Includes loans held for sale
(3) Restated to reflect a 5% stock dividend in 2003 and 2002, 3% stock
dividend in 2001, and a 5% stock dividend in 2000 and 1999
(4) Results of operations are included for the FirstService Bank
acquisition for the period February 25, 2003 through December 31, 2003
and HomeTowne Heritage Bank for the period December 12, 2003 through
December 31, 2003.
</FN>
24
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -----------------------------------------------------------------------
RESULTS OF OPERATIONS.
- ----------------------
The following discussion and analysis is intended to assist in
understanding and evaluating the major changes in the earnings performance and
financial condition of the Company with a primary focus on an analysis of
operating results. Current performance does not guarantee and may not be
indicative of similar performance in the future. The following discussion and
analysis should be read in conjunction with the Company's consolidated financial
statements.
The Company's strategic plan provides for a highly profitable financial
services company within the markets it serves. Specifically, management is
focused on increased market penetration in selected geographic areas, and
achieving excellence in both retail and commercial lines of business. The
acquisitions of FirstService Bank in first quarter 2003 and HomeTowne Heritage
Bank in fourth quarter 2003, the sale of Panasia Bank, N.A. in third quarter
2003, and the pending acquisition of Peoples First, Inc. and its subsidiary, The
Peoples Bank of Oxford in the second quarter 2004, represent strategic
initiatives by the Company in furtherance of its focused goals.
The financial information presented in this Management's Discussion and
Analysis has been restated as a result of the sale of Panasia which is presented
as discontinued operations under SFAS No. 144. The financial results exclude
Panasia in the current year, and in 2002, 2001, and 2000. This presentation is
intended to aid comparison of current year results with future results.
The current economic climate and interest rate environment present
challenges for all financial institutions in achieving their business goals.
During this low interest rate environment, the Company pursued strategic balance
sheet opportunities. In September 2003, the Company:
o Refinanced $77.5 million in long-term Federal Home Loan Bank (FHLB)
borrowings, incurring a prepayment fee of $4.6 million after taxes of
$2.4 million, under the terms of the FHLB borrowing agreements. The
Company lowered interest expense associated with borrowings from the
Federal Home Loan Bank by 191 basis points and will enjoy lower
borrowing costs for the next six years as a result of this
transaction.
o Sold approximately $35 million in investment securities available for
sale resulting in an after tax loss of $240,000. This transaction
allowed NPBC to re-deploy those funds into higher yielding
investments.
In addition to historical information, this Form 10-K contains
forward-looking statements. Forward-looking statements in this document are
subject to risks and uncertainty. Forward-looking statements include information
concerning possible or assumed future results of operations by the Company. When
we use words such as "believe", "expect", "anticipate", or similar expressions,
we are making forward-looking statements. Additional information concerning
forward-looking statements is contained in this Form 10-K at Item 1. Business
under the caption "Forward Looking Statements," which information is
incorporated by reference into this Management's Discussion and Analysis.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
-----------------------------------------------------
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
predominant practice within the banking industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and
25
other relevant factors. However, this evaluation is inherently subjective as it
requires material estimates, including, among others, expected default
probabilities, loss given default, expected commitment usage, the amounts and
timing of expected future cash flows on impaired loans, mortgages, and general
amounts for historical loss experience. The process also considers economic
conditions, uncertainties in estimating losses and inherent risks in the loan
portfolio. All of these factors may be susceptible to significant change. To the
extent actual outcomes differ from management estimates, additional provisions
for loan losses may be required that would adversely impact earnings in future
periods.
With the adoption of SFAS No. 142 on January 1, 2002, the Company
discontinued the amortization of goodwill resulting from acquisitions. Goodwill
is now subject to impairment testing at least annually to determine whether
write-downs of the recorded balances are necessary. The Company tests for
impairment based on the goodwill maintained at each defined reporting unit. A
fair value is determined for each reporting unit based on at least one of three
various market valuation methodologies. If the fair values of the reporting
units exceed their book values, no write-down of recorded goodwill is necessary.
If the fair value of a reporting unit is less, an expense may be required on the
Company's books to write down the related goodwill to the proper carrying value.
As of June 30, 2003, the Company completed its testing which determined that no
impairment write-offs were necessary. No other events occurred since the annual
test completed June 30, 2003 to require additional impairment tests during 2003.
No assurance can be given that future goodwill impairment tests will not result
in a charge to earnings.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
FINANCIAL CONDITION
-------------------
The Company completed the cash sale of its subsidiary Panasia Bank,
N.A., for $34.5 million on September 11, 2003. This transaction is presented in
the financial statements as discontinued operations. The sale resulted in a gain
of $6.68 million after taxes of $1.8 million. At the time of the sale, Panasia
had total assets of $213.5 million, net loans of $99.7 million, and marketable
securities of $84.4 million. Panasia's deposits totaled $188.2 million; it had
no other borrowings. Panasia's total equity was $24.4 million. Net income from
discontinued operations, net of income tax expense of $2.7 million for the year
ended December 31, 2003 was $8.6 million.
The financial information presented in this Management's Discussion and
Analysis has been restated as a result of the sale of Panasia which is presented
as discontinued operations under SFAS No. 144. The financial results exclude
Panasia in the current year, and in 2002, 2001, and 2000. This presentation is
intended to aid comparison of current year results with future results.
At December 31, 2003, total assets were $3.513 billion, an increase of
$654.3 million or 22.9% from the $2.858 billion at December 31, 2002. The
increase in total assets excluding Panasia's assets of $207.3 million at
December 31, 2002 was $861.6 million. The increase in assets in 2003 is
reflected primarily in the loan category, the investment category and the
goodwill and other intangibles category, which increased $476.6 million, $283.4
million and $102.3 million, respectively. The increase in assets as of December
31, 2003 is primarily due to the acquisition of FirstService Bank on February
25, 2003 and HomeTowne Heritage Bank on December 12, 2003, which had $367.1
million and $165.8 million in assets, respectively, at time of acquisition.
Total assets at the end of 2002 increased $130.8 million or 4.6% over the $2.727
billion at year-end 2001.
LOAN PORTFOLIO
- --------------
Net loans and leases, including loans held for sale, increased to $2.221
billion during 2003, an increase of $476.6 million or 27.3% compared to 2002.
Net loans increased $8.5 million in 2002 or .48% compared to 2001. The Company
gained $219.2 million in net loans due to the addition of FirstService Bank and
$154.6 million in net loans from the addition of HomeTowne Heritage Bank. The
Company sold $17.3 million in manufactured housing loans in April 2003
(substantially all such loans, which the Company had ceased originating in 2000)
and securitized approximately $123.8 million in residential mortgages into
mortgage-backed securities in second and fourth quarters 2003. The Company does
not retain the servicing on loans sold. Adjusting for these transactions, core
loan growth
26
was 14.0% for the year ended December 31, 2003. Loans continue to increase at a
modest pace as a result of the overall slow economy and the lack of capital
goods spending by the Company's business customers. Residential mortgages
originated for immediate resale during the year ended December 31, 2003 amounted
to $224.6 million. The Company has $29.3 million in loans held for sale at
December 31, 2003. At December 31, 2003 the Company had no significant exposure
to energy and agricultural-related loans.
The Company's loans are widely diversified by borrower, industry group,
and geographical area in southeastern Pennsylvania. The following summary shows
the year-end composition of the Company's loan portfolio:
December 31,
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
(In thousands) ---- ---- ---- ---- ----
Commercial and Industrial Loans and
Leases $482,884 $355,977 $343,001 $308,179 $275,815
Real Estate Loans:
Construction and Land Dev. 149,531 122,129 128,655 151,364 136,227
Residential 754,977 677,559 650,136 673,807 698,403
Other (nonfarm, nonresidential) 828,843 574,443 575,747 552,279 482,018
Loans to Individuals 54,464 55,299 79,280 77,195 65,028
---------- ---------- ---------- ---------- ----------
Total $2,270,699 $1,785,407 $1,776,819 $1,762,824 $1,657,491
========== ========== ========== ========== ==========
Maturities and sensitivity to changes in interest rates in certain loan
categories in the Company's loan portfolio at December 31, 2003, are summarized
below:
After One Year
One year or Less* to Five Years After Five Years Total
-------------------- ------------------ ------------------ ------------
(In thousands)
Commercial and Industrial Loans
and Leases $289,334 $112,053 $81,497 $482,884
Construction and Land Dev. 65,301 72,279 11,951 149,531
-------- -------- ------- --------
$354,635 $184,332 $93,448 $632,415
======== ======== ======= ========
* Demand loans, past-due loan and overdrafts are reported in "One Year or
Less." An immaterial amount of loans have no stated schedule of repayments.
Loan balances segregated in terms of sensitivity to changes in interest
rates at December 31, 2003, are summarized below:
After One Year to Five Years After Five Years
(In thousands) ---------------------------- ----------------
Predetermined Interest Rate $120,579 $82,211
Floating Interest Rate 63,753 11,237
-------- -------
Total $184,332 $93,448
======== =======
Determinations of maturities included in the loan maturity table are
based upon contract terms. In situations where a renewal is appropriate, the
Company's policy in this regard is to evaluate the credit for collectibility
consistent with the normal loan evaluation process. This policy is used
primarily in evaluating ongoing customers' use of their lines of credit that are
at floating interest rates. The Company's outstanding lines of credit to
customers total $366.1 million.
27
RISK ELEMENTS - LOANS
- ----------------------
A loan is placed in a nonaccrual status at the time when ultimate
collectibility of principal or interest, wholly or partially, is in doubt. Past
due loans are those loans which were contractually past due 90 days or more as
to interest or principal payments but are well secured and in the process of
collection. Restructured loans are those loans which terms have been
renegotiated to provide a reduction or deferral of principal or interest as a
result of the deteriorating financial position of the borrower.
December 31,
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Nonaccrual Loans $13,673 $14,046 $14,234 $10,523 $13,505
Loans Past Due 90 or More Days as
to Interest or Principal 318 928 11,582 3,019 3,258
------- ------- ------- ------- -------
Total Nonperforming Loans 13,991 14,974 25,816 13,542 16,763
Other Real Estate Owned 735 318 1,013 1,485 890
------- ------- ------- ------- -------
Total Nonperforming Assets $14,726 $15,292 $26,829 $15,027 $17,653
======= ======= ======= ======= =======
Gross Amount of Interest That
Would Have Been Recorded at
Original Rate on Nonaccrual
and Restructured Loans $449 $709 $1,547 $1,272 $864
------- ------- ------- ------- -------
Interest Received From
Customers on Nonaccrual and
Restructured Loans 613 463 424 1,152 439
------- ------- ------- ------- -------
Net Impact on Interest
Income of Nonperforming
Loans ($164) $246 $1,123 $120 $425
======= ======= ======= ======= =======
Nonperforming assets, including nonaccruals, loans 90 days past due,
restructured loans and other real estate owned, were $14.7 million at December
31, 2003, compared to $15.3 million at December 31, 2002, with a decrease in the
loans 90 days past due and still accruing category. Nonaccrual loans represented
$13.7 million and $14.0 million at December 31, 2003, and December 31, 2002,
respectively. Loans 90 days past due and still accruing interest were $318,000
and $928,000 at December 31, 2003 and December 31, 2002, respectively.
Additional discussion regarding this issue is set forth in the paragraph of this
Item 7 titled "Allowance for Loan Losses" on page 38.
Other real estate owned was $735,000 at December 31, 2003 and $318,000
at December 31, 2002, respectively. Other real estate owned in 2003 was more
typical of historical results. The Company had no restructured loans at December
31, 2003 or December 31, 2002. The allowance for loan losses to nonperforming
assets was 334.5% and 265.4% at December 31, 2003 and December 31, 2002,
respectively, with the increase in 2003 due to the decreased level of
nonperforming assets discussed above. Another measure of the Company's credit
quality is reflected by the ratio of net chargeoffs to total loans of 0.34% for
2003 versus 0.74% for the year 2002, and the ratio of nonperforming assets to
total loans of .65% at December 31, 2003, compared to .74% at December 31, 2002.
Net loan chargeoffs of $6.8 million during 2003 was typical compared to
historical Company results and peer averages. Of the $6.8 million in net
chargeoffs, $3.6 million were commercial and industrial loans.
The Company has not engaged in any transactions with entities
established and operated by former members of senior management or individuals
with former management relationships with the Company.
28
INVESTMENT PORTFOLIO
- --------------------
Investments, which are the Company's secondary use of funds, increased
$283.4 million or 43.5% to $934.4 million at year-end 2003. This increase was
partially offset by investment sales, calls and maturities of $135.6 million and
the amortization of mortgage-backed securities. The increase in 2003 is due to
three factors; investment purchases of $431.9 million primarily in
mortgage-backed securities and municipals, which included the securitization of
approximately $123.8 million of conforming residential loans through Federal
Home Loan Mortgage Corporation during the second and fourth quarters, and the
additional of FirstService Bank's investment portfolio of $105.0 million on
February 23, 2003. HomeTowne's investment portfolio totaled $2.3 million at the
time of the acquisition. The residential mortgage securitizations resulted in
the transfer of assets from the Company's loan portfolio to the investment
portfolio where they are now held in the form of a mortgage-backed security. The
purpose of these transactions was to provide greater liquidity for the loans as
they are more readily saleable in the form of a security, as well as to provide
collateral for the Company's cash management and municipal deposit programs. In
2002, the investment portfolio reflected an increase of $53.2 million or 8.9%
compared to 2001. The increase in 2002 was due to the addition of $221.2 million
primarily in mortgage-backed securities, which were partially offset by calls
and maturities of securities, investment securities sales and payments on
mortgage-backed securities.
A summary of investment securities available for sale at December 31, 2003, 2002
and 2001 follows (in thousands):
2003 2002 2001
------------------------ ------------------------- --------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
------------ --------- ------------ ---------- -------------- ---------
US Treasuries and Agencies $111,183 $114,792 $ 37,826 $ 41,864 $ 46,141 $ 48,844
State and Municipal 259,623 277,807 248,819 259,673 244,439 242,411
Mortgage-backed securities 480,803 484,746 292,552 301,225 261,232 264,311
Marketable equity secs. & other 53,781 57,030 47,661 48,168 41,099 42,121
-------- -------- -------- -------- -------- --------
Total $905,390 $934,375 $626,858 $650,930 $592,911 $597,687
======== ======== ======== ======== ======== ========
The maturity distribution and weighted average yield of the investment
portfolio of the Company at December 31, 2003 are presented in the following
table. Weighted average yields on tax-exempt obligations have been computed on a
fully taxable equivalent basis assuming a tax rate of 35%. All average yields
were calculated on the book value of the related securities. Stocks and other
securities having no stated maturity have been included in the "After 10 Years"
category.
After 1 But After 5 But
(Dollars in thousands) Within 1 Year Within 5 Yrs Within 10 Yrs After 10 Yrs Total
------------- ------------ ------------- ------------ ------------
Amt Yld Amt Yld Amt Yld Amt Yld Amt Yld
--- --- --- --- --- --- --- --- --- ---
US Treasury and Agencies $4,091 5.17% $88,572 3.96% $22,129 6.53% -- --% $114,792 4.50%
State and Municipal 1,322 8.39% 24,177 5.61% 46,079 6.93% 206,229 8.00% 277,807 7.62%
Mortgage-backed securities 50 6.26% 166,086 3.33% 133,503 4.07% 185,107 4.86% 484,746 4.12%
Marketable equity secs. and
other 304 --% 1,993 --% --- --% 54,733 --% 57,030 --%
------ ---- -------- ---- -------- ---- -------- ---- -------- ----
Total $5,767 5.97% $280,828 3.73% $201,711 4.99% $446,069 6.76% $934,375 5.46%
====== ==== ======== ==== ======== ==== ======== ==== ======== ====
OTHER ASSETS
- ------------
Other assets, which is comprised of premises and equipment, accrued
interest receivable, bank owned life insurance policies and all other assets
increased to $258.4 million, an increase of $127.3 million compared to the
$131.1 million at December 31, 2002. Goodwill and other intangibles accounted
for $102.2 million in the increase, premises and equipment increased $15.2
million due to the FirstService and HomeTowne Heritage Bank acquisitions, as
well as de novo branches, and bank owned life insurance increased $11.6 million,
due to the acquisitions and the increased cash surrender value of the insurance
policies held by NPB. In 2002, other assets decreased $1.7 million or 1.3%
compared to 2001.
In 1998 and 1999, the Company invested in bank owned life insurance
(BOLI) policies that provide earnings to help cover the cost of employee benefit
plans. BOLI involves the purchasing of life insurance by the Company on
29
a chosen group of employees. The Company is the owner and beneficiary of the
policies. The Company has additional BOLI policies that have been received
through several of its bank acquisitions. Cashflow from these policies will
occur over an extended period of time. The Company periodically reviews the
creditworthiness of the insurance companies that have underwritten the policies.
The insurance companies are all highly rated by A.M. Best, and the earnings
accruing to the Company are derived from the general account investments of the
insurance companies. The policies appear on the Company's balance sheet and are
subject to full regulatory capital requirements.
DEPOSITS
- --------
As the primary source of funds, aggregate deposits of $2.435 billion
increased $509.3 million or 26.5% compared to 2002. The increase is due to the
additions of FirstService deposits of $288.9 million and HomeTowne deposits of
$134.4 million and growth of $86.0 million. Non-interest bearing deposits
increased $90.3 million and interest bearing deposits increased $419.0 million.
Deposits of $1.926 billion decreased $5.4 million in 2002 or 0.28% compared to
2001.
The following is a distribution of the average amount of, and the
average rate paid on, the Company's deposits for each year in the three-year
period ended December 31, 2003 (in thousands):
Year Ended December 31,
----------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------ ------------------------
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
Non-interest bearing
Demand deposits $ 344,911 --% $ 270,038 --% $ 248,707 --%
Savings deposits 1,185,821 0.93% 835,032 1.16% 686,480 2.27%
Time deposits 713,874 3.18% 804,999 4.05% 902,425 5.77%
---------- ---- ---------- ---- ---------- -----
Total $2,244,606 1.63% $1,910,069 2.58% $1,837,612 3.81%
========== ==== ========== ==== ========== =====
The aggregate amount of jumbo certificates of deposits, issued in the
amount of $100,000 or more was $137,965,000 in 2003, $169,385,000 in 2002 and
$241,520,000 in 2001.
The following is a breakdown, by maturities, of the Company's time
certificates of deposit of $100,000 or more as of December 31, 2003. The company
has no other time deposits of $100,000 or more as of December 31, 2003 (in
thousands).
Maturity
--------
3 months or less $ 24,864
Over 3 through 6 months 46,969
Over 6 months through 12 months 53,960
Over 12 months 12,172
------
Total $137,965
=========
In addition to deposits, earning assets are funded to some extent
through purchased funds and borrowings. These include securities sold under
repurchase agreements, federal funds purchased, short-term borrowings, long-term
borrowings, and subordinated debentures. In the aggregate, these funds totaled
$737.3 million at the end of 2003, a $241.7 million or 48.8% increase compared
to 2002, primarily due to the decreased level of funding from time deposits. The
2002 amount of borrowings and purchased funds of $495.7 million represented a
increase of $67.2 million or 15.7% compared to 2001.
30
At or for the year ended December 31,
-------------------------------------------------------
2003 2002 2001
Securities sold under repurchase agreements and federal ---- ---- ----
funds purchased
Balance at year-end $500,038 $252,086 $238,726
Average during the year 324,492 237,401 251,583
Maximum month-end balance 500,038 272,322 300,532
Weighted average during the year 1.22% 1.94% 4.10%
Rate at December 31 1.08% 1.25% 2.02%
Short-term borrowings
Balance at year-end $10,000 $10,614 $9,480
Average during the year 5,179 7,146 7,235
Maximum month-end balance 10,045 10,614 10,012
Weighted average rate during the year 0.77% 1.46% 3.65%
Rate at December 31 0.59% 0.78% 1.52%
(This space intentionally left blank)
31
Average Balances, Average Rates, and Interest Rate Spread*
- ----------------------------------------------------------
(Dollars in thousands)
Year Ended December 31,
2003 2002 2001
---------------------------- --------------------------- --------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST EARNING ASSETS:
- ------------------------------------------------------------------------------------------------------------------------------------
Interest bearing deposits
at banks $4,179 $60 1.44% $3,297 $72 2.18% $8,726 $529 6.06%
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury 721 50 6.93 10,332 875 8.47 22,634 1,580 6.98
U.S. Government agencies 430,225 19,044 4.43 345,151 20,115 5.83 278,052 17,744 6.38
State and municipal* 266,259 19,829 7.45 251,413 18,875 7.51 235,649 17,873 7.58
Other bonds and securities 71,345 3,415 4.79 45,905 3,051 6.65 47,988 3,802 7.92
- ------------------------------------------------------------------------------------------------------------------------------------
Total investments 768,550 42,338 5.51 652,801 42,916 6.57 584,323 40,999 7.02
- ------------------------------------------------------------------------------------------------------------------------------------
Federal funds sold 44,320 492 1.11 53,178 822 1.55 5,466 177 3.24
- ------------------------------------------------------------------------------------------------------------------------------------
Trading account securities - - - - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial loans and lease
financing* 1,536,739 97,782 6.36 1,279,792 91,394 7.14 1,246,798 104,282 8.36
Installment loans 245,451 16,677 6.79 263,384 20,727 7.87 302,068 25,685 8.50
Mortgage loans 254,657 16,349 6.42 210,943 15,003 7.11 210,969 16,533 7.84
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans and leases 2,036,847 130,808 6.42 1,754,119 127,124 7.25 1,759,835 146,500 8.32
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 2,853,896 $173,698 6.09% 2,463,395 $170,934 6.94% 2,358,350 $188,205 7.98%
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance for loan and lease losses (45,494) (41,048) (38,647)
Non-interest earning assets 280,319 191,328 177,161
Assets from discontnued operations 144,427 178,381 127,405
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets 3,233,148 $2,792,056 $2,624,269
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST BEARING LIABILITIES:
- ------------------------------------------------------------------------------------------------------------------------------------
Interest bearing deposits $1,899,695 $33,753 1.78% $1,640,031 $42,223 2.57% $1,588,905 $67,514 4.25%
Securities sold under repurchase
agreements and federal funds
purchased 324,492 3,964 1.22 237,401 4,599 1.94 251,583 10,311 4.10
Short-term borrowings 5,179 40 0.77 7,146 104 1.46 7,235 264 3.65
Long-term borrowings 232,169 13,342 5.75 238,439 14,172 5.94 184,418 12,241 6.64
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 2,461,535 $51,099 2.08% 2,123,017 $61,098 2.88% 2,032,141 $90,330 4.45%
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest bearing deposits 344,911 270,038 248,707
Other non-interest bearing liabilities 28,723 24,021 25,331
Liabilities from discontinued operations 130,392 166,278 122,873
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 2,965,561 2,583,354 2,429,052
Equity capital 267,587 208,702 195,217
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity capital $3,233,148 $2,792,056 $2,624,269
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST RATE MARGIN** $122,599 4.30% $109,836 4.46% $97,875 4.15%
Tax equivalent interest 8,050 0.28% 7,756 0.31% 7,457 0.32%
-------- -------- --------
Net interest income $114,549 4.01% $102,080 4.14% $90,418 3.83%
======== ======== ========
* Full taxable equivalent basis, using a 35% effective tax rate.
