UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended: June 30, 2004 Commission File Number: 000-17007 Republic First Bancorp, Inc. ---------------------------- (Exact name of business issuer as specified in its charter) Pennsylvania 23-2486815 ------------ ---------- (State or other jurisdiction of IRS Employer Identification incorporation or organization) Number 1608 Walnut Street, Philadelphia, Pennsylvania 19103 ---------------------------------------------------- (Address of principal executive offices) (Zip code) 215-735-4422 ------------ (Registrant's telephone number, including area code) N/A -------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. YES X NO ____ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): YES ______ NO __X__ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the Issuer's classes of common stock, as of the latest practicable date. 6,759,710 shares of Issuer's Common Stock, par value $0.01 per share, issued and outstanding as of July 31, 2004 Page 1 of 38 Exhibit index appears on page 36 1 TABLE OF CONTENTS ----------------- Page ---- Part I: Financial Information Item 1: Financial Statements (unaudited) 3 Item 2: Management's Discussion and Analysis of Financial 15 Condition and Results of Operations Item 3: Quantitative and Qualitative Information about Market Risk 35 Item 4: Controls and Procedures 35 Part II: Other Information Item 1: Legal Proceedings 36 Item 2: Changes in Securities and Use of Proceeds 36 Item 3: Defaults Upon Senior Securities 36 Item 4: Submission of Matters to a Vote of Security Holders 36 Item 5: Other Information 36 Item 6: Exhibits, Reports on Form 8-K and Certifications 36 2 PART I - FINANCIAL INFORMATION ------------------------------ Item 1: Financial Statements - ---------------------------- Page Number ----------- (1) Consolidated Balance Sheets as of June 30, 2004, (unaudited) and December 31, 2003........................... 4 (2) Consolidated Statements of Income for the three and six months ended June 30, 2004, and 2003(unaudited)........................................................................... 5 (3) Consolidated Statements of Cash Flows for the six months ended June 30, 2004, and 2003(unaudited)........................................................................... 6 (4) Notes to Consolidated Financial Statements................................................................... 7 3 Republic First Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 dollars in thousands, except share data (See notes to consolidated financial statements) ASSETS: June 30, 2004 December 31, 2003 -------------- ----------------- (unaudited) Cash and due from banks $ 20,334 $ 28,103 Interest bearing deposits with banks 582 3,547 Federal funds sold and interest-bearing deposits with banks 46,416 38,952 --------- --------- Total cash and cash equivalents 67,332 70,602 Other interest-earning restricted cash 3,510 3,483 Investment securities available for sale, at fair value 56,981 61,686 Investment securities held to maturity at amortized cost (Fair value of $7,156 and $8,300, respectively) 7,131 8,260 Loans receivable (net of allowance for loan losses of $8,327 and $8,696, respectively) 518,725 479,523 Premises and equipment, net 4,248 4,412 Other real estate owned 207 207 Accrued interest receivable 3,480 3,710 Business owned life insurance 11,981 11,763 Other assets 12,664 11,146 --------- --------- Total Assets $ 686,259 $ 654,792 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY: Liabilities: Deposits: Demand - non-interest-bearing $ 88,420 $ 82,311 Demand - interest-bearing 53,975 73,315 Money market and savings 162,217 110,389 Time under $100,000 111,273 102,508 Time $100,000 or more 68,996 85,082 --------- --------- Total Deposits 484,881 453,605 Short-term borrowings 2,852 FHLB Advances 125,000 125,000 Subordinated Debt 6,186 Accrued interest payable 2,422 2,841 Other liabilities 8,299 8,118 Corporation-obligated-mandatorily redeemable capital securities of subsidiary trust holding solely junior obligations of the corporation -- 6,000 --------- --------- Total Liabilities 626,788 598,416 --------- --------- Shareholders' Equity: Common stock par value $0.01 per share, 20,000,000 shares authorized; shares issued 6,759,710 as of June 30, 2004 and 6,697,660 as of December 31, 2003 68 67 Additional paid in capital 33,753 33,396 Retained earnings 26,868 23,674 Treasury stock at cost (175,172 shares) (1,541) (1,541) Accumulated other comprehensive income 323 780 --------- --------- Total Shareholders' Equity 59,471 56,376 --------- --------- Total Liabilities and Shareholders' Equity $ 686,259 $ 654,792 ========= ========= (See notes to consolidated financial statements) 4 Republic First Bancorp, Inc. and Subsidiaries Consolidated Statements of Income For the Three and Six Months Ended June 30, dollars in thousands, except per share data (unaudited) Three months ended Six months ended June 30 June 30 ------- ------- 2004 2003 2004 2003 ------- ------- ------- ------- Interest income: Interest and fees on loans $ 7,861 $11,543 $16,343 $23,876 Interest and dividend income on federal funds sold and other interest-earning balances 149 264 363 492 Interest and dividends on investment securities 526 746 1,127 1,745 ------- ------- ------- ------- Total interest income 8,536 12,553 17,833 26,113 ------- ------- ------- ------- Interest expense: Demand interest-bearing 84 128 173 247 Money market and savings 520 481 936 913 Time under $100,000 802 1,071 1,612 2,287 Time $100,000 or more 488 532 1,108 1,184 Other borrowed funds 2,035 2,048 4,076 4,089 ------- ------- ------- ------- Total interest expense 3,929 4,260 7,905 8,720 ------- ------- ------- ------- Net interest income 4,607 8,293 9,928 17,393 Provision for loan losses 62 2,286 873 5,698 ------- ------- ------- ------- Net interest income after provision for loan losses 4,545 6,007 9,055 11,695 ------- ------- ------- ------- Non-interest income: Loan advisory and servicing fees 152 109 244 295 Service fees on deposit accounts 475 332 914 652 Tax refund products 295 1 1,174 373 Short-term loan fee income 1,637 -- 2,847 -- Other income 271 55 398 72 ------- ------- ------- ------- 2,830 497 5,577 1,392 ------- ------- ------- ------- Non-interest expenses: Salaries and benefits 2,593 2,414 5,144 4,891 Occupancy 385 374 770 759 Depreciation 295 302 724 597 Legal 285 271 550 511 Advertising 39 46 107 118 Other expenses 1,230 1,363 2,512 2,500 ------- ------- ------- ------- 4,827 4,770 9,807 9,376 ------- ------- ------- ------- Income before income taxes 2,548 1,734 4,825 3,711 Provision for income taxes 865 583 1,631 1,267 ------- ------- ------- ------- Net income $ 1,683 $ 1,151 $ 3,194 $ 2,444 ======= ======= ======= ======= Net income per share: Basic $ 0.26 $ 0.18 $ 0.49 $ 0.38 ======= ======= ======= ======= Diluted $ 0.24 $ 0.17 $ 0.46 $ 0.37 ======= ======= ======= ======= (See notes to consolidated financial statements) 5 Republic First Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Six Months Ended June 30, Dollars in thousands (unaudited) For the six months ended June 30, 2004 2003 --------- --------- Cash flows from operating activities: Net income $ 3,194 $ 2,444 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 873 5,698 Depreciation 724 597 Amortization of premium on investment securities 159 253 Increase in value of business owned life insurance (218) (80) Increase in accrued interest receivable and other assets (1,288) (3,959) Increase in accrued expenses and other liabilities 238 1,893 --------- --------- Net cash provided by operating activities 3,682 6,846 --------- --------- Cash flows from investing activities: Purchase of securities: Held to maturity -- (2,254) Available for sale (6,500) (1,520) Proceeds from principal receipts, calls and maturities of securities: Held to maturity 1,129 2,660 Available for sale 10,237 33,799 Net increase in loans (40,015) (6,971) Increase in other interest-earning restricted cash (27) (324) Purchase of business owned life insurance -- (11,500) Premises and equipment expenditures (560) (413) --------- --------- Net cash (used in) provided by investing activities (35,736) 13,477 --------- --------- Cash flows from financing activities: Net proceeds from exercise of stock options 358 924 Net increase in demand, money market and savings deposits 38,599 43,494 Repayment of overnight borrowing (2,852) Net decrease in time deposits (7,321) (36,879) --------- --------- Net cash provided by financing activities 28,784 7,539 --------- --------- Increase (decrease) in cash and cash equivalents (3,270) 27,862 Cash and cash equivalents, beginning of period 70,602 72,810 --------- --------- Cash and cash equivalents, end of period $ 67,332 $ 100,672 ========= ========= Supplemental disclosure: Interest paid $ 8,324 $ 9,128 ========= ========= Taxes paid $ 1,800 $ 1,950 ========= ========= (See notes to consolidated financial statements) 6 REPUBLIC FIRST BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: Organization Republic First Bancorp, Inc. ("the Company") is a two-bank holding company organized and incorporated under the laws of the Commonwealth of Pennsylvania. It includes two wholly owned subsidiaries, Republic First Bank ("PA Bank"), a Pennsylvania state chartered bank and First Bank of Delaware ("DE Bank), a Delaware state chartered Bank, (together "the Banks"). The PA Bank offers a variety of banking services to individuals and businesses throughout the Greater Philadelphia and South Jersey area through its offices and branches in Philadelphia and Montgomery Counties. The DE Bank is located at Brandywine Commons II, Concord Pike and Rocky Run Parkway in Brandywine, New Castle County Delaware. The DE Bank offers many of the same services and financial products as the PA Bank, and additionally offers nationally, short-term consumer loans and other products not offered by the PA Bank. The Company and the Banks encounter vigorous competition for market share 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 the Banks are subject to regulation by 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. Note 2: Summary of Significant Accounting Policies: Basis of Presentation: The consolidated financial statements include the accounts of Republic First Bancorp, Inc. and its wholly-owned subsidiaries, the PA Bank and the DE Bank. Such statements have been presented in accordance with accounting principles generally accepted in the United States of America or applicable to the banking industry. