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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One):
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2005
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from: ___________ to ___________
Commission File Number: 000-18464
EMCLAIRE FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-1606091
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
612 Main Street, Emlenton, PA 16373
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(Address of principal executive office) (Zip Code)
Registrant's telephone number: (724) 867-2311
Securities registered
pursuant to Section 12(b) of the Act: None. OTC ELECTRONIC BULLETIN
BOARD (OTCBB)
--------------------------
Name of exchange on
which registered
Securities registered pursuant to
Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $1.25 PER SHARE
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES [_] NO [X].
Indicate by checkmark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES [_] NO [X].
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or a non-accelerated filer.
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). YES [ ] NO [X].
As of June 30, 2005, the aggregate value of the 1,267,835 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
130,582 shares held by the directors and officers of the Registrant as a group,
was approximately $33,724 million. This figure is based on the last sales price
of $30.25 per share of the Registrant's Common Stock on June 30, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year ended
December 31, 2005 (Parts I, II, and IV).
2. Portions of the Proxy Statement for the May 17, 2006 Annual Meeting of
Stockholders (Part III).
EMCLAIRE FINANCIAL CORP.
TABLE OF CONTENTS
PART I
Item 1. Business..................................................................................................1
Item 1A. Risk Factors.............................................................................................15
Item 1B. Unresolved Staff Comments................................................................................16
Item 2. Properties...............................................................................................17
Item 3. Legal Proceedings........................................................................................17
Item 4. Submission of Matters to a Vote of Security Holders......................................................17
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities............................................................ 18
Item 6. Selected Financial Data..................................................................................18
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.....................18
Item 7A. Quantitative and Qualitative Disclosure about Market Risk................................................18
Item 8. Financial Statements and Supplementary Data..............................................................19
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................19
Item 9A. Controls and Procedures..................................................................................20
Item 9B. Other Information........................................................................................20
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................................20
Item 11. Executive Compensation...................................................................................20
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...........20
Item 13. Certain Relationships and Related Transactions...........................................................21
Item 14. Principal Accounting Fees and Services...................................................................21
Item 15. Exhibits and Financial Statement Schedules...............................................................21
SIGNATURES .........................................................................................................23
PART I
ITEM 1. BUSINESS
FORWARD LOOKING STATEMENTS
Discussions of certain matters in this Form 10-K and other related year end
documents may constitute forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the Exchange Act), and as such, may
involve risks and uncertainties. Forward-looking statements, which are based on
certain assumptions and describe future plans, strategies, and expectations, are
generally identifiable by the use of words or phrases such as "believe", "plan",
"expect", "intend", "anticipate", "estimate", "project", "forecast", "may
increase", "may fluctuate", "may improve" and similar expressions of future or
conditional verbs such as "will", "should", "would", and "could". These
forward-looking statements relate to, among other things, expectations of the
business environment in which the Corporation operates, projections of future
performance, potential future credit experience, perceived opportunities in the
market and statements regarding the Corporation's mission and vision. The
Corporation's actual results, performance and achievements may differ materially
from the results, performance, and achievements expressed or implied in such
forward-looking statements due to a wide range of factors. These factors
include, but are not limited to, changes in interest rates, general economic
conditions, the local economy, the demand for the Corporation's products and
services, accounting principles or guidelines, legislative and regulatory
changes, monetary and fiscal policies of the U.S. Government, U.S. Treasury, and
Federal Reserve, real estate markets, competition in the financial services
industry, attracting and retaining key personnel, performance of new employees,
regulatory actions, changes in and utilization of new technologies and other
risks detailed in the Corporation's reports filed with the Securities and
Exchange Commission (SEC) from time to time. These factors and those discussed
under "Risk Factors" should be considered in evaluating the forward-looking
statements, and undue reliance should not be placed on such statements. The
Corporation does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
GENERAL
Emclaire Financial Corp. (the Corporation) is a Pennsylvania corporation and
bank holding company that provides a full range of retail and commercial
financial products and services to customers in western Pennsylvania through its
wholly owned subsidiary bank, the Farmers National Bank of Emlenton (the Bank).
The Bank also provides investment advisory services to our customers and
operates as Farmers Financial Services.
During 2004, the Bank entered an agreement with Blue Vase Securities, LLC to
provide investment advisory services to our customers and operates as Farmers
Financial Services. Blue Vase Securities, LLC is a nation-wide, full-service,
independent broker/dealer that offers various services such as investments,
insurances, wealth management, advisory services, estate and retirement planning
and account consolidation. This partnership has enabled the Bank to provide our
customers with financial solutions that extend outside the Bank's ordinary
deposit products and services.
The Bank was organized in 1900 as a national banking association and is a
financial intermediary whose principal business consists of attracting deposits
from the general public and investing such funds in real estate loans secured by
liens on residential and commercial property, consumer loans, commercial
business loans, marketable securities and interest-earning deposits. The Bank
operates through a network of ten retail branch offices in Venango, Butler,
Clarion, Clearfield, Elk and Jefferson counties, Pennsylvania. The Corporation
and the Bank are headquartered in Emlenton, Pennsylvania.
1
The Corporation and the Bank are subject to examination and comprehensive
regulation by the Office of the Comptroller of the Currency (OCC), which is the
Bank's chartering authority, and the Federal Deposit Insurance Corporation
(FDIC), which insures customer deposits held by the Bank to the full extent
provided by law. The Bank is a member of the Federal Reserve Bank of Cleveland
(FRB) and the Federal Home Loan Bank of Pittsburgh (FHLB). The Corporation is a
registered bank holding company pursuant to the Bank Holding Company Act of 1956
(BHCA), as amended.
During January 2006, the Bank submitted an application to the OCC for a new
branch location in Cranberry, Pennsylvania. The Bank posted a legal notification
in a local newspaper and it provides 30 days for public comments.
At December 31, 2005, the Corporation had $275.6 million in total assets, $23.6
million in stockholders' equity, $192.5 million in loans and $230.5 million in
deposits.
LENDING ACTIVITIES
GENERAL. The principal lending activities of the Bank are the origination of
residential mortgage, commercial mortgage, commercial business and consumer
loans. Significantly all of the Bank's loans are secured by property in the
Bank's primary market area.
ONE-TO-FOUR FAMILY MORTGAGE LOANS. The Bank offers first mortgage loans secured
by one-to-four family residences located in the Bank's primary lending area.
Typically such residences are single-family owner occupied units. The Bank is an
approved, qualified lender for the Federal Home Loan Mortgage Corporation
(FHLMC). As a result, the Bank may sell loans to and service loans for the FHLMC
in market conditions and circumstances where this is advantageous in managing
interest rate risk.
HOME EQUITY LOANS. The Bank originates home equity loans secured by
single-family residences. These loans may be either a single advance fixed-rate
loan with a term of up to 20 years, or a variable rate revolving line of credit.
These loans are made only on owner-occupied single-family residences.
COMMERCIAL AND COMMERCIAL REAL ESTATE LOANS. Commercial lending constitutes a
significant portion of the Bank's lending activities. Commercial business and
commercial real estate loans amounted to 41.5% of the total loan portfolio at
December 31, 2005. Commercial real estate loans generally consist of loans
granted for commercial purposes secured by commercial or other nonresidential
real estate. Commercial loans consist of secured and unsecured loans for such
items as capital assets, inventory, operations and other commercial purposes.
CONSUMER LOANS. Consumer loans generally consist of fixed-rate term loans for
automobile purchases, home improvements not secured by real estate, capital and
other personal expenditures. The Bank also offers unsecured revolving personal
lines of credit and overdraft protection.
LOANS TO ONE BORROWER. National banks are subject to limits on the amount of
credit that they can extend to one borrower. Under current law, loans to one
borrower are limited to an amount equal to 15% of unimpaired capital and surplus
on an unsecured basis, and an additional amount equal to 10% of unimpaired
capital and surplus if the loan is secured by readily marketable collateral. At
December 31, 2005, the Bank's loans to one borrower limit based upon 15% of
unimpaired capital was $3.3 million. At December 31, 2005, the Bank's largest
single lending relationship had an outstanding balance of $4.7 million, which
consisted of a loan to a municipality and was not subject to the legal lending
limit. The next largest borrower had loans which totaled $3.2 million and
consisted of loans secured by commercial real estate and business property in
the Bank's lending area. At December 31, 2005, all of such loans were performing
in accordance with their terms.