** Represents the difference between interest earned and interest paid,
divided by total earning assets. Loan outstandings, net of unearned income,
include non-accruing loans. Fee income included.
32
RESULTS OF OPERATIONS
---------------------
The financial information presented in this Management's Discussion and
Analysis has been restated as a result of the sale of Panasia which is presented
as discontinued operations under SFAS No. 144. The financial results exclude
Panasia in the current year, and in 2002, 2001, and 2000. This presentation is
intended to aid comparison of current year results with future results.
The Company recorded a 19.7% net income increase in the year ended
December 31, 2003, compared with the year ended December 31, 2002. Diluted
earnings per share increased $.14 or 8.5% for the year ended December 31, 2003
to $1.78 per share from $1.64 in the year ended December 31, 2002 and $1.47 in
the year ended December 31, 2001. The difference in the change in the percentage
increase in net income when compared to the percentage increase in diluted
earnings per share is due to the larger number of weighted average common shares
outstanding, principally resulting in the issuance of 2,563,552 shares of
commons stock for the acquisition of FirstService Bank which was completed on
February 25, 2003. Net income for 2002 of $36.2 million was 10.7% more than the
$32.7 million reported in 2001. On a per share basis, basic earnings were $1.82,
$1.66 and $1.49 for 2003, 2002, and 2001, respectively.
For the year ended December 31, 2003, the return on average
shareholders' equity and return on average assets were 16.2% and 1.34% compared
to 17.4% and 1.30% for 2002. The decrease in return on shareholders' equity in
2003 is due to the increase in weighted average common shares outstanding.
Net interest income is the difference between interest income on assets
and interest expense on liabilities. Net interest income increased $12.4 million
or 12.2% to $114.5 million in 2003 from the 2002 amount of $102.1 million.
Interest income increased $2.5 million as a result of increased loan income of
$3.6 million offset by an decrease in investment income and income from federal
funds sold and deposits in banks of $805,000 and $342,000 respectively. Interest
expense decreased $10.0 million or 16.4% to $51.1 million in 2003 from the 2002
amount of $61.1 million due to a decrease of $8.5 million in interest on
deposits and a decrease of $1.5 million in interest on borrowed funds. Despite
the current low rate environment, the cost of attracting and holding deposited
funds is an ever-increasing expense in the banking industry. These increases are
the real costs of deposit accumulation and retention, including FDIC insurance
costs, marketing and branch overhead expenses. Such costs are necessary for
continued growth and to maintain and increase market share of available
deposits. The Company's interest rate margin decreased slightly from 4.46% in
2002 to 4.30% in 2003 due to the historically low interest rate environment. The
pricing of liabilities is near a floor; however, assets continue to reprice at
these low interest rate levels.
33
The following table shows, on a taxable equivalent basis, the changes in
the Company's net interest income, by category, due to shifts in volume and
rate, for the years ended December 31, 2003 and 2002. The information is
presented on a taxable equivalent basis, using an effective tax rate of 35% (in
thousands).
Year Ended December 31,
----------------------------------------------------------------------
2003 over 2002 (1) 2002 over 2001 (1)
------------------ ------------------
Increase (decrease) in: Volume Rate Total Volume Rate Total
-------- -------- -------- -------- -------- --------
Interest income:
Interest bearing deposits at banks $ 19 ($ 31) ($ 12) ($ 329) ($ 128) ($ 457)
Securities:
US Treasury and Agencies 4,456 (6,352) (1,896) 3,522 (1,856) 1,666
State and municipal 1,115 (161) 954 1,196 (194) 1,002
Other bonds and securities 1,691 (1,327) 364 (165) (586) (751)
-------- -------- -------- -------- -------- --------
Total investment securities 7,262 (7,840) (578) 4,553 (2,636) 1,917
-------- -------- -------- -------- -------- --------
Federal funds sold (137) (193) (330) 1,545 (900) 645
Loans:
Comml loans and lease financing 18,349 (11,961) 6,388 2,760 (15,648) (12,888)
Installment loans (1,411) (2,639) (4,050) (3,289) (1,669) (4,958)
Mortgage loans 3,109 (1,763) 1,346 (2) (1,528) (1,530)
-------- -------- -------- -------- -------- --------
(1,528)
Total loans 20,047 (16,363) 3,684 (531) (18,845) (19,376)
-------- -------- -------- -------- -------- --------
Total interest income $ 27,191 ($24,427) $ 2,764 $ 5,238 ($22,509) ($17,271)
======== ======== ======== ======== ======== ========
Interest expense:
Interest bearing deposits 6,685 (15,155) (8,470) 2,172 (27,463) (25,291)
Securities sold under repurchase
agreements and federal funds
purchased 1,687 (2,322) (635) (581) (5,131) (5,712)
Short-term borrowings (29) (35) (64) (3) (157) (160)
Long-term borrowings (373) (457) (830) 3,586 (1,655) 1,931
-------- -------- -------- -------- -------- --------
(1,655)
Total borrowed funds 1,285 (2,814) (1,529) 3,002 (6,943) (3,941)
-------- -------- -------- -------- -------- --------
Total interest expense $ 7,970 ($17,969) ($ 9,999) $ 5,174 ($34,406) ($29,232)
======== ======== ======== ======== ======== ========
Increase (decrease) in net interest
income $ 19,221 $ (6,458) $ 12,763 $ 64 $ 11,897 $ 11,961
======== ======== ======== ======== ======== ========
- -------------------------------
(1) Variance not solely due to rate or volume is allocated to the volume
variance. The change in interest due to both rate and volume is allocated to
rate and volume changes in proportion to the relationship of the absolute dollar
amounts of the change in each.
The above rate/volume table demonstrates the downward pricing pressure
of our assets as our interest income dropped $24.4 million due to changes in
rate, while the cost of funds (interest expense) only dropped $18.0 million.
34
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is determined by periodic reviews of loan
quality, current economic conditions, loss experience and loan growth. Based on
these factors, the provision for loan losses was $9.4 million for the year ended
December 31, 2003 and $13.6 million and $8.5 million for the years ended
December 31, 2002 and 2001, respectively. The allowance for loan losses of $49.3
million at year-end 2003 and $40.6 million at year-end 2002 as a percentage of
total loans was 2.17% at year-end 2003 and 2.33% at year-end 2002.
Net loan chargeoffs of $6.8 million in 2003 were typical compared to
historical Company results. Chargeoffs of $15.3 million during 2002 were high
compared to historical Company results and peer averages and were driven by two
large commercial real estate credits, while the $7.5 million in chargeoffs
during 2001 were typical compared to historical Company results. To strengthen
National Penn Bank's credit administration process, National Penn Bank enhanced
its lending policies, and allocated additional resources to oversee its
underwriting procedures in 2002. Management continues to believe its loan loss
allowance is adequate to cover losses inherent in the current portfolio.
A detailed analysis of the Company's allowance for loan losses for the
five years ended December 31, 2003, is shown below:
December 31,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance at beginning of year $40,578 $40,449 $37,724 $35,351 $31,555
Charge-offs:
Commercial and industrial loans and leases 8,066 2,795 1,566 2,433 1,858
Real estate loans:
Construction and land development 75 7,393 1,708 -- --
Residential 611 2,679 1,852 1,424 1,381
Other 1,277 512 436 969 1,262
Loans to individuals 2,315 1,986 1,960 2,111 800
------- ------- ------- ------- -------
Total Charge-offs 12,344 15,365 $7,522 $6,937 $5,301
------- ------- ------- ------- -------
Recoveries:
Commercial and industrial 3,556 166 957 738 278
Real estate loans:
Construction and land development 537 7 56 44 10
Residential 348 794 339 438 555
Other 784 245 252 598 1,571
Loans to individuals 272 697 193 182 113
------- ------- ------- ------- -------
Total Recoveries $5,497 $1,909 $1,797 $2,000 $2,527
------- ------- ------- ------- -------
Net charge-offs $6,847 $13,456 $5,725 $4,937 $2,774
------- ------- ------- ------- -------
Provision charged to expense 9,370 13,585 8,450 7,310 6,570
Adjustments:
Changes incident to mergers and absorptions, net 6,164 -- -- -- --
------- ------- ------- ------- -------
Balance at end of year $49,265 $40,578 $40,449 $37,724 $35,351
------- ------- ------- ------- -------
======= ======= ======= ======= =======
Ratio of net charge-offs during the period to
average loans outstanding during the period 0.34% 0.77% 0.33% 0.30% 0.19%
======= ======= ======= ======= =======
35
Commercial and industrial loans, real estate loans, and construction
loans are charged off to the allowance as soon as it is determined that the
repayment of all or part of the principal balance is highly unlikely. Loans to
individuals are charged off any time repayment is deemed highly unlikely or as
soon as the loan becomes 120 days delinquent. Because all identified losses are
immediately charged off, no portion of the allowance for loan losses is
restricted to any individual loan or groups of loans, and the entire allowance
is available to absorb any and all loan losses.
The Company maintains an allowance for loan losses at a level deemed
sufficient to absorb losses, which are inherent in the loan portfolio at each
balance sheet date. Management reviews the adequacy of the allowance on at least
a quarterly basis to ensure that the provision for loan losses has been charged
against earnings in an amount necessary to maintain the allowance at a level
that is appropriate based on management's assessment of probable estimated
losses. The Company's methodology for assessing the appropriateness of the
allowance for loan losses consists of several key elements. These elements
include a specific reserve for doubtful or high risk loans, an allocated reserve
based on historical trends, and an unallocated portion. The Company consistently
applies the following comprehensive methodology.
The specific reserve for high risk loans is established for specific
commercial and industrial loans, real estate development loans, and construction
loans which have been identified by bank management as being high risk loan
assets. These high risk loans are assigned a doubtful risk rating grade because
the loan has not performed according to payment terms and there is reason to
believe that repayment of the loan principal in whole or part is unlikely. The
specific portion of the allowance is the total amount of potential unconfirmed
losses for these individual doubtful loans. To assist in determining the fair
value of loan collateral, the Company often utilizes independent third party
qualified appraisal firms which in turn employ their own criteria and
assumptions that may include occupancy rates, rental rates, and property
expenses, among others.
The second category of reserves consists of the allocated portion of the
allowance. The allocated portion of the allowance is determined by taking pools
of loans outstanding and commitments that have similar characteristics and
applying historical loss experience for each pool. This estimate represents the
potential unconfirmed losses within the portfolio. Individual loan pools are
created for commercial loans, real estate development and construction loans,
and for the various types of loans to individuals. The historical estimation for
each loan pool is then adjusted to account for current conditions, current loan
portfolio performance, loan policy or management changes or any other factor,
which may cause future losses to deviate from historical levels. Before applying
the historical loss experience percentages, loan balances are reduced by the
portion of the loan balances, if any, which are subject to a guarantee by a
government agency.
The Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions which may cause a potential
loan loss but are not specifically identifiable. It is prudent to maintain an
unallocated portion of the allowance because no matter how detailed an analysis
of potential loan losses is performed, these estimates by definition lack
precision. Management must make estimates using assumptions and information,
which is often subjective and changing rapidly. At December 31, 2003, management
believes that the allowance for loan losses and nonperforming loans remained
safely within acceptable levels
During the review of the allowance for loan losses, the Company
considers a variety of factors that include: economic conditions and market
volatility, the continued concern that a slow economy results in operating
losses for the Company's commercial customers, and the overall concerns of
consumer confidence, including international concerns. Despite these concerns,
the reduction in charge-offs in 2003 compared to 2002 allowed the Company to
reduce its provision for loan and lease losses while maintaining the allowance
for loan and lease losses at a level believed adequate to absorb probable losses
on existing loans.
The following table shows how the allowance for loan losses is allocated
among the various types of loans that the Company has outstanding. This
allocation is based on management's specific review of the credit risk of the
outstanding loans in each category as well as historical trends.
36
Allocation of the Allowance for Loan Losses (1)
- -----------------------------------------------
Allocation of the Allowance for Loan Losses (1)
2003 2002 2001 2000 1999
------------------ ----------------- ------------------ ------------------ ------------------
% Loan % Loan % Loan % Loan % Loan
Type to Type to Type to Type to Type to
Total Total Total Total Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
------------------ ----------------- ------------------ ------------------ ------------------
Commercial and $ 9,884 21.3% $ 7,727 19.9% $ 6,331 19.3% $ 5,803 17.5% $ 6,080 16.7%
industrial
Real estate loans:
Construction and 3,061 6.6% 2,651 6.9% 2,375 7.2% 2,850 8.6% 4,348 8.2%
land dev
Residential 15,453 33.2% 14,707 37.9% 12,001 36.6% 12,689 38.2% 4,278 2.1%
Other 16,965 36.5% 12,469 32.2% 10,628 32.4% 10,400 31.3% 11,312 29.1%
Loans to individuals 1,115 2.4% 1,200 3.1% 1,463 4.5% 1,454 4.4% 4,384 3.9%
Unallocated 2,787 N/A 1,824 N/A 7,651 N/A 4,528 N/A 4,949 N/A
--------------- ---------------- ----------------- --------------- ----------------
$49,265 100.0% $40,578 100.0% $40,449 100.0% $37,724 100.0% $35,351 100.0%
=============== ================ ================= =============== ================
(1) This allocation is made for analytical purposes. The total allowance is
available to absorb losses from any segment of the portfolio.
OTHER INCOME AND EXPENSES
Other income increased $4.7 million or 13.0% in 2003 compared to 2002,
as a result of increased service charges on deposit accounts of $1.3 million,
increased other service charges and fees, including cash management, of $2.0
million, and increased insurance commissions and fees of $2.5 million. The
increase in deposit fees is due primarily to an increase in the collections of
fees on a larger deposit base, resulting from the FirstService acquisition. The
increase in insurance commission and fees is due largely to the addition of
FirstService Insurance Agency Inc., which contributed $2.4 million of the total
$2.7 million in insurance income. The Company received income in 2003 of $1.6
million related to a merger of a mutual insurance company which is the issuer of
certain life insurance policies held by the Company, which accounts for much of
the increase in other service charges and fees. These increases to other income
were offset by a decrease in bank owned life insurance income of $126,000, a
decrease in mortgage banking income of $313,000 due to the slowdown in refinance
volume in third and fourth quarters 2003, and an increase in losses on sale of
investment securities of $583,000. The increase in other income in 2002 compared
to 2001 was $4.4 million or 13.6% as a result of increased service charges on
deposits accounts of $1.8 million, and increased mortgage banking income of $1.0
million, increased other service charges and fees, including cash management, of
$449,000, increased trust income of $142,000, and decreased net gains on sale of
investment securities of $120,000. Sales of investment securities in 2003 and
2002 totaled $35.0 million and $20.5 million, respectively.
Other expenses increased $20.8 million or 25.2% in 2003 compared to 2002
as a result of increased salaries, wages and benefits of $10.9 million, a $7.0
million prepayment fee paid to the Federal Home Loan Bank of Pittsburgh in the
refinancing of long-term debt, and increased other operating expenses of $2.9
million. Salaries, wages and benefits increased due to normal salary increases
and the addition of 137 employees from the acquisition of FirstService as well
as a contractual severance payment in December 2003. The increase in other
operating expenses is also partially associated with the acquisition of
FirstService, which included a community office network of seven offices, as
well as three new proposed offices. Additional marketing expenses were
attributable to additional advertising campaigns conducted in 2003. Other
expenses increased $7.8 million or 10.5% in 2002 when compared to 2001, as a
result of increased salaries, wages and benefits of $3.4 million, and increased
other expenses of $4.4 million. Salaries, wages and benefits increased due to
increased staff and increases in benefit costs. For 2003, 2002, and 2001, there
are no individual items of other operating expenses that exceed one percent of
the aggregate of total interest income and other income, with the exception of
advertising and marketing related expenses and the non-recurring FHLB prepayment
fee in 2003.
Income before income taxes from continuing operations increased $653,000
or 1.53% in 2003 compared to 2002, due primarily to the prepayment fee paid in
the Federal Home Loan Bank long term debt refinancing. Income before income
taxes from continuing operations increased in 2002 by $3.1 million or 7.7%
compared to 2001. In 2003,
37
income from discontinued operations, net of taxes, increased $6.6 million to
$8.7 million compared to 2002, when income from disconitinued operations, net of
taxes increased $1.3 million compared to 2001. The large increase in 2003 is
attributable to the gain on sale of Panasia. Income taxes related to continuing
operations increased $94,000 or 1.1% in 2003 and income taxes related to
continuing operations increased $847,000 in 2002, or 10.9%. The Company's
effective tax rate is 20.0% for 2003, 20.1% for 2002, and 19.5% for 2001,
respectively. The decrease in the effective tax rate from 2002 to 2003 is due to
the increase in tax advantaged income as a percent of taxable income. The
effective tax rate is less than the current 35% incremental rate due to the
Company's investments in tax advantaged municipal securities and bank owned life
insurance.
On January 1, 2002, the Company adopted SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Intangible Assets. These statements
modify the Company's accounting for goodwill and other intangible assets. SFAS
No. 142 modifies the accounting for all purchased goodwill and intangible
assets. As of January 1, 2002, the Company is no longer amortizing its goodwill.
Had the Company not been required to amortize goodwill, reported earnings per
share would have been $0.06 higher on a diluted basis or $1.53 per share versus
the $1.47 per share actually reported for the year ended December 31, 2001.
SFAS No. 142 includes requirements to test goodwill and indefinite
lived intangible assets for impairment rather than amortize them. The Company
will be testing goodwill for impairment at least annually. For the testing
completed as of June 30, 2003, the Company had no impairment of goodwill. No
assurance can be given that future goodwill impairment tests will not result in
a charge to earnings.
LIQUIDITY AND INTEREST RATE SENSITIVITY
-----------------------------------------
The primary functions of asset/liability management are to assure
adequate liquidity and maintain an appropriate balance between interest-earning
assets and interest-bearing liabilities.
Liquidity management involves the ability to meet the cash flow
requirements of customers who may be either depositors wanting to withdraw funds
or borrowers needing assurance that sufficient funds will be available to meet
their credit needs. In the past twelve to twenty-four months, the Company's
liquidity has improved as people have removed money from the declining equity
market. During this time, many customers have preferred the safety of
FDIC-insured deposits compared to the uncertain equity market, despite
historically low interest rates. This has allowed the Company to grow its core
deposit base and significantly reduce reliance on non-core sources of funds.
The Company's main liquidity concern is when the current environment
reverses course - that is, the economy and consequently the equity markets
strengthen and the Company suffers disintermediation back to the equity market.
The Company is currently preparing for this potential disintermediation by
working to build its share of customers' banking business (on the theory that
even if some funds move back to the equity market, the Company will still retain
a larger share than it had two years ago), growing its government banking unit,
reviewing its deposit product offerings, establishing additional non-core
sources of funding, maintaining a more liquid investment portfolio, and
continuing to develop its capability to securitize assets.
The Company's acquisitions of FirstService during the first quarter of
2003 and HomeTowne Heritage during fourth quarter of 2003 did not have an
immediate material impact on the Company's current liquidity. Both FirstService
and HomeTowne have retained their divisional titles and brand identification in
their markets. Accordingly, the Company expects no material run-off in deposits
over the long term, and as a result, does not anticipate a negative material
impact on the Company's overall long-term liquidity position.
We do not expect that the acquisition of Peoples First, Inc. will not
affect our overall liquidity position, either positively or negatively. Peoples'
liquidity position is similar to our liquidity position.
Funding affecting short-term liquidity, including deposits, repurchase
agreements, federal funds purchased, and short-term borrowings increased $756.7
million during 2003. Long-term borrowings decreased $5.7 million during 2003.