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements. Risks and Uncertainties and Certain Significant Estimates: The earnings of the Company depend on the earnings of the Banks. The Banks are dependent primarily upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, the results of operations of the Banks are subject to risks and uncertainties surrounding their exposure to change in the interest rate environment. Prepayments on residential real estate mortgage and other fixed rate loans and mortgage-backed securities vary significantly and may cause significant fluctuations in interest margins. At June 30, 2004, there were approximately $2.1 million of short-term consumer loans outstanding, which were originated in Texas, California, Michigan, Arizona, and Ohio. Effective in the third quarter of 2003, the DE Bank 7 began to sell a majority of these loans to independent third parties while retaining a portion of the interest income, which the DE Bank classifies as non-interest income. The Company evaluated these sales and determined that these transactions qualify as sales under FAS 140. These loans generally have principal amounts of $1,000 or less and terms of approximately two weeks. Legislation eliminating, or limiting interest rates upon short-term consumer loans has from time to time been proposed. The DE Bank offers two tax refund products to customers of Liberty Tax Service. Liberty Tax Service is a nationwide tax service provider which prepares and electronically files federal and state income tax returns and the DE Bank offers certain Liberty Tax Service customers accelerated refunds ("Tax Refund Products"). Prior to the incorporation of the DE Bank, the PA Bank for many years offered tax refund products. Tax Refund Products consist of accelerated check refunds ("ACRs") and refund anticipation loans ("RALs"). There can be no assurance that revenues from these products will continue to grow or be maintained at current levels in future periods. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates are made by management in determining the allowance for loan losses, carrying values of other real estate owned and income taxes. Consideration is given to a variety of factors in establishing these estimates. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers' perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows and other relevant factors. Since the allowance for loan losses and carrying value of other real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond the Banks' control, it is at least reasonably possible that the estimates of the allowance for loan losses and the carrying values of other real estate owned could differ materially in the near term. The Company and its subsidiaries are subject to federal and state regulations governing virtually all aspects of their activities, including but not limited to, lines of business, liquidity, investments, the payment of dividends, and others. Such regulations and the cost of adherence to such regulations can have a significant impact on earnings and financial condition. Stock Based Compensation: The Company accounts for stock options under the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair valued-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 25, Accounting for Stock Issued to Employees. Entities that continue to account for stock options using APB Opinion 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 June 30, 2004, the Company had a stock-based employee compensation plan, The Company accounts for that plan 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 plan had an exercise price equal to the market vale 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 8 fair value recognition provisions of SFAS No. 123, to stock-based employee compensation (in thousands, except per share amounts). Stock Based Compensation (dollar amounts in thousands) Three months ended Six months ended June 30, June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------ ------------ Net income as reported $1,683 $1,151 $ 3,194 $2,444 Less: Stock based compensation costs determined under fair value method for all awards -- -- (54) (102) ------------- ------------- ------------ ------------ Net income, proforma $1,683 $1,151 $3,140 $2,342 ============= ============= ============ ============ Earnings per common share-basic: As reported $ 0.26 $ 0.18 $ 0.49 $ 0.38 ------------- ------------- ------------ ------------ Pro-forma $ 0.26 $ 0.18 $ 0.48 $ 0.37 ------------- ------------- ------------ ------------ Earnings per common share-diluted: As reported $ 0.24 $ 0.17 $ 0.46 $ 0.37 ------------- ------------- ------------ ------------ Pro-forma $ 0.24 $ 0.17 $ 0.45 $ 0.35 ------------- ------------- ------------ ------------ The Company granted 11,667 and 56,667 options during the six months ended June 30, 2004 and 2003, respectively. The proforma compensation expense is based upon the fair value of the option at grant date. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2004 and 2003, respectively: dividend yields of 0% for both periods; expected volatility of 34% for 2004 and 31% for 2003; risk-free interest rates of 3.15% and 4.0%, respectively and an expected life of 5.0 years for both periods. At June 30, 2004, the Company had a stock-based employee compensation plan. The Company accounts for that plan 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 plan had an exercise price equal to the market vale 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). Note 3: Significant Accounting Pronouncements Loan Commitments The SEC recently released Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments. SAB 105 provides guidance about the measurement of loan commitments recognized at fair value under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. SAB 105 also requires companies to disclose their accounting policy for those loan commitments including methods and assumptions used to estimate fair value and associated hedging strategies. SAB 105 is effective for all loan commitments accounted for as derivatives that are entered into after June 30, 2004. The adoption of SAB 105 is not expected to have a material effect on the Company's financial statements. 9 New accounting pronouncement In November 2003, the Emerging Issues Task Force (EITF) of the FASB issued EITF Abstract 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1). The quantitative and qualitative disclosure provisions of EITF 03-1 were effective for years ending after December 15, 2003 and were included in the Corporation's 2003 Form 10-K. In March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the provisions of EITF 03-1 be applied for reporting periods beginning after June 15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1 establishes a three-step approach for determining whether an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. The Corporation is in the process of determining the impact that this EITF will have on its financial statements. Note 4: Variable Interest Entities Management has determined that Republic First Capital Trust I ("RFCT"), utilized for the Company's $6,000,000 of pooled preferred securities issuance, qualifies as a variable interest entity under FIN 46, as revised RFCT issued mandatorily redeemable preferred stock to investors and loaned the proceeds to the Company. RFCT is included in the Company's consolidated balance sheet and statements of income as of and for the year ended December 31, 2003. Subsequent to the issuance of FIN 46 in January 2003, the FASB issued a revised interpretation, FIN 46(R) Consolidation of Variable Interest Entities, the provisions of which were required to be applied to certain variable interest entities by March 31, 2004. The Company adopted the provisions under the revised interpretation in the first quarter of 2004. Accordingly, the Company no longer consolidates RFCT as of June 30, 2004. FIN 46(R) precludes consideration of the call option embedded in the preferred stock when determining if the Company has the right to a majority of RFCT's expected residual returns. The deconsolidation resulted in the investment in the common stock of RFCT to be included in other assets as of June 30, 2004 and the corresponding increase in outstanding debt of $186,000. In addition, the income received on the Company's common stock investment is included in other income. The adoption of FIN 46R did not have a material impact on the financial position or results of operations. The Federal Reserve has issued proposed guidance on the regulatory capital treatment for the trust-preferred securities issued by RFCT as a result of the adoption of FIN 46(R). The proposed rule would retain the current maximum percentage of total capital permitted for trust preferred securities at 25%, but would enact other changes to the rules governing trust preferred securities that affect their use as part of the collection of entities known as "restricted core capital elements". The rule would take effect March 31, 2007; however, a three-year transition period starting now and leading up to that date would allow bank holding companies to continue to count trust preferred securities as Tier 1 Capital after applying FIN-46(R). Management has evaluated the effects of the proposed rule and does not anticipate a material impact on its capital ratios when the proposed rule is finalized. Note 5: Legal Proceedings The Company and the Banks are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management, after reviewing pending actions with legal counsel, is of the opinion that the liabilities of the Company and the Banks, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and the Banks. 10 Note 6: Segment Reporting The Company's reportable segments represent strategic businesses that offer different products and services. The segments are managed separately because each segment has unique operating characteristics, management requirements and marketing strategies. The Company has four reportable segments: two community banking segments; tax refund products; and short-term consumer loans. The community banking segments are primarily comprised of the results of operations and financial condition of the Banks. Tax refund products are comprised of accelerated check refunds and refund anticipation loans offered by the DE Bank on a national basis to customers of Liberty Tax Services, an unaffiliated national tax preparation firm. Short-term consumer loans are loans made to customers offered by the DE Bank, with principal amounts of $1,000 or less and terms of approximately two weeks. These loans typically are made in states that are outside of the Company's normal market area through a small number of marketers and involve rates and fees significantly different from other loan products offered by either of the Banks. The Company evaluates the performance of the community banking segments based upon net income, return on equity and return on average assets. Tax refund products and short-term consumer loans are evaluated based upon net income. Tax refund products and short-term consumer loans are provided to satisfy consumer demands while diversifying the Company's earnings stream. 