Item 1. Business
General. Willow Grove Bancorp, Inc. (the "Company"), a Pennsylvania corporation, was formed to facilitate the reorganization of Willow Grove Bank (the "Bank") from the two-tier mutual holding company form to the stock holding company form of organization. The reorganization was completed on April 3, 2002. The Company issued 6,414,125 shares of common stock in a subscription offering and issued 4,869,375 shares of common stock in exchange for the stock held by the shareholders of the former Willow Grove Bancorp, Inc., the federally chartered stock-form mid-tier holding company. The Bank, which is now a wholly-owned subsidiary of the Company, was originally organized in 1909. In December 1998, the Bank was reorganized from a federally chartered mutual savings bank into a federally chartered stock savings bank in the mutual holding company form of ownership with a "mid-tier" holding company. The Bank is primarily engaged in attracting deposits from the general public and using those funds to invest in loans and securities. At the present time, the business of the Company is primarily the business of the Bank. In September 2000, Willow Grove Investment Corporation ("WGIC"), a Delaware corporation was formed as a wholly owned subsidiary of the Bank to hold and manage certain securities investments of the Bank. In May 2003, Willow Grove Insurance Agency, LLC (the "Agency"), a Pennsylvania limited liability company was formed by the Bank to conduct permitted fixed rate annuity transactions for the Bank.
References in this document to "we," "our" or "us" refer to Willow Grove Bancorp, Inc. together with its subsidiary, Willow Grove Bank, unless the context otherwise requires.
In recent years, we have concentrated our business plan on the following primary goals - changing operations to a full-service community bank, continuing steady growth and maintaining a high level of asset quality. We intend to continue our growth through internal means, and to the extent opportunities are available and deemed prudent by management, through acquisitions of other institutions. We believe our business plan will continue to enhance shareholder value.
Our principal sources of funds are deposits, repayment of loans and mortgage-backed securities, maturities of investments and interest-bearing deposits, funds provided from operations and funds borrowed from outside sources such as the Federal Home Loan Bank ("FHLB") of Pittsburgh. These funds are primarily used for the origination of various loan types including, single-family residential, commercial real estate and multi-family residential mortgage loans, construction real estate loans, home equity loans, consumer loans and commercial business loans. Our major source of income is the interest payments received on our loan and securities portfolios, while our major expense is interest paid on deposit accounts.
The Office of Thrift Supervision ("OTS") is the Bank's chartering authority and primary regulator. The Bank is also regulated by the Federal Deposit Insurance Corporation ("FDIC"), the administrator for the Savings Association Insurance Fund ("SAIF"). The Bank is also subject to reserve requirements established by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board" or "FRB"), and we are a member of the FHLB of Pittsburgh, one of the regional banks comprising the FHLB System.
Our executive offices are located at Welsh and Norristown Roads, Maple Glen, Pennsylvania, and our telephone number is (215) 646-5405. The office for Willow Grove Investment Corporation is 1105 Market Street, Suite 1300, Wilmington, Delaware. The office for Willow Grove Insurance Agency, LLC are located at Welsh and Norristown Roads, Maple Glen, Pennsylvania.
Second Step Conversion
On April 3, 2002 Willow Grove Bank completed its reorganization from the two-tier mutual holding company form of organization to the stock form of organization (the "April 2002 Reorganization"). The former Willow Grove Bancorp, Inc. was a federally chartered mid-tier mutual holding company with approximately 56.9% of its stock being held by Willow Grove Mutual Holding Company and the remaining 43.1% being held by public shareholders. As part of the April 2002 Reorganization, the former Willow Grove Bancorp, Inc., the federal corporation, was merged into Willow Grove Bank and the current Willow Grove Bancorp Inc., a Pennsylvania corporation, was incorporated by the Bank for the purpose of becoming the holding company for the Bank. Willow Grove Bancorp, Inc., the new Pennsylvania corporation, through a public subscription offering, sold 6,414,125 shares of stock at $10.00 per share and issued 4,869,375 to the stockholders of Willow Grove Bancorp, Inc., the former federal corporation, which represented an exchange of 2.28019 shares of its stock for each share of the former company. Willow Grove Bank is now the wholly-owned subsidiary of Willow Grove Bancorp, Inc., the Pennsylvania corporation. All per share data and information prior to April 3, 2002 refers to the former Willow Grove Bancorp, Inc., the federal corporation and has been restated to reflect the effect of the increased shares resulting from the share issuance and exchange resulting from the April 2002 Reorganization.
Available Information
The Company files annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). Our SEC filings are available to the public at the SEC's web site at http://www.sec.gov. Members of the public may also read and copy any document we file at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information about the operation of the public reference room. In addition, our stock is listed for trading on the Nasdaq National Market and trades under the symbol "WGBC". You may find additional information regarding Willow Grove Bancorp, Inc. at www.nasdaq.com. In addition to the foregoing, we maintain a web site at www.willowgrovebank.com. We make available on our Internet web site copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such documents as soon as reasonably practicable after we file such material with or furnish such documents to the SEC.
Market Area and Competition
Our main office is in Montgomery County, Pennsylvania, approximately 20 miles north of downtown Philadelphia. The primary market areas that we serve are: Montgomery County, Bucks County and the northeast section of Philadelphia that borders these counties. To a lesser extent, we provide services to areas of Chester and Delaware counties, the remainder of the City of Philadelphia, and central and southern New Jersey.
Most of our direct competition for attracting deposits and originating loans has historically come from savings associations, other savings banks, commercial banks and credit unions. We face additional competition for deposits from short-term money market funds and other corporate and government securities funds, mutual funds, and other non-financial institutions such as securities brokerage firms and insurance companies. Locally, in the three counties where our banking offices reside we estimate that we compete with approximately 84 other financial institutions and 55 offices of securities brokers in our market service area.
Lending Activities
General. At June 30, 2003 our net loan portfolio totaled $413.8 million or 48.96% of our total assets. Historically, our primary emphasis has been the origination of loans secured by first liens on single-family (one-to four-units) residences. In recent years, we have changed the focus of our lending to place more emphasis on home equity loans, construction, commercial real estate and multi-family residential loans and commercial business loans. At June 30, 2003, commercial real estate and multi-family residential loans amounted to $155.9 million, or 37.14% of our total loan portfolio. As of that date, construction loans were $36.2 million or 8.62% of our loan portfolio; commercial business loans totaled $20.5 million or 4.90% of the total loan portfolio. Loans secured by liens on single-family residential properties include first mortgage loans totaling $131.8 million, or 31.40% of the loan portfolio, and $73.0 million of home equity loans and lines of credit, which accounted for 17.39% of the loan portfolio at June 30, 2003.
The types of loans that we originate are subject to federal and state laws and regulations. Interest rates and fees charged on these loans are affected primarily by the demand for loans by borrowers and the supply of funds available for lending purposes and rates and fees charged by our competitors. Local, national and international economic conditions and their effect on the monetary policies of the Federal Reserve Board, legislative and tax policies and budgetary matters of local, state, and federal governmental bodies affect the supply of funds available and the demand for loans.