2
3
LOAN PORTFOLIO. The following table sets forth the composition and percentage of
the Corporation's loans receivable in dollar amounts and in percentages of the
portfolio as of December 31:
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2005 2004 2003 2002 2001
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Dollar Dollar Dollar Dollar Dollar
(Dollar amounts in thousands) Amount % Amount % Amount % Amount % Amount %
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Mortgage loans on real estate:
Residential
first mortgages $ 66,011 34.0% $ 69,310 38.2% $ 76,396 39.7% $ 82,449 48.2% $ 84,974 52.5%
Home equity loans
and lines
of credit 39,933 20.5% 31,548 17.4% 30,316 15.8% 19,136 11.2% 15,446 9.5%
Commercial 52,990 27.3% 48,539 26.8% 44,935 23.4% 34,986 20.4% 26,470 16.3%
-------- ------- -------- ------ -------- ------ -------- ------ -------- ------
Total real
estate loans 158,934 81.8% 149,397 82.4% 151,647 78.9% 136,571 79.8% 126,890 78.3%
Other loans:
Commercial business 27,732 14.2% 23,898 13.2% 26,470 13.8% 21,913 12.8% 20,806 12.9%
Consumer 7,729 4.0% 8,090 4.4% 14,142 7.3% 12,660 7.4% 14,308 8.8%
-------- ------- -------- ------ -------- ------ -------- ------ -------- ------
Total other loans 35,461 18.2% 31,988 17.6% 40,612 21.1% 34,573 20.2% 35,114 21.7%
-------- ------- -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable 194,395 100.0% 181,385 100.0% 192,259 100.0% 171,144 100.0% 162,004 100.0%
======= ====== ====== ====== ======
Less:
Allowance
for loan
losses 1,869 1,810 1,777 1,587 1,464
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Net loans receivable $192,526 $179,575 $190,482 $169,557 $160,540
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The following table sets forth the scheduled contractual principal repayments or
interest repricing of loans in the Corporation's portfolio as of December 31,
2005. Demand loans having no stated schedule of repayment and no stated maturity
are reported as due within one year.
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Due in one Due from one Due from five Due after
(Dollar amounts in thousands) year or less to five years to ten years ten years Total
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Residential mortgages $ 847 $ 4,108 $ 12,915 $ 48,141 $ 66,011
Home equity loans and lines of credit 148 7,334 13,047 19,404 39,933
Commercial mortgages 1,466 2,850 15,869 32,805 52,990
Commercial business 2,276 7,051 3,934 14,471 27,733
Consumer 443 6,023 848 415 7,729
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$ 5,180 $ 27,366 $ 46,613 $115,236 $194,395
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The following table sets forth the dollar amount of the Corporation's fixed- and
adjustable-rate loans with maturities greater than one year as of December 31,
2005:
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Fixed Adjustable
(Dollar amounts in thousands) rates rates
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Residential mortgage $ 58,463 $ 6,701
Home equity loans and lines of credit 35,192 4,594
Commercial mortgage 18,831 32,693
Commercial business 20,154 5,303
Consumer 7,285 --
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$139,925 $ 49,291
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Contractual maturities of loans do not reflect the actual term of the
Corporation's loan portfolio. The average life of mortgage loans is
substantially less than their contractual terms because of loan prepayments and
enforcement of due-on-sale clauses, which give the Corporation the right to
declare a loan immediately payable in the event, among other things, that the
borrower sells the real property subject to the mortgage. Scheduled principal
amortization also reduces the average life of the loan portfolio. The average
life of mortgage loans tends to increase when current market mortgage rates
substantially exceed rates on existing mortgages and conversely, decrease when
rates on existing mortgages substantially exceed current market interest rates.
3
DELINQUENCIES AND CLASSIFIED ASSETS
DELINQUENT LOANS AND REAL ESTATE ACQUIRED THROUGH FORECLOSURE (REO). Typically,
a loan is considered past due and a late charge is assessed when the borrower
has not made a payment within fifteen days from the payment due date. When a
borrower fails to make a required payment on a loan, the Corporation attempts to
cure the deficiency by contacting the borrower. The initial contact with the
borrower is made shortly after the seventeenth day following the due date for
which a payment was not received. In most cases, delinquencies are cured
promptly.
If the delinquency exceeds 60 days, the Corporation works with the borrower to
set up a satisfactory repayment schedule. Typically loans are considered
non-accruing upon reaching 90 days delinquency, although the Corporation may be
receiving partial payments of interest and partial repayments of principal on
such loans. When a loan is placed in non-accrual status, previously accrued but
unpaid interest is deducted from interest income. The Corporation institutes
foreclosure action on secured loans only if all other remedies have been
exhausted. If an action to foreclose is instituted and the loan is not
reinstated or paid in full, the property is sold at a judicial or trustee's sale
at which the Corporation may be the buyer.
Real estate properties acquired through, or in lieu of, loan foreclosure are to
be sold and are initially recorded at fair value at the date of foreclosure
establishing a new cost basis. After foreclosure, management periodically
performs valuations and the real estate is carried at the lower of carrying
amount or fair value less cost to sell. Revenue and expenses from operations and
changes in the valuation allowance are included in loss on foreclosed real
estate. The Corporation generally attempts to sell its REO properties as soon as
practical upon receipt of clear title. The original lender typically handles
disposition of those REO properties resulting from loans purchased in the
secondary market.
As of December 31, 2005, the Corporation's non-performing assets, which include
non-accrual loans, loans delinquent due to maturity, troubled debt
restructuring, repossessions and REO, amounted to $1.6 million or 0.58% of the
Corporation's total assets.
CLASSIFIED ASSETS. Regulations applicable to insured institutions require the
classification of problem assets as "substandard," "doubtful," or "loss"
depending upon the existence of certain characteristics as discussed below. A
category designated "special mention" must also be maintained for assets
currently not requiring the above classifications but having potential weakness
or risk characteristics that could result in future problems. An asset is
classified as substandard if not adequately protected by the current net worth
and paying capacity of the obligor or of the collateral pledged, if any. A
substandard asset is characterized by the distinct possibility that the
Corporation will sustain some loss if the deficiencies are not corrected. Assets
classified as doubtful have all the weaknesses inherent in those classified as
substandard. In addition, these weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions and values, highly
questionable and improbable. Assets classified as loss are considered
uncollectible and of such little value that their continuance as assets is not
warranted.
The Corporation's classification of assets policy requires the establishment of
valuation allowances for loan losses in an amount deemed prudent by management.
Valuation allowances represent loss allowances that have been established to
recognize the inherent risk associated with lending activities. When the
Corporation classifies a problem asset as a loss, the asset is charged-off
immediately.
The Corporation regularly reviews the problem loans and other assets in its
portfolio to determine whether any require classification in accordance with the
Corporation's policy and applicable regulations. As of December 31, 2005, the
Corporation's classified and criticized assets amounted to $6.4 million with
$4.6 million classified as substandard and $1.8 million identified as special
mention.
4
The following table sets forth information regarding the Corporation's
non-performing assets as of December 31:
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(Dollar amounts in thousands) 2005 2004 2003 2002 2001
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Non-performing loans $ 1,452 $ 840 $ 1,329 $ 1,160 $ 1,245
Total as a percentage of gross loans 0.75% 0.46% 0.69% 0.69% 0.78%
--------- --------- --------- --------- ---------
Repossessions -- 2 45 -- --
Real estate acquired through foreclosure 106 69 -- 3 20
--------- --------- --------- --------- ---------
Total as a percentage of total assets 0.04% 0.03% 0.00% 0.00% 0.01%
--------- --------- --------- --------- ---------
Total non-performing assets $ 1,558 $ 911 $ 1,374 $ 1,163 $ 1,265
========= ========= ========= ========= =========
Total non-performing assets
as a percentage of total assets 0.57% 0.33% 0.52% 0.49% 0.58%
========= ========= ========= ========= =========
Allowance for loan losses as a
percentage of non-performing loans 128.72% 215.48% 133.71% 136.81% 117.59%
========= ========= ========= ========= =========
ALLOWANCE FOR LOAN LOSSES. Management establishes allowances for estimated
losses on loans based upon its evaluation of the pertinent factors underlying
the types and quality of loans; historical loss experience based on volume and
types of loans; trend in portfolio volume and composition; level and trend on
non-performing assets; detailed analysis of individual loans for which full
collectibility may not be assured; determination of the existence and realizable
value of the collateral and guarantees securing such loans and the current
economic conditions affecting the collectibility of loans in the portfolio. The
Corporation analyzes its loan portfolio each month for valuation purposes and to
determine the adequacy of its allowance for losses. Based upon the factors
discussed above, management believes that the Corporation's allowance for losses
as of December 31, 2005 of $1.9 million is adequate to cover probable losses
inherent in the portfolio.