11 Segment information for the six and three month period ended June 30, 2004 and 2003, is as follows: As of and for the six months ended June 30, 2004 (dollars in thousands) Short-term Republic First First Bank of Tax Refund Consumer Bank Delaware Products loans Total --------------- --------- -------------- --------------- ------------ Net interest income $ 7,562 $ 714 $ 1,026 $ 626 $ 9,928 Provision for loan losses - 60 500 313 873 Non-interest income 1,434 122 1,174 2,847 5,577 Non-interest expenses 7,334 610 643 1,220 9,807 --------------- --------- -------------- --------------- ------------ Net income $ 1,096 $ 113 $ 698 $ 1,287 $ 3,194 =============== ========= ============== =============== ============ Selected Balance Sheet Accounts: Total assets 637,314 43,285 - 5,660 686,259 Total loans 494,033 30,943 - 2,076 527,052 Total deposits 449,130 35,751 - - 484,881 June 30, 2003 (dollars in thousands) Short-term Republic First First Bank of Tax Refund Consumer Bank Delaware Products loans Total --------------- --------- -------------- --------------- ------------ Net interest income $ 7,752 $ 739 $ 1,191 $ 7,711 $17,393 Provision for loan losses 60 61 1,042 4,535 5,698 Non-interest income 872 147 373 - 1,392 Non-interest expenses 7,218 766 400 992 9,376 --------------- --------- -------------- --------------- ------------ Net income $ 902 $ 39 $ 81 $ 1,422 $ 2,444 =============== ========= ============== =============== ============ Selected Balance Sheet Accounts: Total assets 594,181 56,907 - 7,798 658,886 Total loans 432,839 32,584 - 773 466,196 Total deposits 423,782 39,135 - - 462,917 12 As of and for the three months ended June 30, 2004 (dollars in thousands) Short-term Republic First First Bank of Tax Refund Consumer Bank Delaware Products loans Total ------------------- --------------- ------------------- ------------------- ----------------- Net interest income $ 3,803 $ 361 $ 30 $ 413 $ 4,607 Provision for loan losses - 30 (200) 232 62 Non-interest income 841 57 295 1,637 2,830 Non-interest expenses 3,659 310 245 613 4,827 ------------------- --------------- ------------------- ------------------- ----------------- Net income (loss) $ 670 $ 51 $ 167 $ 795 $ 1,683 =================== =============== =================== =================== ================= Selected Balance Sheet Accounts: Total assets 637,314 43,285 - 5,660 686,259 Total loans 494,033 30,943 - 2,076 527,052 Total deposits 449,130 35,751 - - 484,881 June 30, 2003 (dollars in thousands) Short-term Republic First First Bank of Tax Refund Consumer Bank Delaware Products loans Total ------------------- --------------- ------------------- ------------------- ----------------- Net interest income $ 3,719 $ 375 $ 37 $ 4,162 $ 8,293 Provision for loan losses - 30 24 2,232 2,286 Non-interest income 440 56 1 - 497 Non-interest expenses 3,722 477 141 430 4,770 ------------------- --------------- ------------------- ------------------- ----------------- Net income (loss) $ 302 $ (50) $ (81) $ 980 $ 1,151 =================== =============== =================== =================== ================= Selected Balance Sheet Accounts: Total assets 594,181 56,907 - 7,798 658,886 Total loans 432,839 32,584 - 773 466,196 Total deposits 423,782 39,135 - - 462,917 13 Note 7: Earnings Per Share: Earnings per share ("EPS") consists of two separate components; basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income by the weighted average number of common shares outstanding plus dilutive common stock equivalents ("CSEs"). CSEs consist of dilutive stock options granted through the Company's stock option plan. The following table is a reconciliation of the numerator and denominator used in calculating basic and diluted EPS. CSEs which are anti-dilutive are not included in the following calculation. At June 30, 2004, and 2003, respectively, there were 0 and 35,840 of stock options, that were not included in the calculation of EPS because the option price is greater than the average market price for the period. The following table is a comparison of EPS for the three and six months ended June 30, 2004, and 2003. Three months ended June 30, Six months ended June 30, 2004 2003 2004 2003 Net Income $1,683,000 $1,151,000 $3,194,000 $2,444,000 Per Per Per Per Shares Share Shares Share Shares Share Shares Share ------ ----- ------ ----- ------ ----- ------ ----- Weighted average shares For period 6,541,682 6,476,159 6,535,885 6,358,245 Basic EPS $0.26 $0.18 $0.49 $0.38 Add common stock equivalents representing dilutive stock options 332,903 294,980 322,605 264,820 ------- ------- ------- ------- Effect on basic EPS of dilutive CSE $(0.02) $(0.01) $(0.03) $(0.01) ------ ------ ------ ------ Equals total weighted average shares and CSE (diluted) 6,874,585 6,771,139 6,858,490 6,623,065 ========= ========= ========= ========= Diluted EPS $0.24 $0.17 $0.46 $0.37 ----- ----- ===== ===== Note 8: Comprehensive Income The following table displays net income and the components of other comprehensive income to arrive at total comprehensive income. For the Company, the only components of other comprehensive income are those related to the unrealized gains (losses) on available for sale investment securities. (dollar amounts in thousands) Three months ended Six months ended June 30, June 30, --------------------------------- ---------------------------------- 2004 2003 2004 2003 ------------ ------------ ------------- ------------- Net income $ 1,683 $ 1,151 $ 3,194 $ 2,444 Other comprehensive income, net of tax: Unrealized gains/(losses) on securities: Unrealized holding gains/(losses) during the period (432) (329) (457) (683) ------------ ------------ ------------- ------------- Comprehensive income $ 1,251 $ 822 $ 2,737 $ 1,761 ============ ============ ============= ============= 14 Note 9: Stock Dividend On July 13, 2004, the Board of Directors declared a 10% stock dividend with a record date of August 5, 2004 and a payable date of August 24, 2004. The financial information and per share information in this report have not been adjusted to reflect the 10% stock dividend. ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of significant changes in the Company's results of operations, financial condition and capital resources presented in the accompanying consolidated financial statements. This discussion should be read in conjunction with the accompanying notes to the consolidated financial statements. Certain statements in this document may be considered to be "forward-looking statements" as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words "may", "believes", "expect", "estimate", "project", anticipate", "should", "intend", "probability", "risk", "target", "objective" and similar expressions or variations on such expressions. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For example, risks and uncertainties can arise with changes in: general economic conditions, including their impact on capital expenditures; new service and product offerings by competitors and price pressures; and similar items. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the year ended December 31, 2003, Quarterly Reports on Form 10-Q, filed by the Company in 2003 and 2002, and any Current Reports on Form 8-K filed by the Company, as well as other filings. Financial Condition: June 30, 2004, Compared to December 31, 2003 Total assets increased $31.5 million to $686.3 million at June 30, 2004, versus $654.8 million at December 31, 2003. This net increase reflected higher federal funds and commercial loans. Loans: The loan portfolio represents the Company's largest asset category and is its most significant source of interest income. The Company's lending strategy focuses on small and medium size businesses and professionals that seek highly personalized banking services. Total loans increased $38.9 million, to $527.1 million at June 30, 2004, versus $488.2 million at December 31, 2003. Substantially all of the increase resulted in the commercial and construction loan category. The loan portfolio consists of secured and unsecured commercial loans including commercial real estate, construction loans, residential mortgages, automobile loans, home improvement loans, short-term consumer loans, home equity loans and lines of credit, overdraft lines of credit and others. Commercial loans are originated as 15 either fixed or variable rate loans with typical terms of 1 to 5 years. The Banks' commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to the Banks' combined legal lending limit of approximately $10.3 million at June 30, 2004. Individual customers may have several loans that are secured by different collateral. The aggregate amount of those relationships that exceeded $6.8 million at June 30, 2004, was $46.4 million. The $6.8 million threshold approximates 10% of total capital and reserves and reflects an additional internal monitoring guideline. At June 30, 2004, the Company through the DE Bank had $2.1 million in short-term consumer loans outstanding versus $1.4 million at December 31, 2003. These loans have principal amounts of less than $1,000, and terms of approximately two weeks and at June 30, 2004, were originated in Michigan, Texas, Arizona, Ohio and California through a small number of marketers. The De Bank began making loans in Michigan in the second quarter of 2004. In April, 2004, the State of Georgia enacted Act No. 440. Effective May 1, 2004, Act No. 440 substantially increased the penalties under Georgia law for making payday loans prohibited by Georgia usury laws, and adopted a presumption that an agent assisting in such loans is the de facto lender if the agent receives a predominant economic interest in loan revenues. The DE Bank's marketing and servicing agent receives the predominant share of loan revenues. The DE Bank and its servicer, together with a number of other banks and servicers, have challenged Act No. 440 in the U. S. District Court for the Northern District of Georgia. The plaintiffs allege, among other things, that the Act conflicts with and is preempted by Section 27 of the Federal Deposit Insurance Act because it prevents FDIC insured state banks from lending at the (non-Georgia) rates of interest expressly authorized for state banks (but not other lenders) by Section 27. Prior to the effective date of Act No. 440, the DE Bank discontinued making short-term loans in Georgia. Investment Securities: Investment securities available-for-sale are investments which may be sold in response to changing market and interest rate conditions and for liquidity and other purposes. The Company's investment securities available-for-sale consist primarily of U.S Government debt securities, U.S. Government agency issued mortgage-backed securities, and debt securities which include corporate bonds and trust preferred securities. Available-for-sale securities totaled $57.0 million at June 30, 2004, a decrease of $4.7 million or 7.62%, from year-end 2003. This decrease resulted primarily from prepayments on mortgage-backed securities. At June 30, 2004, and December 31, 2003, the portfolio had net unrealized gains of $514,000 and $1.2 million, respectively. Investment securities held-to-maturity are investments for which there is the intent and ability to hold the investment to maturity. These investments are carried at amortized cost. The held-to-maturity portfolio consists primarily of Federal Home Loan Bank ("FHLB") securities. At June 30, 2004, securities held to maturity totaled $7.1 million, a decrease of $1.1 million, or 13.7% from $8.3 million at year-end 2003. At both dates, respective carrying values approximated market values. Cash and Due From Banks: Cash and due from banks, interest bearing deposits and federal funds sold are all liquid funds. The aggregate amount in these three categories decreased by $3.3 million, to $67.3 million at June 30, 2004, from $70.6 million at December 31, 2003, reflecting lower due from bank balances which more than offset increase in federal funds sold. Other Interest-Earning Restricted Cash: Other interest-earning restricted cash represents funds provided to fund an offsite ATM network for which the Company is compensated. At June 30, 2004, and December 31, 2003 the balance was $3.5 million. 