Loan Portfolio Composition. The following table sets forth the composition of the loan portfolio at the dates indicated. This data does not include single family loans classified as held for sale which amounted to $5.3 million, $1.6 million, $2.6 million, $35.8 million, and zero at June 30, 2003, 2002, 2001, 2000 and 1999, respectively.
Contractual Principal Repayments and Interest Rates. The following table sets forth scheduled contractual amortization of the loan portfolio at June 30, 2003. Demand loans, loans having no schedule of repayments and no stated maturity and overdraft loans are reported as due in one year or less.
Of the $383.2 million of loan principal repayments due after June 30, 2004, $230.7 million have fixed rates of interest and $152.5 million have adjustable rates of interest.
Lending Activity. Our lending activities are subject to underwriting standards and origination procedures which have been approved by our Board of Directors. We process, underwrite and originate single-family residential mortgage loans on both a retail and wholesale basis. We have developed a network of approximately 25 active residential mortgage brokers and mortgage bankers to support our wholesale production system. These correspondents identify, process and close loans on our behalf based upon rates and terms that we provide to them on a regular basis which correlate to our assessment of our demand for various types of loans. The correspondents forward completed loan applications for our review. Based upon this review, we will determine whether to reject the loan if it fails to meet our prescribed standards or acquire the loan for our portfolio or for sale into the secondary market. Depending upon the various programs we have with the correspondents, loans will be classified as either purchased or originated. When the correspondent advances funds for the closing of a loan we have committed to purchase, it is classified as "purchased". When we provide the funds for the closing of the loan, it is classified as "originated". In either case, we may retain the loan in our portfolio or sell it (on either a servicing released or retained basis) in the secondary market. Retail production is supported through bank loan officers who obtain loan applications through our branch network and referrals from local builders, real estate brokers and financial consultants. Single-family residential mortgage loans generally are required to be underwritten in accordance with Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") guidelines (this facilitates resale into the secondary market). We also acquire loans that do not conform to FHLMC/FNMA guidelines ("non-conforming" loans) for the portfolio. Non-conforming loans that we place in the portfolio include, but are not limited to, sub-prime, investor loans and non-FNMA "A" paper. Non-conforming loans are underwritten according to our alternative underwriting guidelines. We believe that our underwriting guidelines are consistent with industry standards. These non-conforming loans account for approximately 24.7% of our single-family loan portfolio.
In addition to originating loans, the Bank periodically purchases participation interests in larger balance loans, typically multi-family and commercial real estate mortgage loans and construction loans from other financial institutions in our market area. These participations are reviewed for compliance with our underwriting standards before they are purchased. Recently the Bank has considered purchasing larger pools of high quality single-family
residential loans that may include local or geographically dispersed loans. Any purchased loan pool would be subject to our due diligence review and would conform to our internal underwriting standards.
Our loan underwriting function is managed at our main office. The majority of our conforming loans are contractually underwritten by any one of several private mortgage insurance companies to ensure saleability in the secondary market. From time to time we also underwrite conforming loans based on our internal capacity and market conditions. We require a current appraisal prepared by an independent appraiser or an acceptable alternative property valuation on all new mortgage loans. We require title insurance on loans secured by real estate with the exception of certain single-family residential loans originated under $150,000 and most home equity loans originated under $100,000. Hazard insurance is required on all real estate loans. Flood insurance is also required for all loans secured by properties located in a designated flood area.
Our loan policy authorizes certain officers to approve loans up to certain designated amounts, not exceeding $500,000, collectively, in the case of the President and Chief Operating Officer. Loans exceeding individual or collective limits must be approved by: the Management Loan Committee consisting of the President, Chief Operating Officer, other executive officers and other Bank lending vice-presidents; the Director's Loan Committee, consisting of three outside directors, the President, the Chief Operating Officer and Chief Lending Officer or the full Board of Directors. The Director's Loan Committee and the full Board of Directors are also provided with summaries of new loan activity on a routine basis.
As a federal savings bank, we are limited in the amount of loans we make to any one borrower. This amount is equal to 15% of the Bank's unimpaired capital and surplus (in our case, this amount would be approximately $13.7 million at June 30, 2003), although there are provisions that would allow us to lend an additional 10% of unimpaired capital and surplus if the loans are secured by readily marketable securities. Our aggregate loans to any one borrower have been within these limits. At June 30, 2003, our three largest credit relationships with an individual borrower and related entities amounted to $11.6 million, $7.7 million and $7.2 million; all the loans included in these relationships were performing in accordance with their terms and conditions.
The following table shows the activity in our loan portfolio during the periods indicated.
Single-Family Residential Loans. We utilize bank loan officers and a network of mortgage brokers and bankers to originate and buy conventional single-family (one-to-four-units) mortgage loans. During the year ended June 30, 2003, single-family residential loans originated to be kept in our portfolio amounted to $91.9 million. In addition, we originated $80.1 million of single-family residential mortgage loans for resale in the secondary market. Our total single-family residential mortgage loans originated for portfolio or resale amounted to $172.0 million in the year ended June 30, 2003, of which $103.2 million were originated through our wholesale network and the remaining $68.8 million was originated through our retail sources. Conventional loans are loans that are neither insured by the Federal Housing Administration ("FHA") nor partially guaranteed by the Department of Veterans Affairs ("VA"). The majority of our single-family mortgage loans are secured by properties located in our primary lending area which includes Montgomery, Bucks and Philadelphia Counties, Pennsylvania. Our residential lending areas have expanded to include northeastern Pennsylvania, central and southern New Jersey and Delaware. At June 30, 2003, single-family mortgage loans amounted to $131.8 million, or 31.40% of our total loan portfolio. Due to our strategic plan to diversify the loan portfolio, the single-family portion of our loan portfolio has decreased during the past five years. However, we expect future changes in this portfolio to include increases from the balances at June 30, 2003.
Single-family residential mortgage loans which we purchase or originate for sale generally are underwritten with terms conforming to FHLMC/FNMA guidelines. Loans purchased or originated for our portfolio, may conform to these guidelines, may exceed the conforming loan amount for those agencies, or may otherwise not comply with the underwriting standards of the agencies for a variety of reasons, including credit risk. Recently we have been more active in selling conforming loans, in excess of our portfolio needs, in the secondary market. We have generally sold loans to three national investors who purchase our loans primarily on a best efforts, servicing released basis. This arrangement, although not eliminating all risks associated with secondary market activity, can provide an additional source of non-interest income. As of June 30, 2003, $5.3 million of our single-family residential mortgage loans were classified as held-for-sale. During the year ended June 30, 2003, we sold an aggregate of $74.8 million of single-family residential mortgage loans at a gain of $1.2 million while for the year ended June 30, 2002, we had loan sales of $77.8 million at a gain of $519,000. Although we anticipate continuing sales of loans in the secondary market, there can be no assurance that this activity will continue as currently
structured or result in the realization of non-interest income. Low interest rates among other factors have led to the increased sales activity over the past two years.