38
The following table shows separately the interest rate sensitivity of
each category of interest earning assets and interest bearing liabilities at
December 31, 2003:
Repricing Periods
-------------------------------------------------------------------------
Within Three Months One Year Over
Three Through Through Five
Months One Year Five Years Years
-------------- ---------------- ---------------- ---------------
(In Thousands)
Assets
Interest bearing deposits at banks $ 2,233 $ --- $ --- $ ---
Investment securities 81,311 150,988 454,211 247,865
Loans and Leases(1) 968,793 359,280 721,405 171,956
Other assets --- --- --- 354,532
-------------- ---------------- ---------------- ---------------
1,052,337 510,268 1,175,616 774,353
-------------- ---------------- ---------------- ---------------
Liabilities and equity
Non-interest bearing deposits 386,620 --- --- ---
Interest bearing deposits (2) 811,450 247,984 318,377 670,865
Borrowed funds (3) 372,759 --- 70,018 231,298
Subordinated debt --- --- --- 63,250
Other liabilities --- --- --- 22,140
Hedging instruments 40,000 (40,000) ---
Shareholders' equity --- --- --- 317,813
-------------- ---------------- ---------------- ---------------
1,610,829 207,984 388,395 1,305,366
-------------- ---------------- ---------------- ---------------
Interest sensitivity gap (558,492) 302,284 787,221 (531,013)
-------------- ---------------- ---------------- ---------------
Cumulative interest rate sensitivity gap (558,492) (256,208) 531,013 $ ---
============== ================ ================ ===============
- -----------------------------
(1) Adjustable rate loans are included in the period in which interest
rates are next scheduled to adjust rather than in the period in which
they are due. Fixed-rate loans are included in the period in which they
are scheduled to be repaid and are adjusted to take into account
estimated prepayments based upon assumptions estimating the expected
prepayments in the interest rate environment prevailing during the
fourth calendar quarter of 2003. The table assumes prepayments and
scheduled principal amortization of fixed-rate loans and
mortgage-backed securities, and assumes that adjustable-rate mortgages
will reprice at contractual repricing intervals. There has been no
adjustment for the impact of future commitments and loans in process.
(2) Savings and NOW deposits are scheduled for repricing based on
historical deposit decay rate analyses, as well as historical moving
averages of run-off for the Company's deposits in these categories.
While generally subject to immediate withdrawal, management considers a
portion of these accounts to be core deposits having significantly
longer effective maturities based upon the Company's historical
retention of such deposits in changing interest rate environments.
Specifically, 50.0% of these deposits are considered repriceable within
three months and 50.0% are considered repriceable in the over five-year
category.
(3) Includes federal funds purchased, securities sold under repurchase
agreements, and short and long term borrowings.
Interest rate sensitivity is a function of the repricing characteristics
of the Company's assets and liabilities. These characteristics include the
volume of assets and liabilities repricing, the timing of the repricing, and the
relative levels of repricing. Attempting to minimize the interest rate
sensitivity gaps is a continual challenge in a changing rate environment. Based
on the Company's gap position as reflected in the above table, current accepted
theory would indicate that net interest income would decrease in a falling
interest rate environment and would increase in a rising interest rate
environment. An interest rate gap table does not, however, present a complete
picture of the impact of interest rate changes on net interest income. First,
changes in the general level of interest rates do not affect all categories
39
of assets and liabilities equally or simultaneously. Second, assets and
liabilities which can contractually reprice within the same period may not, in
fact, reprice at the same time or to the same extent. Third, the table
represents a one-day position; variations occur daily as the Company adjusts its
interest sensitivity throughout the year. Fourth, assumptions must be made to
construct such a table. For example, non-interest bearing deposits are assigned
a repricing interval of within three months, although history indicates a
significant amount of these deposits will not move into interest bearing
categories regardless of the general level of interest rates. Finally, the
repricing distribution of interest sensitive assets may not be indicative of the
liquidity of those assets.
Gap analysis is a useful measurement of asset and liability management;
however, it is difficult to predict the effect of changing interest rates based
solely on this measure. Therefore, the Company supplements gap analysis with the
calculation of the Economic Value of Equity. This report forecasts changes in
the Company's market value of portfolio equity ("MVPE") under alternative
interest rate environments. The MVPE is defined as the net present value of the
Company's existing assets, liabilities, and off-balance sheet instruments. The
calculated estimates of change in MVPE at December 31, 2003 are as follows:
MVPE
Change in Interest Rate Amount % Change
- ----------------------- ------- ---------
(In Thousands)
+300 Basis Points 403,503 1.13
+200 Basis Points 416,600 4.42
+100 Basis Points 392,462 -1.63
Flat Rate 398,976 ----
- -100 Basis Points 409,671 2.68
- -200 Basis Points 367,767 -7.82
- -300 Basis Points 319,017 -20.04
Management believes that the assumptions utilized in evaluating the
vulnerability of the Company's earnings and capital to changes in interest rates
approximate actual experience; however, the interest rate sensitivity of the
Company's assets and liabilities as well as the estimated effect of changes in
interest rates on MVPE could vary substantially if different assumptions are
used, such as 400 or 500 basis point changes in interest rates, or actual
experience differs from the experience on which the assumptions were based.
If the Company should experience a mismatch in its desired gap ranges or
an excessive decline in its MVPE subsequent to an immediate and sustained change
in interest rate, it has a number of options which it could utilize to remedy
such mismatch. The Company could restructure its investment portfolio through
the sale or purchase of securities with more favorable repricing attributes. It
could also emphasize loan products with appropriate maturities or repricing
attributes, or it could emphasize deposits or obtain borrowings with desired
maturities.
The Company anticipates a rise in interest rates through 2004. Given
this assumption, the Company's asset/liability strategy for 2004 is to achieve a
positive gap position (interest-bearing assets subject to repricing more than
interest-earning liabilities subject to repricing) for periods up to a year. The
impact of changing interest rates on net interest income is not expected to be
significant to the Company's results of operations. Effective monitoring of
these interest sensitivity gaps is the priority of the Company's asset/liability
management committee.
40
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The following table sets forth contractual obligations and other
commitments representing required and potential cash outflows as of December 31,
2003:
One to Four to After
Less than Three Five Five
(dollars in thousands) Total One Year Years Years Years
----- -------- ----- ------ ------
Minimum annual rentals on noncancellable
Operating leases $ 20,337 $ 2,579 $ 4,389 $ 3,215 $ 10,154
Remaining contractual maturities of time
deposits 658,605 335,631 260,674 57,703 4,597
Loan commitments 747,838 498,932 64,672 13,426 170,808
Long-term borrowed funds 164,037 13,938 34,607 35,411 80,081
Guaranteed preferred beneficial interests in
Company's subordinated debentures 63,250 -- -- -- 63,250
Standby letters of credit 54,533 30,183 14,275 10,075 --
---------- ---------- ---------- ---------- -----------
Total $1,708,600 $ 881,263 $ 378,617 $ 119,830 $ 328,890
========== ========== ========== ========== ==========
The Company had no capital leases at December 31, 2003.
CAPITAL ADEQUACY
----------------
Shareholders' equity increased by $95.5 million or 42.9% in 2003 to
$317.8 million. This increase was principally due to the acquisitions of
HomeTowne Heritage Bank and FirstService Bank, an increase in the valuation
adjustment for securities available for sale, as well as the increase in
retained earnings from 2003 net income, less cash dividends paid in 2003. Cash
dividends paid in 2003 increased $3.8 million or 20.2% compared to the cash
dividends paid in 2002, which increased $1.1 million or 6.9% compared to cash
dividends paid in 2001. Earnings retained in 2003 were 51.0% compared to 51.3%
in 2002.
The following table sets forth certain capital performance ratios for
the Company.
2003 2002 2001
---- ---- ----
CAPITAL PERFORMANCE
Return on average assets 1.34% 1.30% 1.25%
Return on average equity 16.20% 17.40% 16.80%
Dividend payout ratio 48.98% 48.75% 50.46%
Earnings retained 51.02% 51.25% 49.54%
We retain approximately 50% of our earnings in the form of capital to support
future growth.
CAPITAL LEVELS
Tier 1 Capital to Tier 1 Capital to Risk- Total Capital to Risk-
Average Assets Ratio Weighted Assets Ratio Weighted Assets Ratio
------------------------------------------------------------------------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31,
2003 2002 2003 2002 2002 2003
------ ------ ------ ------ ------ ------
The Company 7.84% 8.66% 9.74% 11.81% 11.00% 13.08%
National Penn Bank 7.06% 6.91% 8.88% 9.33% 10.14% 10.59%
Well capitalized institution 5.00% 5.00% 6.00% 6.00% 10.00% 10.00%
(under banking regulations)
The Company's capital ratios above compare favorably to the minimum
required amounts of Tier 1 and total capital to risk-weighted assets and the
minimum Tier 1 leverage ratio, as defined by banking regulators. At December
41
31, 2001, the Company was required to have minimum Tier 1 and total capital
ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of
4.0%. In order for the Company to be considered well capitalized, as defined by
banking regulators, the Company must have Tier 1 and total capital ratios of
6.0% and 10.0%, respectively, and a minimum Tier 1 leverage ratio of 5.0%. At
December 31, 2003, National Penn Bank meet the criteria for a well capitalized
institution, and management believes that, under current regulations, the
Company will continue to meet its minimum capital requirements in the
foreseeable future.
The Company does not presently have any commitments for significant
capital expenditures. The Company is not under any agreement with regulatory
authorities nor is it aware of any current recommendations by the regulatory
authorities which, if they were to be implemented, would have a material effect
on liquidity, capital resources, or operations of the Company.
In July 2001, the Company's Board of Directors approved the repurchase
of up to 975,000 shares of its common stock to be used for the general corporate
purposes, including the Company's dividend reinvestment, stock option, employee
stock purchase plans, and other stock-based corporate plans. The stock
repurchase plan authorized the Company to make repurchases from time to time in
open market or privately negotiated transactions. The Company purchased 652,653
shares at an aggregate cost of approximately $15,942,000 in the period January
1, 2002 through August 27, 2002, the date of the completion of the 2001
repurchase program.
On June 26, 2002, the Company's Board of Directors approved a stock
repurchase plan of up to 1,000,000 shares of its common stock. The Company
completed the 2002 repurchase plan on October 29, 2003 with an average price of
$30.02.
On September 24, 2003, the Company's Board of Directors authorized the
repurchase of up to one million shares of the Company's common stock (2003
repurchase plan) to be used to fund the Company's dividend reinvestment plan,
stock option plans, stock-based benefit plans and employee stock purchase plan.
As of December 31, 2003, 152,921 shares have been repurchased at an average
price of $30.95 under the 2003 repurchase plan.
SALE OF PANASIA BANK, N.A
--------------------------
On September 11, 2003, the Company completed the cash sale of Panasia
Bank N.A., its wholly owned subsidiary for $34.5 million, which resulted in a
gain of $5.99 million after taxes of $2.5 million. In accordance with SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets, the income
of Panasia is presented as discontinued operations for all periods presented. At
the time of the sale, Panasia had total assets of $213.5 million, net loans of
$99.7 million, investments of $84.4 million, deposits of $188.2 million, and
total equity of $24.4 million. The Company has classified the results of
operations of Panasia from January 1, 2003 through September 11, 2003 as
discontinued operations in the consolidated statement of income. Net income from
discontinued operations, net of taxes of $3.4 million for the nine months ended
September 30, 2003 was $7.9 million.
More information is provided in National Penn's Reports on Form 8-K
dated February 10, 2003 and September 11, 2003 filed with the Securities and
Exchange Commission ("SEC").
ACQUISITION OF COMMUNITY INDEPENDENT BANK, INC.
-----------------------------------------------
On January 3, 2001, the Company acquired Community Independent Bank,
Inc. ("Community") by its merger with and into the Company. Community's banking
subsidiary, Bernville Bank, N.A., had $100 million in assets as of December 31,
2000. Under the terms of the merger, each outstanding share of Community stock
was converted into .945 share of the Company's common stock, resulting in
issuance of 659,245 shares of the Company's common stock. Outstanding options
for Community stock were converted into options for 19,184 shares of the
Company's common stock. The transaction was accounted for under the pooling of
interests method of accounting.
More information is available in the Company's Reports on Form 8-K dated
July 11, 2000, October 25, 2000, and December 20, 2000, each filed with the SEC,
and in the Company's registration statement on Form S-4, filed with the SEC on
September 12, 2000.
42
ACQUISITION OF FIRSTSERVICE BANK
--------------------------------
On February 25, 2003, the Company acquired FirstService Bank
("FirstService") by its merger into National Penn Bank. FirstService Bank was a
commercial bank offering a broad range of personal and commercial banking
services, headquartered in Doylestown, Bucks County, Pennsylvania, with six
other community offices in Bucks and Montgomery Counties, Pennsylvania, and an
additional office under construction in Souderton, Pennsylvania. Through its
subsidiaries, FirstService Bank also offered casualty insurance, asset
management services and non-deposit investment products. FirstService also had a
proprietary interest in a title insurance agency.
Under the terms of the merger, each outstanding share of FirstService
Bank common stock was converted into .5954 share of the Company's common stock,
plus $3.90, resulting in issuance of 2,563,552 shares of the Company's common
stock. Outstanding options for 860,489 shares of FirstService Bank stock were
converted into options for shares of the Company's common stock. The transaction
was accounted for under the purchase method of accounting.
The Company's results of operations include FirstService's results from
and after February 25, 2003. The acquisition resulted in the recording of
approximately $54.0 million of goodwill and other intangible assets.
More information is available in the Company's Reports on Form 8-K
dated September 24, 2002 and February 4, 2003, each filed with the SEC, and in
the Company's registration statement on Form S-4, filed with the SEC on December
6, 2002, and amended on December 31, 2002.
ACQUISITION OF HOMETOWNE HERITAGE BANK
--------------------------------------
On December 12, 2003, the Company completed a merger with HomeTowne
Heritage Bank ("HomeTowne"). Under the terms of the merger, each outstanding
share of common stock of HomeTowne was exchanged for $13.697 in cash resulting
in the payment of approximately $37.6 million. In addition, outstanding stock
options to purchase 984,332 shares of HomeTowne common stock were converted into
stock options to purchase shares of the Company's common stock, with an exercise
price ranging between $12.10 and $24.20 per share. This transaction was
accounted for in accordance with SFAS No. 141, Business Combinations. The
results of operations of the Company include HomeTowne's results from and after
December 12, 2003. The acquisition resulted in the recording of approximately
$25.6 million of goodwill and other intangible assets.
More information is available in the Company's Reports on Form 8-K
dated April 30, 2003 and December 12, 2003, filed with the SEC.
PENDING ACQUISITION OF PEOPLES FIRST, INC.
------------------------------------------
On December 18, 2003, National Penn announced the execution of a
definitive agreement for National Penn to acquire Peoples First, Inc.,
("Peoples"), parent company of The Peoples Bank of Oxford, in a stock and cash
transaction valued at approximately $148 million. The Peoples Bank of Oxford is
a $456 million bank headquartered in Oxford, Pennsylvania, operating eight
community offices in Chester and Lancaster Counties, Pennsylvania and one
community office in Cecil County, Maryland.
Under the terms of the merger agreement, Peoples shareholders will be
entitled to select to receive either 1.505 shares of National Penn common stock,
$49.54 in cash, or a combination of both, for each share of Peoples common
stock. Peoples shareholder elections are subject to allocation procedures. The
application of these procedures will result in the exchange of 30 percent of the
Peoples shares for cash, and the remaining shares will be exchanged for shares
of National Penn common stock. Options to purchase shares of Peoples common
stock will be converted into options to purchase shares of National Penn common
stock. Based upon a stated value of $49.54 per share, the transaction price
represents 3.03 times Peoples' book value and 28.65 times Peoples' estimated
trailing twelve months earnings, as of September, 2003.
The acquisition of Peoples will require approximately $50 million in
cash and approximately $20 million in capital. The trust preferred securities
issuance completed on February 20, 2004 satisfied the capital need and
43
provided a portion of the cash need. We intend to obtain the remaining cash
through issuance of additional trust preferred securities or senior debt.
The merger is subject to a number of conditions, including approval by
the Board of Governors of the Federal Reserve System, the Pennsylvania
Department of Banking and the shareholders of Peoples First. No assurance can be
given that all required approvals will be obtained, that all other closing
conditions will be satisfied or waived, or that the transaction will in fact be
consummated.
The foregoing description does not purport to be complete and is
qualified in its entirety by reference to the Merger Agreement. Additional
information is provided in the Company's Report on Form 8-K dated December 17,
2003, filed with the SEC. This Report includes a copy of the Merger Agreement.
ISSUANCE OF TRUST PREFERRED SECURITIES
--------------------------------------
On February 20, 2004, National Penn completed the private placement of
$20 million of floating rate (three month London InterBank Offered Rate
("LIBOR") plus a margin of 2.75%) trust preferred securities. National Penn
intends to use the net proceeds of this sale, among other things:
o To fund part of the cash portion of the merger consideration to be paid to
the shareholders of Peoples First, Inc. upon completion of the merger of
Peoples with and into National Penn (as discussed above);
o For general corporate purposes, including capital contributions to National
Penn Bank, to support its growth strategies;
o For working capital;
o To repurchase shares of National Penn common stock under National Penn's
stock repurchase program; and
o To fund future acquisitions.
More information is provided in the Company's Report on Form 8-K dated
February 20, 2004, filed with the SEC.
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
Off Balance Sheet Commitments
- -----------------------------
The Company adopted FASB Interpretation 45 (FIN 45), Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others, on January 1, 2003. FIN 45 requires a
guarantor entity, at the inception of a guarantee covered by the measurement
provisions of the interpretation, to record a liability for the fair value of
the obligation undertaken in issuing the guarantee. The Company issues financial
and performance letters of credit. Financial letters of credit require the
Company to make payment if the customer's financial condition deteriorates, as
defined in the agreements. Performance letters of credit require the Company to
make payments if the customer fails to perform identified non-financial
contractual obligations. The Company previously did not record an initial
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002.
The Company defines the initial fair value of these letters of credit
as the fee received from the customer. The maximum potential undiscounted amount
of future payments on these letters of credit as of December 31, 2003 is $54.5
million and they expire through 2008. The amounts due under these letters of
credit would be reduced by any proceeds that the Company would be able to obtain
in liquidating the collateral for these loans. The adoption of FIN 45 did not
have a material impact on the Company's consolidated financial position or
results of operations.
44
Acquired Loans
- --------------
In October 2003, the AICPA issued Statement of Position 03-3 (SOP 03-3)
Accounting for Loans or Certain Debt Securities Acquired in a Transfer. SOP 03-3
applies to a loan with the evidence of deterioration of credit quality since
origination acquired by completion of a transfer for which it is probable at
acquisition, that the Company will be unable to collect all contractually
required payments receivable. SOP 03-3 requires that the Company recognize the
excess of all cash flows expected at acquisition over the investor's initial
investment in the loan as interest income on a level-yield basis over the life
of the loan as the accretable yield. The loan's contractual required payments
receivable in excess of the amount of its cash flows excepted at acquisition
(nonaccretable difference) should not be recognized as an adjustment to yield, a
loss accrual or a valuation allowance for credit risk. SOP 03-3 is effective for
loans acquired in fiscal years beginning after December 31, 2004. Early adoption
is permitted. Management is currently evaluating the provisions of SOP 03-3.
Variable Interest Entities
- --------------------------
In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities. FIN 46 clarifies the application of Accounting Research
Bulletin 51, Consolidated Financial Statements, to certain entities in which
voting rights are not effective in identifying the investor with the controlling
financial interest. An entity is subject to consolidation under FIN 46 if the
investors either do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support, are unable to
direct the entity's activities, or are not exposed to the entity's losses or
entitled to its residual returns ("variable interest entities"). Variable
interest entities within the scope of FIN 46 will be required to be consolidated
by their primary beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of the entity's
expected losses, receives a majority of its expected returns, or both.
Management has determined that NPB Capital Trust II qualifies as a
variable interest entity under FIN 46. NPB Capital Trust II issued mandatorily
redeemable preferred stock to investors and loaned the proceeds to the Company.
NPB Capital Trust II holds, as its sole asset, subordinated debentures issued by
the Company in 2002. NPB Capital Trust II is currently included in the Company's
consolidated balance sheet and statements of income. The Company has evaluated
the impact of FIN 46 and concluded it should continue to consolidate NPB Trust
II as of December 31, 2003, in part due to its ability to call the preferred
stock prior to the mandatory redemption date and thereby benefit from a decline
in required dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to certain
variable interest entities by March 31, 2004. The Company plans to adopt the
provisions under the revised interpretation in the first quarter of 2004. FIN
46(R) will require NPB to deconsolidate NPB Capital Trust II as of March 31,
2004. FIN 46(R) precludes consideration of the call option embedded in the trust
preferred securities when determining if the Company has the right to a majority
of NPB Capital Trust II's expected residual returns. Accordingly, the Company
will deconsolidate NPB Capital Trust II at the end of the first quarter, which
will result in an increase in outstanding debt by $2.71 million. The banking
regulatory agencies have not issued any guidance that would change the
regulatory capital treatment for the trust-preferred securities issued by NPB
Capital Trust II based on the adoption of FIN 46(R). However, as additional
interpretations from the banking regulators related to entities such as NPB
Capital Trust II become available, management will reevaluate its potential
impact to its Tier I capital calculation under such interpretations.
Amendment to SFAS 133 on Derivative Instruments and Hedging Activities
- ----------------------------------------------------------------------
The Company adopted Statement of Financial Accounting Standard 149
(SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, on July 1, 2003. SFAS No. 149 clarifies or amends SFAS No. 133 for
implementation issues raised by constituents or includes the conclusions reached
by the FASB on certain FASB Staff Implementation Issues. Statement 149 also
amends paragraph SFAS No. 133 to require a lender to account for loan
commitments related to mortgage loans that will be held for sale as derivatives.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003. The Company periodically enters into commitments with its customers, which
it intends to sell in the future. The adoption of SFAS No. 149 did not have a
material impact on the Company's financial position or results of operations.
45
Financial Instruments with Characteristics of Both Liabilities and Equity
- -------------------------------------------------------------------------
The FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, on May 15,
2003. SFAS No. 150 changes the classification in the statement of financial
position of certain common financial instruments from either equity or mezzanine
presentation to liabilities and requires an issuer of those financial statements
to recognize changes in fair value or redemption amount, as applicable, in
earnings. SFAS No. 150 is effective for public companies for financial
instruments entered into or modified after May 31, 2003 and is effective at the
beginning of the first interim period beginning after June 15, 2003. Management
has not entered into any financial instruments that would qualify under SFAS No.
150. The Company currently classifies its Guaranteed Preferred Beneficial
Interest in the Company's Subordinated Debt as a liability. As a result,
management does not anticipate the adoption of SFAS No. 150 will have a material
impact on the Company's financial position or results of operations.