16 Fixed Assets: Bank premises and equipment, net of accumulated depreciation, decreased $164,000 to $4.2 million at June 30, 2004, from $4.4 million at December 31, 2003. The decrease reflected depreciation of equipment and software. Other Real Estate Owned: Other real estate owned mounted to $207,000 at June 30, 2004 and December 31, 2003. Business Owned Life Insurance: The balance of business owned life insurance amounted to $12.0 million at June 30, 2004 and $11.8 million at December 31,2003. The income earned on these policies is reflected in other income. Deposits: Deposits, which include non-interest and interest-bearing demand, money market, savings and time deposits, are the Banks' major source of funding. Deposits are generally solicited from the Company's market area through the offering of a variety of products to attract and retain customers, with a primary focus on multi-product relationships. Period ended deposits increased by $31.3 million, or 6.9% to $484.9 million at June 30, 2004, from $453.6 million at December 31, 2003. Average core deposits (transaction accounts) increased 11.1%, or $30.0 million more than the prior year period to $299.4 million in the second quarter 2004. Deposit growth benefited from the Company's business development efforts and bank consolidations in the Philadelphia market which, in management's opinion, continue to leave some customers underserved. Period end time deposits decreased $7.3 million, or 3.90% to $180.3 million at June 30, 2004, versus $187.6 million at the prior year-end. The decrease reflected the increase in lower cost core deposits. FHLB Borrowings: FHLB borrowings totaled $125.0 million at both June 30, 2004 and December 31, 2003. The Company's borrowings primarily mature in the fourth quarter of 2004 and first quarter of 2005. Shareholders' Equity: Total shareholders' equity increased $3.1 million to $59.5 million at June 30, 2004, versus $56.4 million at December 31, 2003. This increase was primarily the result of year-to-date 2004 net income of $3.2 million. Three Months Ended June 30, 2004 Compared to June 30, 2003 - ---------------------------------------------------------- Results of Operations: Overview The Company's net income increased to $1.7 million or $0.24 per diluted share for the three months ended June 30, 2004, compared to $1.2 million, or $0.17 per diluted share for the comparable prior year period. The improvement reflected a $331,000 reduction in interest expense resulting primarily from lower rates paid on time deposits (certificates of deposit). It also reflected an increase in tax refund product revenue of approximately $294,000. Of the $4.0 million decrease in interest income, $3.9 million related to the participation of short-term consumer loans to third parties in 2004. Non-interest income increased $2.3 million of which $1.6 million is due to the classification of fees on short-term loans to non-interest income after such participation. The impact of the participation of short term loans was further offset by the reduction in short term loan related provision for loan 17 losses expense, which decreased $2.0 million between the two periods. Interest margins were also impacted by prepayments in the residential real estate and mortgage-backed securities portfolios. Average commercial and construction loans increased 20.2% and average core deposits increased 11.1% in the second quarter of 2004, respectively, compared to the prior year comparable period. The increased net income resulted in a return on average assets and average equity of .98% and 11.47% respectively, in the second quarter of 2004 compared to 0.70% and 8.60% respectively for the comparable prior year period. Analysis of Net Interest Income Historically, the Company's earnings have depended significantly upon the Banks' net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is impacted by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities. 18 For the three months ended For the three months ended June 30, 2004 June 30, 2003 --------------------------------------------------- --------------------------------------------- Interest-earning assets: Interest Interest (Dollars in thousands) Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate ------------------ ------------ ------------- ----------------- -------------- ------------ Federal funds sold and other interest- earning assets 56,350 149 1.06% 84,876 264 1.25% Securities 65,764 526 3.20% 67,323 746 4.43% Loans receivable 516,087 7,861 6.11% 463,733 11,543 9.98% ------------------ ------------ ------------- ----------------- -------------- ------------ Total interest-earning assets 638,201 8,536 5.36% 615,932 12,553 8.17% Other assets 48,352 46,782 ------------------ ----------------- Total assets $ 686,553 $ 662,714 ================== ================= Interest-bearing liabilities: Demand-non interest bearing $ 96,227 $ 71,936 Demand interest-bearing 56,511 84 0.60% 59,924 128 0.86% Money market & savings 146,703 520 1.42% 137,568 481 1.40% Time deposits 178,549 1,290 2.90% 195,706 1,603 3.29% ------------------ ------------ ------------- ----------------- -------------- ------------ Total deposits 477,990 1,894 1.59% 465,134 2,212 1.91% Total interest-bearing deposits 381,763 1,894 1.99% 393,198 2,212 2.26% ------------------ ------------ ------------- ----------------- -------------- ------------ Other borrowings 131,000 2,035 6.23% 131,033 2,048 6.27% ------------------ ------------ ------------- ----------------- -------------- ------------ Total interest-bearing liabilities $ 512,763 $ 3,929 3.07% 524,231 4,260 3.26% ================== ============ ============= ================= -------------- ------------ Total deposits and other borrowings 608,990 3,929 2.59% 596,167 4,260 2.87% ------------------ ------------ ------------- ----------------- -------------- ------------ Noninterest-bearing liabilites 17,335 12,876 Shareholders' equity 60,228 53,671 ------------------ ----------------- Total liabilities and shareholders' equity $ 686,553 $ 662,714 ================== ================= Net interest income $ 4,607 $ 8,293 ============ ============== Net interest spread 2.78% 5.31% ============= ============ Net interest margin 2.90% 5.40% ============= ============ Net interest margin not including short-term loan and tax refund products 2.63% 2.63% ============= ============ 19 The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volumes and rates during the period. Changes due to rate and volume variances have been allocated to rate. Rate/Volume Table Three months ended June 30, 2004 versus 2003 (dollars in thousands) Due to change in: Volume Rate Total ---------------- ---------------- ---------------- Interest earned on: Federal funds sold $ (75) $ (40) $ (115) Securities (12) (208) (220) Loans 798 (4,480) (3,682) - ---------------------------------------------------------------------------------------------------------- Total interest-earning assets 711 (4,728) (4,017) Interest expense of deposits Interest-bearing demand deposits 4 40 44 Money market and savings (32) (7) (39) Time deposits 124 189 313 - ---------------------------------------------------------------------------------------------------------- Total deposit interest expense 96 222 318 Other borrowings 1 12 13 - ---------------------------------------------------------------------------------------------------------- Total interest expense 97 234 331 - ---------------------------------------------------------------------------------------------------------- Net interest income $ 808 $ (4,494) $ (3,686) ========================================================================================================== The Company's net interest margin decreased 250 basis points to 2.9% for the three months ended June 30, 2004, versus the prior year comparable period. The decline reflected the decision to participate a majority of the short-term loan outstandings to third parties beginning in the third quarter of 2003, thereby reducing interest income and increasing non-interest income. Fees on short-term consumer loans contributed approximately $423,000 to net interest income for the quarter ended June 30, 2004 and 27 basis points to the margin versus $4.3 million and 2.77% for the prior year comparable period. Excluding the impact of short-term loans and tax products, margins remained constant at 2.63% in the second quarter of 2004 and the prior year comparable period. Lower loan rates and the negative impact of the residential mortgage and mortgage-backed security prepayments, were partially offset by the impact of the 11.1% increase in average lower cost core deposits (transaction accounts), and the repricing of certificates of deposit and other deposits in the lower interest rate environment. While management could replace significant amounts of security prepayments, it has deferred longer term security purchases in light of the lower interest rate environment. A total of $125.0 million of Federal Home loan Bank ("FHLB") advances which carry an average interest rate of 6.20% mature beginning the third quarter of 2004 through the first quarter of 2005. These advances would be repriceable to a significantly lower rate in the current interest rate environment. The average yield on interest-earning assets declined 2.81% to 5.36% for the three months ended June 30, 2004, from 8.17% for the prior year comparable period due primarily to the participation of short-term loans which commenced in the third quarter of 2003. The average rate paid on interest-bearing liabilities decreased 19 basis points to 3.07% for the three months ended June 30, 2004, from 3.26% in the prior year comparable period, as the Company repriced its deposits to the lower rate environment. The Company's net interest income decreased $3.7 million, or 44.4%, to $4.6 million for the three months ended June 30, 2004, from $8.3 million for the prior year comparable period. As shown in the Rate Volume table above, the decrease in net interest income was due primarily to lower rates on loans reflecting lower short-term loan 20 income which was classified as non-interest income after the participation of such loans. Excluding the impact of short-term loans and tax products, the net interest margin increased by approximately $206,000 as increased volume offset lower yields. That increase reflected a $652,000 increase in commercial loan income, resulting from increased volume. Average interest-earning assets increased $22.2 million to $638.2 million versus $615.9 for prior year period. The Company's total interest income decreased $4.0 million, or 32.0%, to $8.5 million for the three months ended June 30, 2004, from $12.5 million for the prior year comparable period. Interest and fees on loans decreased $3.7 million to $7.9 million for the three months ended June 30, 2004, from $11.5 million for the prior year comparable period. This decline reflects a $3.9 million reduction in short term loan income. The yield on loans declined 3.87% to 6.11% primarily reflecting the reduced short-term loan fees. Interest and dividends on