Interest rates on our single-family residential mortgage loans either are fixed for the life of the loan ("fixed-rate") or are subject to adjustment at certain pre-determined dates throughout the life of the loan ("ARM"). Our fixed-rate loans generally mature in 10, 15, 20 or 30 years, and have equal monthly payments to repay the loan with interest by the end of the loan term. At June 30, 2003, the fixed-rate portion of our residential mortgage loan portfolio which includes single-family real estate loans and home equity loans, totaled $151.0 million which was 73.7% of the total single-family residential loans plus home equity loans outstanding at that date.
We offer a variety of ARM loans. These loans have a pre-determined interest rate for a specified period of time ranging from one to ten years. After this initial period, the interest rate will adjust on a periodic basis in accordance with a designated index such as the one-year US Treasury yield adjusted to a constant maturity ("CMT") plus a stipulated margin. Also, ARM loans generally carry an annual limit for rate changes of 1% or 2%, and a maximum amount the rate can increase or decrease from the initial rate of 4% to 6% during the life of the loan. From time to time, we offer ARM loans with an initial rate less than the fully-indexed rate (the index at the time of origination plus the stipulated margin). These loans are underwritten based upon the borrower making payments calculated at the fully-indexed rate. Our ARM loans require that any payment adjustment caused by a change in the interest rate result in full amortization of the loan by the end of the original loan term, and no portion of the payment increase is permitted to be added to the principal balance of the loan, so-called negative amortization. At June 30, 2003, $53.8 million or 26.3% of our residential mortgage loan portfolio, which includes single-family real estate loans and home equity loans, were adjustable rate.
ARM loans decrease some of the risks associated with changing interest rates. However, increases in the amount of a borrower's payment due to interest rate increases may affect the borrower's ability to repay the loan increasing the potential for default. To date, we have not experienced a material impact as a result of this additional credit risk associated with ARM loans, and believe that this risk is less than the interest rate risk of holding fixed-rate loans in a rising interest rate environment.
Such factors as consumer preferences, the general level of interest rates, competition, and the availability of funds affect the amount of ARM loans we originate. Although we anticipate that we will continue to offer ARM loans, there can be no assurance that we can originate a sufficient amount of such loans to increase or maintain the percentage of such loans in our portfolio.
Generally the largest single-family mortgage loan we originate or purchase does not exceed $500,000. In addition, our maximum loan-to-value ratio (the rate of the loan amount to the lesser of the appraised value or sales price - - "LTV") is 95%. Some special first time homebuyer programs have loan to value ratios of 100%. In all cases when the loan to value ratio exceeds 80%, we require the borrower to maintain private mortgage insurance until the loan balance is reduced to 80% of current market value.
Home Equity Loans. In recent years, we have increased our emphasis on the origination of home equity loans and lines of credit, due to their shorter maturities (the maximum term of our home equity loans is 20 years with the exception of purchase money second mortgage loans whose maximum term may be up to 30 years) and higher interest rates. A home equity loan is a fixed-rate loan where the borrower receives the total loan amount at a closing and makes monthly payments to repay the loan within a specific time period. Home equity lines of credit are a revolving line of credit with a variable rate and no stated maturity date. The borrower may draw on this account (up to the maximum credit amount) and repay this line at any time. At June 30, 2003 we had $73.0 million or 17.39% of the total loan portfolio in home equity loans and lines of credit outstanding. Of the $73.0 million outstanding at June 30, 2003, $11.6 million were in lines of credit. The unused portion of equity lines of credit was $14.5 million at that date. The low level of interest rates in recent periods has increased amortization and prepayments on home equity loans. This has resulted in a slight decline in the outstanding balance of home equity loans held at June 30, 2003 despite increases in the amount of home equity loans originated during the year.
Home equity loans and lines of credit are secured by the borrower's residence, and we generally obtain a second lien position on these loans. We offer home equity programs in amounts, when combined with the first
mortgage, up to 100% of the value of the property securing the loan. In addition to originating home equity loans through our branch offices, we purchase loans from our network of correspondents.
Commercial Real Estate and Multi-Family Residential Real Estate Loans. At June 30, 2003 commercial real estate and multi-family residential loans amounted to $155.9 million or 37.14% of the total loan portfolio. This compares to $134.3 million or 29.90% at June 30, 2002.
Our commercial real estate and multi-family residential loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, residential properties with five or more units, non-FNMA eligible single-family residential investment properties and other properties used for commercial and multi-family purposes located in our market area. Our commercial and multi-family real estate loans tend to be originated in an amount less than $3.0 million but will occasionally exceed that amount. At June 30, 2003, the average commercial and multi-family residential loan size was $504,000. The five largest commercial real estate and multi-family residential loans outstanding at June 30, 2003, were $4.2 million, $4.1 million, $3.9 million, $3.5 million and $3.4 million and all of such loans were performing in accordance with their terms. However, during an internal review of the portfolio in fiscal 2002, it was determined that the debt service coverage ratio for the loan in the amount of $4.1 million was no longer meeting our underwriting standards and therefore was classified as substandard. During the year ended June 30, 2003, our commercial real estate and multi-family loan portfolio grew by $21.6 million, or 16.1% as the result of originations, purchases and the conversion of loans from construction to permanent status. The relatively low interest rate environment during the year ended June 30, 2003 stimulated increased amortization and prepayments which partially offset the total amount of multi-family and commercial real estate originations of $46.8 million during the year.
Although terms for commercial real estate and multi-family loans vary, our underwriting standards generally allow for terms up to 20 years with monthly amortization over the life of the loan and LTV ratios of not more than 80%. Interest rates are either fixed or adjustable, based upon designated market indices such as the 5-year Treasury CMT or 5-year FHLB of Pittsburgh advance rate plus a margin, and fees ranging from 0.5% to 1.5% are generally charged to the borrower at the origination of the loan. Prepayment fees are generally charged on most commercial real estate and multi-family loans in the event of early repayment. Generally we obtain personal guarantees of the principals as additional collateral for commercial real estate and multi-family real estate loans.
Commercial real estate and multi-family real estate lending involves different risks than single-family residential lending. These risks include, but are not limited to, larger loans to individual borrowers and loan payments that are dependent upon the successful operation of the project or the borrower's business. These risks can be affected by supply and demand conditions in the project's market area of rental housing units, office and retail space, warehouses, and other commercial space. We attempt to minimize these risks by limiting our loans to proven businesses, only considering properties with existing operating performance which can be analyzed, using conservative debt coverage ratios in our underwriting, and periodically monitoring the operation of the business or project and the physical condition of the property. As of June 30, 2003, $48,000, or 0.03% of our commercial real estate and multi-family residential mortgage loans were on non-accrual status compared to $1.2 million or 0.88% at June 30, 2002. The decrease was primarily related to an impaired $675,000 loan subsequently acquired in foreclosure and reclassified as real-estate owned during fiscal 2003.
Various aspects of a commercial and multi-family loan transaction are evaluated in our effort to mitigate the additional risk in these types of loans. In our underwriting procedures, consideration is given to the stability of the property's cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 115%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property's market value, and are reviewed by us prior to the closing of the loan.