Other than Temporary Impairment and Its Application to Certain Investments
- --------------------------------------------------------------------------
The Company adopted EITF 03-1, The Meaning of Other than Temporary
Impairment and Its Application to Certain Investments, as of December 31, 2003.
EITF 03-1 includes quantitative and qualitative disclosures for investment
securities accounted for under FAS 115, Accounting for Certain Investments in
Debt and Equity Securities, that have an unrealized loss and are considered
impaired at December 31, 2003, but the Company has not recorded an
other-than-temporary impairment, as defined by SFAS No. 115. The disclosure
provisions under EITF 03-1 are required for financial statements for years
ending after December 15, 2003 and are included in these financial statements.
FUTURE OUTLOOK
--------------
The Company's market area, while diverse, is subject to many of the same
economic forces being experienced regionally and nationally:
o The nascent recovery in the general economy and fallout from
bank mergers will likely generate loan growth in 2004, possibly
in the range of ten to twelve percent.
o In 2003, net charge-offs returned to the Company's historical
levels from the elevated level in 2002. The Company anticipates
that net charge-offs for 2004 will likely be in line with its
historical levels.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
- ---------------------------------------------------------------------
Information with respect to quantitative and qualitative disclosures
about market risk is included in the information under Management's Discussion
and Analysis at Item 7 hereof.
46
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per share data)
- -------------------------------------------------------------------------------
December 31,
2003 2002
------------ ------------
ASSETS
Cash and due from banks $ 96,164 $ 73,518
Interest bearing deposits in banks 2,233 2,606
Federal funds sold - 48,000
--------- ---------
Total cash and cash equivalents 98,397 124,124
Investment securities available for sale, at fair value 934,375 650,930
Loans held for sale 29,344 52,992
Loans, less allowance for loan losses of $49,265
and $40,578 in 2003 and 2002, respectively 2,192,090 1,691,837
Premises and equipment, net 43,653 28,448
Accrued interest receivable 14,309 13,944
Bank owned life insurance 69,937 58,360
Goodwill and other intangibles 111,210 8,947
Unconsolidated investments under the equity method 2,968 2,702
Assets from discontinued operations - 207,275
Other assets 16,291 18,703
--------- ---------
Total assets $ 3,512,574 $ 2,858,262
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 386,620 $ 296,247
Interest-bearing 2,048,676 1,629,717
--------- ---------
Total deposits 2,435,296 1,925,964
Securities sold under repurchase agreements and federal funds purchased 500,038 252,096
Short-term borrowings 10,000 10,614
Long-term borrowings 164,037 169,703
Guaranteed preferred beneficial interests in Company's subordinated debentures 63,250 63,250
Liabilities from discontinued operations - 190,684
Accrued interest payable and other liabilities 22,140 23,591
--------- ---------
Total liabilities 3,194,761 2,635,902
--------- ---------
Shareholders' equity
Preferred stock, no stated par value;
authorized 1,000,000 shares, none issued -
Common stock, no stated par value; authorized 62,500,000 shares,
issued and outstanding 2003 - 24,284,506; 2002 - 21,734,771,
net of shares in Treasury: 2003 - 2,626; 2002 - -0- 272,534 172,471
Retained earnings 25,770 30,593
Accumulated other comprehensive income 19,595 19,296
Treasury stock, at cost (86) -
---------- ---------
Total shareholders' equity 317,813 222,360
--------- ---------
Total liabilities and shareholders' equity $ 3,512,574 $ 2,858,262
========== ==========
The accompanying notes are an integral part of these statements.
47
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except per share data)
- ----------------------------------------------
Year ended December 31,
---------------------------------------------
2003 2002 2001
---------- ----------- ----------
INTEREST INCOME
Loans, including fees $ 129,569 $ 125,952 $ 145,267
Investment securities
Taxable 22,510 24,040 23,126
Tax-exempt 13,017 12,292 11,649
Federal funds sold 492 822 177
Deposits in banks 60 72 529
--------- --------- ---------
Total interest income 165,648 163,178 180,748
--------- --------- ---------
INTEREST EXPENSE
Deposits 33,753 42,223 67,514
Securities sold under repurchase agreements
and federal funds purchased 3,964 4,599 10,311
Short-term borrowings 40 104 264
Long-term borrowings 13,342 14,172 12,241
--------- --------- ---------
Total interest expense 51,099 61,098 90,330
--------- --------- ---------
Net interest income 114,549 102,080 90,418
Provision for loan losses 9,371 13,585 8,450
--------- --------- ---------
Net interest income after provision for loan losses 105,178 88,495 81,968
--------- --------- ---------
NON-INTEREST INCOME
Trust income 5,322 5,314 5,172
Service charges on deposit accounts 12,099 10,840 9,088
Bank owned life insurance income 3,590 3,716 2,754
Other service charges and fees 10,365 8,510 8,122
Net gains (losses) on sale of investment securities (369) 214 334
Mortgage banking income 5,146 5,459 4,450
Insurance commissions and fees 2,654 197 125
Service charges cash management 2,212 2,032 1,971
Equity in undistributed net earnings of affiliates 266 268 170
--------- --------- ---------
Total non-interest income 41,285 36,550 32,186
--------- --------- ---------
NON-INTEREST EXPENSES
Salaries, wages and employee benefits 56,181 45,258 41,834
Net premises and equipment 14,133 12,436 11,613
Advertising and marketing expense 3,604 3,234 2,560
FHLB prepayment fee 7,002
Other operating 22,113 21,340 18,426
--------- --------- ---------
Total non-interest expenses 103,033 82,268 74,433
--------- --------- ---------
Income before income taxes 43,430 42,777 39,721
Income taxes 8,697 8,603 7,756
--------- --------- ---------
Net income from continuing operations 34,733 34,174 31,965
Net income from discontinued operations, net of taxes 8,621 2,060 769
--------- --------- ---------
NET INCOME $ 43,354 $ 36,234 $ 32,734
========= ========= =========
PER SHARE OF COMMON STOCK
Basic earnings $ 1.82 $ 1.66 $ 1.49
Diluted earnings $ 1.78 $ 1.64 $ 1.47
Dividends paid $ .89 $ 0.81 $ 0.75
The accompanying notes are an integral part of these statements.
48
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity
(Dollars in thousands)
- --------------------------------------------------------------------------------
Accumulated
Common other Compre-
---------------------- Retained comprehensive Treasury hensive
Shares Amount earnings income stock Total income
----------- --------- --------- --------------- --------- -------- ---------
Balance at January 1, 2001 19,353,448 $ 154,719 $ 26,597 $ 2,753 $ (853) $183,216
Net income - - 32,734 - - 32,734 $ 32,734
Cash dividends declared - - (16,974) - - (16,974)
3% stock dividend 581,979 13,024 (13,024) - - -
Other comprehensive income, net
of reclassification adjustment
and taxes - - - 366 - 366 366
---------
Total comprehensive income - - - - - - $ 33,100
=========
Effect of treasury stock
transactions (8,564) (1,605) - - (2,055) (3,660)
---------- ------- ------ ------ ------- -------
Balance at December 31, 2001 19,926,863 166,138 29,333 3,119 (2,908) 195,682
Net income - - 36,234 - - 36,234 $ 36,234
Cash dividends declared - - (18,040) - - (18,040)
5% stock dividend 673,764 8,757 (16,934) - 8,177 -
Other comprehensive income, net
of reclassification adjustment
and taxes - - - 16,177 - 16,177 16,177
---------
Total comprehensive income - - - - - - $ 52,411
=========
Effect of treasury stock
transactions 99,155 (2,424) - - (5,269) (7,693)
---------- ------- ------ ------ ------- -------
Balance at December 31, 2002 20,699,782 172,471 30,593 19,296 222,360
---------- ------- ------ ------ ------- -------
Net income - - 43,354 - - 43,354 $ 43,354
Cash dividends declared - - (16,475) - - (16,475)
5% stock dividend 1,152,796 31,702 (31,702) - - -
Shares issued under stock
based plans 66,884 4,890 - - - 4,890
Shares issued for acquisition of
FirstService Bank 2,563,337 68,726 - - 5,610 74,336
Valuation of stock options for
Acquisition of HomeTowne - 4,388 - - - 4,388
Heritage Bank
Other comprehensive income, net
of reclassification adjustment
and taxes - - - 299 - 299 299
---------
Total comprehensive income - - - - - - $ 43,653
=========
Effect of treasury stock
transactions (198,293) (9,643) - - (5,696) (15,339)
---------- ------- ------ ------ ------- -------
Balance at December 31, 2003 24,284,506 $ 272,534 $ 25,770 $ 19,595 $ (86) $317,813
========== ======== ======== ======== ========= =======
The accompanying notes are an integral part of this statement.
49
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands, except per share data)
- -----------------------------------------------------------------------------------------------------------------
Year ended December 31,
---------------------------------------------
2003 2002 2001
---------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 43,354 $ 36,234 $ 32,734
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan and lease losses 9,371 13,585 8,450
Depreciation and amortization 6,260 4,459 6,048
Deferred income tax expense 2,895 6,676 210
Amortization of premiums and discounts on investment
securities, net 319 2,597 2,064
Investment securities gains (losses), net 369 (214) (334)
Mortgage loans originated for resale (224,585) (109,946) (65,329)
Sale of mortgage loans originated for resale 228,986 112,372 66,272
Gain on sale of mortgage loans originated for resale (4,401) - -
Changes in assets and liabilities
(Increase) decrease in accrued interest receivable 1,299 613 2,237
(Decrease) increase in accrued interest payable (1,865) (3,719) (5,542)
(Increase) decrease in goodwill and other intangibles - 148 (3,962)
(Decrease) increase in other assets 333 (4,567) 113
Increase (decrease) in other liabilities (64) 1,781 1,764
Decrease (increase) in assets from discontinued operations 207,275 (41,527) (61,600)
Increase (decrease) in liabilities from discontinued
operations (190,684) (43,817) 38,680
---------- ----------- ----------
Net cash provided by operating activities 78,862 62,309 21,805
---------- ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash received for business sold 34,500 - -
Cash paid in excess
of cash equivalents for business acquired (33,998) (8,624) -
Proceeds from sales of investment securities available for sale 34,663 20,458 25,601
Proceeds from maturities of investment securities available
for sale 100,895 63,910 157,584
Purchase of investment securities available for sale (347,742) (124,085) (218,425)
Net increase in loans (111,924) (6,217) (19,720)
Purchases of premises and equipment (9,507) (4,824) (5,392)
Purchase of bank owned life insurance - (2,637) (2,750)
---------- ----------- ----------
Net cash used in investing activities (333,113) (62,019) (63,102)
---------- ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in interest and non-interest
bearing demand deposits and savings accounts 138,495 138,768 167,289
Net (decrease) increase in certificates of deposit (52,474) (151,635) (37,735)
Net increase (decrease) in securities sold under
agreements to repurchase and federal funds purchased 191,750 13,370 (59,323)
Net (decrease) in short-term borrowings (614) 1,135 439
Proceeds from new long-term borrowings 70,000 70,000 -
Repayments of long-term borrowings (82,854) (40,272) (6,458)
Issuance of subordinated debentures - 63,250 -
Redemption of subordinated debentures - (40,250) -
Issuance of common stock under dividend reinvestment and stock
option plans 794 - -
Effect of treasury stock transactions (15,339) (7,693) (3,660)
Cash dividends (21,234) (17,664) (16,519)
---------- ----------- ----------
Net cash provided by financing activities 228,524 29,009 44,033
---------- ----------- ----------
Net increase (decrease) in cash and cash equivalents (25,727) 29,299 2,736
Cash and cash equivalents at beginning of year 124,124 94,825 92,089
---------- ----------- ----------
Cash and cash equivalents at end of year $ 98,397 $ 124,124 $ 94,825
========== =========== ==========
The accompanying notes are an integral part of these statements.
50
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
National Penn Bancshares, Inc. (the Company), primarily through its
Bank subsidiaries, National Penn Bank (NPB) and Panasia Bank, N.A.
(Panasia) (collectively, the Banks), has been serving residents and
businesses of southeastern Pennsylvania since 1874 and New Jersey since
July 2000. In September 2003, the Company sold Panasia Bank. NPB, which has
66 community office locations, is a locally managed community bank
providing commercial banking products, primarily loans and deposits.
Trust and investment management services are provided through Investors
Trust Company (ITC) and FirstService Capital, Inc. Penn 1st Financial
Services, Inc. (Penn 1st) is a mortgage banking company and is engaged in
the activity of extending residential mortgages. Penn Securities, Inc.
(Penn Securities) is a registered broker dealer with the Securities and
Exchange Commission and is a member of the National Association of
Securities Dealers. National Penn Leasing Company (NP Leasing) commenced
operations in November 2002 and provides commercial equipment leases.
Insurance services are provided through FirstService Insurance Agency, Inc.
The Company and its operating subsidiaries encounter vigorous competition
for market share in the communities they serve from bank holding companies,
other community banks, thrift institutions and other non-bank financial
organizations, such as mutual fund companies, insurance companies and
brokerage companies.
The Company and its operating subsidiaries are subject to regulations
of certain state and federal agencies. These regulatory agencies
periodically examine the Company and its subsidiaries for adherence to laws
and regulations. As a consequence, the cost of doing business may be
affected.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accounting policies followed by the Company conform with accounting
principles generally accepted in the United States of America and with
predominant practice within the banking industry.
The consolidated financial statements include the accounts of the
Company and the Company's wholly owned subsidiaries, NPB, ITC, National
Penn Investment Company, National Penn Life Insurance Company, NPB Capital
Trust II, and NPB's wholly owned subsidiaries Penn 1st, Penn Securities, NP
Leasing, Link Financial Services, Inc., NPB Delaware, Inc., FirstService
Capital, FirstService Insurance Agency, FirstService Realty and National
Penn Management Services LLP. The Company's investment in unconsolidated
subsidiaries that range between 20% and 50% are accounted for using the
equity method of accounting. All material intercompany balances have been
eliminated.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the
date of the balance sheets, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
The principal estimates that are susceptible to significant change in
the near term relate to the allowance for loan losses and certain
intangible assets, such as goodwill and core deposits. The evaluation of
the adequacy of the allowance for loan losses includes an analysis of the
individual loans and overall risk characteristics and size of the different
loan portfolios, and takes into consideration current economic and market
conditions, the capability of specific borrowers to pay specific loan
obligations, as well as current loan collateral values. However, actual
losses on specific loans, which also are encompassed in the analysis, may
vary from estimated losses.
(Continued)
51
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Substantially all outstanding goodwill resulted from the acquisitions
of FirstService Bank and HomeTowne Heritage Bank. The Company expanded its
market role in Bucks County and Lancaster County, Pennsylvania. However, if
such benefits, including new business, are not derived, impairment may be
recognized.
Core deposit intangibles are amortized over estimated lives of deposit
accounts. However, decreases in deposit lives may result in increased
amortization and/or a charge for impairment may be recognized.
INVESTMENT SECURITIES
Investment securities which are held for indefinite periods of time,
which management intends to use as part of its asset/liability strategy, or
which may be sold in response to changes in interest rates, changes in
prepayment risk, increases in capital requirements, or other similar
factors, are classified as available for sale and are carried at fair
value. Net unrealized gains and losses for such securities, net of tax, are
required to be recognized as a separate component of shareholders' equity
and excluded from determination of net income. Gains or losses on
disposition are based on the net proceeds and cost of the securities sold,
adjusted for amortization of premiums and accretion of discounts, using the
specific identification method. NPB sold the servicing on all of the loans
securitized.
In 2003 and 2002, NPB securitized approximately $123.8 million and
$35.4 million, respectively, of one-to-four family residential mortgage
loans in a guaranteed mortgage securitization with the Federal National
Mortgage Association. NPB recognized no gain or loss on the transaction as
it retained all of the resulting securities. All of the resulting
securities were classified as investment securities available for sale.
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal, reduced by unearned income and an allowance for loan
losses. Interest on loans is calculated based upon the principal amount
outstanding. The Company defers and amortizes certain origination and
commitment fees, and certain direct loan origination costs over the
contractual life of the related loans. This results in an adjustment of the
related loan's yield. The allowance for loan losses is established through
a provision for loan losses charged as an expense. Loans are charged
against the allowance for loan losses when management believes that the
collectibility of the principal is unlikely. The allowance is an amount
that management believes will be adequate to absorb probable losses on
existing loans that may become uncollectible based on evaluations of the
collectibility of loans, and prior loan loss experience. The evaluations
take into consideration such factors as changes in the nature and volume of
the loan portfolio, overall portfolio quality, review of specific problem
loans, and current economic conditions that may affect the borrower's
ability to pay. Accrual of interest is stopped on a loan when management
believes, after considering economic and business conditions and collection
efforts that the borrower's financial condition is such that collection of
interest is doubtful.
Loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated fair value in the aggregate. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Servicing is not retained on residential mortgage sales
or securitizations. At December 31, 2003 and December 31, 2002, cost
approximated fair value.
(Continued)
52
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The Company accounts for its impaired loans in accordance with
Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by
Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures.
This standard requires that a creditor measure impairment based on the
present value of expected future cash flows discounted at the loan's
effective interest rate, except that as a practical expedient, a creditor
may measure impairment based on a loan's observable market price, or the
fair value of the collateral if the loan is collateral dependent.
Regardless of the measurement method, a creditor must measure impairment
based on the fair value of the collateral when the creditor determines that
foreclosure is probable. SFAS No. 114 excludes such homogeneous loans as
consumer and mortgage.
The Company accounts for its transfers and servicing financial assets
in accordance with SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. SFAS No. 140 revises
the standards for accounting for the securitizations and other transfers of
financial assets and collateral.
In July 2001, Staff Accounting Bulletin (SAB) No. 102, Selected Loan
Loss Allowance Methodology and Documentation Issues was issued. SAB No. 102
provides guidance on the development, documentation, and application of a
systematic methodology for determining the allowance for loans and leases
in accordance with US GAAP and is effective upon issuance. The adoption of
SAB No. 102 did not have a material impact on the Company's financial
position or results of operations.
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan
with the evidence of deterioration of credit quality since origination
acquired by completion of a transfer for which it is probable at
acquisition, that the Company will be unable to collect all contractually
required payments receivable. SOP 03-3 requires that the Company recognize
the excess of all cash flows expected at acquisition over the investor's
initial investment in the loan as interest income on a level-yield basis
over the life of the loan as the accretable yield. The loan's contractual
required payments receivable in excess of the amount of its cash flows
excepted at acquisition (nonaccretable difference) should not be recognized
as an adjustment to yield, a loss accrual or a valuation allowance for
credit risk. SOP 03-3 is effective for loans acquired in fiscal years
beginning after December 31, 2004. Early adoption is permitted. Management
is currently evaluating the provisions of SOP 03-3.
The Company adopted FIN 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of Indebtedness
of Others, on January 1, 2003. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company issues financial and
performance letters of credit. The Company previously did not record an
initial liability, except to the extent fees were paid by the customer,
when guaranteeing obligations unless it became probable that the Company
would have to perform under the guarantee. FIN 45 applies prospectively to
guarantees the Company issues or modifies subsequent to December 31, 2002.
PREMISES AND EQUIPMENT
Buildings, equipment and leasehold improvements are stated at cost less
accumulated depreciation and amortization computed by the straight-line
method over the estimated useful lives of the assets.
(Continued)
53
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The Company adopted SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets on January 1, 2002. SFAS No. 144 retains the
existing requirements to recognize and measure the impairment of long-lived
assets to be held and used or to be disposed of by sale. SFAS No. 144
changes the requirements relating to reporting the effects of a disposal or
discontinuation of a segment of a business. The adoption of this statement
did not have a material impact on the financial condition or results of
operations of the Company.
GOODWILL AND INTANGIBLE ASSETS
The Company has recognized core deposit intangibles, as a result of
branch acquisitions. Core deposit intangibles of $11,138,000 and
$1,029,000, net of accumulated amortization at December 31, 2003 and
December 31, 2002, respectively, are being amortized over nine years. The
estimated useful lives of the existing deposit base is an average of ten
years. Amortization expense for core deposit intangibles for the year ended
December 31, 2003 and 2002 was $1,110,000 and $149,000, respectively.
Substantially all outstanding goodwill resulted from the acquisitions
of FirstService Bank and Hometowne Heritage Bank in 2003. The balance of
goodwill at December 31, 2003 and 2002 was $111,210,000 and $8,947,000,
respectively. As a result of the adoption of SFAS No. 142 on January 1,
2002, the Company no longer amortizes goodwill.
The Company adopted SFAS No. 142, Goodwill and Intangible Assets, on
January 1, 2002. SFAS No. 142 modifies the accounting for all purchased
goodwill and intangible assets. SFAS No. 142 includes requirements to test
goodwill and indefinite lived intangible assets for impairment rather than
amortize them. The Company has completed the transitional testing of its
goodwill. The Company did not identify any impairment on its outstanding
goodwill and its identifiable intangible assets from its testing, performed
at June 30, 2003.
(Continued)
54
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The following table presents a reconciliation of net income and
earnings-per-share amounts, as reported in the financial statements, to
those amounts adjusted for goodwill and intangible asset amortization
determined in accordance with the provisions of SFAS No. 142.
For the year ended December 31,
---------------------------------------------
2003 2002 2001
---------- ----------- ----------
(in thousands except for
earnings-per-share amounts)
Reported net income $ 43,354 $ 36,234 $ 32,734
Add back goodwill amortization, net of taxes - - 1,203
-------- --------- --------
Adjusted net income $ 43,354 $ 36,234 $ 33,937
========= ========== =========
Basic earnings per share
Reported basic earnings per shares $ 1.82 $ 1.66 $ 1.49
Goodwill amortization - - 0.05
-------- --------- --------
Adjusted basic earnings per share $ 1.82 $ 1.66 $ 1.54
========= ========== =========
Diluted earnings per share
Reported diluted earnings per shares $ 1.78 $ 1.64 $ 1.47
Goodwill amortization - - 0.05
-------- --------- --------
Adjusted diluted earnings per share $ 1.78 $ 1.64 $ 1.52
========= ========== =========
The FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions: An amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No 9, which removes acquisitions of financial institutions
from the scope of SFAS 72, Accounting for Certain Acquisitions of Banking
or Thrift Institutions. SFAS No. 147 also requires that the acquisition of
a less-than-whole financial institution, such as a branch, be accounted for
as a business combination if the transferred assets and activities
constitute a business. The adoption of SFAS No. 147 did not have a material
impact on the Company's financial position or results of operations.