investment securities decreased $220,000 to $526,000 for the three months ended June 30, 2004, from $746,000 for the prior year comparable period. The average rate earned on investment securities declined 123 basis points to 3.20% as higher coupon mortgage backed securities prepaid more rapidly than lower coupons and were replaced with shorter term, lower rate securities and the rates earned on variable rate securities declined due to the lower interest rate environment. Interest income on federal funds sold decreased $115,000, primarily as a result of lower average balances. The Company's total interest expense decreased $332,000, or 7.8%, to $3.9 million for the three months ended June 30, 2004, from $4.3 million for the prior year comparable period, primarily due to the lower rate environment. The Company repriced deposits to the lower rate environment, particularly certificates of deposit. Interest-bearing liabilities averaged $512.8 million for the three months ended June 30, 2004, versus $524.2 million for the prior year comparable period reflecting lower amounts of higher cost certificates of deposit. The average rate paid on interest-bearing liabilities decreased 19 basis points to 3.07% for the three months ended June 30, 2004, due primarily to the decrease in average rates paid on deposit products resulting from the lower interest rate environment. Interest expense on time deposits (certificates of deposit) decreased $313,000, or 19.5%, to $1.3 million at June 30, 2004, from $1.6 million for the prior year comparable period. This decline reflected the lower interest rate environment as the average rate declined 39 basis points to 2.90%. In addition, average certificates of deposit outstanding decreased $17.2 million, or 8.8%, to $178.5 million, for the quarter ended June 30, 2004, from $195.7 million in the prior year comparable period, as higher cost time deposits matured and were not replaced due to the growth in lower cost core deposits. Interest expense on other borrowings, primarily FHLB advances, was comparable in both periods, as were average balances and yields. Provision for Loan Losses The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that reflects the known and estimated inherent losses in the portfolio. The provision for loan losses decreased $2.2 million to $62,000 for the three months ended June 30, 2004, from $2.3 million for the prior year comparable period. This decrease based upon the Company's quarterly analysis primarily reflected a $2.0 million decrease in the provision for short term loans, as the majority of such loans were participated to third parties, beginning in the third quarter of 2003. The decrease also reflected the impact of $200,000 of recoveries of tax refund loans. 21 Non-Interest Income Total non-interest income increased $2.3 million to $2.8 million for the three months ended June 30, 2004, versus $497,000 for the prior year comparable period. Of the $2.3 million increase, $1.6 million resulted from the participation of most short term loans. In 2003, such loans were not participated, and fees were recognized as interest income. Tax refund product income increased by $294,000, primarily as a result of increases in the volume of such products. Service fees on deposit accounts also increased $143,000, primarily as a result of volume. Of the $216,000 increase in other income, approximately $108,000 resulted from income from business owned life insurance. The balance of the increase resulted from one time charges for special services to a bank customer. Non-Interest Expenses Total non-interest expenses increased $57,000 to $4.8 million for the three months ended June 30, 2004, from $4.8 million for the prior year comparable period. Salaries and employee benefits increased $179,000 or 7.4%, to $2.6 million for the three months ended June 30, 2004, from $2.4 million for the prior year comparable period resulting primarily from additional incentive expense related to loan and deposit generation. Occupancy, depreciation, legal fees and advertising expense were all comparable in both periods. Other expenses decreased $133,000, or 9.8% to $1.2 million for the three months ended June 30, 2004, from $1.4 million for the prior year comparable period reflecting $111,000 in lower expenses associated with OREO properties and the absence of $200,000 in severance costs incurred in second quarter 2003. These items were partially offset by a $78,000 increase in state taxes, and lesser increases in several other categories. Provision for Income Taxes The provision for income taxes increased $282,000, to $865,000 for the three months ended June 30, 2004, from $583,000 for the prior year comparable period. This increase was primarily the result of the increase in pre-tax income. The effective tax rate increased to 33.9% from 33.6%. Six Months Ended June 30, 2004 Compared to June 30, 2003 - -------------------------------------------------------- Results of Operations: Overview The Company's net income increased $750,000, or 30.7% to $3.2 million or $0.46 per diluted share for the six months ended June 30, 2004, compared to $2.4 million, or $0.37 per diluted share for the prior year comparable period. The improvement reflected an $815,000 reduction in interest expense resulting primarily from lower rates paid on time deposits (certificates of deposit). It also reflected an increase in tax refund product revenue of approximately $801,000. Of the $8.3 million decrease in interest income, $7.3 million related to the participation of short-term consumer loans to third parties in 2004. Non-interest income increased $4.2 million, of which $2.8 million due to the classification of fees on short-term loans which were participated beginning in the third quarter 2003. The impact of the participation of short-term loans was further offset by the reduction in short-term loan related provision expense, which decreased $4.2 million. Interest margins were also impacted by prepayments in the residential real estate and 22 mortgage-backed securities portfolios. Average commercial and construction loans increased 17.3% and average core deposits increased 10.5% in the first six months of 2004, respectively, compared to the prior year comparable period. The increased net income resulted in a return on average assets and average equity of .92% and 11.03%, respectively, in the first six months of 2004 compared to ..74% and 9.26% for the comparable prior year period. Analysis of Net Interest Income Historically, the Company's earnings have depended significantly upon the Banks' net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is impacted by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities. 23 For the six months ended For the six months ended June 30, 2004 June 30, 2003 ------------------------------------------------- ------------------------------------------- Interest Interest Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate ------------------ -------------- -------------- ----------------- ------------ ---------- Interest-earning assets: Federal funds sold and other interest- earning assets 68,668 363 1.07% 76,512 492 1.30% Securities 67,682 1,127 3.33% 76,158 1,745 4.58% Loans receivable 507,254 16,343 6.50% 474,606 23,876 10.14% ------------------ -------------- -------------- ----------------- ------------ ---------- Total interest-earning assets 643,604 17,833 5.59% 627,276 26,113 8.38% Other assets 48,461 40,469 ------------------ ----------------- Total assets $ 692,065 $ 667,745 ================== ================= Interest-bearing liabilities: Demand-non interest bearing 97,191 - 74,555 - Demand interest-bearing 57,536 173 0.61% 58,979 247 0.84% Money market & savings 136,398 936 1.38% 129,847 913 1.42% Time deposits 199,014 2,720 2.76% 207,072 3,471 3.38% ------------------ -------------- -------------- ----------------- ------------ ---------- Total deposits 490,139 3,829 1.58% 470,453 4,631 1.99% Total interest-bearing deposits 392,948 3,829 1.97% 395,898 4,631 2.36% ------------------ -------------- -------------- ----------------- ------------ ---------- Other borrowings 132,041 4,076 6.23% 132,959 4,089 6.20% ------------------ -------------- -------------- ----------------- ------------ ---------- Total interest-bearing liabilities $ 524,989 $ 7,905 3.04% $ 528,857 $ 8,720 3.33% ================== ============== ============== ================= ============ ========== Total deposits and other borrowings 622,180 7,905 2.56% 603,412 8,720 2.91% ---------------------------------- -------------- ------------------------------ ---------- Noninterest-bearing liabilites 12,156 11,105 Shareholders' equity 57,729 53,228 ------------------ ----------------- Total liabilities and shareholders' equity $ 692,065 $ 667,745 ================== ================= Net interest income $ 9,928 $ 17,393 ============== ============ Net interest spread 3.03% 5.47% ============== ========== Net interest margin 3.11% 5.59% ============== ========== Net interest margin not including short-term loan and tax refund products 2.61% 2.71% ============== ========== 24 The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volumes and rates during the period. Changes due to rate and volume variances have been allocated to rate. Rate/Volume Table Six months ended June 30, 2004 versus 2003 (dollars in thousands) Due to change in: Volume Rate Total ----------------- ---------------- ---------- Interest earned on: Federal funds sold $ (42) $ (87) $ (129) Securities (141) (477) (618) Loans 1,052 (8,585) (7,533) - ------------------------------------------------------------------------------------------------ Total interest-earning assets 869 (9,149) (8,280) Interest Expense of Deposits Interest-bearing demand deposits 4 70 74 Money market and savings (45) 22 (23) Time deposits 110 641 751 - ------------------------------------------------------------------------------------------------ Total deposit interest expense 69 733 802 Other borrowed funds 28 (15) 13 - ------------------------------------------------------------------------------------------------ Total interest expense 97 718 815 - ------------------------------------------------------------------------------------------------ Net interest income $ 966 $ (8,431) $ (7,465) ================================================================================================ The Company's net interest margin decreased 248 basis points to 3.11% for year to date 2004, versus the prior year comparable period. The decline reflected the decision to participate a majority of the short-term loan outstandings to third parties beginning in the third quarter of 2003, thereby reducing interest income and increasing non-interest income. Fees on short-term consumer loans contributed approximately $650,000 to net interest income year to date 2004 and 20 basis points to the margin versus $8.0 million and 2.54% for the prior year comparable period. Excluding the impact of short-term loans and tax products, margins decreased to 2.61% year to date 2004 from 2.71% in the prior year comparable period. That decrease reflected lower loan rates and the negative impact of residential mortgage and mortgage-backed security prepayments, partially offset by the increases in average lower cost