Construction Loans. We originate construction loans for residential and commercial uses within our market area. We generally limit construction loans to builders and developers with whom we have an established relationship, or who are otherwise known to officers of the Bank. Construction loans outstanding at June 30, 2003 were $36.2 million, or 8.62% of total loans, compared to $29.3 million or 6.52% of total loans at June 30, 2002.
Our construction loans generally have variable rates of interest, a maximum term to maturity of three years and LTV ratios less than 80%. Residential construction loans to developers are made on either a pre-sold or speculative (unsold) basis. Limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Generally a limit of two to six model homes is permitted per project.
Prior to committing to a construction loan, we require that an independent appraiser prepare an appraisal of the property. We also review and inspect each project at its inception and prior to every disbursement of loan proceeds. Disbursements are made after inspections based upon a percentage of project completion. Monthly payment of interest is required on all construction loans.
We also make construction loans for the acquisition and development of land for sale (i.e. roads, sewer and water lines). We make these loans only in conjunction with a commitment for a construction loan for the units to be built on the site. These loans are secured by a lien on the property and are limited to a LTV ratio of 75% of the appraised value. The loans have a variable rate of interest and require monthly payments of interest. The principal of the loan is repaid as units are sold and released. All of our loans of this type are in our market area and are to developers with whom we have established relationships. In most cases, we also obtain personal guarantees from the borrowers.
Construction and land loans generally are considered to involve a higher level of risk than single-family residential lending, due to the concentration of principal in a limited number of loans and borrowers and the effect of economic conditions on developers, builders and projects. Additional risk is also associated with construction lending because of the inherent difficulty in estimating both a property's value at completion and the estimated cost (including interest) to complete a project. The nature of these loans is such that they are more difficult to evaluate and monitor. In addition, speculative construction loans to a builder are not pre-sold and thus pose a greater potential risk than construction loans to individuals on their personal residences. At June 30, 2003, our five largest construction loans had outstanding balances of $4.3 million, $2.3 million, $2.3 million, $2.0 million and $2.0 million and all were performing in accordance with the terms of their agreements with the exception of the $4.3 million loan representing a 25.3% loan participation on the construction of a commercial real estate office building located in Montgomery County in the suburbs of Philadelphia. The loan which has a loan-to-value ratio of 88.0%, is secured by a property which is approximately 50% tenant occupied but has fallen behind original leasing projections necessitating two extensions of the original maturity date of November 2002 to October 2003, and as a result has been classified as substandard. It is anticipated that an additional two year extension will be granted upon expiration of the current extension.
In order to mitigate some of the risks inherent to construction lending, we inspect properties under construction, review construction progress prior to advancing funds, work with builders who have established relationships, and obtain personal guarantees from the principals.
Commercial Business Loans. At June 30, 2003, we had $20.5 million in commercial business loans (4.90% of gross loans outstanding) compared to $19.1 million at June 30, 2002, an increase of $1.4 million or 7.3%. During the year ended June 30, 2003, we originated or advanced additional funds on business lines of credit in the amount of $10.8 million. These originations were offset by increased amortization and prepayments of loans primarily due to the low interest rate environment. We began originating loans to small-to-mid-sized businesses in our market area in May 1997. Since that time, we have hired commercial lenders to actively solicit commercial business loans as well as commercial real estate and multi-family real estate loans. During fiscal 2002 and 2003, we generally did not originate new commercial business loans in amounts exceeding $250,000. Management undertook a process designed to enhance the Company's commercial business lending function. During fiscal 2003 we hired a Chief Lending Officer, experienced in business lending, and a Credit Risk Manager whose responsibilities include reviewing existing systems and policies, establishing or improving procedures, where necessary, and training new and existing personnel with respect to the origination and oversight of commercial business loans. Such steps were taken in anticipation of a renewal in fiscal 2004 of the Company's efforts to increase originations of commercial business loans in excess of $250,000. During fiscal 2003, the Company restricted its originations of new commercial business loans in excess of $250,000. Only eight such loans were originated after they had been reviewed and approved by the full
board of directors. The Company expects that in fiscal 2004 it will gradually increase the amount of its originations of commercial business loans in excess of $250,000 as it fully implements its enhanced policies and procedures with respect to such loans. In addition to our commercial loan officers, we use our business development officers working from several of our branch locations to actively solicit potential customers in the Bank's market area. No assurance can be given as to the volume of new commercial loans originated in the future. This portfolio may decline in the near term as previously originated larger balance loans are repaid and replaced with smaller balance new originations. We believe that these types of loans assist in our asset/liability management since they generally provide shorter maturities and/or adjustable rates of interest in addition to generally having higher rates of return which are designed to compensate for the additional credit risk associated with these loans.
Generally, the Bank provides secured revolving lines of credit for short term working capital support of a business's accounts receivables and inventory. Typically the secured revolving line of credit is collateralized based upon an advance rate of up to 75% of eligible accounts receivable and up to 30% of finished goods inventory. Secured term loan financing is provided for the acquisition of fixed business assets, such as real property, vehicles, equipment and machinery. Generally, we provide financing up to 80% of the purchase price for the new fixed assets and 70% of book value for pre-owned fixed assets. In addition to business assets pledged as collateral, most commercial business loans are personally guaranteed by the principal owner(s) of the borrower. Interest rates are adjustable, indexed to a published prime rate of interest or fixed. At June 30, 2003, the Bank's five largest commercial business loans were $849,000, $560,000 $448,000, $407,000 and $335,000 and all such loans were performing in accordance with their terms with the exception of the $849,000 loan which was delinquent 61 days. The total credit relationship associated with this borrower is $953,000. The Bank is carefully monitoring this loan and understands that the borrower is experiencing financial difficulties. Management believes that certain additional provisions to its allowance for loan losses may be necessary in the quarter ending September 30, 2003 due to this loan. At June 30, 2003 the average balance of the Bank's commercial business loans was $84,000.
Generally, commercial business loans have been characterized as having higher risks associated with them than single-family mortgage loans. We have hired individuals, experienced in this type of lending, and have implemented policies and procedures which we deem to be prudent. As of June 30, 2003, the Bank had $360,000 of non-accrual commercial business loans compared to $724,000 at June 30, 2002. Charge-offs of commercial business loans amounted to $103,000 during the year ended June 30, 2003 compared to $769,000 in the year ended June 30, 2002.
Other Consumer Lending Activities. In our efforts to provide a full range of financial services to our customers, we offer various types of consumer loans primarily consisting of loans secured by automobiles and to a much lesser extent deposit account loans, and unsecured personal loans. In addition to originating consumer loans we facilitate the funding of student loans through our banking offices in conjunction with American Education Services ("AES/PHEAA"). Consumer loans are originated and facilitated primarily through existing and walk-in customers and direct advertising. At June 30, 2003, $2.3 million, or 0.55% of our total loan portfolio consisted of these types of loans. This compares to $10.1 million of consumer loans, or 2.24% of the total loan portfolio at June 30, 2002. The decline was exclusively related to $7.8 million received from the liquidation of our education loan portfolio.
Consumer loans, other than loans secured by deposit accounts, generally have higher interest rates and shorter terms than residential loans, however they have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral. In the fiscal year ended June 30, 2003, there were charge-offs, net of recoveries totaling $4,000 related to other consumer loans. This compares to $162,000 in net consumer loan charge-offs in the fiscal year ended June 30, 2002.