The following table sets forth an analysis of the allowance for losses on loans
receivable for the years ended December 31:
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(Dollar amounts in thousands) 2005 2004 2003 2002 2001
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Balance at beginning of period $ 1,810 $ 1,777 $ 1,587 $ 1,464 $ 1,460
Provision for loan losses 205 290 330 381 154
Charge-offs:
Mortgage loans (46) (165) (25) (36) (27)
Commercial business loans (60) (36) (26) (186) (62)
Consumer loans (91) (117) (154) (109) (108)
------- ------- ------- ------- -------
(197) (318) (205) (331) (197)
Recoveries:
Mortgage loans -- 17 -- 26 --
Commercial business loans 18 19 22 20 --
Consumer loans 33 25 43 27 47
------- ------- ------- ------- -------
51 61 65 73 47
Balance at end of period $ 1,869 $ 1,810 $ 1,777 $ 1,587 $ 1,464
======= ======= ======= ======= =======
Ratio of net charge-offs to
average loans outstanding 0.08% 0.14% 0.08% 0.15% 0.10%
======= ======= ======= ======= =======
Ratio of allowance to
total loans at end of period 0.96% 1.00% 0.92% 0.93% 0.90%
======= ======= ======= ======= =======
5
The following table provides a breakdown of the allowance for loan losses by
major loan category for the years ended December 31:
2005 2004 2003 2002 2001
----------------- ----------------- ----------------- ---------------- ------------------
Loan Categories: Amount % Amount % Amount % Amount % Amount %
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Commercial, financial
and agricultural $ 554 29.6% $ 503 27.8% $ 623 35.1% $ 479 30.2% $ 649 44.3%
Commercial mortgages 841 45.0% 1,137 62.8% 798 44.9% 625 39.4% 515 35.2%
Residential mortgages 211 11.3% 10 0.6% 20 1.1% 21 1.3% 23 1.6%
Home equity loans 150 8.0% 39 2.2% 68 3.8% 63 4.0% 7 0.5%
Consumer loans 106 5.7% 121 6.7% 190 10.7% 119 7.5% 107 7.3%
Unallocated 7 0.4% -- 0.0% 78 4.4% 280 17.6% 163 11.1%
------ ------ ------ ------ ------ ------ ------ ----- ------ -----
$1,869 100% $1,810 100% $1,777 100% $1,587 100% $1,464 100%
====== ====== ====== ====== ======
INVESTMENT PORTFOLIO
GENERAL. The Corporation maintains an investment portfolio of securities such as
U.S. government and agency securities, state and municipal debt obligations,
corporate notes and bonds, and to a lesser extent, mortgage-backed and equity
securities. Management generally maintains an investment portfolio with
relatively short maturities to minimize overall interest rate risk. However, at
December 31, 2005 approximately $14.7 million was invested in longer-term
callable municipal securities, as part of strategy to moderate federal income
taxes. The Bank has no investment with any one issuer in an amount greater than
10% of stockholders' equity.
Investment decisions are made within policy guidelines established by the Board
of Directors. This policy is aimed at maintaining a diversified investment
portfolio, which complements the overall asset/liability and liquidity
objectives of the Bank, while limiting the related credit risk to an acceptable
level.
The following table sets forth certain information regarding the amortized cost,
fair value, weighted average yields and contractual maturities of the
Corporation's securities as of December 31, 2005:
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Due in 1 Due from 1 Due from 3 Due from 5 Due after No scheduled
(Dollar amounts in thousands) year or less to 3 years to 5 years to 10 years 10 years maturity Total
- ---------------------------------------------------------------------------------------------------------------------------
U.S. Government securities $2,972 $14,682 $12,947 $2,934 $ -- $ -- $33,535
Mortgage-backed securities -- -- 839 2,083 15 -- 2,937
Municipal securities -- -- -- -- 15,349 -- 15,349
Corporate securities 2,249 -- -- -- -- -- 2,249
Equity securities -- -- -- -- -- 2,234 2,234
------ ------- ------- ------ ------- ------ -------
Estimated Fair Value $5,221 $14,682 $13,786 $5,017 $15,364 $2,234 $56,304
====== ======= ======= ====== ======= ====== =======
Weighted average yield (1) 3.84% 3.14% 5.89% 4.31% 4.80% 2.50% 4.41%
====== ======= ======= ====== ======= ====== =======
(1) Weighted average yield is calculated based upon amortized cost.
For additional information regarding the Corporation's investment portfolio see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Notes to Consolidated Financial Statements" in the Annual
Report incorporated herein by reference.
6
SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for lending and
investing activities. Secondary sources of funds are derived from loan
repayments and investment maturities. Loan repayments can be considered a
relatively stable funding source, while deposit activity is greatly influenced
by interest rates and general market conditions. The Bank also has access to
funds through credit facilities available from the FHLB. In addition, the Bank
can obtain advances from the FRB discount window. For a description of the
Bank's sources of funds, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Annual Report incorporated herein by
reference.
DEPOSITS. The Bank offers a wide variety of retail deposit account products to
both consumer and commercial deposit customers, including time deposits,
non-interest bearing and interest bearing demand deposit accounts, savings
deposits and money market accounts.
Deposit products are promoted in periodic newspaper and radio advertisements,
along with notices provided in customer account statements. The Bank's market
strategy is based on its reputation as a community bank that provides quality
products and personal customer service.
The Bank pays interest rates on its interest bearing deposit products that are
competitive with rates offered by other financial institutions in its market
area. Management reviews interest rates on deposits weekly and considers a
number of factors, including (1) the Bank's internal cost of funds; (2) rates
offered by competing financial institutions; (3) investing and lending
opportunities; and (4) the Bank's liquidity position.
For additional information regarding the Corporation's deposit base and borrowed
funds, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Notes to Consolidated Financial Statements" in the
Annual Report incorporated herein by reference.
SUBSIDIARY ACTIVITY
The Corporation has one wholly owned subsidiary, the Bank, a national
association. As of December 31, 2005, the Bank had no subsidiaries.
PERSONNEL
At December 31, 2005, the Bank had 111 full time equivalent employees. There is
no collective bargaining agreement between the Bank and its employees, and the
Bank believes its relationship with its employees to be satisfactory.
COMPETITION
The Bank competes for loans, deposits and customers with other commercial banks,
savings and loan associations, securities and brokerage companies, mortgage
companies, insurance companies, finance companies, money market funds, credit
unions and other nonbank financial service providers.
SUPERVISION AND REGULATION
GENERAL. Bank holding companies and banks are extensively regulated under both
federal and state law. Set forth below is a summary description of certain
provisions of certain laws that relate to the regulation of the Corporation and
the Bank. The description does not purport to be complete and is qualified in
its entirety by reference to the applicable laws and regulations.
7
THE CORPORATION. The Corporation is a registered bank holding company, and
subject to regulation and examination by the FRB under the Bank Holding Company
Act of 1956, as amended (the "BHCA"). The Corporation is required to file with
the FRB periodic reports and such additional information as the FRB may require.
Recent changes to the Bank Holding Company rating system emphasizes risk
management and evaluation of the potential impact of non-depository entities on
safety and soundness.
The FRB may require the Corporation to terminate an activity or terminate
control of or liquidate or divest certain subsidiaries, affiliates or
investments when the FRB believes the activity or the control of the subsidiary
or affiliate constitutes a significant risk to the financial safety, soundness
or stability of any of its banking subsidiaries. The FRB also has the authority
to regulate provisions of certain bank holding company debt, including the
authority to impose interest ceilings and reserve requirements on such debt.