OTHER ASSETS
Financing costs related to the issuance of junior subordinated
debentures are being amortized over the life of the instruments and are
included in other assets.
(Continued)
55
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
BANK OWNED LIFE INSURANCE
In 1998 and 1999, the Company invested in bank owned life insurance
(BOLI) policies that provide earnings to help cover the cost of employee
benefit plans. BOLI involves the purchasing of life insurance by the
Company on a chosen group of employees. The Company is the owner and
beneficiary of the policies. The Company has additional BOLI policies that
have been received through several of its bank acquisitions. Cashflow from
these policies will occur over an extended period of time. The Company
periodically reviews the creditworthiness of the insurance companies that
have underwritten the policies. The insurance companies are all highly
rated by A.M. Best, and the earnings accruing to the Company are derived
from the general account investments of the insurance companies. The
policies appear on the Company's balance sheet and are subject to full
regulatory capital requirements.
EMPLOYEE BENEFIT PLANS
The Company has certain employee benefit plans covering substantially
all employees. The Company follows the disclosure provisions of SFAS No.
132, Employers' Disclosures about Pensions and Other Postretirement
Benefits, which was revised in December 2003. SFAS No. 132, as revised,
requires additional employers' disclosures about pension and other
postretirement benefit plans as of December 31, 2003. Certain disclosures
related to estimated future benefit payments are effective for fiscal years
ending after June 14, 2004. Net pension expense consists of service cost,
interest cost, return on pension assets and amortization of unrecognized
initial net assets. The Company accrues pension costs as incurred.
STOCK-BASED COMPENSATION
The Company accounts for stock options under SFAS No. 123, Accounting
for Stock-Based Compensation, as amended by SFAS No. 148, which contains a
fair value-based method for valuing stock-based compensation that entities
may use, which measures compensation cost at the grant date based on the
fair value of the award. Compensation is then recognized over the service
period, which is usually the vesting period. Alternatively, SFAS No. 123
permits entities to continue accounting for employee stock options and
similar equity instruments under Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees. Entities that continue to
account for stock options using APB Opinion No. 25 are required to make pro
forma disclosures of net income and earnings per share, as if the fair
value-based method of accounting defined in SFAS No. 123 had been applied.
At December 31, 2003, the Company had two stock-based employee
compensation plans, which are more fully described in note 15. The Company
accounts for these plans under the recognition and measurement principles
of APB No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Stock-based employee compensation costs are not reflected
in net income, as all options granted under the plans had an exercise price
equal to the market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, to stock-based employee compensation (in
thousands, except per share amounts). Not included in these computations
are substitute options granted in the course of bank acquisitions that are
accounted for at fair value through the application of the purchase
accounting requirements.
(Continued)
56
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Year ended December 31,
--------------------------------------
2003 2002 2001
--------- --------- ---------
Net income, as reported $ 43,354 $ 36,234 $ 32,734
Less: stock-based compensation costs
determined under fair value based
method for all awards 852 558 552
--------- --------- ---------
Net income, pro forma $ 42,502 $ 35,676 $ 32,182
========= ========= =========
Earnings per share of common stock - basic As reported $ 1.82 $ 1.66 $ 1.49
Pro forma 1.78 1.64 1.46
Earnings per share of common stock - diluted As reported 1.78 1.64 1.47
Pro forma 1.74 1.61 1.45
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing model with the following weighted
average assumptions used for grants in 2003, 2002 and 2001, respectively:
dividend yield of 3.02%, 3.28% and 3.85%; expected volatility of 27.7%,
35.1% and 14.0%; risk-free interest rates for each plan of 3.93% and 4.04%
for 2003 and 5.50% and 3.93% for 2002 and 5.23% and 5.04% for 2001; and
expected lives of 6.83 years and 6 years for each plan in 2003 and 8.50
years and 6.83 years for each plan in 2002, 8.11 years and 7.02 years for
each plan in 2001.
INCOME TAXES
The Company accounts for income taxes under the liability method of
accounting for income taxes. Deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax
bases of assets and liabilities as measured by the enacted tax rates that
will be in effect when these differences reverse. Deferred tax expense is
the result of changes in deferred tax assets and liabilities. The principal
types of differences between assets and liabilities for financial statement
and tax return purposes are allowance for loan losses, deferred loan fees,
deferred compensation and investment securities available for sale.
STATEMENTS OF CASH FLOWS
The Company considers cash and due from banks, interest bearing
deposits in banks and federal funds sold as cash equivalents for the
purposes of reporting cash flows. Cash paid for interest and taxes is as
follows (in thousands):
Year ended December 31,
---------------------------------------------
2003 2002 2001
---------- ----------- ----------
Interest $ 50,525 $ 64,637 $ 94,535
Taxes 9,999 10,174 9,113
(Continued)
57
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
OTHER REAL ESTATE OWNED
Other real estate owned is recorded at the lower of cost or estimated
fair market value less costs of disposal. When property is acquired, the
excess, if any, of the loan balance over fair market value is charged to
the allowance for possible loan losses. Periodically thereafter, the asset
is reviewed for subsequent declines in the estimated fair market value.
Subsequent declines, if any, and holding costs, as well as gains and losses
on subsequent sale, are included in the consolidated statements of income.
EARNINGS PER SHARE
Earnings per share are calculated on the basis of the weighted average
number of common shares outstanding during the year. All weighted average,
actual shares or per share information in the financial statements have
been adjusted retroactively for the effect of stock dividends and splits.
The Company calculates earnings per share under the provisions of SFAS
No. 128, Earnings Per Share. Basic earnings per share excludes dilution and
is computed by dividing income available to common shareholders by the
weighted average common shares outstanding during the period. Diluted
earnings per share takes into account the potential dilution that could
occur if securities or other contracts to issue common stock were exercised
and converted into common stock.
ADVERTISING COSTS
It is the Company's policy to expense advertising costs in the period
in which they are incurred.
DERIVATIVES
The Company adopted the provisions of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended, as of January 1,
2001. The statement requires the Company to recognize all derivative
instruments at fair value as either assets or liabilities. Financial
derivatives are reported at fair value in other assets or other
liabilities. The accounting for changes in the fair value of a derivative
instrument depends on whether it has been designated and qualifies as part
of a hedging relationship. For derivatives not designated as hedges, the
gain or loss is recognized in current earnings.
The Company enters into interest rate swap contracts to modify the
interest rate characteristics from variable to fixed in order to reduce the
impact of interest rate changes on future interest expense. Net amounts
payable or receivable from this contract are accrued as an adjustment to
interest expense. The fair value of these derivatives is reported in other
assets or other liabilities and offset in accumulated other comprehensive
income for the effective portion of the derivatives. Amounts reclassed into
earnings, when the hedged transaction culminates, are included in interest
expense. Ineffectiveness of the strategy, as defined under SFAS No. 133, if
any, is reported in interest expense. The Company performs an assessment,
both at the inception of the hedge and quarterly thereafter, to determine
whether these derivatives are highly effective in offsetting changes in the
value of the hedged items. The change in fair value of the swaps attributed
to hedge ineffectiveness was not material for the years ended December 31,
2003 and 2002.
(Continued)
58
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The Company adopted Statement of Financial Accounting Standard 149
(SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and
Hedging Activities, on July 1, 2003. SFAS No. 149 clarifies or amends SFAS
No. 133 for implementation issues raised by constituents or includes the
conclusions reached by the FASB on certain FASB Staff Implementation
Issues. Statement 149 also amends paragraph SFAS No. 133 to require a
lender to account for loan commitments related to mortgage loans that will
be held for sale as derivatives. SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003. The Company periodically
enters into commitments with its customers for loans which it intends to
sell in the future. The adoption of SFAS No. 149 did not have a material
impact on the Company's financial position or results of operations.
VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the
application of Accounting Research Bulletin 51, Consolidated Financial
Statements, to certain entities in which voting rights are not effective in
identifying the investor with the controlling financial interest. An entity
is subject to consolidation under FIN 46 if the investors either do not
have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support, are unable to direct the
entity's activities, or are not exposed to the entity's losses or entitled
to its residual returns ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by
their primary beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of the
entity's expected losses, receives a majority of its expected returns, or
both.
Management has determined that NPB Capital Trust II qualifies as a
variable interest entity under FIN 46. NPB Capital Trust II issued
mandatorily redeemable preferred securities to investors and loaned the
proceeds to the Company. NPB Capital Trust II holds, as its sole asset,
subordinated debentures issued by the Company in 2002. NPB Capital Trust II
is currently included in the Company's consolidated balance sheet and
statements of income. The Company has evaluated the impact of FIN 46 and
concluded it should continue to consolidate NPB Trust II as of December 31,
2003, in part due to its ability to call the preferred stock prior to the
mandatory redemption date and thereby benefit from a decline in required
dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to
certain variable interest entities by March 31, 2004. The Company plans to
adopt the provisions under the revised interpretation in the first quarter
of 2004. FIN 46(R) will require NPB to deconsolidate NPB Capital Trust II
as of March 31, 2004. FIN 46(R) precludes consideration of the call option
embedded in the trust preferred securities when determining if the Company
has the right to a majority of NPB Capital Trust II's expected residual
returns. Accordingly, the Company will deconsolidate NPB Capital Trust II
at the end of the first quarter, which will result in an increase in
outstanding debt by $2.71 million. The banking regulatory agencies have not
issued any guidance that would change the regulatory capital treatment for
the trust-preferred securities issued by NPB Capital Trust II based on the
adoption of FIN 46(R). However, as additional interpretations from the
banking regulators related to entities such as NPB Capital Trust II become
available, management will reevaluate its potential impact to its Tier I
capital calculation under such interpretations.
(Continued)
59
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the reporting of
comprehensive income, which includes net income as well as certain other
items, which results in a change to equity during the period (in
thousands).
December 31, 2003 December 31, 2002 December 31, 2001
--------------------------- ----------------------------- ------------------------------
Before Tax Net of Before Tax Net of Before Tax Net of
tax (expense) tax tax (expense) tax tax (expense) tax
amount benefit amount amount benefit amount amount benefit amount
--------------------------- ----------------------------- ------------------------------
Unrealized gains (losses) on
investment securities
Unrealized holding
gains (losses)
arising during period $ 3,589 $ (1,568) $ 2,021 $ 20,858 $ (7,301) $ 13,557 $ 897 $ (314) $ 583
Less reclassification
adjustment for
gains (losses)
realized in net income (369) 129 (240) 214 (75) 139 334 (117) 217
------- -------- ----- -------- -------- -------- ----- ------ -----
Unrealized gains (losses) on
investment securities 3,958 (1,697) 2,261 20,644 (7,226) 13,418 563 (197) 366
------- -------- ----- -------- -------- -------- ----- ------ -----
Change in fair value of cash
flow hedges (1,962) - (1,962) 2,759 - 2,759 - - -
------- -------- ----- -------- -------- -------- ----- ------ -----
Other comprehensive income
(loss), net $ 1,996 $ (1,697) $ 299 $ 23,403 $ (7,226) $ 16,177 $ 563 $ (197) $ 366
======= ======== ===== ======== ======== ======== ===== ====== =====
2. ACQUISITIONS AND DISPOSITIONS
Acquisition of Peoples First, Inc.
On December 18, 2003, National Penn Bancshares, Inc. announced the
execution of a definitive agreement for National Penn to acquire Peoples
First, Inc. ("Peoples"), parent company of The Peoples Bank of Oxford in a
stock and cash transaction valued at approximately $148 million. The
Peoples Bank of Oxford is a $456 million bank headquartered in Oxford,
Pennsylvania, operating eight community offices in Chester and Lancaster
Counties, Pennsylvania, and one community office in Cecil County, Maryland.
Under the terms of the merger agreement, Peoples shareholders will be
entitled to select to receive either 1.505 shares of National Penn common
stock, $49.54 in cash, or a combination of both, for each share of Peoples
common stock. Peoples shareholder elections are subject to allocation
procedures. The application of these procedures will result in the exchange
of 30 percent of the Peoples shares for cash, and the remaining shares will
be exchanged for shares of National Penn common stock. Options to purchase
shares of Peoples common stock will be converted into options to purchase
shares of National Penn common stock.
Acquisition of HomeTowne Heritage Bank
On December 12, 2003, the Company completed a merger with HomeTowne
Heritage Bank ("HomeTowne"). Under the terms of the merger, each
outstanding share of common stock of HomeTowne was exchanged for $13.697 in
cash resulting in the payment of approximately $37.6 million. In addition,
outstanding stock options to purchase 984,332 shares of HomeTowne common
stock were converted into stock options to purchase 288,721 shares of the
Company's common stock, with an exercise price ranging between $12.10 and
$24.20 per share. This transaction was accounted for in accordance with
SFAS No. 141, Business Combinations and the results of operations of the
Company included HomeTowne's results from and after December 12, 2003. The
acquisition resulted in the recording of approximately $25.6 million of
goodwill and other intangible assets.
(Continued)
60
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
2. ACQUISITIONS AND DISPOSITIONS - Continued
Acquisition of FirstService Bank
--------------------------------
On February 25, 2003, the Company completed a merger with FirstService
Bank (FirstService). Under the terms of the merger, each outstanding share
of FirstService common stock was converted into 0.5954 share of the
Company's common stock plus $3.90, resulting in an issuance of 2,563,552
shares of the Company's common stock and approximately $16.8 million in
cash. In addition, outstanding stock options to purchase FirstService
common stock were converted into stock options to purchase 643,169 shares
of the Company's common stock, with an exercise price of either $6.69 or
$13.38 per share. This transaction was accounted for under the purchase
method of accounting and the results of operations of the Company includes
FirstService's results from and after February 25, 2003. The acquisition
resulted in the recording of approximately $52 million of goodwill and
other intangibles.
Disposition of Panasia Bank, N.A.
---------------------------------
On September 11, 2003, the Company completed the cash sale of Panasia
Bank N.A., its wholly owned subsidiary for $34.5 million, which resulted in
a gain of $6.68 million after taxes of $1.8 million. In accordance with
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, the income of Panasia is presented as discontinued operations for
all periods presented. At the time of the sale, Panasia had total assets of
$213.5 million, net loans of $99.7 million, investments of $84.4 million,
deposits of $188.2 million, and total equity of $24.4 million. The Company
has classified the results of operations of Panasia from January 1, 2003
through September 11, 2003 as discontinued operations in the consolidated
statement of income. Net income from discontinued operations, net of taxes
of $2.7 million for the year ended December 31, 2003 was $8.6 million.
The following represents the components of net assets from discontinued
operations as of December 31, 2002:
Cash and cash equivalents $10,323
Investments 82,844
Loans receivable, net 98,158
Goodwill 12,434
Other assets 3,516
--------
Total $207,275
--------
Deposits $186,676
Other liabilities 4,008
--------
Total $190,684
--------
Net assets from discontinued $ 16,591
========
operations
(Continued)
61
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
2. ACQUISITIONS AND DISPOSITIONS - Continued
The following represents the per share amounts for continuing and
discontinued operations for the years ended December 31, 2003, 2002 and
2001:
Years ended December 31,
-----------------------------
2003 2002 2001
---- ---- ----
Net income per share - basic
Continuing operations $1.45 $1.57 $1.45
Discontinued operations 0.37 0.09 0.04
----- ----- -----
Net income per share - basic $1.82 $1.66 $1.49
===== ===== =====
Net income per share - diluted
Continuing operations $1.42 $1.55 $1.43
Discontinued operations 0.36 0.09 0.04
----- ----- -----
Net income per share - diluted $1.78 $1.64 $1.47
===== ===== =====
On September 27, 2002, the Company, through its subsidiary Panasia,
acquired the United Asian Bank division of Wilmington Savings Fund Society,
FSB. The Company acquired $15.8 million of loans and $9.6 million of
deposits. This acquisition resulted in the recording of approximately $1.2
million in core deposit intangibles and goodwill.
Acquisition of Community Independent Bank, Inc.
-----------------------------------------------
On January 3, 2001, the Company completed a merger with Community
Independent Bank, Inc. (CIB). Under the terms of the merger, each share of
CIB stock was converted into 0.90 share of the Company's common stock,
resulting in an issuance of 712,973 shares of the Company's common stock.
In addition, outstanding stock options to purchase CIB common stock were
converted into stock options to purchase 20,752 shares of the Company's
common stock, with an exercise price of $8.47 to $11.64 per share. This
transaction was accounted for under the pooling of interests method of
accounting.
62
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
3. INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and fair values
of the Company's investment securities are summarized as follows (in
thousands):
December 31, 2003
----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
---------- ---------- ---------- -----
U.S. Treasury and U.S. Government
agencies $ 111,183 $ 4,122 $ (513) $ 114,792
State and municipal bonds 259,623 18,189 (5) 277,807
Mortgage-backed securities 480,803 5,937 (1,994) 484,746
Marketable equity securities and other 53,781 4,177 (928) 57,030
-------- -------- --------- --------
Totals $ 905,390 $ 32,425 $ (3,440) $ 934,375
========= ========= ========== =========
December 31, 2002
----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
---------- ---------- ---------- -----
U.S. Treasury and U.S. Government
agencies $ 37,826 $ 4,048 $ (10) $ 41,864
State and municipal bonds 248,819 10,901 (47) 259,673
Mortgage-backed securities 292,552 8,674 (1) 301,225
Marketable equity securities and other 47,661 2,528 (2,021) 48,168
-------- -------- -------- --------
Totals $ 626,858 $ 26,151 $ (2,079) $ 650,930
========= ========= ========= =========
The amortized cost and fair value of investment securities available
for sale, by contractual maturity, at December 31, 2003 (in thousands), are
shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Amortized Fair
cost value
------------ ------------
Due in one year or less $ 5,325 $ 5,463
Due after one through five years 277,456 278,835
Due after five through ten years 196,202 201,711
Due after ten years 372,626 391,336
Marketable equity securities and other 53,781 57,030
---------- ----------
$ 905,390 $ 934,375
=========== ===========
(Continued)
63
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
3. INVESTMENT SECURITIES - Continued
Proceeds from the sales of investment securities during 2003, 2002 and
2001, were $35,000,000, $20,458,000 and $25,601,000, respectively. Gross gains
realized on those sales were $0, $464,000 and $961,000 in 2003, 2002 and 2001,
respectively, gross losses were $369,000 in 2003 and $250,000 in 2002 and
$627,000 in 2001. As of December 31, 2003 and 2002, investment securities with a
fair value of $684,357,000 and $514,894,000, respectively, were pledged to
secure public deposits and for other purposes as provided by law. As of December
31, 2003 and 2002, the Company did not have any investment securities of any one
issuer where the carrying value exceeded 10% of shareholders' equity.
The table below indicates the length of time individual securities have
been in a continuous unrealized loss position at December 31, 2003:
Less than 12 months 12 months or longer Total
------------------------ ----------------------- ------------------------
Number of Fair Unrealized Fair Unrealized Fair Unrealized
Securities Value Losses Value Losses Value Losses
-----------------------------------------------------------------------------------------
U.S. Treasury and U.S.
Government Agencies 5 $ 34,491 $ 509 $ 992 $ 4 $ 35,483 $ 513
State and municipal bonds 1 -- -- 336 5 336 5
Mortgage-backed securities 33 1,994 -- -- 1,994 196,487 196,487
Other bonds -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Total debt securities 39 2,503 1,328 9 2,512 230,978 232,306
Marketable equity securities 20 4,905 259 11,784 669 16,689 928
-------- -------- -------- -------- -------- -------- --------
Total securities 59 $235,883 $ 2,762 $ 13,112 $ 678 $248,995 $ 3,440
======== ======== ======== ======== ======== ======== ========
The impairment of the investment portfolio at December 31, 2003 totaled
$3.4 million in 59 securities, or .37% of the total investment portfolio of
$934.7 million. The unrealized loss is due to changes in market value stemming
from changes in the general level of interest rates and is considered to be
temporary.
4. LOANS
Major classifications of loans are as follows (in thousands):
December 31,
2003 2002
------------ ------------
Commercial and industrial loans and leases $ 482,884 $ 355,977
Real estate loans
Construction and land development 149,531 122,129
Residential, including $29,344 and $52,992 in loans held for sale 754,977 677,559
Other (nonfarm, nonresidential real estate) 828,843 574,443
Loans to individuals 54,466 55,299
Unearned income on loans reflected in balances above (9,104) (7,626)
------------ ------------
2,270,701 1,785,407
Allowance for loan losses (49,265) (40,578)
------------ ------------
Total loans, net $ 2,221,436 $ 1,744,829
============ ============
(Continued)
64
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
4. LOANS - Continued
Loans on which the accrual of interest has been discontinued or reduced
amounted to approximately $13,673,000 and $14,046,000 at December 31, 2003
and 2002, respectively. If interest on these loans had been accrued,
interest income would have decreased by approximately $164,000 for 2003, as
interest collected in this period was accrued in prior years. Interest
income would have increased $246,000 and $1,123,000 for 2002 and 2001,
respectively, if interest on these loans had been accrued.. Loan balances
past due 90 days or more and still accruing interest, but which management
expects will eventually be paid in full, amounted to $318,000 and $928,000
at December 31, 2003 and 2002, respectively.