core deposits (transaction accounts), and the repricing of certificates of deposit and other deposits in the lower interest rate environment. While management could replace significant amounts of such security prepayments, it has deferred long term security purchases in light of the lower interest rate environment. A total of $125.0 million of Federal Home loan Bank ("FHLB") advances which carry an average interest rate of 6.20% mature beginning the third quarter of 2004 through the first quarter of 2005. These advances would be repriceable to a significantly lower rate in the current interest rate environment. The average yield on interest-earning assets declined 2.79% to 5.59% year to date 2004, from 8.38% for the prior year comparable period due primarily to the participation of short-term loans which commenced in the third quarter of 2003. The average rate paid on interest-bearing liabilities decreased 29 basis points to 3.04% year to date 2004, from 3.33% in the prior year comparable period, as the Company repriced its deposits to the lower rate environment. The Company's net interest income decreased $7.5 million, or 42.9%, to $9.9 million for year to date 2004, from $17.4 million for the prior year comparable period. As shown in the Rate Volume table above, the decrease in 25 net interest income was due primarily to lower rates earned on loans reflecting lower short-term loan income which was classified as non-interest income after the participation of such loans. Excluding the impact of short-term loans and tax products, the total net interest margins were relatively comparable between the two periods, as increased volume offset most of the impact of lower yields. The Company's total interest income decreased $8.3 million, or 31.7%, to $17.8 million year to date 2004, from $26.1 million for the prior year comparable period. Interest and fees on loans decreased $7.5 million to $16.3 million year to date 2004, from $23.9 million for the prior year comparable period. This decline reflects a $7.3 million reduction in short term loan income. The yield on loans declined 3.64% to 6.50% primarily reflecting the reduced short-term loan fees. Interest and dividends on investment securities decreased $618,000 to $1.1 million year to date 2004, from $1.7 million for the prior year comparable period. This decline reflected the $8.5 million, or 11.1%, decrease in average investment securities outstanding to $67.7 million year to date 2004 from $76.2 million for the prior year period. In addition, the average rate earned on investment securities declined 125 basis points to 3.33% as higher coupon mortgage backed securities prepaid more rapidly than lower coupons and were replaced with shorter term, lower rate securities and the rates earned on variable rate securities declined due to the lower interest rate environment. Interest income on federal funds sold, and related average balances were comparable in both periods. The Company's total interest expense decreased $815,000, or 9.4%, to $7.9 million year to date 2004, from $8.7 million for the prior year comparable period, due to the lower rate environment. The Company repriced deposits to the lower rate environment, particularly certificates of deposit. The average rate paid on interest-bearing liabilities decreased 29 basis points to 3.04% year to date 2004, compared to the comparable prior year period, due primarily to the decrease in average rates paid on deposit products resulting from the lower interest rate environment. Interest expense on time deposits (certificates of deposit) decreased $751,000, or 21.63%, to $2.7 million year to date 2004, from $3.5 million for the prior year comparable period. This decline reflected the lower interest rate environment as the average rate declined 62 basis points to 2.76%. In addition, average certificates of deposit outstanding decreased $8.1 million, or 3.9%, to $199.0 million, year to date 2004, from $207.1 million in the prior year comparable period, as higher cost time deposits matured and were not replaced due to the growth in lower cost core deposits. Interest expense on other borrowings, primarily FHLB advances, was comparable in both periods. Provision for Loan Losses The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that reflects the known and estimated inherent losses in the portfolio. The year to date 2004 provision for loan losses decreased $4.8 million to $873,000, from $5.7 million for the prior year comparable period. This decrease based upon the Company's quarterly analysis reflected a $4.2 million decrease in the provision for short-term loans, as the majority of such loans were participated to third parties, beginning in the third quarter of 2003. It also reflected the impact of $200,000 of recoveries on tax refund loans. Non-Interest Income Total non-interest income increased $4.2 million to $5.6 million year to date 2004, versus $1.4 million for the prior year comparable period. Of the $4.2 million increase, $2.8 million resulted from the participation of short term loans. In 2003, such loans were not participated and fees were recognized as interest income. Tax refund product income increased by $801,000, primarily as a result of volume. Of the $326,000 increase in other income, 26 approximately $218,000 resulted from income from business owned life insurance. The balance of the increase resulted primarily from one time charges for special services to a bank customer. Non-Interest Expenses Total non-interest expenses increased $431,000, or 4.6% to $9.8 million year to date 2004, from $9.4 million for the prior year comparable period. Salaries and employee benefits increased $253,000 or 5.2%, to $5.2 million year to date 2004, from $4.9 million for the prior year comparable period. The increase resulted primarily from additional incentive expense related to loan and deposit generation. Occupancy, legal, advertising and other expense were comparable in both periods. Depreciation expense increased $127,000, or 21.3% to $724,000 year to date 2004, versus $597,000 for the prior year comparable period. Substantially all of the increase resulted from a write-off of software related to the tax refund products. Provision for Income Taxes The provision for income taxes increased $364,000, or 28.7%, to $1.6 million year to date 2004, from $1.3 million for the prior year comparable period. This increase was primarily the result of the increase in pre-tax income. The effective tax rate was 33.8% for year to date 2004, versus 34.1% for the prior year comparable period. Commitments, Contingencies and Concentrations The Banks are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit totaling $130.4 million at June 30, 2004. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. Credit risk is defined as the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform in accordance with the terms of the contract. The maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same underwriting standards and policies in making credit commitments as it does for on-balance-sheet instruments. Financial instruments whose contract amounts represent potential credit risk are commitments to extend credit of approximately $125.9 million and $94.8 million and standby letters of credit of approximately $4.5 million and $4.0 million at June 30, 2004, and December 31, 2003, respectively. 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 many require the 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 upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable. 27 Standby letters of credit are conditional commitments that guarantee the performance of a customer to a third party. The credit risk and collateral policy involved in issuing letters of credit is essentially the same as that involved in extending loan commitments. The amount of collateral obtained is based on management's credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable. At June 30, 2004, the Company had no foreign loans and no loan concentrations exceeding 10% of total loans except for credits extended to real estate operators and lessors in the aggregate amount of $161.2 million, which represented 30.6% of gross loans receivable at June 30, 2004. Various types of real estate are included in this category, including industrial, retail shopping centers, office space, residential multi-family and others. Loan concentrations are considered to exist when there is amounts loaned to a multiple number of borrowers engaged in similar activities that management believes would cause them to be similarly impacted by economic or other conditions. Regulatory Matters The following table presents the Company's capital regulatory ratios at June 30, 2004, and December 31, 2003: Actual For Capital To be well Adequacy purposes capitalized under FRB capital guidelines Amount Ratio Amount Ratio Amount Ratio ------------- ------------ ------------- ----------- ----------- ----------- Dollars in thousands At June 30, 2004 Total risk based capital Republic First Bank $59,216 12.34% $38,390 8.00% $47,988 10.00% First Bank of Delaware 10,253 28.19% 2,909 8.00% 3,637 10.00% Republic First Bancorp, 71,391 13.79% 41,406 8.00% -- N/A Inc. Tier one risk based capital Republic First Bank 53,205 11.09% 19,195 4.00% 28,798 6.00% First Bank of Delaware 9,788 26.92% 1,455 4.00% 2,182 6.00% Republic First Bancorp, 64,898 12.54% 20,703 4.00% -- N/A Inc. Tier one leveraged capital Republic First Bank 53,205 8.39% 31,689 5.00% 31,689 5.00% First Bank of Delaware 9,788 19.60% 2,496 5.00% 2,496 5.00% Republic First Bancorp, 64,898 9.68% 33,533 5.00% -- N/A Inc. Actual For Capital To be well Adequacy purposes capitalized under FRB capital guidelines Amount Ratio Amount Ratio Amount Ratio ------------- ----------- ----------- ---------- ----------- ---------- At December 31, 2003 Total risk based capital Republic First Bank $57,417 12.57% $36,534 8.00% 45,667 10.00% First Bank of Delaware 8,399 29.06% 2,312 8.00% 2,891 10.00% Republic First Bancorp, Inc. 67,436 13.92% 38,765 8.00% - N/A Tier one risk based capital Republic First Bank 51,689 11.32% 18,267 4.00% 27,475 6.00% First Bank of Delaware 8,025 27.76% 1,156 4.00% 1,734 6.00% Republic First Bancorp, Inc. 61,346 12.66% 19,382 4.00% - N/A 28 Tier one leveraged capital Republic First Bank 51,689 8.77% 29,475 5.00% 29,475 5.00% First Bank of Delaware 8,025 16.55% 2,410 5.00% 2,410 5.00% Republic First Bancorp, Inc. 61,346 9.64% 31,817 5.00% - N/A Dividends The Company has not paid any cash dividends on its Common Stock. Liquidity Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities and provide a cushion against unforeseen needs. Liquidity needs can be met by utilizing cash and federal funds sold, converting assets to cash through computer repurchase or sale various or drawing upon lines of credit cash generated by increasing deposits represents the primarily source of liquidity. Regulatory authorities require the Banks to maintain certain liquidity ratios such that the Banks maintain available funds, or can obtain available funds at reasonable rates, in order to satisfy commitments to borrowers and the demands of depositors. In response to these requirements, the Banks have each formed Asset/Liability Committees ("ALCOs"), comprised of selected members of