Under certain circumstances, the Corporation must file written notice and obtain
FRB approval prior to purchasing or redeeming its equity securities.
Further, the Corporation is required by the FRB to maintain certain levels of
capital. See "Capital Standards."
The Corporation is required to obtain prior FRB approval for the acquisition of
more than 5% of the outstanding shares of any class of voting securities or
substantially all of the assets of any bank or bank holding company. Prior FRB
approval is also required for the merger or consolidation of the Corporation and
another bank holding company.
The Corporation is prohibited by the BHCA, except in certain statutorily
prescribed instances, from acquiring direct or indirect ownership or control of
more than 5% of the outstanding voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than those of banking, managing or controlling banks, or furnishing
services to its subsidiaries. However, subject to the prior FRB approval, The
Corporation may engage in any, or acquire shares of companies engaged in,
activities that the FRB deems to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto.
Under FRB regulations, the Corporation is required to serve as a source of
financial and managerial strength to the Corporation's subsidiary bank and may
not conduct operations in an unsafe or unsound manner. In addition, it is the
FRB's policy that a bank holding company should stand ready to use available
resources to provide adequate capital funds to its subsidiary banks during
periods of financial stress or adversity and should maintain the financial
flexibility and capital-raising capacity to obtain additional resources for
assisting its subsidiary banks. A bank holding company's failure to meet its
obligations to serve as a source of strength to its subsidiary banks will
generally be considered by the FRB to be an unsafe and unsound banking practice
or a violation of FRB regulations or both.
The Corporation is also a bank holding company within the meaning of the
Pennsylvania Banking Code. As such, the Corporation and its subsidiaries are
subject to examination by, and may be required to file reports with, the
Pennsylvania Department of Banking.
The Corporation's securities are registered with the SEC under the Exchange Act.
As such, the Corporation is subject to the information, proxy solicitation,
insider trading, corporate governance, and other requirements and restrictions
of the Exchange Act. The public may obtain all forms and information filed with
the SEC through their website http://www.sec.gov.
8
THE BANK. As a national banking association, the Bank is subject to primary
supervision, examination and regulation by the OCC. The Corporation is also
subject to regulations of the FDIC as administrator of the Bank Insurance Fund
("BIF") and the FRB. If, as a result of an examination of the Bank, the OCC
should determine that the financial condition, capital resources, asset quality,
earnings prospects, management, liquidity or other aspects of the Corporation's
operations are unsatisfactory or that the Bank is violating or has violated any
law or regulation, various remedies are available to the OCC. Such remedies
include the power to enjoin "unsafe or unsound practices," to require
affirmative action to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to
direct an increase in capital, to restrict the Bank's growth, to assess civil
monetary penalties, and to remove officers and directors. The FDIC has similar
enforcement authority, in addition to its authority to terminate the Bank's
deposit insurance in the absence of action by the OCC and upon a finding that
the Bank is operating in an unsafe or unsound condition, is engaging in unsafe
or unsound activities, or that the Corporation's conduct poses a risk to the
deposit insurance fund or may prejudice the interest of its depositors.
A national bank may have a financial subsidiary engaged in any activity
authorized for national banks directly or certain permissible activities.
Generally, a financial subsidiary is permitted to engage in activities that are
"financial in nature" or incidental thereto, even though they are not
permissible for the national bank itself. The definition of "financial in
nature" includes, among other items, underwriting, dealing in or making a market
in securities, including, for example, distributing shares of mutual funds. The
subsidiary may not, however, engage as principal in underwriting insurance,
issue annuities or engage in real estate development or investment or merchant
banking.
THE SARBANES-OXLEY ACT OF 2002. The Sarbanes-Oxley Act of 2002 addresses
accounting oversight and corporate governance matters, including:
o the prohibition of accounting firms from providing various types
of consulting services to public clients and requiring accounting
firms to rotate partners among public client assignments every
five years;
o increased penalties for financial crimes and forfeiture of
executive bonuses in certain circumstances;
o required executive certification of financial presentations;
o increased requirements for board audit committees and their
members;
o enhanced disclosure of controls and procedures and internal
control over financial reporting;
o enhanced controls on, and reporting of, insider trading; and o
statutory separations between investment bankers and analysts.
The new legislation and its implementing regulations have resulted in increased
costs of compliance, including certain outside professional costs. To date these
costs have not had a material impact on the Corporation's operations.
USA PATRIOT ACT OF 2001. The USA PATRIOT Act of 2001 and its implementing
regulations significantly expanded the anti-money laundering and financial
transparency laws. Under the USA PATRIOT Act, financial institutions are subject
to prohibitions regarding specified financial transactions and account
relationships as well as enhanced due diligence and "know your customer"
standards in their dealings with foreign financial institutions and foreign
customers. For example, the enhanced due diligence policies, procedures, and
controls generally require financial institutions to take reasonable steps:
o To conduct enhanced scrutiny of account relationships to guard
against money laundering and report any suspicious transaction,
o To ascertain the identity of the nominal and beneficial owners
of, and the source of funds deposited into, each account as
needed to guard against money laundering and report any
suspicious transactions,
9
o To ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank,
and the nature and extent of the ownership interest of each such
owner, and
o To ascertain whether any foreign bank provides correspondent
accounts to other foreign banks and, if so, the identity of those
foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions are required to establish and
maintain anti-money laundering programs which included
o The establishment of a customer identification program,
o The development of internal policies, procedures, and controls,
o The designation of a compliance officer, o An ongoing employee
training program, and
o An independent audit function to test the programs.
The Bank has implemented comprehensive policies and procedures to address the
requirements of the USA PATRIOT Act.
PRIVACY. Federal banking rules limit the ability of banks and other financial
institutions to disclose non-public information about consumers to nonaffiliated
third parties. Pursuant to these rules, financial institutions must provide:
o initial notices to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic
personal information to nonaffiliated third parties and
affiliates;
o annual notices of their privacy policies to current customers;
and
o a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
These privacy provisions affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors. The
Corporation's privacy policies have been implemented in accordance with the law.
DIVIDENDS AND OTHER TRANSFERS OF FUNDS. Dividends from the Bank constitute the
principal source of income to the Corporation. The Corporation is a legal entity
separate and distinct from the Bank. The Bank is subject to various statutory
and regulatory restrictions on its ability to pay dividends to the Corporation.
In addition, the Bank's regulators have the authority to prohibit the Bank from
paying dividends, depending upon the Bank's financial condition, if such payment
is deemed to constitute an unsafe or unsound practice.
TRANSACTIONS WITH AFFILIATES. The Bank is subject to certain restrictions
imposed by federal law on any extensions of credit to, or the issuance of a
guarantee or letter of credit on behalf of, any affiliates, the purchase of, or
investments in, stock or other securities thereof, the taking of such securities
as collateral for loans, and the purchase of assets of any affiliates. Such
restrictions prevent any affiliates from borrowing from the Bank unless the
loans are secured by marketable obligations of designated amounts. Further, such
secured loans and investments by the Bank to or in any affiliate are limited,
individually, to 10.0% of the Bank's capital and surplus (as defined by federal
regulations), and such secured loans and investments are limited, in the
aggregate, to 20.0% of the Bank's capital and surplus. Some of the entities
included in the definition of an affiliate are parent companies, sister banks,
sponsored and advised companies, investment companies whereby the Bank or its
affiliate serves as investment advisor, and financial subsidiaries of the bank.
Additional restrictions on transactions with affiliates may be imposed on the
Bank under the prompt corrective action provisions of federal law. See "Prompt
Corrective Action and Other Enforcement Mechanisms."
10
LOANS-TO-ONE BORROWER LIMITATIONS. With certain limited exceptions, the maximum
amount that a national bank may lend to any borrower (including certain related
entities of the borrower) at one time may not exceed 15% of the unimpaired
capital and surplus of the institution, plus an additional 10% of unimpaired
capital and surplus for loans fully secured by readily marketable collateral. At
December 31, 2005, the Bank's loans-to-one-borrower limit was $3.3 million based
upon the 15% of unimpaired capital and surplus measurement. At December 31,
2005, the Bank's largest single lending relationship had an outstanding balance
of $4.7 million, which consisted of a loan to a municipality and was not subject
to the legal lending limit. The next largest borrower had loans which totaled
$3.2 million and consisted of loans secured by commercial real estate and
business property in the Bank's lending area. At December 31, 2005, all of such
loans were performing in accordance with their terms.