The balance of impaired loans was $10,707,000 at December 31, 2003. The
Company has identified a loan as impaired when it is probable that interest
and principal will not be collected according to the contractual terms of
the loan agreement. The allowance for loan loss associated with the
$10,707,000 of impaired loans was $971,000 at December 31, 2003. The
average impaired loan balance was $13,589,000 during 2003 and the income
recognized on impaired loans during 2003 was $452,000. The Company
recognizes income on impaired loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Company. If these factors do not exist, the
Company will not recognize income on such loans.
The balance of impaired loans was $10,508,000 at December 31, 2002. The
Company has identified a loan as impaired when it is probable that interest
and principal will not be collected according to the contractual terms of
the loan agreement. The allowance for loan loss associated with the
$10,508,000 of impaired loans was $1,323,000 at December 31, 2002. The
average impaired loan balance was $15,921,000 and $19,371,000 during 2002
and 2001, respectively, and the income recognized on impaired loans during
2002 and 2001 was $386,000 and $863,000, respectively. The Company
recognizes income on impaired loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Company. If these factors do not exist, the
Company will not recognize income on such loans.
Changes in the allowance for loan losses are as follows (in thousands):
Year ended December 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
Balance, beginning of year $ 40,578 $ 40,449 $ 37,724
Provision charged to operations 9,371 13,585 8,450
Loans charged off (12,344) (15,365) (7,522)
Recoveries 5,497 1,909 1,797
Acquisition of FirstService and HomeTowne 6,163 -- --
--------- --------- ---------
Balance, end of year $ 49,265 $ 40,578 $ 40,449
========= ========= =========
65
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
5. PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as
follows (in thousands):
December 31,
Estimated -------------
useful lives 2003 2002
------------ ------- -------
Land Indefinite $ 6,690 $ 3,356
Buildings 5 to 40 years 33,488 22,469
Equipment 3 to 10 years 43,844 36,562
Leasehold improvements 2 to 40 years 6,001 5,567
--------- ---------
90,023 67,954
Accumulated depreciation and amortization (46,370) (39,506)
--------- ---------
$ 43,653 $ 28,448
========= =========
Depreciation and amortization expense amounted to $5,249,000 $4,310,000
and $4,481,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
6. DEPOSITS
The aggregate amount of jumbo certificates of deposit, each with a
minimum denomination of $100,000, was approximately $137,965,000 and
$169,385,000 in 2003 and 2002, respectively.
At December 31, 2003, the scheduled maturities of certificates of
deposit are as follows (in thousands):
2004 $ 335,631
2005 224,624
2006 36,050
2007 44,940
2008 12,763
Thereafter 4,597
----------
$ 658,605
==========
66
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
7. SHORT-TERM BORROWINGS
Federal funds purchased and securities sold under agreements to
repurchase generally mature within 30 days from the date of the
transactions. Short-term borrowings consist of Treasury Tax and Loan Note
Options and various other borrowings, which generally have maturities of
less than one year. The details of these categories are presented below (in
thousands):
At or for the year ended December 31,
------------------------------------------
2003 2002 2001
---------- ---------- ----------
Securities sold under repurchase agreements
and federal funds purchased
Balance at year-end $ 500,038 $ 252,086 $ 238,726
Average during the year 324,492 237,401 251,583
Maximum month-end balance 500,038 272,322 300,532
Weighted average rate during the year 1.22% 1.94% 4.10%
Rate at December 31 1.08% 1.25% 2.02%
Short-term borrowings
Balance at year-end $ 10,000 $ 10,614 $ 9,480
Average during the year 5,179 7,146 7,235
Maximum month-end balance 10,045 10,614 10,012
Weighted average rate during the year 0.77% 1.46% 3.65%
Rate at December 31 0.59% 0.78% 1.52%
The weighted average rates paid in aggregate on these borrowed funds
for 2003, 2002 and 2001 were 1.21%, 1.83% and 3.78%, respectively.
8. LONG-TERM BORROWINGS
FHLB ADVANCES
At December 31, 2003, advances from the Federal Home Loan Bank (FHLB)
totaling $157,992,000 will mature within one to eight years and are
reported as long-term borrowings. The advances are collateralized by FHLB
stock and certain first mortgage loans and mortgage-backed securities.
These advances had a weighted average interest rate of 4.36%. Unused lines
of credit at the FHLB were $909,959,000 and $539,306,000 at December 31,
2003 and 2002, respectively.
Outstanding borrowings mature as follows (in thousands):
2004 $ 10,000
2005 12,500
2006 20,000
2007 10,411
2008 25,000
Thereafter 80,081
----------
$ 157,992
==========
(Continued)
67
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
8. LONG-TERM BORROWINGS - Continued
In September 2003, the Company refinanced approximately $77.5 million
of long-term debt with the Federal Home Loan Bank of Pittsburgh with a
weighted average rate of 5.13% and a weighted average remaining life of
approximately 47 months. The Company paid a prepayment fee of $7.0 million
before taxes and included the prepayment fee in other expenses. The Company
obtained new debt of $70.0 million, which has a weighted average interest
rate of 3.22% and a weighted average life of approximately 54 months. In
addition, this new debt also does not include certain call provisions that
applied to the retired debt.
OTHER BORROWINGS
During 2000, the Company borrowed $21,000,000 with an interest rate of
the federal funds rate plus 0.875%. The note matures on June 30, 2004 and
requires monthly interest and quarterly principal payments. The balance as
of December 31, 2003 is $3,938,000 with an interest rate of 1.855%.
SUBORDINATED DEBENTURES
On August 20, 2002, the Company issued $65.21 million of 7.85% junior
subordinated debentures (the 2002 Debentures) due September 30, 2032 to NPB
Capital Trust II (the Trust), a Delaware business trust, which is a
wholly-owned subsidiary of the Company. The 2002 Debentures are the sole
asset of the Trust. The Trust issued 2,530,000 shares of trust preferred
securities, $25 face value, for total proceeds of $63.25 million. The
Company's obligations under the 2002 Debentures and related documents,
taken together, constitute a full, irrevocable and unconditional guarantee
on a subordinated basis by the Company of the Trust's obligations under the
preferred securities. The preferred securities are redeemable by the
Company on or after September 30, 2007, or earlier if the deduction of
related interest for federal income taxes is prohibited, treatment as Tier
I capital is no longer permitted, or certain other contingencies arise. The
preferred securities must be redeemed upon maturity of the debentures in
2032. The ability of the Company's banking subsidiaries to pay dividends or
extend credit to the Company is subject to legal and regulatory
limitations.
On October 31, 2002, the Company used a portion of the net proceeds
from the 2002 Debentures transaction to redeem the $40.25 million aggregate
amount of 9% trust preferred securities issued by the Company in May 1997.
As a result, the Company wrote-off the associated unamortized issuance cost
of $822,000 which is included in other operating expense.
(Continued)
68
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
9. BENEFIT PLANS
PENSION PLAN
The Company has a non-contributory defined benefit pension plan
covering substantially all employees. The Company-sponsored pension plan
provides retirement benefits under pension trust agreements and under
contracts with insurance companies. The benefits are based on years of
service and the employee's compensation during the highest five consecutive
years during the last 10 years of employment. The Company's policy is to
fund pension costs allowable for income tax purposes.
The following table sets forth the plan's funded status and amounts
recognized in the Company's consolidated balance sheets (in thousands):
December 31,
2003 2002
--------- ---------
Change in benefit obligation
Benefit obligation at beginning of year $ 15,961 $ 14,080
Service cost 1,264 1,274
Interest cost 1,069 977
Actual gain 654 (163)
Benefits paid (391) (306)
Effect of change in assumptions 1,827 99
--------- ---------
Benefits obligation at end of year 20,384 15,961
--------- ---------
Change in plan assets
Fair value of plan assets at beginning of year 15,620 15,565
Actual return on plan assets 2,492 (523)
Employer contribution 1,187 884
Benefits paid (391) (306)
--------- ---------
Fair value of plan assets at end of year 18,908 15,620
--------- ---------
Funded status (1,476) (341)
Unrecognized net actuarial gain 3,341 2,226
Unrecognized prior service cost 24 (17)
--------- ---------
Prepaid benefit cost (included in other assets) $ 1,889 $ 1,868
========= =========
The accumulated benefit obligation was $14,789,000 and $11,659,000 at
December 31, 2003 and 2002, respectively.
(Continued)
69
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- ------------------------------------------------------------------------------------------------------------------------------------
9. PENSION PLANS - Continued
Net pension cost included the following components (in thousands):
Year ended December 31,
--------------------------------------------
2003 2002 2001
--------- --------- ---------
Service cost $ 1,264 $ 1,274 $ 1,089
Interest cost on projected benefit obligation 1,069 977 832
Actual return on plan assets (2,492) 523 1,305
Net amortization and deferral 1,324 (1,734) (2,670)
--------- --------- ---------
Net periodic benefit cost $ 1,165 $ 1,040 $ 556
========= ========= =========
Weighted-average assumptions used
To determine benefit obligations at
December 31
2003 2002
---- ----
Discount rate 6.50% 6.88%
Rate of compensation increase 4.00% 4.25%
Weighted-average assumptions used To determine net periodic
benefit cost For years ended December 31
2003 2002
---- ----
Discount rate 6.50% 6.88%
Expected long-term return on plan assets 8.25% 8.25%
Rate of compensation increase 4.00% 4.25%
Plan Assets
-----------
The Company's pension plan weighted-average asset allocations at
December 31, 2003, and 2002, by asset category are as follows:
Plan Assets
At December 31,
----------------
2003 2002
Asset Category ---- ----
Equity securities 47% 37%
Debt securities 36 49
Real estate - -
Other 17 14
-- --
Total 100% 100%
=== ===
The plan does not have any assets in the Company's common stock.
(Continued)
70
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
9. PENSION PLANS - Continued
CAPITAL ACCUMULATION PLAN
The Company has a capital accumulation and salary reduction plan under
Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the
plan, all employees are eligible to contribute from 3% to a maximum of 15%
of their annual salary, with the Company matching 50% of any contribution
between 3% and 7%. Matching contributions to the plan were $965,000,
$758,000 and $765,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
DEFERRED COMPENSATION ARRANGEMENTS
The Company has established deferred compensation arrangements for
certain executives. The deferred compensation plans provide for annual
payments for fifteen years following retirement. The Company's liabilities
under these arrangements are being accrued from the commencement of the
plans over the participant's remaining periods of service. The expense
recorded in connection with these deferred compensation plans, which are
unfunded, was $320,000, $464,000 and $542,000 for the years ended December
31, 2003, 2002 and 2001.
The Company, through its acquisition of FirstService Bank and HomeTowne
Heritage Bank, has several non-qualified, unfunded Supplemental Executive
Retirement Plans (SERPs) for certain executive officers. These SERPs
supplement the benefit these executive officers will receive under the
Company's qualified retirement plans, and provide annual benefits up to 60%
of the executives' final compensation, as defined under the SERPs, payable
over the executives' remaining lifetime assuming the executive attains age
62. The SERPs also provide for survivor and certain other termination
benefits. The expense recorded in connection with these SERPs was $231,000
for the year ended December 31, 2003. The Company is the beneficiary of
life insurance policies with an aggregate cash surrender value of $9.5
million. The Company is using these policies as a method of funding
benefits under these plans.
10. INCOME TAXES
The components of the income tax expense included in the consolidated
statements of income are as follows (in thousands):
Year ended December 31,
------------------------------------
2003 2002 2001
--------- --------- ---------
Income tax expense
Current $ 5,104 $ 7,379 $ 7,130
Deferred federal benefit (503) (78) (217)
--------- --------- ---------
4,601 7,301 6,193
Additional paid-in capital from benefit
of stock options exercised 4,096 1,302 843
--------- --------- ---------
Applicable income tax expense $ 8,697 $ 8,603 $ 7,756
========= ========= =========
(Continued)
71
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
10. INCOME TAXES - Continued
The differences between applicable income tax expense and the amount
computed by applying the statutory federal income tax rate of 35% are as
follows (in thousands):
Year ended December 31,
--------------------------------------------
2003 2002 2001
--------- --------- ---------
Computed tax expense at statutory rate $ 15,201 $ 14,972 $ 13,902
Decrease in taxes resulting from
Tax-exempt loan and investment income (6,697) (6,478) (5,826)
Other, net 193 109 (320)
--------- --------- ---------
Applicable income tax expense $ 8,697 $ 8,603 $ 7,756
========= ========= =========
Deferred tax assets and liabilities consist of the following (in
thousands):
2003 2002
--------- ---------
Deferred tax assets
Deferred loan fees $ - $ 16
Allowance for loan loss 16,015 13,179
Deferred compensation 2,342 1,827
Loan sales valuation 54 54
--------- ---------
18,411 15,076
--------- ---------
Deferred tax liabilities
Pension 1,006 949
Partnership investments 588 518
Depreciation 1,293 -
Investment securities available for sale 10,122 8,425
Rehab credit adjustment 44 44
Core deposit intangibles 3,591 -
--------- ---------
16,644 9,936
--------- ---------
Net deferred tax asset (included in other assets) $ 1,767 $ 5,140
========= =========
As a result of the acquisitions of FirstService and HomeTowne Heritage,
the Company acquired a net deferred tax liability of $2,199,000, which
included $3.6 million related to the recognition of the core deposit
intangible and in unrealized holding gains in 2003.
As a result of discontinued operations, the Company disposed of a net
deferred tax liability of $21,000, which included $479,000 in unrealized
holding gains in 2002. The total income tax expense related to discontinued
operations in 2003, 2002, and 2001, was $2,704,000, $743,000 and $274,000,
respectively.
(Continued)
72
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
11. SHAREHOLDERS' EQUITY
On September 24, 2003, the Company's Board of Directors authorized the
repurchase of up to one million shares of the Company's common stock (2003
repurchase plan) to be used to fund the Company's dividend reinvestment
plan, stock option plans, stock-based benefit plans and employee stock
purchase plan. As of December 31, 2003, 152,921 shares have been
repurchased at an average price of $30.95 under the 2003 repurchase plan.
On August 27, 2003, the Company's Board of Directors declared a 5%
stock dividend to shareholders of record on September 12, 2003 which was
paid on September 30, 2003.
On October 23, 2002, the Company's Board of Directors declared a 5%
stock dividend to shareholders of record on December 6, 2002 and which was
paid on December 27, 2002.
On June 26, 2002, the Company's Board of Directors authorized the
repurchase of up to one million shares of the company's common stock (2002
repurchase plan) to be used to fund the Company's dividend reinvestment
plan, stock option plans, stock-based benefit plans and employee stock
purchase plan. The Company completed the 2002 repurchase plan on October
29, 2003 with an average price of $30.02.
On October 24, 2001, the Company's Board of Directors declared a 3%
stock dividend to shareholders of record on December 11, 2001 which was
paid on December 27, 2001.
On July 25, 2001, the Company's Board of Directors authorized a stock
repurchase plan (2001 repurchase plan) for 975,000 shares of its common
stock. Repurchases can be from time to time and will be used for general
corporate purposes including the Company's dividend reinvestment plan,
stock option plans, employee stock purchase plan, and other stock benefit
plans. The Company completed the 2001 repurchase plan on August 27, 2002
with an average price of $24.43.
12. SHAREHOLDER RIGHTS PLAN
The Company adopted a Shareholder Rights Plan (the Rights Plan) in 1989
to protect shareholders from attempts to acquire control of the Company at
an inadequate price. Under the Rights Plan, the Company distributed a
dividend of one right to purchase a unit of preferred stock on each
outstanding common share of the Company. The rights are not currently
exercisable or transferable, and no separate certificates evidencing such
rights will be distributed, unless certain events occur. The rights were to
expire on August 22, 1999. On August 21, 1999, the Plan was amended to
extend the expiration date to August 22, 2009.
After the rights become exercisable, under certain circumstances, the
rights (other than rights held by a 19.9% beneficial owner or an "adverse
person") will entitle the holders to purchase either the Company's common
shares or the common shares of the potential acquirer at a substantially
reduced price.
The Company is generally entitled to redeem the rights at $0.001 per
right at any time until the 10th business day following a public
announcement that a 19.9% position has been acquired. Rights are not
redeemable following an "adverse person" determination.
The Rights Plan was not adopted in response to any specific effort to
acquire control of the Company. The issuance of rights had no dilutive
effect, did not affect the Company's reported earnings per share, and was
not taxable to the Company or its shareholders.
73
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
13. EARNINGS PER SHARE
Year ended December 31, 2003
--------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
Basic earnings per share
Net income available to common stockholders $ 43,354 23,813 $1.82
Effect of dilutive securities
Options - 598 (.04)
------- ------- -----
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions $ 43,354 24,411 $1.78
======== ======= =====
Options to purchase 327,000 shares of common stock at $32.35 to $33.13
per share were outstanding during 2003. They were not included in the
computation of diluted earnings per share because the option exercise price
was greater than the average market price.
Year ended December 31, 2002
--------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
Basic earnings per share
Net income available to common stockholders $ 36,234 21,817 $ 1.66
Effect of dilutive securities
Options - 286 (0.02)
------- ------- -----
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions $ 36,234 22,103 $1.64
======== ======= =====
Options to purchase 581,024 shares of common stock at $24.25 to $24.76
per share were outstanding during 2002. They were not included in the
computation of diluted earnings per share because the option exercise price
was greater than the average market price.
Year ended December 31, 2001
--------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
Basic earnings per share
Net income available to common stockholders $ 32,734 22,033 $ 1.49
Effect of dilutive securities
Options - 263 (0.02)
--------- --------- -----
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions $ 32,734 22,296 $ 1.47
======== ========= =====
Options to purchase 1,209,325 shares of common stock at $21.11 to
$24.76 per share were outstanding during 2001. They were not included in
the computation of diluted earnings per share because the option exercise
price was greater than the average market price.
74
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
14. COMMITMENTS AND CONTINGENT LIABILITIES
LEASE COMMITMENTS
Future minimum payments under non-cancelable operating leases are due
as follows (in thousands):
Year ending December 31,
------------------------
2004 $ 2,579
2005 2,323
2006 2,066
2007 1,785
2008 1,430
Thereafter 10,154
------
$20,337
======
The total rental expense was approximately $3,462,000, $3,088,000 and
$2,770,000 in 2003, 2002 and 2001, respectively.
OTHER
In the normal course of business, the Company, the Banks and ITC have
been named as defendants in several lawsuits. Although the ultimate outcome
of these suits cannot be ascertained at this time, it is the opinion of
management that the resolution of such suits will not have a material
adverse effect on the financial position or results of operations of the
Company.
15. STOCK-BASED COMPENSATION
The Company maintains an Officers' and Key Employees' Stock
Compensation Plan (Officers' Plan). A total of 2,700,539 shares of common
stock have been made available for options or restricted stock to be
granted through December 17, 2006. Options granted under the Officers' Plan
will vest over a five-year period, in 20% increments on each successive
anniversary of the date of grant. There are 1,596,017 outstanding options
under the Officers' Plan at December 31, 2003. Options granted under the
Company's previous stock option plan, are subject to a vesting schedule
commencing at two years and expire ten years and one month from the date of
issue. Under the prior plan, there are 286,335 outstanding options at
December 31, 2003.
In addition, the Company has a Non-Employee Directors' Stock Option
Plan (Directors' Plan). Under the Directors' Plan, a total of 345,072
shares of common stock have been made available for options to be granted
through January 3, 2004. The options granted under the Directors' Plan
fully vest after two years and expire ten years from the date of issue.
There are 75,427 outstanding options under the Directors' Plan at December
31, 2003.
The number of shares available for granting totaled 622,226 at December
31, 2003. As of December 31, 2003, 663,722 options were outstanding as a
result of previous acquisitions.
(Continued)
75
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
15. STOCK-BASED COMPENSATION - Continued
A summary of the status of the Company's fixed option plans is
presented below:
2003 2002 2001
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
---------- --------- ---------- --------- ---------- ---------
Outstanding, beginning of year 2,097,293 $19.52 2,348,335 $ 18.07 2,441,553 $ 16.69
Granted 1,377,216 16.96 318,551 24.10 330,793 21.41
Exercised (772,437) 14.54 (543,073) 15.98 (333,422) 11.19
Forfeited (80,571) 18.51 (26,520) 18.68 (90,589) 18.41
---------- ---------- ----------
Outstanding, end of year 2,621,501 $ 19.67 2,097,293 $ 19.52 2,348,335 $ 18.07
========== ========== ==========
Options exercisable at year-end 1,733,382 1,269,629 1,542,391
========== ========== ==========
Weighted average fair value of
options granted during the year $ 13.41 $ 7.21 $ 2.87
======== ======== ========
The following table summarizes information about nonqualified options
outstanding at December 31, 2003:
Options outstanding Options exercisable
------------------------------------------------------------------------ ---------------------------------
Weighted
Number average Number
outstanding at remaining Weighted outstanding at Weighted
Range of December 31, contractual average December 31, average
exercise prices 2003 life (years) exercise price 2003 exercise price
---------------- ---------- ------------- --------------- -------------- -----------------
$3.31 - $6.62 84,001 4.2 $ 6.37 84,001 $ 6.37
6.63 - 9.94 8,755 3.5 8.70 8,755 8.70
9.95 - 13.25 790,981 4.5 12.31 790,981 12.31
13.26 - 16.56 17,874 7.3 14.56 11,353 14.59
16.57 - 19.88 233,576 7.1 17.72 132,950 17.73
19.89 - 23.19 637,662 6.3 21.16 426,482 21.04
23.20 - 26.50 521,652 7.8 24.43 278,860 24.55
29.83 - 33.13 327,000 10.0 32.37 - -
----------- ------------
2,621,501 1,733,382
=========== ============
76
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
16. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
The Company grants commercial and residential loans to customers
throughout southeastern Pennsylvania. Although the Company has a
diversified loan portfolio, a substantial portion of its debtors' ability
to honor their contracts is dependent upon the economic sector.