Asset Quality
General. As a part of our efforts to maintain asset quality, we have developed and implemented an asset classification system in conjunction with federal regulations. All of our assets are subject to this classification system. Loans are periodically reviewed and the classifications reviewed at least quarterly by the Asset Quality Committee of the Board of Directors.
When a borrower fails to make a scheduled payment, we attempt to cure the deficiency by making personal contact with the borrower. Initial contacts are generally made 16 days after the date the payment is due. In most cases, deficiencies are promptly resolved. If the delinquency continues, late charges are assessed and additional efforts are made to collect the deficiency. We generally work with borrowers to resolve such problems, however, when the account becomes 90 days delinquent, we institute foreclosure or other proceedings, as necessary, to minimize any potential loss.
On loans which we consider the collection of principal or interest payments doubtful, we cease the accrual of interest income ("non-accrual" loans). On loans more than 90 days past due, as to principal and interest payments, it is our policy to discontinue accruing additional interest and reverse any interest currently accrued (unless we determine that the loan principal and interest are fully secured and in the process of collection). On occasion, we may take this action earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan. Interest income is not accrued on these loans until the borrower's financial condition and payment record demonstrate an ability to service the debt.
Real estate which we acquire as a result of foreclosure or deed-in-lieu of foreclosure is classified as real estate owned until sold. Real estate owned is recorded at the lower of cost or fair value less estimated selling cost. Costs associated with acquiring and improving a foreclosed property are usually capitalized to the extent that the carrying value does not exceed fair value less estimated selling costs. Holding costs are charged to expense. Gains and losses on the sale of real estate owned are reflected in operations, as incurred.
Delinquent Loans. The following table sets forth information concerning delinquent loans at the dates indicated. The amounts presented represent the total outstanding principal balances of the related loans rather than the actual payment amounts that are past due.
Loans delinquent 30 to 89 days amounted to $4.5 million at June 30, 2003 compared to $4.4 million at June 30, 2002. Increases in the amount of delinquent commercial business loans were offset by decreases in delinquent commercial real estate loans and to a lesser extent single-family mortgage loans. Management continues to regularly monitor all delinquent loan activity. Management does not consider the current level of delinquencies to be of any significant concern as, based upon past experience, most of such loans are expected to return to fully performing status without going to non-accrual status. In any event, management believes that for the most part these loans are adequately collateralized.
Non-Performing Assets. The following table sets forth information with respect to non-performing assets we have identified, including non-accrual loans and other real estate owned. The decrease in non-performing assets from $5.8 million at June 30, 2002 to $4.1 million at June 30, 2003 was the result of decreases in non-accrual single family, multi-family and commercial real estate mortgage loans, consumer loans and commercial business loans.
Classified and Criticized Assets. Federal regulations require that each insured institution classify its assets on a regular basis. Furthermore, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, based upon their judgment, classify them. There are three classifications for problem assets: "substandard," "doubtful," and "loss". Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of current existing facts, conditions and values, questionable, and there is a high probability of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Federal regulations also require another unclassified category designated "special mention" to be established and maintained for assets that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful, or loss. At June 30, 2003, we had $13.3 million of our assets classified as substandard ($1.3 million of single-family mortgage loans, $5.8 million of multi-family and commercial real estate loans, $4.4 million of construction loans, $1.5 million of commercial business loans, $250,000 of home equity loans and $66,000 of consumer loans); $28,000 of business loans classified as doubtful and no loans classified as loss. This compares to $13.6 million in assets classified as substandard, $93,000 classified as doubtful and no assets classified as a loss, at June 30, 2002.
Allowance for Loan Losses. The allowance for loan losses is maintained at a level we believe is adequate to cover known and inherent losses in the loan portfolio that are both probable and reasonable to estimate at each reporting date. Our determination of the adequacy of the allowance is based upon an evaluation of the portfolio, loss experience, current economic conditions, volume, growth, composition of the portfolio, and other relevant factors. With the expansion of our lending activities into commercial real estate, business and other consumer loans in recent years, we consider industry-wide loss experience in our process when we determine the adequacy of our allowance
for loan losses. We believe that due to the changing mix of our loan portfolio and our relative lack of historical loss experience with these types of loans, considering loan loss data from other banking institutions with loan portfolios similar to ours and in a similar geographic setting will provide us with a more representative approach to evaluating the credit risks in our loan portfolio. During the year ended June 30, 2001, based upon a more detailed stratification of the loan portfolio, we modified the formulas we use to calculate the allowance on various loan types. In some cases, such as business lending and home equity lending where the combined LTV exceeds 80%, the percentage used to calculate the allowance was increased. In other cases, such as single-family first mortgage lending with LTVs below 60%, the percentage used was decreased. The overall effect of this modification did not materially impact the amount of the allowance for loan loss. During the fiscal year ended June 30, 2002 we modified the methodology for calculating the allowance for loan loss based upon the guidance provided by the SEC and the Federal Financial Institutions Examination Council ("FFIEC"). We continue to use historical loss factors for each loan type and for loans that we consider higher risk for all but single-family mortgage loans and guaranteed consumer loans, we now add a component for factors that may not be included in the historical loss calculation. This component establishes a range for factors such as, but not limited to, delinquency trends, asset classification trends and current economic conditions. Management then assesses these conditions and establishes, to the best of its ability, the allowance for loan loss from within the range calculated, based upon the facts known at that time. At June 30, 2003, our allowance for loan loss was in the lower quartile of the range established by this methodology. The result of this change in methodology is to allocate the entire allowance for loan loss to specific loan types, whereas prior methodology had an unallocated component. The change in methodology does not imply that any portion of the allowance for loan loss is restricted, but the allowance for loan loss applies to the entire loan portfolio.
The allowance is increased by provisions for loan losses which are charges against income. As shown in the table below, at June 30, 2003, our allowance for loan losses amounted to $5.3 million or 143.88% and 1.27% of our non-performing loans and total loans receivable less deferred fees, respectively.
Provisions for loan losses for the year ended June 30, 2003 were $1.0 million, a decline from $1.2 million in the prior year. Charge-offs also decreased from $954,000 in fiscal year 2002 to $391,000 in fiscal year 2003. The primary reason for the increase in the percent of the allowance for loan loss to total loans was the increase of commercial real estate and multi-family real estate loan portfolios as a percentage of the total loan portfolio. We assess our allowance for loan losses at least quarterly, and make any necessary provision for losses needed to maintain our allowance for losses at a level deemed adequate. We believe that the allowance for losses was adequate at June 30, 2003 to cover losses that are both probable and reasonably estimable based upon the facts and circumstances known to us at that date.