CAPITAL STANDARDS. The federal banking agencies have adopted risk-based minimum
capital guidelines intended to provide a measure of capital that reflects the
degree of risk associated with a banking organization's operations for both
transactions reported on the balance sheet as assets and transactions which are
recorded as off-balance sheet items. Under these guidelines, nominal dollar
amounts of assets and credit equivalent amounts of off-balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as federal banking agencies, to 100% for
assets with relatively high credit risk.
The risk-based capital ratio is determined by classifying assets and certain
off-balance sheet financial instruments into weighted categories, with higher
levels of capital being required for those categories perceived as representing
greater risk. Under the capital guidelines, a banking organization's total
capital is divided into tiers. "Tier I capital" consists of (1) common equity,
(2) qualifying noncumulative perpetual preferred stock, (3) a limited amount of
qualifying cumulative perpetual preferred stock and (4) minority interests in
the equity accounts of consolidated subsidiaries (including trust-preferred
securities), less goodwill and certain other intangible assets. Not more than
25% of qualifying Tier I capital may consist of trust-preferred securities.
"Tier II capital" consists of hybrid capital instruments, perpetual debt,
mandatory convertible debt securities, a limited amount of subordinated debt,
preferred stock that does not qualify as Tier I capital, a limited amount of the
allowance for loan and lease losses and a limited amount of unrealized holding
gains on equity securities. "Tier III capital" consists of qualifying unsecured
subordinated debt. The sum of Tier II and Tier III capital may not exceed the
amount of Tier I capital.
The guidelines require a minimum ratio of qualifying total capital to
risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to
risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal
banking regulators require banking organizations to maintain a minimum amount of
Tier 1 capital to total assets, referred to as the leverage ratio. For a banking
organization rated in the highest of the five categories used by regulators to
rate banking organizations, the minimum leverage ratio of Tier 1 capital to
total assets must be 3%. In addition to these uniform risk-based capital
guidelines and leverage ratios that apply across the industry, the regulators
have the discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
In addition, federal banking regulators may set capital requirements higher than
the minimums described above for financial institutions whose circumstances
warrant it. For example, a financial institution experiencing or anticipating
significant growth may be expected to maintain capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets.
PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS. Federal banking
agencies possess broad powers to take corrective and other supervisory action to
resolve the problems of insured depository institutions, including but not
limited to those institutions that fall below one or more prescribed minimum
capital ratios. Each federal banking agency has promulgated regulations defining
the following five categories in which an insured depository institution will be
placed, based on its capital ratios: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized. At December 31, 2005, the Bank exceeded the required ratios
for classification as "well/adequately capitalized."
11
An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized, or undercapitalized may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat a significantly undercapitalized institution as
critically undercapitalized unless its capital ratio actually warrants such
treatment.
In addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal regulators for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation, or any condition
imposed in writing by the agency or any written agreement with the agency.
Finally, pursuant to an interagency agreement, the FDIC can examine any
institution that has a substandard regulatory examination score or is considered
undercapitalized - without the express permission of the institution's primary
regulator.
SAFETY AND SOUNDNESS STANDARDS. The federal banking agencies have adopted
guidelines designed to assist the federal banking agencies in identifying and
addressing potential safety and soundness concerns before capital becomes
impaired. The guidelines set forth operational and managerial standards relating
to: (i) internal controls, information systems and internal audit systems, (ii)
loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings,
and (vi) compensation, fees and benefits. In addition, the federal banking
agencies have also adopted safety and soundness guidelines with respect to asset
quality and earnings standards. These guidelines provide six standards for
establishing and maintaining a system to identify problem assets and prevent
those assets from deteriorating. Under these standards, an insured depository
institution should: (i) conduct periodic asset quality reviews to identify
problem assets, (ii) estimate the inherent losses in problem assets and
establish reserves that are sufficient to absorb estimated losses, (iii) compare
problem asset totals to capital, (iv) take appropriate corrective action to
resolve problem assets, (v) consider the size and potential risks of material
asset concentrations, and (vi) provide periodic asset quality reports with
adequate information for management and the board of directors to assess the
level of asset risk. These guidelines also set forth standards for evaluating
and monitoring earnings and for ensuring that earnings are sufficient for the
maintenance of adequate capital and reserves.
PREMIUMS FOR DEPOSIT INSURANCE. Through the BIF, the FDIC insures the Bank's
customer deposits up to prescribed limits for each depositor. The amount of FDIC
assessments paid by each BIF member institution is based on its relative risk of
default as measured by regulatory capital ratios and other factors.
Specifically, the assessment rate is based on the institution's capitalization
risk category and supervisory subgroup category. An institution's capitalization
risk category is based on the FDIC's determination of whether the institution is
well capitalized, adequately capitalized or less than adequately capitalized. An
institution's supervisory subgroup category is based on the FDIC's assessment of
the financial condition of the institution and the probability that FDIC
intervention or other corrective action will be required.
FDIC-insured depository institutions pay an assessment rate equal to the rate
assessed on deposits insured by the Savings Association Insurance Fund ("SAIF").
The assessment rate currently ranges from zero to 27 cents per $100 of domestic
deposits. The FDIC may increase or decrease the assessment rate schedule on a
semi-annual basis. Due to continued growth in deposits and some recent bank
failures, the BIF is nearing its minimum ratio of 1.25% of insured deposits as
mandated by law. If the ratio drops below 1.25%, it is likely the FDIC will be
required to assess premiums on all banks. Any increase in assessments or the
assessment rate could have a material adverse effect on the Corporation's
earnings, depending on the amount of the increase. Furthermore, the FDIC is
authorized to raise insurance premiums under certain circumstances.
12
The FDIC is authorized to terminate a depository institution's deposit insurance
upon a finding by the FDIC that the institution's financial condition is unsafe
or unsound or that the institution has engaged in unsafe or unsound practices or
has violated any applicable rule, regulation, order or condition enacted or
imposed by the institution's regulatory agency. The termination of deposit
insurance for the Bank could have a material adverse effect on the Corporation's
earnings, depending on the collective size of the particular institutions
involved.
All FDIC-insured depository institutions must pay an annual assessment to
provide funds for the payment of interest on bonds issued by the Financing
Corporation, a federal corporation chartered under the authority of the Federal
Housing Finance Board. The bonds, commonly referred to as FICO bonds, were
issued to capitalize the Federal Savings and Loan Insurance Corporation. The
FICO assessment rates for fourth quarter of fiscal 2005 were 1.46 cents for each
$100 of assessable deposits. The FICO assessments are adjusted quarterly to
reflect changes in the assessment bases of the FDIC's insurance funds and do not
vary depending on a depository institution's capitalization or supervisory
evaluations.
DEPOSIT INSURANCE REFORM. On February 8, 2006, President Bush signed into law
legislation that merges the BIF and the SAIF, eliminates any disparities in bank
and thrift risk-based premium assessments, reduces the administrative burden of
maintaining and operating two separate funds and establishes certain new
insurance coverage limits and a mechanism for possible periodic increases. The
legislation also gives the FDIC greater discretion to identify the relative
risks all institutions present to the deposit insurance fund and set risk-based
premiums.
Major provisions in the legislation include: maintaining basic deposit and
municipal account insurance coverage at $100,000 but providing for a new basic
insurance coverage for retirement accounts of $250,000. Insurance coverage for
basic deposit and retirement accounts could be increased for inflation every
five years in $10,000 increments beginning in 2011; providing the FDIC with the
ability to set the designated reserve ratio within a range of between 1.15
percent and 1.50 percent, rather than maintaining 1.25 percent at all times
regardless of prevailing economic conditions; providing a one-time assessment
credit of $4.7 billion to banks and savings associations in existence on
December 31, 1996. The institutions qualifying for the credit may use it to
offset future premiums with certain limitations; requiring the payment of
dividends of 100% of the amount that the insurance fund exceeds 1.5% of the
estimated insured deposits and the payment of 50% of the amount that the
insurance fund exceeds 1.35% of the estimated insured deposits. (when the
reserve is greater than 1.35% but no more than 1.5%); the merger of the SAIF and
BIF must occur no later than July 1, 2006. Other provisions will become
effective within 90 days of the publication date of the final FDIC regulations
implementing the legislation.