17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit, standby
letters of credit and interest rate swaps. Those instruments involve, to
varying degrees, elements of credit, interest rate risk in excess of the
amount recognized in the consolidated balance sheets. The contract or
notional amounts of those instruments reflect the extent of involvement the
Company has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance
by the other party to the financial instrument for commitments to extend
credit and standby letters of credit is represented by the contractual
notional amount of these instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments. For interest rate swaps, the contract or
notional amounts do not represent exposure to credit loss. The Company
controls the credit risk of its interest rate swap agreements through
credit approvals, limits and monitoring procedures.
Unless otherwise noted, the Company does not require collateral or
other security to support financial instruments with credit risk. The
contract or notional amounts as of December 31, 2003 and 2002, are as
follows (in thousands):
2003 2002
----------- ----------
Financial instruments whose contract amounts represent
credit risk
Commitments to extend credit $ 747,338 $ 591,890
Standby letters of credit 54,533 37,322
Financial instruments whose notional or contract amounts
exceed the amount of credit risk
Interest rate swap agreements 40,000 60,000
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation. Collateral
held varies but may include personal or commercial real estate, accounts
receivable, inventory and equipment.
(Continued)
77
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK - Continued
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The Bank defines the fair value of these letters of credit as
the fees paid by the customer or similar fees collected on similar
instruments. The Bank amortizes the fees collected over the life of the
instrument. Management, based upon their periodic analysis, has determined
that a SFAS No. 5 reserve is not necessary at December 31, 2003. The
standby letters of credit expire as follows: $30,183,000 in 2004,
$14,275,000 by 2007, and the remaining $10,075,000 by 2008. The Bank also
obtains collateral, such as real estate or liens on their customer's assets
depending on the customer, for these types of commitments. The Bank would
reduce any potential liability based upon estimated proceeds obtained in
liquidation of the collateral held. Fair values of unrecognized financial
instruments including commitments to extend credit and the fair value of
letters of credit are considered immaterial. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. The extent of collateral held for
those commitments at December 31, 2003, varies up to 100%; the average
amount collateralized is 73%.
Interest rate swap transactions generally involve the exchange of fixed
and floating rate interest payment obligations without the exchange of the
underlying principal amounts. The Company uses swaps as part of its asset
and liability management process with the objective of hedging the
relationship between money market deposits that are used to fund prime rate
loans. Past experience has shown that as the prime interest rate changes,
rates on money market deposits do not change with the same volatility. The
interest rate swaps have the effect of converting the rates on money market
deposit accounts to a more market-driven floating rate typical of prime in
order for the Company to recognize a more even interest rate spread on this
business segment. In 2003, 2002 and 2001, the interest rate swaps had the
effect of increasing the Company's net interest income by $1,484,886,
$1,713,000 and $1,029,000, respectively, over what would have been realized
had the Company not entered into the swap agreements.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires disclosure of the estimated fair value of an entity's assets and
liabilities considered to be financial instruments. For the bank, as for
most financial institutions, the majority of its assets and liabilities are
considered to be financial instruments as defined in SFAS No. 107. However,
many of such instruments lack an available trading market as characterized
by a willing buyer and willing seller engaging in an exchange transaction.
Also, it is the Company's general practice and intent to hold its financial
instruments to maturity and to not engage in trading or sales activities.
Therefore, the Company had to use significant estimations and present value
calculations to prepare this disclosure.
Changes in assumptions or methodologies used to estimate fair values
may materially affect the estimated amounts. Also, management is concerned
that there may not be reasonable comparability between institutions due to
the wide range of permitted assumptions and methodologies in the absence of
active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
(Continued)
78
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
18. FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
Fair values have been estimated using data that management considered
the best available and estimation methodologies deemed suitable for the
pertinent category of financial instrument. The estimation methodologies,
resulting fair values and recorded carrying amounts at December 31, 2003
and 2002, were as follows (in thousands):
December 31, 2003 December 31, 2002
---------------------------- ----------------------------
Carrying Estimated fair Carrying Estimated fair
amount value amount value
---------- --------------- ---------- ---------------
Cash and cash equivalents $ 98,397 $ 98,397 $ 124,124 $ 124,124
Investment securities available for sale 934,375 934,375 650,930 650,930
Fair value of loans and deposits with floating interest rates is
generally presumed to approximate the recorded carrying amounts. Financial
instruments actively traded in a secondary market have been valued using
quoted available market prices.
Fair value of financial instruments with stated maturities has been
estimated using present value cash flow, discounted at a rate approximating
current market for similar assets and liabilities.
December 31, 2003 December 31, 2002
---------------------------- ----------------------------
Carrying Estimated fair Carrying Estimated fair
amount value amount value
---------- --------------- ---------- ---------------
(in thousands)
Deposits with stated maturities $ 658,605 $ 670,613 $ 707,813 $ 731,568
Repurchase agreements, federal funds
purchased and short-term borrowings 510,038 510,038 262,710 262,710
Long-term borrowings 164,037 169,558 169,703 184,968
Subordinated debentures 63,250 74,329 63,250 86,593
Fair value of financial instrument liabilities with no stated
maturities has been estimated to equal the carrying amount (the amount
payable on demand), totaling $1.78 billion for 2003 and $1.22 billion for
2002.
The fair value of the net loan portfolio has been estimated using
present value cash flow, discounted at the treasury rate adjusted for
non-interest operating costs and giving consideration to estimated
prepayment risk and credit loss factors.
December 31, 2003 December 31, 2002
----------------------------- ------------------------------
Carrying Estimated fair Carrying Estimated fair
amount value amount value
----------- --------------- ------------ ---------------
(in thousands)
Net loans $ 2,221,434 $ 1,934,278 $ 1,744,829 $ 1,831,390
(Continued)
79
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
18. FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
The fair value of commitments to extend credit is estimated based on
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based on the amount of unearned fees plus the
estimated cost to terminate the letters of credit.
The fair value of interest rate swaps are based upon the estimated
amount the Company would receive or pay to terminate the contracts or
agreements, taking into account current interest rates and, when
appropriate, the current creditworthiness of the counterparties. The fair
value of the interest rate swaps are $797,000 and $2,759,000 at December
31, 2003 and 2002, respectively.
19. REGULATORY MATTERS
National Penn Bank (NPB) is required to maintain average reserve
balances with the Federal Reserve Bank. The average amount of these
balances for the year ended December 31, 2003, was approximately
$21,650,000.
Dividends are paid by the Company from its assets, which are mainly
provided by dividends NPB. However, certain restrictions exist regarding
the ability of NPB to transfer funds to the Company in the form of cash
dividends, loans or advances. Under the restrictions in 2003, NPB, without
prior approval of bank regulators, can declare dividends to the Company
totaling $8,618,000 plus additional amounts equal to the net earnings of
NPB for the period January 1, 2004, through the date of declaration less
dividends previously paid in 2004.
NPB is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possible additional
discretionary - actions by regulators that, if undertaken, could have a
direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, NPB must meet specific capital guidelines that involve
quantitative measures of NPB's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting
practices. NPB's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings
and other factors.
Quantitative measures established by regulations to ensure capital
adequacy require NPB and the Company to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier I capital (as defined
in the regulations) to risk-weighted assets, and of Tier I capital to
average assets. Management believes, as of December 31, 2003, that NPB and
Company meet all capital adequacy requirements to which they are subject.
(Continued)
80
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
19. REGULATORY MATTERS - Continued
As of December 31, 2003, NPB met all regulatory requirements for
classification as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, NPB must
maintain minimum total risk-based, core risk-based and core leverage ratios
as set forth in the table. There are no conditions or events that
management believes have changed the institution's category.
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
-------------------- ---------------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
As of December 31, 2003
Total capital (to risk-weighted assets)
(greater
than or
National Penn Bancshares, Inc. $282,581 11.00% $205,507 equal to) 8.00% N/A N/A
(greater
than or
National Penn Bank 255,915 10.14 201,973 8.00 $252,466 equal to)10.00%
Tier I capital (to risk-weighted assets)
National Penn Bancshares, Inc. 250,259 9.74 102,754 4.00 N/A N/A
National Penn Bank 224,188 8.88 100,986 4.00 151,479 6.00
Tier I capital (to average assets)
National Penn Bancshares, Inc. 250,259 7.84 127,740 4.00 N/A N/A
National Penn Bank 224,138 7.06 127,025 4.00 158,781 5.00
As of December 31, 2002
Total capital (to risk-weighted assets)
(greater
than or
National Penn Bancshares, Inc. $271,184 13.08% $165,855 equal to) 8.00% N/A N/A
(greater
than or
National Penn Bank 203,455 10.59 153,667 8.00 $192,084 equal to)10.00%
Panasia Bank, N.A. 12,320 11.36 8,769 8.00 10,848 10.00
Tier I capital (to risk-weighted assets)
National Penn Bancshares, Inc. 244,932 11.81 82,928 4.00 N/A N/A
National Penn Bank 179,240 9.33 76,834 4.00 115,250 6.00
Panasia Bank, N.A. 10,956 10.10 4,339 4.00 6,509 6.00
Tier I capital (to average assets)
National Penn Bancshares, Inc. 244,932 8.66 113,181 4.00 N/A N/A
National Penn Bank 179,240 6.91 103,725 4.00 129,456 5.00
Panasia Bank, N.A. 10,956 5.61 7,819 4.00 9,773 5.00
81
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
20. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The following is a summary of selected financial information of
National Penn Bancshares, Inc., parent company only (in thousands):
CONDENSED BALANCE SHEETS
December 31,
2003 2002
------------ ------------
Assets
Cash $ 26 $ -
Investment in Bank subsidiaries, at equity 352,904 230,684
Investment in other subsidiaries, at equity 47,574 63,952
Other assets 1,889 6,894
------------ ------------
$ 402,393 $ 301,530
============ ============
Liabilities and shareholders' equity
Long-term borrowings $ 3,938 $ 9,188
Guaranteed preferred beneficial interests in Company's
subordinated debentures 65,206 65,206
Other liabilities 15,436 4,776
Shareholders' equity 317,813 222,360
------------ ------------
$ 402,393 $ 301,530
============ ============
(Continued)
82
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
20. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued
CONDENSED STATEMENTS OF INCOME
Year ended December 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
Income
Equity in undistributed net earnings of subsidiaries $ 4,921 $ 6,312 $ 10,123
Dividends from subsidiary 34,149 31,789 24,441
Interest and other income 29 253 483
--------- --------- ---------
39,099 38,354 35,047
Expense
Interest on subordinated debentures 5,119 4,983 3,735
Interest on long-term borrowings 121 288 837
Other operating expenses 68 1,024 115
--------- --------- ---------
5,308 6,295 4,687
Income before income tax benefit 33,791 32,059 30,360
Income tax benefit (942) (2,115) (1,605)
--------- --------- ---------
Income from continuing operations 34,733 34,174 31,965
Income from discontinued operations 8,621 2,060 769
--------- --------- ---------
Net income $ 43,354 $ 36,234 $ 32,734
========= ========= =========
(Continued)
83
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
20. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities
Net income $ 43,354 36,234 $ 32,734
Equity in undistributed net earnings of subsidiaries 8,459 (6,312) (10,123)
Equity in discontinued subsidiary (8,621) (2,060) (769)
(Increase) decrease in other assets 5,005 (5,980) 1,674
(Decrease) increase in other liabilities 10,660 - 1,091
-------- ---------- -------
Net cash provided by operating activities 58,857 21,882 24,607
-------- ---------- -------
Cash flows from investing activities
Cash received for business sold 34,500 - -
Cash paid to acquire businesses (54,400)
Sale or repayment of investments in subsidiaries - 24,280 1,918
Additional investment in subsidiaries, at equity (1,998) (41,292) 644
-------- ---------- -------
Net cash (used in) provided by investing activities (21,898) (17,212) 2,562
-------- ---------- -------
Cash flows from financing activities
Repayment of long-term debt (5,250) (5,249) (3,938)
Proceeds from issuance of subordinated debt - 65,206 -
Repayment of subordinated debt - (41,495) -
Proceeds from issuance of stock 4,890 - -
Effect of treasury stock transactions (15,339) (7,693) (3,660)
Cash dividends (21,234) (18,040) (16,974)
-------- ---------- -------
Net cash (used in) provided by financing activities (36,933) (7,271) (24,572)
-------- ---------- -------
Net (decrease) increase in cash and cash equivalents 26 (2,601) 2,597
Cash and cash equivalents at beginning of year - 2,601 4
-------- ---------- -------
Cash and cash equivalents at end of year $ 26 $ - $ 2,601
========= ========= ========
84
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
21. SEGMENT INFORMATION
SFAS No. 131, Segment Reporting, establishes standards for public
business enterprises to report information about operating segments in
their annual financial statements and requires that those enterprises
report selected information about operating segments in subsequent interim
financial reports issued to shareholders. It also established standards for
related disclosure about products and services, geographic areas, and major
customers. Operating segments are components of an enterprise, which are
evaluated regularly by the chief operating decision maker in deciding how
to allocate and assess resources and performance. The Company's chief
operating decision maker is the President and Chief Executive Officer. The
Company has applied the aggregation criteria set forth in SFAS No. 131 for
its National Penn operating segments to create one reportable segment,
"Community Banking."
The Company's community banking segment consists of commercial and
retail banking. The community banking business segment is managed as a
single strategic unit which generates revenue from a variety of products
and services provided by the Banks. For example, commercial lending is
dependent upon the ability of the Bank to fund itself with retail deposits
and other borrowings and to manage interest rate and credit risk. This
situation is also similar for consumer and residential mortgage lending.
The Company has also identified several other operating segments. These
operating segments within the Company's operations do not have similar
characteristics to the community banking operations and do not meet the
quantitative thresholds requiring separate disclosure. These nonreportable
segments include ITC, Penn Securities, National Penn Life Insurance
Company, NPB Capital Trust II, NP Leasing and the Parent are included in
the "Other" category.
The accounting policies used in this disclosure of operating segments
are the same as those described in the summary of significant accounting
policies. The consolidating adjustments reflect certain eliminations of
intersegment revenues, cash and investment in subsidiaries.
Reportable segment-specific information and reconciliation to
consolidated financial information is as follows:
Community
Banking Other Consolidated
-------------- ------------ ---------------
(in thousands)
December 31, 2003
Total assets $ 3,109,969 $ 402,605 $3,512,574
Total deposits 2,435,296 -- 2,435,296
Net interest income (loss) 118,636 (4,087) 114,549
Total noninterest income 30,063 11,222 41,285
Total noninterest expense 92,357 10,676 103,033
Net income (loss) from continuing operations 38,509 (3,776) 34,733
Net income from discontinued operations 1,935 6,686 8,621
Net income (loss) $ 40,444 $ 2,910 $ 43,354
(Continued)
85
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
21. SEGMENT INFORMATION - Continued
Community
Banking Other Consolidated
-------------- ------------ ---------------
(in thousands)
December 31, 2002
Total assets $ 2,561,860 $ 296,402 $ 2,858,262
Total deposits 1,925,964 - 1,925,964
Net interest income (loss) 107,020 (4,940) 102,080
Total noninterest income 28,388 8,162 36,550
Total noninterest expense 74,630 7,638 82,268
Net income (loss) from continuing operations 37,043 (2,869) 34,174
Net income from discontinued operations 2,060 - 2,060
Net income (loss) $ 39,103 $ (2,869) $ 36,234
December 31, 2001
Total assets $ 2,470,622 $ 256,860 $ 2,727,482
Total deposits 1,931,350 - 1,931,350
Net interest income (loss) 94,645 (4,227) 90,418
Total noninterest income 24,742 7,444 32,186
Total noninterest expense 68,274 6,159 74,433
Net income (loss) from continuing operations 33,742 (1,777) 31,965
Net income from discontinued operations 769 - 769
Net income (loss) $ 34,511 $ (1,777) $ 32,734
22. QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
The following represents summarized quarterly financial data of the
Company, which, in the opinion of management, reflects all adjustments
(comprising only normal recurring accruals) necessary for a fair
presentation. Net income per share of common stock has been restated to
retroactively reflect certain stock dividends.
(Dollars in thousands, except per share data)
Three months ended
----------------------------------------------------
2003 Dec. 31 Sept. 30 June 30 March 31
---------------- ----------------------------------------------------
Interest income $ 42,628 $ 41,149 $ 41,770 $ 40,101
Net interest income 30,264 28,561 28,541 27,183
Provision for loan losses 2,475 2,286 2,355 2,255
Net gains (losses) on sale of investment securities - (369) - -
Income before income taxes 12,506 5,370 12,799 12,755
Net income from continuing operations 10,499 4,419 10,057 9,758
Net income from discontinued operations 698 6,585 706 632
Net income 11,197 11,004 10,763 10,390
Earnings per share of common stock - basic 0.47 0.46 0.45 0.44
Earnings per share of common stock - diluted 0.46 0.45 0.44 0.43
(Continued)
86
NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Concluded
December 31, 2003 and 2002
- --------------------------------------------------------------------------------
22. QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED) - Continued
Three months ended
----------------------------------------------------
2002 Dec. 31 Sept. 30 June 30 March 31
---------------- ----------------------------------------------------
Interest income $ 40,439 $ 40,827 $ 40,748 $ 41,164
Net interest income 14,128 15,602 15,269 16,088
Provision for loan losses 2,725 4,410 2,650 3,800
Net gains (losses) on sale of investment securities 97 367 - (250)
Income before income taxes 10,694 10,804 10,887 10,392
Net income from continuing operations 8,680 8,729 8,453 8,312
Net income from discontinued operation 540 482 585 453
Net income 9,220 9,211 9,038 8,765
Earnings per share of common stock - basic 0.42 0.42 0.42 0.40
Earnings per share of common stock - diluted 0.42 0.41 0.41 0.40
87
Report of Independent Certified Public Accountants
Board of Directors
National Penn Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of
National Penn Bancshares, Inc. and Subsidiaries as of December 31, 2003 and
2002, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
National Penn Bancshares, Inc. and Subsidiaries as of December 31, 2003 and
2002, and the consolidated results of their operations and their consolidated
cash flows for each of the three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
January 19, 2004
88
Item 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
- ----------------------------------------------------------------------------
None.
Item 9A. CONTROLS AND PROCEDURES.
- ---------------------------------
National Penn's chief executive officer and chief financial officer
evaluated National Penn's "disclosure controls and procedures" as of December
31, 2003. Disclosure controls and procedures are defined in SEC Rule 13a-15(e)
as controls and other procedures of an issuer that are designed to ensure that
information required to be disclosed by the issuer in the reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. For National Penn, these reports are its annual reports on Form 10-K, its
quarterly reports on Form 10-Q, and its reports on Form 8-K. These officers
concluded that such controls and procedures are adequate and effective.
There were no changes in the registrant's internal control over
financial reporting during the fiscal quarter ended December 31, 2003 that
materially affected, or are reasonably likely to materially affect, National
Penn's internal control over financial reporting.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- ------------------------------------------------------------
Information relating to executive officers of National Penn is included
under Item 4A in Part I of this Report. Information relating to directors of
National Penn and compliance with Section 16(a) of the Securities Exchange Act
of 1934 is incorporated by reference to the section captioned "Election of
Directors" and the subsection captioned "Section 16(a) Beneficial Ownership
Reporting Compliance" of National Penn's definitive Proxy Statement to be used
in connection with National Penn's 2004 Annual Meeting of Shareholders (the
"Proxy Statement").
National Penn maintains in effect a written Code of Conduct that applies
to National Penn's directors, executive officers, employees and others acting on
behalf of National Penn, including our principal executive officer, principal
financial officer, principal accounting officer, controller, and any other
person performing similar functions. A copy of the Code of Conduct is filed in
this Report as Exhibit 14.1.
Item 11. EXECUTIVE COMPENSATION.
- --------------------------------
Information required by this item is incorporated by reference to the
subsection captioned "Director Compensation" and the section captioned
"Execution Compensation" of the Proxy Statement.
89
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
---------------------------------------------------
MANAGEMENT AND RELATED MATTERS.
------------------------------
The following table provides information as of December 31, 2003, with
respect to shares of National Penn's common stock that may be issued under
National Penn's existing equity compensation plans:
(a) (b) (c)
Plan category(1) Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation plans
(excluding securities
reflected in column(a))
Equity compensation
plans approved by
security holders 1,957,779 $22.03 1,079,381(2)(3)
Equity compensation
plans not approved by
security holders(4) None N/A N/A
Total 1,957,779 $22.03 1,079,381
<FN>
(1) The table does not include information on stock options assumed by National
Penn through acquisitions. At December 31, 2003, 663,722 shares of common
stock are issuable upon exercise of substitute stock options issued in
connection with acquisitions. Of this total, 49,816 shares are issuable
upon exercise of substitute stock options issued in the acquisition of
Elverson National Bank, 10,149 shares are issuable upon exercise of
substitute stock options issued in the acquisition of Community Independent
Bank, Inc., 316,036 shares are issuable upon exercise of substitute stock
options issued in the acquisition of FirstService Bank, and 288,721 shares
are issuable upon exercise of substitute stock options issued in the
acquisition of HomeTowne Heritage Bank. The weighted average exercise price
of all substitute stock options issued in acquisitions and outstanding at
December 31, 2003 was $12.72 per share. National Penn cannot grant
additional stock options under any of these substitute stock option plans.
(2) Includes 435,926 shares available for future issuance under National Penn's
Employee Stock Purchase Plan.
(3) Includes 21,229 shares available for future issuance under National Penn's
Directors' Fee Plan. Under the Fee Plan, shares or phantom stock units may
be issued at fair market value in lieu of cash for directors' fees.
(4) National Penn does not maintain equity compensation plans that have not
been approved by its shareholders.
</FN>
Other information required by this item is incorporated by reference to
the section captioned "Stock Ownership" of the Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- --------------------------------------------------------
Information required by this item is incorporated by reference to the
subsection captioned "Related Party and Similar Transactions" of the Proxy
Statement.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
- ------------------------------------------------
Information required by this item is incorporated by reference to the
subsection captioned "Audit Commttee Report" of the Proxy Statement.