Effective December 21, 1993, the OTS in conjunction with the Comptroller of the Currency, the FDIC and the Federal Reserve Board issued a Policy Statement regarding a financial institution's allowance for loan and lease losses. The Policy Statement, which reflects the position of the regulatory agencies and does not necessarily constitute generally accepted accounting principles, includes guidance (i) on our responsibilities for the assessment and establishment of an adequate allowance; and (ii) for the agencies' examiners to use in evaluating the adequacy of such allowance and the policies used to determine such allowance. The Policy Statement also sets forth quantitative measures for the allowance with respect to assets classified substandard and doubtful and with respect to the remaining portion of the institution's portfolio. Specifically, the Policy Statement sets forth the following quantitative measures which examiners may use to determine the reasonableness of an allowance: (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio classified substandard; and (iii) for the portions of the portfolio that have not been classified (including loans designated special mention), estimated credit losses over the upcoming twelve months based on facts and circumstances available as of the evaluation date. While the Policy Statement sets forth this quantitative measure, such guidance is not intended as a "floor" or "ceiling". Our policy for establishing loan losses is consistent with the Policy Statement. In July 2001, the SEC issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology And Documentation Issues". The guidance in the SAB was effective immediately and focuses on the documentation the SEC staff normally expects registrants to prepare and maintain in support of the allowance for loan losses. Concurrent with the SEC's issuance of SAB No. 102, the federal banking agencies, represented by the FFIEC issued an interagency policy statement entitled "Allowance For Loan and Lease Loss Methodologies And Documentation For Banks and Savings Institutions" ("FFIEC Policy Statement"). The SAB and FFIEC Policy Statement were the result of an agreement between the SEC and the federal banking agencies in March 1999 to provide guidance on allowance for loan loss methodologies and supporting documentation. We believe to the best of our knowledge that our documentation relating to the allowance for loan loss is consistent with these pronouncements.
We have allocated the allowance for loan losses as shown in the table below into components by loan types at year end. Due to a change in methodology there is no unallocated portion of the allowance after June 30, 2001. Through such allocations, we do not intend to imply that actual future charge-offs will necessarily follow the same pattern or that any portion of the allowance is restricted.
Securities Activities
General. Our investment policy is designed, among other things, to assist us in our asset/liability management strategies. It emphasizes principal preservation, favorable returns, maintaining liquidity and flexibility, and minimizing credit risk. The policy permits investments in US Government and agency securities, investment grade corporate bonds and commercial paper, municipal bonds, various types of mortgage-backed securities, certificates of deposit and federal funds sold to financial institutions approved by our Board of Directors, equity investments in the FHLB of Pittsburgh, the FNMA, the FHLMC, and mutual funds with investments in the above described investments.
Currently, we are not participating in hedging programs, interest rate swaps, caps, collars or other activities involving the use of off-balance sheet financial derivatives. Also, we do not purchase mortgage-backed derivative instruments that would be characterized "high-risk" under OTS regulations at the time of purchase, nor do we purchase corporate obligations, which are not rated investment grade. Although permissible by our policy, currently we do not own any corporate bonds regardless of rating.
In order to maintain a high degree of flexibility with our investment securities, prior to January 2002, all of our investment securities were classified as Available For Sale ("AFS") pursuant to Statement of Financial Accounting Standards No. 115. In January 2002 we changed the classification on our municipal bond portfolio from AFS to Held to Maturity ("HTM"). This accounting pronouncement requires us to classify a security as AFS, Held to Maturity, or trading, at the time of acquisition. Securities being classified as HTM must be purchased with the intent and ability to hold that security until its final maturity, and can be sold prior to maturity only under rare circumstances. HTM securities are accounted for based upon the historical cost of the security. AFS securities can be sold at any time based upon our needs or judgment as to market changes. AFS securities are accounted for at fair value, unrealized gains and losses on these securities, net of income tax effects, are reflected in the stockholders' equity section of our Statement of Financial Condition.
At June 30, 2003, our investment securities amounted to $309.2 million, or 36.59% of total assets. This includes a $1.9 million unrealized gain, net of income tax, on those investment securities classified as AFS. The portfolio consists primarily of US government agency securities, most with callable features and agency mortgage-backed pass-through securities. Other investments include municipal bonds, equity investments in the FHLB of Pittsburgh, other equity securities and a mutual fund consisting of adjustable-rate mortgage-backed securities.
The following table sets forth information on the carrying value and the amortized cost of our securities classified as held to maturity and available for sale at the dates indicated.
Mortgage-Backed Securities. At June 30, 2003, we had mortgage-backed securities totaling $198.0 million compared to $168.5 million at June 30, 2002. Mortgage-backed securities represent a participation interest in a pool of single-family or multi-family mortgages. Mortgages are sold by various originators to intermediaries (generally agencies of the US Government and government sponsored enterprises) that pool and repackage the mortgages and sell participation interests in the pools to investors. The servicer of the mortgage loan collects the principal and interest payments and passes those payments through to the intermediary who then remits the payment to the investor. The US Government agencies and government sponsored enterprises, primarily the Government National Mortgage Association ("GNMA"), FNMA and FHLMC, guarantee the timely payment of principal and interest on these securities.
Mortgage-backed securities are issued in stated principal amounts and are backed by mortgage loans within a specific interest rate range, but may have varying maturity dates. The underlying pool of mortgages may be comprised of either fixed-rate or adjustable-rate mortgage loans. Each mortgage-backed security pool will also differ based upon the actual level of prepayment experienced by the underlying mortgage loans.
At June 30, 2003, the weighted average life of our mortgage-backed securities was approximately 3.2 years, based upon our assumptions related to the future prepayments of the underlying mortgages. Prepayments that are greater than those projected will shorten the remaining term of the security, while a decrease in the amount of prepayments will lengthen the amount of time until the security matures. Prepayments depend on many factors, including the type of mortgage, the coupon rate, the geographic region, and the general level of market interest rates. During periods of rising interest rates, if the coupon rates of the underlying mortgages are less than prevailing market rates offered on mortgages, refinancings will decrease and prepayments of the mortgages underlying the security will decline. Conversely, when market interest rates are falling, and the coupon rate on the underlying mortgage exceeds the prevailing market interest rate for mortgages offered, refinancings tend to increase which will increase the amount of prepayments of the underlying mortgages. During the year ended June 30, 2003, prepayments on mortgage-backed securities exceeded $60.3 million compared to $28.0 million for the year ended June 30, 2002. This increase in prepayments is primarily related to the general level of interest rates which has been favorable for refinancing activity.
Our average yield on our mortgage-backed securities was 3.95% at June 30, 2003. This yield is computed by decreasing/increasing the amount of interest income collected on the security by the amortization/accretion of the premium/discount associated with the acquisition of the security. In accordance with generally accepted accounting principles, premiums/discounts are amortized/accreted over the estimated remaining life of the security. The yield on the security may vary if the prepayment assumptions used to determine the remaining life differ from actual prepayment experiences. These assumptions are reviewed on a periodic basis to reflect actual prepayments.