INTERSTATE BANKING AND BRANCHING. Banks have the ability, subject to certain
State restrictions, to acquire, by acquisition or merger, branches outside its
home state. The establishment of new interstate branches is also possible in
those states with laws that expressly permit it. Interstate branches are subject
to certain laws of the states in which they are located. Competition may
increase further as banks branch across state lines and enter new markets.
CONSUMER PROTECTION LAWS AND REGULATIONS. The bank regulatory agencies are
focusing greater attention on compliance with consumer protection laws and their
implementing regulations. Examination and enforcement have become more intense
in nature, and insured institutions have been advised to monitor carefully
compliance with such laws and regulations. The bank is subject to many federal
consumer protection statutes and regulations, some of which are discussed below.
The Community Reinvestment Act, or CRA, is intended to encourage insured
depository institutions, while operating safely and soundly, to help meet the
credit needs of their communities. The CRA specifically directs the federal
regulatory agencies, in examining insured depository institutions, to assess a
bank's record of helping meet the credit needs of its entire community,
including low- and moderate-income neighborhoods, consistent with safe and sound
banking practices. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, mergers or
acquisitions, or holding company formations. The agencies use the CRA assessment
factors in order to provide a rating to the financial institution. The ratings
range from a high of "outstanding" to a low of "substantial noncompliance." In
its last examination for CRA compliance, as of March 22, 1999, the Bank was
rated "satisfactory."
On February 22, 2005, the federal banking agencies re-proposed amendments to the
CRA regulations that would:
o increase the definition of "small institution" from total assets
of $250 million to $1 billion, without regard to any holding
company; and
o take into account abusive lending practices by a bank or its
affiliates in determining a bank's CRA rating.
There can be no assurances such proposal will be adopted or, if adopted, in what
form.
The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit
Transactions Act, or FACT, requires financial firms to help deter identity
theft, including developing appropriate fraud response programs, and give
consumers more control of their credit data. It also reauthorizes a federal ban
on state laws that interfere with corporate credit granting and marketing
practices. In connection with FACT, financial institution regulatory agencies
proposed rules that would prohibit an institution from using certain information
about a consumer it received from an affiliate to make a solicitation to the
consumer, unless the consumer has been notified and given a chance to opt out of
such solicitations. A consumer's election to opt out would be applicable for at
least five years.
13
The Check Clearing for the 21st Century Act, or Check 21, facilitates check
truncation and electronic check exchange by authorizing a new negotiable
instrument called a "substitute check," which is the legal equivalent of an
original check. Check 21, effective October 28, 2004, does not require banks to
create substitute checks or accept checks electronically; however, it does
require banks to accept a legally equivalent substitute check in place of an
original.
The Equal Credit Opportunity Act, or ECOA, generally prohibits discrimination in
any credit transaction, whether for consumer or business purposes, on the basis
of race, color, religion, national origin, sex, marital status, age (except in
limited circumstances), receipt of income from public assistance programs, or
good faith exercise of any rights under the Consumer Credit Protection Act.
The Truth in Lending Act, or TILA, is designed to ensure that credit terms are
disclosed in a meaningful way so that consumers may compare credit terms more
readily and knowledgeably. As a result of the TILA, all creditors must use the
same credit terminology to express rates and payments, including the annual
percentage rate, the finance charge, the amount financed, the total of payments
and the payment schedule, among other things.
The Fair Housing Act, or FH Act, regulates many practices, including making it
unlawful for any lender to discriminate in its housing-related lending
activities against any person because of race, color, religion, national origin,
sex, handicap or familial status. A number of lending practices have been found
by the courts to be, or may be considered, illegal under the FH Act, including
some that are not specifically mentioned in the FH Act itself.
The Home Mortgage Disclosure Act, or HMDA, grew out of public concern over
credit shortages in certain urban neighborhoods and provides public information
that will help show whether financial institutions are serving the housing
credit needs of the neighborhoods and communities in which they are located. The
HMDA also includes a "fair lending" aspect that requires the collection and
disclosure of data about applicant and borrower characteristics as a way of
identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes.
The term "predatory lending," much like the terms "safety and soundness" and
"unfair and deceptive practices," is far-reaching and covers a potentially broad
range of behavior. As such, it does not lend itself to a concise or a
comprehensive definition. But typically predatory lending involves at least one,
and perhaps all three, of the following elements:
o making unaffordable loans based on the assets of the borrower
rather than on the borrower's ability to repay an obligation
("asset-based lending")
o inducing a borrower to refinance a loan repeatedly in order to
charge high points and fees each time the loan is refinanced
("loan flipping")
o engaging in fraud or deception to conceal the true nature of the
loan obligation from an unsuspecting or unsophisticated borrower.
FRB regulations aimed at curbing such lending significantly widen the pool of
high-cost home-secured loans covered by the Home Ownership and Equity Protection
Act of 1994, a federal law that requires extra disclosures and consumer
protections to borrowers. Lenders that violate the rules face cancellation of
loans and penalties equal to the finance charges paid.
Effective April 8, 2005, OCC guidelines require national banks and their
operating subsidiaries to comply with certain standards when making or
purchasing loans to avoid predatory or abusive residential mortgage lending
practices. Failure to comply with the guidelines could be deemed an unsafe and
unsound or unfair or deceptive practice, subjecting the bank to supervisory
enforcement actions.
14
Finally, the Real Estate Settlement Procedures Act, or RESPA, requires lenders
to provide borrowers with disclosures regarding the nature and cost of real
estate settlements. Also, RESPA prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts. Penalties
under the above laws may include fines, reimbursements and other penalties. Due
to heightened regulatory concern related to compliance with the CRA, TILA, FH
Act, ECOA, HMDA and RESPA generally, the Bank may incur additional compliance
costs or be required to expend additional funds for investments in its local
community.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the Federal Home Loan
Bank of Pittsburgh. Among other benefits, each FHLB serves as a reserve or
central bank for its members within its assigned region. Each FHLB is financed
primarily from the sale of consolidated obligations of the FHLB system. Each
FHLB makes available loans or advances to its members in compliance with the
policies and procedures established by the Board of Directors of the individual
FHLB. As an FHLB member, the Bank is required to own a certain amount of capital
stock in the FHLB. At December 31, 2005, the Bank was in compliance with the
stock requirements.
FEDERAL RESERVE SYSTEM. The FRB requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW, and Super NOW checking accounts) and
non-personal time deposits. At December 31, 2005, the Bank was in compliance
with these requirements.
ITEM 1A. RISK FACTORS
The following discusses certain factors that may affect the Corporation's
financial condition and results of operations and should be considered in
analyzing whether to make or continue an investment in our common stock.
ABILITY OF THE CORPORATION TO EXECUTE ITS BUSINESS STRATEGY. The financial
performance and profitability of the Corporation will depend, in large part, on
its ability to favorably execute its business strategy. This execution entails
risks in, among other areas, technology implementation, market segmentation,
brand identification, banking operations, and capital and human resource
investments. Accordingly, there can be no assurance that the Corporation will be
successful in its business strategy.
ECONOMIC CONDITIONS AND GEOGRAPHIC CONCENTRATION. The Corporation's operations
are located in western Pennsylvania and are concentrated in Venango, Clarion and
Butler Counties, Pennsylvania. Although management has diversified the
Corporation's loan portfolio into other Pennsylvania counties, and to a very
limited extent into other states, the vast majority of the Corporation's credits
remain concentrated in the three primary counties. As a result of this
geographic concentration, the Corporation's results depend largely upon economic
and real estate market conditions in these areas. Deterioration in economic or
real estate market conditions in the Corporation's primary market areas could
have a material adverse impact on the quality of the Corporation's loan
portfolio, the demand for its products and services, and its financial condition
and results of operations.
INTEREST RATES. By nature, all financial institutions are impacted by changing
interest rates, due to the impact of such upon:
o the demand for new loans
o prepayment speeds experienced on various asset classes,
particularly residential mortgage loans
o credit profiles of existing borrowers
o rates received on loans and securities
o rates paid on deposits and borrowings.
As presented previously, the Corporation is financially exposed to parallel
shifts in general market interest rates, changes in the relative pricing of the
term structure of general market interest rates, and relative credit spreads.