90
PART IV
-------
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
- --------------------------------------------------------------------------
(a) 1. Financial Statements.
---------------------
The following consolidated financial statements are included in Part
II, Item 8, of this Report:
National Penn Bancshares, Inc. and Subsidiaries.
Consolidated Balance Sheets.
Consolidated Statements of Income.
Consolidated Statement of Changes in Shareholders' Equity.
Consolidated Statements of Cash Flows.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules.
------------------------------
Financial statement schedules are omitted because the required
information is either not applicable, not required, or is shown in the
financial statements or in their notes.
3. Exhibits.
---------
2.1 Agreement dated September 24, 2002 between National Penn Bancshares,
Inc., National Penn Bank and FirstService Bank. (Schedules are omitted
pursuant to Regulation S-K, Item 601(d)(2); National Penn agrees to
furnish a copy of such schedules to the Securities and Exchange
Commission upon request.) (Incorporated by reference to Exhibit 2.1 of
National Penn's Report on Form 8-K dated September 24, 2002, as filed
on September 27, 2002.)
2.2 Form of Letter Agreement between FirstService Bank directors and
National Penn Bancshares, Inc. (Incorporated by reference to Exhibit
2.2 of National Penn's Report on Form 8-K dated September 24, 2002.)
2.3 Agreement dated February 10, 2003 among National Penn Banchsares,
Inc., Panasia Bank, N.A., and Woori America Bank. (Schedules are
omitted pursuant to Regulation S-K, Item 601(d)(2); National Penn
agrees to furnish a copy of such schedules to the Securities and
Exchange Commission upon request.) (Incorporated by reference to
Exhibit 2.1 to National Penn's Report on Form 8-K dated February 10,
2003).
2.4 Guaranty Agreement dated February 10, 2003 of Woori Bank in favor of
National Penn Bancshares, Inc. and Panasia Bank, N.A. (Incorporated by
reference to Exhibit 2.2 to National Penn's Report on Form 8-K dated
February 10, 2003.)
2.5 Agreement and Plan of Merger dated April 30, 2003, by and among
National Penn Bancshares, Inc., National Penn Bank and HomeTowne
Heritage Bank. (Schedules are omitted pursuant to Regulation S-K, Item
601(d)(2); National Penn agrees to furnish a copy of such schedules to
the Securities and Exchange Commission upon request.) (Incorporated by
reference to Exhibit 2.1 to National Penn's Report on Form 8-K dated
April 23, 2003, as filed on May 2, 2003.)
2.6 Form of Letter Agreement between National Penn Bancshares, Inc. and
directors of HomeTowne Heritage Bank. (Incorporated by reference to
Exhibit 2.2 to National Penn's Report on Form 8-K dated April 23,
2003, as filed on May 2, 2003.)
2.7 Agreement dated December 17, 2003 between National Penn Bancshares,
Inc. and Peoples First, Inc. (Schedules are omitted pursuant to
Regulation S-K, Item 601(d)(2); National Penn agrees to furnish a copy
of such schedules to the Securities and Exchange Commission upon
request.)
91
(Incorporated by reference to Exhibit 2.1 to National Penn's Report on
Form 8-K dated December 17, 2003, as filed on December 19, 2003.)
2.8 Form of Letter Agreement between Peoples First, Inc. directors,
executive officers and five percent shareholders and National Penn
Bancshares, Inc. (Incorporated by reference to Exhibit 2.2 to National
Penn's Report on Form 8-K dated December 17, 2003.)
3.1 Articles of Incorporation, as amended, of National Penn Bancshares,
Inc. (Incorporated by reference to Exhibit 3.1 to National Penn's
Registration Statement No. 333-88536 on Form S-3, as filed on May 17,
2002.)
3.2 Bylaws, as amended, of National Penn Bancshares, Inc. (Incorporated by
reference to Exhibit 3.1 to National Penn's Report on Form 8-K dated
April 24, 2002, as filed on April 29, 2002.)
4.1 Form of Trust Agreement between National Penn Bancshares, Inc. and
Christiana Bank & Trust Company, as Trustee. (Incorporated by
reference to Exhibit 4.1 to National Penn's Registration Statement
Nos. 333-97361 and 333-97361-01 on Form S-3, as filed on July 30,
2002.)
4.2 Form of Amended and Restated Trust Agreement among National Penn
Bancshares, Inc., Christiana Bank & Trust Company, as Property
Trustee, and Christiana Bank & Trust Company, as Delaware Trustee.
(Incorporated by reference to Exhibit 4.2 to National Penn's
Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as
filed on August 6, 2002.)
4.3 Form of Subordinated Debenture Indenture between National Penn
Bancshares, Inc. and Christiana Bank & Trust Company, as Trustee.
(Incorporated by reference to Exhibit 4.4 to National Penn's
Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as
filed on August 6, 2002.)
4.4 Form of Preferred Securities Guarantee Agreement between National Penn
Bancshares, Inc. and Christiana Bank & Trust Company, as Trustee.
(Incorporated by reference to Exhibit 4.6 to National Penn's
Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as
filed on August 6, 2002.)
4.5 Term Loan Agreement dated July 11, 2000, between National Penn
Bancshares, Inc. and the Northern Trust Company. (Omitted pursuant to
Regulation S-K, Item 601(b)(4)(iii); National Penn agrees to furnish a
copy of such agreement to the Securities and Exchange Commission upon
request.)
4.6 Form of Declaration of Trust between National Penn Bancshares, Inc.,
as sponsor, and Chase Manhattan Bank USA, National Association.
(Incorporated by reference to Exhibit 4.1 to National Penn's Report on
Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
4.7 Form of Amended and Restated Trust Agreement among National Penn
Bancshares, Inc., as sponsor, Chase Manhattan Bank USA, National
Association, as Delaware Trustee, JPMorgan Chase Bank, as
Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd, as
Administrators. (Incorporated by reference to Exhibit 4.2 to National
Penn's Report on Form 8-K dated February 20, 2004, as filed on
February 24, 2004.)
4.8 Form of Indenture between National Penn Bancshares, Inc. and JPMorgan
Chase Bank, as Trustee. (Incorporated by reference to Exhibit 4.3 to
National Penn's Report on Form 8-K dated February 20, 2004, as filed
on February 24, 2004.)
4.9 Form of Guarantee Agreement between National Penn Bancshares, Inc., as
Guarantor, and JPMorgan Chase Bank, as Guarantee Trustee.
(Incorporated by reference to Exhibit 4.4 to National Penn's Report on
Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
92
10.1 National Penn Bancshares, Inc. Amended and Restated Dividend
Reinvestment Plan. (Incorporated by reference to Exhibit 10.1 to
National Penn's Report on Form 8-K dated March 27, 2002, as filed on
April 8, 2002.)
10.2 National Penn Bancshares, Inc. Pension Plan (Amended and Restated
Effective January 1, 2001).* (Incorporated by reference to Exhibit
10.2 to National Penn's Annual Report on Form 10-K for the year ended
December 31, 2001.)
10.3 Bernville Bank, N.A. Employees' Profit Sharing Plan - Plan Compliance
and Merger Amendment.* (Incorporated by reference to Exhibit 10.1 to
National Penn's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2001.)
10.4 Amendment No. 1 to National Penn Bancshares, Inc. Pension Plan
(Amended and Restated Effective January 1, 2001).* (Incorporated by
reference to Exhibit 10.1 to National Penn's Report on Form 8-K dated
December 18, 2002, as filed on January 9, 2003.)
10.5 Amendment No. 2 to National Penn Bancshares, Inc. Pension Plan
(Amended and Restated Effective January 1, 1997).* (Incorporated by
reference to Exhibit 10.1 to National Penn's Report on Form 8-K dated
August 27, 2003, as filed on August 27, 2003.)
10.6 National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and
Restated Effective January 1, 1997) (Revised 2001).* (Incorporated by
reference to Exhibit 10.2 to National Penn's Quarterly Report on Form
10-Q for the quarter ended June 30, 2001.)
10.7 Amendment No. 1 to National Penn Bancshares, Inc. Capital Accumulation
Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).*
(Incorporated by reference to Exhibit 4.2 to National Penn's
Registration Statement No. 333-75730 on Form S-8, as filed on December
21, 2001.)
10.8 Amendment No. 2 to National Penn Bancshares, Inc. Capital Accumulation
Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).*
(Incorporated by reference to Exhibit 4.6 to National Penn's
Post-Effective Amendment to Registration Statement No. 333-75730 on
Form S-8, as filed on January 7, 2002.)
10.9 Amendment No. 3 to National Penn Bancshares, Inc. Capital Accumulation
Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).*
(Incorporated by reference to Exhibit 10.2 to National Penn's Report
on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)
10.10 Amendment No. 4 to National Penn Bancshares, Inc. Capital Accumulation
Plan (Amended and Restated Effective January 1, 1997).* (Incorporated
by reference to Exhibit 10.1 to National Penn's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 2003.)
10.11 Amendment No. 5 to National Penn Bancshares, Inc. Capital Accumulation
Plan (Amended and Restated Effective January 1, 1997).* (Incorporated
by reference to Exhibit 10.2 to National Penn's Report on Form 8-K
dated August 27, 2003, as filed on August 27, 2003.)
10.12 National Penn Bancshares, Inc. Amended and Restated Executive
Incentive Plan--Plan Year 2004.* (Incorporated by reference to Exhibit
10.1 to National Penn's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2003.)
10.13 National Penn Bancshares, Inc. Executive Incentive Plan/Schedules -
Plan Year 2004.*
10.14 National Penn Bancshares, Inc. Amended and Restated Executive
Incentive Plan - Plan Year 2003.* (Incorporated by reference to
Exhibit 10.1 to National Penn's Report on Form 8-K dated December 20,
2000, as filed on January 4, 2001.)
93
10.15 National Penn Bancshares, Inc. Amended and Restated Stock Option
Plan.* (Incorporated by reference to Exhibit 10.1 to National Penn's
Report on Form 8-K dated July 12, 2002, as filed on July 16, 2002.)
10.16 National Penn Bancshares, Inc. Amended Officers' and Key Employees'
Stock Compensation Plan.* (Incorporated by reference to Exhibit 10.1
to National Penn's Report on Form 8-K dated September 26, 2001, as
filed on September 27, 2001.)
10.17 National Penn Bancshares, Inc. Directors' Fee Plan.* (Incorporated by
reference to Exhibit 10.3 to National Penn's Report on Form 8-K dated
December 18, 2002, as filed on January 9, 2003.)
10.18 National Penn Bancshares, Inc. Non-Employee Directors' Stock Option
Plan.* (Incorporated by reference to Exhibit 10.2 to National Penn's
Report on Form 8-K dated September 26, 2001, as filed on September 27,
2001.)
10.19 National Penn Bancshares, Inc. Amended and Restated Employee Stock
Purchase Plan.* (Incorporated by reference to Exhibit 10.2 to National
Penn's Report on Form 8-K dated December 20, 2000, as filed on January
1, 2001.)
10.20 National Penn Bancshares, Inc. Elverson Substitute Stock Option Plan.*
(Incorporated by reference to Exhibit 4.1 to National Penn's
Registration Statement No. 333-71391 on Form S-8, as filed on January
29, 1999.)
10.21 National Penn Bancshares, Inc. Community Employee Substitute Stock
Option Plan.* (Incorporated by reference to Exhibit 4.1 to National
Penn's Registration Statement No. 333-54520 on Form S-8, as filed on
January 29, 2001.)
10.22 National Penn Bancshares, Inc. Community Non-Employee Director
Substitute Stock Option Plan.* (Incorporated by reference to Exhibit
4.1 to National Penn's Registration Statement No. 333-54556 on Form
S-8, as filed on January 29, 2001.)
10.23 Form of Amended and Restated Director Deferred Fee Agreement between
Bernville Bank, N.A. and certain former Bernville Bank, N.A.
directors.* (Incorporated by reference to Exhibit 10.18 to National
Penn's Annual Report on Form 10-K for the year ended December 31,
2000.)
10.24 National Penn Bancshares, Inc. FirstService Substitute Incentive Stock
Plan." (Incorporated by reference to Exhibit 10.20 to National Penn's
Annual Report on Form 10-K for the year ended December 31, 2002.
10.25 National Penn Bancshares, Inc. FirstService Non-Employee Directors
Substitute Stock Option Plan.* (Incorporated by reference to Exhibit
10.21 to National Penn's Annual Report on Form 10-K for the year ended
December 31, 2002.)
10.26 HomeTowne Heritage Bank Substitute 2000 Employee Stock Option Plan*
(Incorporated by reference to Exhibit 10.1 to National Penn's
Registration Statement No. 333-11376 on Form S-8, as filed on December
19, 2003.)
10.27 HomeTowne Heritage Bank Substitute 2000 Non-Employee Directors Stock
Option Plan* (Incorporated by reference to Exhibit 10.1 to National
Penn's Registration Statement No. 333-11377 on Form S-8, as filed on
December 19, 2003.)
10.28 HomeTowne Heritage Bank Substitute 1999 Option Plan* (Incorporated by
reference to Exhibit 10.1 to National Penn's Registration Statement
No. 333-11375 on Form S-8, as filed on December 19, 2003.)
94
10.29 Executive Supplemental Benefit Agreement dated December 27, 1989,
among National Penn Bancshares, Inc., National Bank of Boyertown and
Lawrence T. Jilk, Jr.* (Incorporated by reference to Exhibit 10.19 to
National Penn's Annual Report on Form 10-K for the year ended December
31, 2000.)
10.30 Amendatory Agreement dated February 23, 1994, among National Penn
Bancshares, Inc., National Penn Bank and Lawrence T. Jilk, Jr.*
(Incorporated by reference to Exhibit 10.20 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2000.)
10.31 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Lawrence T. Jilk, Jr.*
(Incorporated by reference to Exhibit 10.1 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.)
10.32 Employment Agreement dated February 4, 2003, among National Penn
Bancshares, Inc., National Penn Bank and Wayne R. Weidner.*
(Incorporated by reference to Exhibit 10.1 to National Penn's Report
on Form 8-K dated February 4, 2003, as filed on February 4, 2003.)
10.33 Employment Agreement dated December 18, 2002, among National Penn
Bancshares, Inc., National Penn Bank and Glenn E. Moyer.*
(Incorporated by reference to Exhibit 10.4 to National Penn's Report
on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)
10.34 Executive Agreement dated July 23, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Gary L. Rhoads.*
(Incorporated by reference to Exhibit 10.1 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1997.)
10.35 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Gary L. Rhoads.*
(Incorporated by reference to Exhibit 10.4 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.)
10.36 Amendatory Agreement dated February 24, 1999, among National Penn
Bancshares, Inc., National Penn Bank and Gary L. Rhoads.*
(Incorporated by reference to Exhibit 10.26 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2001.)
10.37 Executive Agreement dated July 23, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Sandra L. Spayd.*
(Incorporated by reference to Exhibit 10.2 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1997.)
10.38 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Sandra L. Spayd.*
(Incorporated by reference to Exhibit 10.5 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.)
10.39 Executive Agreement dated September 24, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Garry D. Koch.* (Incorporated
by reference to Exhibit 10.3 to National Penn's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.)
10.40 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Garry D. Koch.* (Incorporated
by reference to Exhibit 10.3 to National Penn's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998.)
10.41 Executive Agreement dated as of July 23, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Sharon L. Weaver.*
(Incorporated by reference to Exhibit 10.29 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 1998.)
10.42 Amendatory Agreement dated September 24, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Sharon L. Weaver.*
(Incorporated by reference to Exhibit 10.30 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 1998.)
95
10.43 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Sharon L. Weaver.*
(Incorporated by reference to Exhibit 10.6 to National Penn's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.)
10.44 Executive Agreement dated as of August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Bruce G. Kilroy.*
(Incorporated by reference to Exhibit 10.35 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2001.)
10.45 Amendatory Agreement dated August 23, 2000, among National Penn
Bancshares, Inc., National Penn Bank and Bruce G. Kilroy.*
(Incorporated by reference to Exhibit 10.36 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2001.)
10.46 Executive Agreement dated June 22, 2001, among National Penn
Bancshares, Inc., National Penn Bank and Paul W. McGloin.*
(Incorporated by reference to Exhibit 10.1 to National Penn's Report
on Form 8-K dated April 24, 2002, as filed on April 29, 2002.)
10.47 Amendatory Agreement dated January 27, 2002, among National Penn
Bancshares, Inc., National Penn Bank and Paul W. McGloin.*
(Incorporated by reference to Exhibit 10.2 to National Penn's Report
on Form 8-K dated April 24, 2002, as filed on April 29, 2002.)
10.48 Executive Agreement dated July 23, 1997, among National Penn
Bancshares, Inc., National Penn Bank and Michael R. Reinhard.*
(Incorporated by reference to Exhibit 10.41 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2002.)
10.49 Amendatory Agreement dated August 26, 1998, among National Penn
Bancshares, Inc., National Penn Bank and Michael R. Reinhard.*
(Incorporated by reference to Exhibit 10.42 to National Penn's Annual
Report on Form 10-K for the year ended December 31, 2002.)
10.50 Employment Agreement dated as of September 24, 2002, between National
Penn Bank and John C. Spier.* (Incorporated by reference to Exhibit
10.1 to National Penn's Pre-Effective Amendment No. 1 to Registration
Statement No. 333-101689 on Form S-4, as filed on December 31, 2002.)
10.51 Consulting Agreement dated December 9, 2003 between National Penn Bank
and John C. Spier.
10.52 Employment Agreement dated as of September 24, 2002 between National
Penn Bank and Donald P. Worthington.* (Incorporated by reference to
Exhibit 10.2 to National Penn's Pre-Effective Amendment No. 1 to
Registration Statement No. 333-101689 on Form S-4, as filed on
December 31, 2002.)
10.53 Investment Agreement dated September 4, 2003 between The Pennsylvania
State Banking Company and National Penn Bank.
10.54 Amendment to Rights Agreement dated as of August 21, 1999, between
National Penn Bancshares, Inc. and National Penn Bank, as Rights Agent
(including as Exhibit "A" thereto, the Rights Agreement dated as of
August 23, 1989, between National Penn Bancshares, Inc. and National
Bank of Boyertown, as Rights Agent). (Incorporated by reference to
Exhibit 4.1 to National Penn's Report on Form 8-K, dated August 21,
1999, as filed on August 26, 1999.)
14.1 National Penn Bancshares, Inc. Code of Conduct
21 Subsidiaries of the Registrant.
23 Consent of Independent Certified Public Accountants.
96
31.1 Certification of Chairman and Chief Executive Officer of National Penn
Bancshares, Inc., pursuant to Commission Rule 13a-14(a) and Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Treasurer and Chief Financial Officer of National
Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(a) and
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman and Chief Executive Officer of National Penn
Bancshares, Inc., pursuant to Commission Rule 13a-14(b) and 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. (Furnished, not filed.)
32.2 Certification of Treasurer and Chief Financial Officer of National
Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(b) and 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. (Furnished, not filed.)
99 Forward-Looking Statements.
- ------------------
* Denotes a compensatory plan or arrangement.
(b) Reports on Form 8-K.
--------------------
During fourth quarter 2003, National Penn filed the following Reports
on Form 8-K:
o Report dated October 15, 2003. The Report provided information
under Item 12 on National Penn's earnings for third quarter
2003. The Report did not contain any financial statements.
o Report dated November 26, 2003. The Report provided
information under Item 5 on amendments to National Penn's
Executive Incentive Plan and changes in National Penn's
executive management. The Report did not contain any financial
statements.
o Report dated December 9, 2003. The Report provided information
under Item 5 on additional changes in National Penn's
executive management. The Report did not contain any financial
statements.
o Report dated December 12, 2003. The Report provided
information under Item 5 on the completion of National Penn's
acquisition of HomeTowne Heritage Bank. The Report did not
contain any financial statements.
o Report dated December 17, 2003. The Report provided
information under Item 5 on National Penn's execution of a
definitive agreement providing for National Penn's acquisition
of Peoples First, Inc. and its subsidiary, The Peoples Bank of
Oxford. The Report did not contain any financial statements.
97
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NATIONAL PENN BANCSHARES, INC.
(Registrant)
March 8, 2004 By /s/ Wayne R. Weidner
----------------------------------
Wayne R. Weidner
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated:
Signatures Title
- ---------- -----
/s/ John H. Body Director March 8, 2004
- --------------------------------------------------
John H. Body
/s/ J. Ralph Borneman, Jr. Director March 8, 2004
- --------------------------------------------------
J. Ralph Borneman, Jr.
/s/ Frederick H. Gaige Director March 8, 2004
- --------------------------------------------------
Frederick H. Gaige
/s/ Fred D. Hafer Director March 8, 2004
- --------------------------------------------------
Fred D. Hafer
/s/ John W. Jacobs Director March 8, 2004
- --------------------------------------------------
John W. Jacobs
/s/ Frederick P. Krott Director March 8, 2004
- --------------------------------------------------
Frederick P. Krott
/s/ Patricia L. Langiotti Director March 8, 2004
- --------------------------------------------------
Patricia L. Langiotti
/s/ Kenneth A. Longacre Director March 8, 2004
- --------------------------------------------------
Kenneth A. Longacre
98
/s/ Glenn E. Moyer Director March 8, 2004
- --------------------------------------------------
Glenn E. Moyer
/s/ Alexander Rankin V Director March 8, 2004
- --------------------------------------------------
Alexander Rankin V
Director
- --------------------------------------------------
Robert E. Rigg
/s/ C. Robert Roth Director March 8, 2004
- --------------------------------------------------
C. Robert Roth
/s/ Donald P. Worthington Director March 8, 2004
- --------------------------------------------------
Donald P. Worthington
/s/ Wayne R. Weidner Director, Chairman March 8, 2004
- -------------------------------------------------- and Chief Executive Officer
Wayne R. Weidner (Principal Executive Officer)
/s/ Gary L. Rhoads Treasurer (Principal Financial March 8, 2004
- -------------------------------------------------- and Accounting Officer)
Gary L. Rhoads
99