US Government Agency Securities and Municipal Bonds. At June 30, 2003, we had $78.2 million, which includes approximately $1.2 million in unrealized gains, in securities issued by US government agencies, primarily the FHLB, FNMA, FHLMC and the Federal Farm Credit Bank compared to $76.7 million at June 30, 2002. Most of these securities have call features that allow the issuer to redeem these securities at par value prior to their stated maturity. Generally, if the prevailing market interest rate on new issue callable agency securities with similar maturities exceeds the coupon rate of the security with the call feature, the call will not be exercised. Conversely, if the prevailing market interest rate for new issue agency callable securities with similar maturities is below the coupon rate of the security with the call feature, the call will be exercised and the bond will be redeemed. When calls are exercised and bonds redeemed prior to their maturity, we face the risk of re-investing those proceeds into other investments with lower yields or longer terms.
Our Municipal bonds were classified as held to maturity at June 30, 2003 and are recorded at an amortized cost basis of $17.3 million. The market value of these securities at June 30, 2003 was $18.0 million. These municipal bonds include issues from various townships and school districts located in Pennsylvania.
The following table sets forth certain information regarding the contractual maturities (without regard to any call provisions) of the carrying value of our US government agency securities and municipal bonds at June 30, 2003. The yields on tax-exempt bonds have not been adjusted to taxable equivalent yield.
Carrying Average value yield ---------- --------- (Dollars in thousands) Maturing in: One year or less $ 2,999 5.08% One to five years 52,737 3.69 Five to ten years 22,974 3.90 Over ten years 15,590 4.70 -------- ----- Total $ 94,300 3.95% ======== =====
Other Investments. Other than mortgage-backed securities and US Government agency securities, we have investments in various equity securities and mutual funds. At June 30, 2003, $9.7 million was invested in equity securities and $6.0 million was invested in mutual funds. The equity securities include stock in the FHLB of Pittsburgh and equity securities of several publicly traded companies. FHLB stock at June 30, 2003 was $9.3 million and the other equity investments amounted to $477,000. The mutual fund investment of $6.0 million is backed primarily by investments in adjustable-rate mortgage-backed securities.
Sources of Funds
General. Deposits are the primary source of funds for our lending and investment activities. In addition to deposits, we obtain funds from the amortization and prepayments on our loan and mortgage-backed security portfolio, maturities of investments, and borrowings. Scheduled loan amortization is a relatively stable source of funds. However, competition and the general level of interest rates and market conditions significantly influence deposit inflows and outflows. Borrowings may be used on a short-term basis to compensate for reductions in other funding sources. On a longer-term basis, borrowings may be used for general business purposes.
Deposits
As shown in the table below, during the year ended June 30, 2003, certificates of deposit fell as a percentage of total deposits from 57.7% to 51.1% while other core deposit accounts increased to 48.9% of total deposits from 42.3% of deposits at June 30, 2002.
At June 30, -------------------------------------------- 2003 2002 ---- ---- Percent Percent Amount of total Amount of total -------- -------- -------- -------- (Dollars in thousands)
Savings accounts (passbooks, $ 86,447 14.7% $ 73,218 13.8% statements and clubs) Money market accounts 79,280 13.5 47,752 9.0 Certificates of deposit 299,794 51.1 305,807 57.7 Checking accounts: Interest-bearing 51,541 8.8 40,045 7.6 Non-interest-bearing 69,581 11.9 62,930 11.9 -------- ------- -------- ------- Total $586,643 100.0% $529,752 100.0% ======== ======= ======== =======
During the year ended June 30, 2003, total deposits increased by $56.9 million or 10.7% compared to an increase of $32.7 million, or 6.6% for the year ended June 30, 2002.
Year ended June 30, ---------------------------------- 2003 2002 2001 -------- -------- -------- (Dollars in thousands)
Beginning balance $529,752 $497,030 $452,857
Net increase in deposits 45,268 16,979 27,942 Interest credited 11,623 15,743 16,231 -------- -------- -------- Total increase in deposits 56,891 32,722 44,173 -------- -------- --------
Ending balance $586,643 $529,752 $497,030 ======== ======== ========
The following table sets forth by various interest rate categories, the amount of certificates of deposit at the dates indicated.
At June 30, -------------------- 2003 2002 -------- -------- (Dollars in thousands) Interest rates: - -------------------- from 0.00% to 2.99% $181,942 $106,833 from 3.00% to 3.99% 56,897 71,310 from 4.00% to 4.99% 43,394 76,275 from 5.00% to 6.99% 17,101 48,853 7.00% and over 460 2,536 -------- -------- Total $299,794 $305,807 ======== ========
Shown below are the amount and remaining term to maturity for certificates of deposit as of June 30, 2003.
At June 30, 2003 the total amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $57.0 million. The following table provides information regarding the maturity of these certificates of deposit.
Borrowings.
We use outside borrowings to supplement our funding needs. We also use borrowings in revenue enhancement programs that allow us to take advantage of arbitrage opportunities when investment returns exceed the cost of borrowings. At June 30, 2003 we had $132.5 million in borrowings outstanding, all of which were from the FHLB of Pittsburgh. Advances from the FHLB of Pittsburgh are secured by our investment in FHLB stock and a portion of our residential mortgage loan portfolio. The FHLB of Pittsburgh provides an array of borrowing programs which include: fixed or variable rate programs; various fixed terms ranging from overnight to 20 years; and other programs that have callable or putable features attached to them. We intend to continue to utilize borrowings in the future as an alternative source of funds.
The following table sets forth certain information regarding our outside borrowings for the periods indicated.
At or for the year ended -------------------------------- June 30, 2003 June 30, 2002 ------------- ------------- (Dollars in thousands)
FHLB advances: Average balance outstanding for the period $ 129,633 $ 73,830 Maximum outstanding at any month end 139,132 100,800 Balance outstanding at end of the period 132,557 97,824 Average interest rate for the period 4.57% 5.58% Interest rate at the end of the period 3.84% 5.05%
At June 30, 2003 the maturity of our FHLB advances ranged from July 2003 to May 2013. Certain advances also require monthly payments of principal. At June 30, 2003, $70.5 million of FHLB advances were callable at the option of the FHLB within certain parameters, of which $56.5 million could be called within one year. Of the $70.5 million of FHLB advances that are callable at the discretion of the FHLB, $37.5 million of these advances could be called only if an index exceeded a specific pre-determined rate.
Subsidiaries. Willow Grove Bank, a federally chartered stock savings bank, is the wholly owned subsidiary of Willow Grove Bancorp, Inc. The Bank has two direct subsidiaries, Willow Grove Investment Corporation and Willow Grove Insurance Agency. WGIC is a Delaware corporation formed in 2000 to hold and manage certain securities investments of the Bank. At June 30, 2003, assets under management at WGIC totaled $229.4 million. The Agency, formed in May 2003, is a Pennsylvania limited liability company that conducts fixed rate annuity transactions for the Bank.
Employees. At June 30, 2003, we had 182 full-time employees, and 63 part-time employees. None of our employees are represented by a collective bargaining group, and we believe that our relationship with our employees is good.
REGULATION
Set forth below is a brief description of certain laws and regulations which are applicable to Willow Grove Bancorp and Willow Grove Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
General
Willow Grove Bank, as a federally chartered savings institution, is subject to federal regulation and oversight by the Office of Thrift Supervision extending to all aspects of its operations. Willow Grove Bank also is subject to regulation and examination by the Federal Deposit Insurance Corporation, which insures the deposits of Willow Grove Bank to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. Federally chartered savings institutions are required to file periodic reports with the Office of Thrift Supervision and are subject to periodic examinations by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. The investment and lending authority of savings institutions is prescribed by federal laws and regulations, and such institutions are prohibited from engaging in any activities not permitted by such laws and regulations. Such regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting stockholders.