Therefore, significant fluctuations in interest rates may present an adverse
effect upon the Corporation's financial condition and results of operations.
15
GOVERNMENT REGULATION AND MONETARY POLICY. The financial services industry is
subject to extensive federal and state supervision and regulation. Significant
new laws, changes in existing laws, or repeals of present laws could cause the
Corporation's financial results to materially differ from past results. Further,
federal monetary policy, particularly as implemented through the Federal Reserve
System, significantly affects credit conditions for the Corporation, and a
material change in these conditions could present an adverse impact on the
Corporation's financial condition and results of operations.
COMPETITION. The financial services business in the Corporation's market areas
is highly competitive, and is becoming more so due to technological advances
(particularly Internet based financial services delivery), changes in the
regulatory environment, and the enormous consolidation that has occurred among
financial services providers. Many of the Corporation's competitors are much
larger in terms of total assets and market capitalization, enjoy greater
liquidity in their equity securities, have greater access to capital and
funding, and offer a broader array of financial products and services. In light
of this environment, there can be no assurance that the Corporation will be able
to compete effectively. The results of the Corporation may materially differ in
future periods depending upon the nature or level of competition.
CREDIT QUALITY. A significant source of risk arises from the possibility that
losses will be sustained because borrowers, guarantors, and related parties may
fail to perform in accordance with the terms of their loans. The Corporation has
adopted underwriting and credit monitoring procedures and credit policies,
including the establishment and review of the allowance for loan losses, that
management believes are appropriate to control this risk by assessing the
likelihood of non-performance, tracking loan performance, and diversifying the
credit portfolio. Such policies and procedures may not, however, prevent
unexpected losses that could have a material adverse effect on the Corporation's
financial condition or results of operations. Unexpected losses may arise from a
wide variety of specific or systemic factors, many of which are beyond the
Corporation's ability to predict, influence, or control.
THERE ARE INCREASED RISKS INVOLVED WITH COMMERCIAL REAL ESTATE, CONSTRUCTION,
COMMERCIAL BUSINESS AND CONSUMER LENDING ACTIVITIES.
Our lending activities include loans secured by existing commercial
real estate. Commercial real estate lending generally is considered to involve a
higher degree of risk than single-family residential lending due to a variety of
factors, including generally larger loan balances and the dependency on
successful operation of the project for repayment. Our lending activities also
include commercial business loans to small to medium business, which generally
are secured by various equipment, machinery and other corporate assets, and a
wide variety of consumer loans, including home equity and second mortgage loans,
automobile loans and unsecured loans. Although commercial business loans and
consumer loans generally have shorter terms and higher interest rates than
mortgage loans, they generally involve more risk than mortgage loans because of
the nature of, or in certain cases the absence of, the collateral which secures
such loans.
OUR ALLOWANCE FOR LOAN LOSSES ON LOANS MAY NOT BE ADEQUATE TO COVER PROBABLE
LOSSES.
We have established an allowance for loan losses which we believe is
adequate to offset probable losses on our existing loans. There can be no
assurance that any future declines in real estate market conditions, general
economic conditions or changes in regulatory policies will not require us to
increase our allowance for loan losses, which could adversely affect our results
of operations.
OTHER RISKS. From time to time, the Corporation details other risks with respect
to its business and financial results in its filings with the SEC.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
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ITEM 2. PROPERTIES
The Corporation owns no real property but utilizes the main office of the Bank.
The Corporation's and the Bank's executive offices are located at 612 Main
Street, Emlenton, Pennsylvania. The Corporation pays no rent or other form of
consideration for the use of this facility. The following table sets forth
information with respect to the Bank's offices at December 31, 2005:
- -------------------------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands) Owned Lease Net Book Deposits
or Expiration Value or at
Location County Leased Date (1) Annual Rent 12/31/2005
- -------------------------------------------------------------------------------------------------------------------------
Corporate and Bank Main Offices:
- --------------------------------
Headquarters and Main Office Venango Owned -- $1,793 $ 45,895
612 Main Street, Emlenton, Pennsylvania 16373
Data Center Venango Owned -- 984 --
708 Main Street, Emlenton, Pennsylvania 16373
Bank Branch Offices
- -------------------
Bon Aire Office Butler Leased May 2011 36 35,479
1101 North Main Street, Butler, Pennsylvania 16003
Brookville Office Jefferson Owned -- 211 21,419
263 Main Street, Brookville, Pennsylvania 15825
Clarion Office Clarion Owned -- 330 35,260
Sixth & Wood Street, Clarion, Pennsylvania 16214
DuBois Office Clearfield Leased June 2010 20 13,678
861 Beaver Drive, Dubois, Pennsylvania 15801
East Brady Office Clarion Owned -- 53 18,555
323 Kelly's Way, East Brady, Pennsylvania 16028
Eau Claire Office Butler Owned -- 161 14,280
207 Washington Street, Eau Claire, Pennsylvania 16030
Knox Office Clarion Leased December 2011 27 27,109
Route 338 South, Knox, Pennsylvania 16232
Meridian Office Butler Leased December 2012 26 8,494
101 Meridian Road, Butler, Pennsylvania 16003
Ridgway Office Elk Owned -- 166 10,334
173 Main Street, Ridgway, Pennsylvania 15853
-----------
$230,503
===========
ITEM 3. LEGAL PROCEEDINGS
Neither the Bank nor the Corporation is involved in any material legal
proceedings. The Bank, from time to time, is party to litigation that arises in
the ordinary course of business, such as claims to enforce liens, claims
involving the origination and servicing of loans, and other issues related to
the business of the Bank. In the opinion of management, the resolution of any
such issues would not have a material adverse impact on the financial position,
results of operation, or liquidity of the Bank or the Corporation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to stockholders for a vote during the quarter ended
December 31, 2005.
17
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES.
(a) The information is contained under the section captioned "Common Stock
Information" in the Corporation's Annual Report for the fiscal year ended
December 31, 2005, and is incorporated herein by reference. For information
with respect to equity compensation plans, see "Item 12 - Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters." There were no sales of the Corporation's unregistered
securities during the period covered by this report.
(b) Not applicable.
(c) Issuer Purchases of Equity Securities. The Corporation did not repurchase
any of its equity securities in the year ended December 31, 2005.
ITEM 6: SELECTED FINANCIAL DATA
The required information is contained in the section captioned "Selected
Consolidated Financial Data" in the Corporation's Annual Report for the year
ended December 31, 2005 and incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The required information is contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Corporation's Annual Report for the year ended December 31, 2005 and is
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk for the Corporation is comprised primarily from interest rate risk
exposure and liquidity risk. Since virtually all of the interest-earning assets
and paying liabilities are at the Bank, virtually all of the interest rate risk
and liquidity risk lies at the Bank level. The Bank is not subject to currency
exchange risk or commodity price risk, and has no trading portfolio, and
therefore, is not subject to any trading risk. In addition, the Bank does not
participate in hedging transactions such as interest rate swaps and caps.
Changes in interest rates will impact both income and expense recorded and also
the market value of long-term interest-earning assets. Interest rate risk and
liquidity risk management is performed at the Bank level. Although the Bank has
a diversified loan portfolio, loans outstanding to individuals and businesses
depend upon the local economic conditions in the immediate trade area.
One of the primary functions of the Corporation's asset/liability management
committee is to monitor the level to which the balance sheet is subject to
interest rate risk. The goal of the asset/liability committee is to manage the
relationship between interest rate sensitive assets and liabilities, thereby
minimizing the fluctuations in the net interest margin, which achieves
consistent growth of net interest income during periods of changing interest
rates.
18
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of the bank's rate sensitive assets and rate sensitive
liabilities. These differences, or interest rate repricing "gap", provide an
indication of the extent that the Corporation's net interest income is affected
by future changes in interest rates. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest
rate-sensitive liabilities and is considered negative when the amount of
interest rate-sensitive liabilities exceeds the amount of interest
rate-sensitive assets. Generally, during a period of rising interest rates, a
negative gap would adversely affect net interest income while a positive gap
would result in an increase in net interest income. Conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The closer to zero that gap is maintained, generally, the lesser the impact of
market interest rate changes on net interest income.