the Banks' boards of directors and senior management, which monitor such ratios. The purpose of the Committees are in part, to monitor the Banks' liquidity and adherence to the ratios in addition to managing the relative interest rate risk to the Banks'. The ALCOs meet at least quarterly. The Company's most liquid assets, consisting of cash due from banks, deposits with banks and federal fund sold, totaled $67.3 million at June 30, 2004, compared to $70.6 million at December 31, 2003, due primarily to a decrease in federal funds sold. Loan maturities and repayments, if not reinvested in loans, also are immediately available for liquidity. At June 30, 2004, the Company estimated that in excess of $50.0 million of loans would mature or be repaid in the six month period that will end December 31, 2004. Additionally, the majority of its securities are available to satisfy liquidity requirements through pledges to the Federal Home Loan Bank System ("FHLB") to access the Banks' line of credit. Funding requirements have historically been satisfied primarily by generating core deposits and certificates of deposit with competitive rates, and utilizing the facilities of the FHLB. At June 30, 2004, the PA Bank had $51.3 million in unused lines of credit available under arrangements with the FHLB and correspondent banks compared to $67.0 million at December 31, 2003. These lines of credit enable the PA Bank to purchase funds for short or long-term needs at rates often lower than other sources and require pledging of securities or loan collateral. The amount of available credit has been decreasing with the prepayment of mortgage backed loans and securities. At June 30, 2004, the Company had aggregate outstanding commitments (including unused lines of credit and letters of credit) of $130.4 million. Certificates of deposit scheduled to mature in one year totaled $100.4 million at June 30, 2004, and borrowings scheduled to mature within one year totaled $125.0 million. These borrowings, callable by the FHLB, will likely be replaced by borrowings at then current rates or a combination of borrowings and certificates of deposit. The Company anticipates that it will have sufficient funds available to meet its current commitments. The Banks target and actual liquidity levels are determined by comparisons of the estimated repayment and marketability of the Banks interest-earning assets with projected future outflows of deposits and other liabilities. The 29 PA Bank has established a line of credit from a correspondent bank to assist in managing the PA Banks' liquidity position. That line of credit totaled $10.0 million and was unused at June 30, 2004. The PA Bank has established a line of credit with the Federal Home Loan Bank of Pittsburgh with a maximum borrowing capacity of approximately $166.3 million. As of June 30, 2004, and December 31, 2003, the PA Bank had borrowed $125.0 million under that line of credit. Securities also represent a primary source of liquidity for the Banks. Accordingly, investment decisions generally reflect liquidity over other considerations. The Company's primary short-term funding sources are certificates of deposit and its securities portfolio. The circumstances that are reasonably likely to affect those sources are as follows. The Banks have historically been able to generate certificates of deposit by matching Philadelphia market rates or paying a premium rate of 25 to 50 basis points over those market rates. It is anticipated that this source of liquidity will continue to be available; however, its incremental cost may vary depending on market conditions. The Company's securities portfolio is also available for liquidity, usually as collateral for FHLB advances. Because of the FHLB's AAA rating, it is unlikely those advances would not be available. But even if they are not, numerous investment companies would likely provide repurchase agreements up to the amount of the market value of the securities. The Banks' ALCOs are responsible for managing the liquidity position and interest sensitivity of the Banks. Those committees' primary objective is to maximize net interest income while configuring the Banks' interest-sensitive assets and liabilities to manage interest rate risk and provide adequate liquidity. Investment Securities Portfolio At June 30, 2004, the Company had identified certain investment securities that are being held for indefinite periods of time, including securities that will be used as part of the Company's asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors. These securities are classified as available for sale and are intended to increase the flexibility of the Company's asset/liability management. Available for sale securities consist of US Government Agency securities and other investments. The book and market values of securities available for sale were $56.5 million and $57.0 million as of June 30, 2003, respectively. The net unrealized gain on securities available for sale as of that date was $514,000. Loan Portfolio The Company's loan portfolio consists of secured and unsecured commercial loans including commercial real estate loans, loans secured by one-to-four family residential property, commercial construction and residential construction loans as well as residential mortgages, home equity loans, short-term consumer and other consumer loans. Commercial loans are primarily term loans made to small to medium-sized businesses and professionals for working capital, asset acquisition and other purposes. Commercial loans are originated as either fixed or variable rate loans with typical terms of 1 to 5 years. The Banks commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to the Banks combined legal lending limit of $10.3 million at June 30, 2004. Individual customers may have several loans often secured by different collateral. The aggregate amount of those relationships that exceeded $6.8 million (an internal monitoring guideline which approximates 10% of capital and reserves) at June 30, 2004, was $46.4 million. Total loans increased $38.9 million, to $527.1 million at June 30, 2004, from $488.2 million at December 31, 2003. Commercial and construction loans increased $41.5 million due to increased volume in the commercial real estate and commercial and industrial loan portfolios. This more than offset a decline in the residential real estate mortgage portfolio of $6.0 million which reflected prepayments in that portfolio resulting from the lower rate environment. 30 The following table sets forth the Company's gross loans by major categories for the periods indicated: (dollars in thousands) As of June 30, 2004 As of December 31, 2003 -------------------------------------------------------------------------------- Balance % of Total Balance % of Total -------------------------------------------------------------------------------- Commercial: Real estate secured $ 336,705 63.9 $ 302,618 62.0 Construction and land development 101,909 19.3 88,850 18.2 Non real estate secured 52,670 10.0 52,041 10.7 Unsecured 7,421 1.4 13,688 2.7 --------------------------------------------------------------------------- 498,705 94.6 457,197 93.6 Residential real estate 8,841 1.7 14,875 3.0 Consumer, short-term & other 19,506 3.7 16,147 3.4 --------------------------------------------------------------------------- Total loans 527,052 100.0% 488,219 100.0% Less allowance for loan losses (8,327) (8,696) ------------- ----------------- Net loans $ 518,725 $ 479,523 ============= ================= Credit Quality The Banks' written lending policies require specified underwriting, loan documentation and credit analysis standards to be met prior to funding, with independent credit department approval for the majority of new loan balances. A committee of the Board of Directors oversees the loan approval process to monitor that proper standards are maintained, while approving the majority of commercial loans. Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity or payment of interest or principal for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms. While a loan is classified as non-accrual or as an impaired loan and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a non-accrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. 31 The following summary shows information concerning loan delinquency and other non-performing assets at the dates indicated. June 30, December 31, 2004 2003 ----------------------------- (dollars in thousands) Loans accruing, but past due 90 days or more $ 860 $3,084 Non-accrual loans 6,403 5,527 ----------------------------- Total non-performing loans (1) $7,263 $8,611 Other real estate owned 207 207 ----------------------------- Total non-performing assets (2) $7,470 $8,818 ============================= Non-performing loans as a percentage of total loans net of unearned Income 1.38% 1.76% Non-performing assets as a percentage of total assets 1.08% 1.35% (1) Non-performing loans are comprised of (i) loans that are on a nonaccrual basis; (ii) accruing loans that are 90 days or more past due and (iii) restructured loans. (2) Non-performing assets are composed of non-performing loans and other real estate owned (assets acquired in foreclosure). Non accrual-loans increased $876,000, to $6.4 million at June 30, 2004, from $5.5 million at December 31, 2003. The increase resulted from the addition of several loans each with principal amounts of less than $200,000. Loans accruing, but past due 90 days or more decreased $2.2 million to $860,000 at June 30, 2004 from $3.1 million at December 31, 2003. That decrease reflected the sale and refinancing of a property collateralizing a $1.9 million loan balance included at December 31, 2003, to a new purchaser, after the loan was transferred to other real estate owned. The sale and subsequent refinance were arms length and the new loan was made in accordance with the Company's normal underwriting terms. The transaction is further detailed under "Other Real Estate Owned." Problem loans consist of loans that are included in performing loans, but for which potential credit problems of the borrowers have caused management to have serious doubts as to the ability of such borrowers to continue to comply with present repayment terms. At June 30, 2004, all identified problem loans are included in the preceding table or are classified as substandard or doubtful, with a specific reserve allocation in the allowance for loan losses (see "Allowance For Loan Losses"). Management believes that the appraisals and other estimates of the value of the collateral pledged against the non-accrual loans generally exceed the amount of its outstanding balances. The recorded investment in loans which are impaired totaled $6.4 million at June 30, 2004, and $5.5 million at December 31, 2003, and the amount of such valuation allowances were $901,000 and $1.4 million, respectively. The primary reason for the reduction was the disposition of the loan detailed under "Other Real Estate Owned". There were no commitments to extend credit to any borrowers with impaired loans as of the end of the periods presented herein. 