Based on certain assumptions by a federal regulatory agency, which management
believes most accurately represents the sensitivity of the Corporation's assets
and liabilities to interest rate changes, at December 31, 2005, the
Corporation's interest-earning assets maturing or repricing within one year
totaled $67.2 million while the Corporation's interest-bearing liabilities
maturing or repricing within one-year totaled $83.1 million, providing an excess
of interest-bearing liabilities over interest-earning assets of $15.9 million or
a negative 15.5% of total assets. At December 31, 2005, the percentage of the
Corporation's assets to liabilities maturing or repricing within one year was
80.9%.
For more information, see "Market Risk Management" in Exhibit 13 to the
Corporation's Annual Report on Form 10-K for the year ended December 31, 2005.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Corporation's consolidated financial statements required herein are
contained in the Corporation's Annual Report for the year ended December 31,
2005 and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On January 19, 2005, the Corporation's Board of Directors dismissed its
independent auditors, Crowe Chizek and Company LLC (Crowe Chizek) to be
effective upon filing of the 2004 Form 10-K. Crowe Chizek completed its
engagement as independent auditor for the Corporation's fiscal year ended
December 31, 2004 upon the filing of the Corporation's Form 10-K for the year
ended December 31, 2004. Crowe Chizek's report on the Corporation's consolidated
financial statements during the fiscal years ended December 31, 2004 and 2003
contained no adverse opinion or a disclaimer of opinion, and was not qualified
or modified as to uncertainty, audit scope or accounting principles. The
decision to change accountants was approved by the Corporation's Audit
Committee. During the two fiscal years ended December 31, 2004 and 2003 and the
subsequent interim period to the date of their dismissal, there were no
disagreements between the Corporation and Crowe Chizek on any matters of
accounting principles or practices, financial statement disclosure, or auditing
scope or principles, which disagreement(s), if not resolved to the satisfaction
of Crowe Chizek, would have caused it to make a reference to the subject matter
of the disagreement(s) in connection with its reports. None of the "REPORTABLE
EVENTS" described in Item 304(a)(1)(v) of Regulation S-K occurred with respect
to the Corporation within the two fiscal years ended December 31, 2004 and 2003
and the subsequent interim period to the date of their dismissal.
Effective January 19, 2005, the Corporation engaged BEARD MILLER COMPANY LLP
(Beard Miller) as its independent auditors for the fiscal year ending December
31, 2005. During the two fiscal years ended December 31, 2004 and 2003 and the
subsequent interim period to the date of their engagement, the Corporation did
not consult Beard Miller regarding any of the matters or events set forth in
Item 304(a)(2)(i) and (ii) of Regulation S-K.
19
ITEM 9A. CONTROLS AND PROCEDURES.
The Corporation maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Corporation's reports
in compliance with the Exchange Act, is recorded, processed, summarized, and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to the Corporation's
Management, including its Chief Executive Officer and Principal Financial and
Accounting Officer, as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-14(c) promulgated under the Exchange Act. As of December
31, 2005, the Corporation carried out an evaluation, under the supervision and
with the participation of the Corporation's Management, including the
Corporation's Chief Executive Officer and the Corporation's Principal Financial
and Accounting Officer, of the effectiveness of the design and operation of the
Corporation's disclosure controls and procedures. Based on the foregoing, the
Corporation's Chief Executive Officer and Principal Financial and Accounting
Officer concluded that the Corporation's disclosure controls and procedures were
effective.
During the fourth quarter of fiscal year 2005, there were no significant changes
in the Corporation's internal control over financial reporting or in other
factors that could significantly affect the internal controls subsequent to the
date of the evaluation referenced above.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the sections captioned "Principal Beneficial
Owners of the Corporation's Common Stock" and "Information as to Nominees,
Directors and Executive Officers" is incorporated by reference to the
Corporation's definitive proxy statement for the Corporation's Annual Meeting of
Stockholders to be held on May 17, 2006 (the Proxy Statement) which will be
filed no later than 120 days following the Corporation's fiscal year end.
The Corporation maintains a Code of Personal and Business Conduct and Ethics
(the "Code") that applies to all employees, including the CEO and the principal
financial and accounting officer. A copy of the Code has previously been filed
with the SEC and is posted on our website at www.farmersnb.com. Any waiver of
the Code with respect to the CEO and the principal financial and accounting
officer will be publicly disclosed in accordance with applicable regulations.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the section captioned "Information as to
Nominees, Directors and Executive Officers" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information required by this item is incorporated herein by reference to the
section captioned "Principal Beneficial Owners of the Corporation's Common
Stock" in the Proxy Statement.
20
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
section captioned "Information as to Nominees, Directors and Executive Officers"
in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to the
section captioned "Ratification of Independent Public Accountants" in the Proxy
Statement.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL SCHEDULES
(a) (1)-(2) Financial Statements and Schedules:
(i) Financial statements and schedules included in Exhibit 13 to
this Form 10-K are filed as part of this report.
(ii) All other financial statement schedules are omitted because
the required information is not applicable, or because the information
required is included in the consolidated financial statements and
notes thereto.
(3) Management Contracts or Compensatory Plans:
(i) Exhibits 10.1-10.3 listed below in (b) below identify
management contracts or compensatory plans or arrangements required to
be filed as exhibits to this report, and such listing is incorporated
herein by reference.
(b) Exhibits are either attached as part of this Report or incorporated herein
by reference.
3.1 Articles of Incorporation of Emclaire Financial Corp. (1)
3.2 Bylaws of Emclaire Financial Corp. (1)
4 Specimen Stock Certificate of Emclaire Financial Corp. (2)
10.1 Form of Change in Control Agreement between Registrant and two executive
officers. (3)
10.2 Form of Group Term Carve-Out Plan between the Farmers National Bank of
Emlenton and 20 Officers and Employees. (5)
10.3 Form of Supplemental Executive Retirement Plan Agreement between the
Farmers National Bank of Emlenton and Six Officers. (5)
11 Statement regarding computation of earnings per share (see Note 1 of the
Notes to Consolidated Financial Statements in the Annual Report).
13 Annual Report to Stockholders for the fiscal year ended December 31, 2005.
14 Code of Personal and Business Conduct and Ethics. (6)
21
16 Letter regarding change in certifying accountant
20 Emclaire Financial Corp. Dividend Reinvestment and Stock Purchase Plan.(4)
21 Subsidiaries of the Registrant (see information contained herein under
"Item 1. Description of Business - Subsidiary Activity").
31.1 CEO 302 Certification.
31.2 Principal Financial and Accounting Officer 302 Certification.
32.1 Chief Executive Officer 906 Certification.
32.2 Principal Financial and Accounting Officer 906 Certification.
- -------------------------------------------------------------------------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form SB-2, as amended, (File No. 333-11773) declared effective by the SEC
on October 25, 1996.
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
(3) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(4) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2001.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2002.
(6) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2004.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
EMCLAIRE FINANCIAL CORP.
Dated: March 27, 2006 By: /S/ DAVID L. COX
------------------------------------------------
David L. Cox
President, Chief Executive Officer, and Director
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /S/ DAVID L. COX By:/S/ SHELLY L. RHOADES
----------------------------------------------- --------------------------------------------
David L. Cox Shelly L. Rhoades
President, Chief Executive Officer, and Director Treasurer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
Date: March 27, 2006 Date:March 27, 2006
By: /S/ RONALD L. ASHBAUGH By:/S/ BRIAN C. MCCARRIER
----------------------------------------------- --------------------------------------------
Ronald L. Ashbaugh Brian C. McCarrier
Director Director
Date: March 27, 2006 Date:March 27, 2006
By: /S/ JAMES M. CROOKS By:/S/ GEORGE W. FREEMAN
----------------------------------------------- --------------------------------------------
James M. Crooks George W. Freeman
Director Director
Date: March 27, 2006 Date:March 27, 2006
By: /S/ MARK A. FREEMER By:/S/ ROBERT L. HUNTER
----------------------------------------------- --------------------------------------------
Mark A. Freemer Robert L. Hunter
Director Director
Date: March 27, 2006 Date:March 27, 2006
By: /S/ J. MICHAEL KING By:/S/ JOHN B. MASON
----------------------------------------------- --------------------------------------------
J. Michael King John B. Mason
Director Director
Date: March 27, 2006 Date:March 27, 2006
23