32 At June 30, 2004, and December 31, 2003, internally classified accruing substandard loans totaled approximately $7.6 million and $11.2 million respectively; and doubtful loans totaled approximately $1.1 million and $895,000 respectively. There were no loans classified as loss at those dates. The Bank had delinquent loans as follows: (i) 30 to 59 days past due, at June 30, 2004 and December 31, 2003, in the aggregate principal amount of $811,000 and $2.6 million; and (ii) 60 to 89 days past due, at June 30, 2004 and December 31, 2003, in the aggregate principal amount of $143,000 and $2.1 million, respectively. At June 30, 2004, the Company had no foreign loans and no loan concentrations exceeding 10% of total loans except for credits extended to real estate operators and lessors in the aggregate amount of $161.2 million, which represented 30.6% of gross loans receivable at June 30, 2004. Various types of real estate are included in this category, including industrial, retail shopping centers, office space, residential multi-family and others. Loan concentrations are considered to exist when multiple number of borrowers are engaged in similar activities that management believes would cause them to be similarly impacted by economic or other conditions. Other Real Estate Owned: The balance of other real estate owned amounted to $207,000 at June 30, 2004 and December 31, 2003. Second quarter activity in other real estate owned included the addition of a $1.5 million property, related to a $1.9 million loan, which was sold during the quarter. Of the $1.5 million sales price, a total of approximately $300,000 was received in cash. The balance of $1.2 million was financed by the Company at prevailing rates and terms. Substantially all of the $427,000 difference between the $1.9 million loan and the $1.5 million transferred to OREO was fully reserved and was charged off during the quarter. At June 30, 2004, the Company had no credit exposure to "highly leveraged transactions" as defined by the Federal Reserve Bank. Allowance for Loan Losses An analysis of the Company's allowance for loan losses for the six months ended June 30, 2004, and 2003, and the twelve months ended December 31, 2003 is as follows: For the six months For the twelve months For the six months ended ended ended (dollars in thousands) June 30, 2004 December 31, 2003 June 30, 2003 ---------------------- ----------------------- ----------------------- Balance at beginning of period........... $8,696 $6,642 $ 6,642 Charge-offs: Commercial and construction............. 452 365 1 Short-term loans............... 301 4,299 4,153 Tax refund loans............... 700 1,393 1,393 Consumer............... - 53 - ---------------------- ----------------------- ----------------------- Total charge-offs 1,453 6,110 5,547 ---------------------- ----------------------- ----------------------- Recoveries: Commercial and construction............. 8 1,066 750 Tax refund loans............... 200 334 333 Consumer................................ 3 - - ---------------------- ----------------------- ----------------------- Total recoveries.................... 211 1,400 1,083 ---------------------- ----------------------- ----------------------- Net charge-offs..................... 1,242 4,710 4,464 ---------------------- ----------------------- ----------------------- Provision for loan losses................. 873 6,764 5,698 ---------------------- ----------------------- ----------------------- 33 Balance at end of period............... $8,327 $8,696 $7,876 ====================== ======================= ======================= Average loans outstanding (1)....... $507,254 $470,237 $474,606 ====================== ======================= ======================= As a percent of average loans (1): Net charge-offs (annualized)............... .49% 1.00% 1.88% Provision for loan losses................. .17% 1.44% 1.20% Allowance for loan losses................ 1.64% 1.85% 1.66% Allowance for loan losses to: Total loans, net of unearned income at period end.............................. 1.58% 1.78% 1.69% Total non-performing loans at period end..................................... 114.65% 101.00% 95.26% (1) Includes non accruing loans. On July 2, 2004, PA Bank was awarded a damage verdict in the amount of $4,439,000 against a Philadelphia law firm in connection with their improper representation of the PA Bank in a loan transaction which caused prior year losses for the Company. Prior to the entry of the verdict as a final judgment, there may be post-trial motions and appeals. The Company is unable to predict the amount of the judgment, if any, that would be received by the Bank until all post-trial motions and appeals have been resolved. In the event that the Company is successful in pursuing this verdict to final judgment, an unrelated loan participant would be entitled to 31.5%, and the Company 68.5% of the judgment, after deduction of the attorney's fees to achieve the final result. Substantially all of the decrease in short-term loan charge-offs resulted from the participation of the vast majority of such loans to third parties, beginning in the third quarter of 2003. The reduction in tax refund loan charge-offs in 2004 compared to 2003, reflected the addition of significant new controls and underwriting requirements for such loans. Management makes at least a quarterly determination as to an appropriate provision from earnings to maintain an allowance for loan losses that is management's best estimate of known and inherent losses. The Company's Board of Directors periodically reviews the status of all non-accrual and impaired loans and loans classified by the Banks' regulators or internal loan review officer, who reviews both the loan portfolio and overall adequacy of the allowance for loan losses. The Board of Directors also considers specific loans, pools of similar loans, historical charge-off activity, economic conditions and other relevant factors in reviewing the adequacy of the loan loss reserve. Any additions deemed necessary to the allowance for loan losses are charged to operating expenses. The Company has an existing loan review program, which monitors the loan portfolio on an ongoing basis. Loan review is conducted by a loan review officer who reports quarterly, directly to the Board of Directors. Estimating the appropriate level of the allowance for loan losses at any given date is difficult, particularly in a continually changing economy. In Management's opinion, the allowance for loan losses was appropriate at June 30, 2004. However, there can be no assurance that, if asset quality deteriorates in future periods, additions to the allowance for loan losses will not be required. The Banks' management is unable to determine in what loan category future charge-offs and recoveries may occur. The following schedule sets forth the allocation of the allowance for loan losses among various categories. The allocation is based upon historical experience. The entire allowance for loan losses is available to absorb loan losses in any loan category: The majority of the Company's loan portfolio represents loans made for commercial purposes, while significant amounts of residential property may serve as collateral for such loans. The Company attempts to evaluate larger 34 loans individually, on the basis of its loan review process, which scrutinizes loans on a selective basis and other available information. Even if all commercial purpose loans could be reviewed, there is no assurance that information on potential problems would be available. The Company's portfolios of loans made for purposes of financing residential mortgages and consumer loans are evaluated in groups. At June 30, 2004, loans made for commercial and construction, residential mortgage and consumer purposes, respectively, amounted to $498.7 million, $8.8 million and $19.5 million. Effects of Inflation The majority of assets and liabilities of a financial institution are monetary in nature. Therefore, a financial institution differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Management believes that the most significant impact of inflation on financial results is the Company's need and ability to react to changes in interest rates. As discussed previously, management attempts to maintain an essentially balanced position between rate sensitive assets and liabilities over a one year time horizon in order to protect net interest income from being affected by wide interest rate fluctuations. ITEM 3: QUANTITATIVE AND QUALITATIVE INFORMATION ABOUT MARKET RISK Interest Rate Risk Management There has been no material change in the Company's assessment of its sensitivity to market risk since its presentation in the 2003 Annual Report on Form 10-K filed with the SEC. Item 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. The management of the Company, including the Chief Executive Officer and the Chief Financial Officer, has conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934 as of a date (the "Evaluation Date") within 90 days prior to the filing date of this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were effective in ensuring that all material information relating to the Company, including its consolidated subsidiaries, required to be filed in this quarterly report has been made known to them in a timely manner. (b) Changes in internal controls. There have been no significant changes made in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the Evaluation Date. Part II Other Information 35 Item 1: LEGAL PROCEEDINGS ----------------- None. Item 2: CHANGES IN SECURITIES AND USE OF PROCEEDS ----------------------------------------- None. Item 3: DEFAULTS UPON SENIOR SECURITIES ------------------------------- None. Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None. Item 5: OTHER INFORMATION ----------------- Our chief executive officer and chief financial officer have furnished to the SEC the certification with respect to this Report that is required by Section 906 of the Sarbanes-Oxley Act of 2003. Item 6: EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- The following Exhibits are filed as part of this report. (Exhibit numbers correspond to the exhibits required by Item 601 of Regulation S-K for an annual report on Form 10-K). Exhibit No. - ----------- 10 Material Contracts.- None 21 Subsidiaries of the Company Republic First Bank First Bank of Delaware 31.1 Certification of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act 31.2 Certification of the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act 32.1 Section 1350 certifications pursuant to Section 906 of the Sarbanes-Oxley Act 2002 (furnished but not filed for purposes of the Securities Exchange Act of 1934. All other schedules and exhibits are omitted because they are not applicable or because the required information is set out in the financial statements or the notes hereto. **Incorporated by reference in the Company's Form 10-K, filed March 13, 2003. Reports on Form 8-K and 8-KA 36 Press release dated July 20, 2004. Other Events dated July 8, 2004 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Issuer has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Republic First Bancorp, Inc. Harry D. Madonna ---------------- President and Chief Executive Officer Paul Frenkiel ------------- Executive Vice President and Chief Financial Officer Dated: August 9, 2004 38