The Office of Thrift Supervision regularly examines Willow Grove Bank and prepares reports for consideration by its Board of Directors on any deficiencies that it may find in the bank's operations. The Federal Deposit Insurance Corporation also has the authority to examine Willow Grove Bank in its role as the administrator of the Savings Association Insurance Fund. Willow Grove Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and, to a lesser extent, state laws, especially in such matters as the ownership of savings accounts and the form and content of Willow Grove Bank's mortgage requirements. The Office of Thrift Supervision's enforcement authority over all savings institutions and their holding companies includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the Office of Thrift Supervision. Any change in such laws or regulations, whether by the Federal Deposit Insurance Corporation, Office of Thrift Supervision or Congress, could have a material adverse impact on us and Willow Grove Bank and our operations.
Willow Grove Bancorp, Inc.
Willow Grove Bancorp is a registered savings and loan holding company under Section 10 of the Home Owners' Loan Act, as amended and subject to Office of Thrift Supervision examination and supervision as well as certain reporting requirements. In addition, because Willow Grove Bank's deposits are insured by the Savings Association Insurance Fund maintained by the Federal Deposit Insurance Corporation, Willow Grove Bank is subject to certain restrictions in dealing with us and with other persons affiliated with the Bank.
Generally the Home Owners' Loan Act prohibits a savings and loan holding company, such as us, directly or indirectly, from (1) acquiring control (as defined) of a savings institution (or holding company thereof) without prior Office of Thrift Supervision approval, (2) acquiring more than 5% of the voting shares of a savings institution (or holding company thereof) which is not a subsidiary, subject to certain exceptions, without prior Office of Thrift Supervision approval, or (3) acquiring through a merger, consolidation or purchase of assets of another savings institution (or holding company thereof) or acquiring all or substantially all of the assets of another savings institution (or holding company thereof) without prior Office of Thrift Supervision approval or (4) acquiring control of an uninsured institution. A savings and loan holding company may not acquire as a separate subsidiary a savings institution which has its principal offices outside of the state where the principal offices of its subsidiary institution is located, except (a) in the case of certain emergency acquisitions approved by the Federal Deposit Insurance Corporation, (b) if the holding company controlled (as defined) such savings institution as of March 5, 1987 or (c) when the laws of the state in which the savings institution to be acquired is located specifically authorize such an acquisition. No director or officer of a savings and loan holding company or person owning or controlling more than
25% of such holding company's voting shares may, except with the prior approval of the Office of Thrift Supervision, acquire control of any savings institution which is not a subsidiary of such holding company.
Willow Grove Bank
Insurance of Accounts. The deposits of Willow Grove Bank are insured to the maximum extent permitted by the Savings Association Insurance Fund, which is administered by the Federal Deposit Insurance Corporation, and are backed by the full faith and credit of the U.S. Government. As insurer, the Federal Deposit Insurance Corporation is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity the Federal Deposit Insurance Corporation determines by regulation or order to pose a serious threat to the Federal Deposit Insurance Corporation. The Federal Deposit Insurance Corporation also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action.
Under current Federal Deposit Insurance Corporation regulations, Savings Association Insurance Fund-insured institutions are assigned to one of three capital groups which are based solely on the level of an institution's capital - "well capitalized," "adequately capitalized," and "undercapitalized" - which are defined in the same manner as the regulations establishing the prompt corrective action system discussed below. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates during the last six months of 2001 ranging from zero for well capitalized, healthy institutions, such as Willow Grove Bank, to 27 basis points for undercapitalized institutions with substantial supervisory concerns.
In addition, all institutions with deposits insured by the Federal Deposit Insurance Corporation are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate for the second quarter of 2003 was .004% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019.
The Federal Deposit Insurance Corporation may terminate the deposit insurance of any insured depository institution, including Willow Grove Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the Federal Deposit Insurance Corporation. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the Federal Deposit Insurance Corporation. Management is aware of no existing circumstances which would result in termination of Willow Grove Bank's deposit insurance.
Regulatory Capital Requirements. The Office of Thrift Supervision capital requirements consist of a "tangible capital requirement," a "leverage capital requirement" and a "risk-based capital requirement." The Office of Thrift Supervision is authorized to impose capital requirements in excess of those standards on individual institutions on a case-by-case basis.
Under the tangible capital requirement, a savings bank must maintain tangible capital in an amount equal to at least 1.5% of adjusted total assets. Tangible capital is defined as core capital less all intangible assets (including supervisory goodwill), plus a specified amount of purchased mortgage servicing rights.
Under the leverage capital requirement adopted by the Office of Thrift Supervision, savings banks must maintain "core capital" in an amount equal to at least 3.0% of adjusted total assets. Core capital is defined as common stockholders' equity (including retained earnings), non-cumulative perpetual preferred stock, and minority interests in the equity accounts of consolidated subsidiaries, plus purchased mortgage servicing rights valued at the lower of 90% of fair market value, 90% of original cost or the current amortized book value as determined under generally accepted accounting principles, and "qualifying supervisory goodwill," less non-qualifying intangible assets.
Under the risk-based capital requirement, a savings bank must maintain total capital (which is defined as core capital plus supplementary capital) equal to at least 8.0% of risk-weighted assets. A savings bank must calculate its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors, which range from 0% for cash and securities issued by the United States Government or its agencies to 100% for repossessed assets or loans more than 90 days past due. Qualifying one- to four-family residential real estate loans and qualifying multi-family residential real estate loans (not more than 90 days delinquent and having an 80% or lower loan-to-value ratio), which at June 30, 2003, represented 45.4% of the total loans receivable of Willow Grove Bank, are weighted at a 50% risk factor. Supplementary capital may include, among other items, cumulative perpetual preferred stock, perpetual subordinated debt, mandatory convertible subordinated debt, intermediate-term preferred stock, and general allowances for loan losses. The allowance for loan losses includable in supplementary capital is limited to 1.25% of risk-weighted assets. The amount of supplementary capital that can be included is limited to 100% of core capital.
Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and non-residential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. However, in calculating regulatory capital, institutions can add back unrealized losses and deduct unrealized gains net of taxes, on debt securities reported as a separate component of capital calculated according to generally accepted accounting principles.
Office of Thrift Supervision regulations establish special capitalization requirements for savings banks that own service corporations and other subsidiaries, including subsidiary savings banks. According to these regulations, certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks, engaged solely in mortgage-banking activities, or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to Willow Grove Bank's level of ownership, including the assets of includable subsidiaries in which Willow Grove Bank has a minority interest that is not consolidated for generally accepted accounting principles purposes. For excludable subsidiaries, the debt and equity investments in such subsidiaries are deducted from assets and capital. At June 30, 2003, Willow Grove Bank had no investments subject to a deduction from tangible capital.
Under currently applicable Office of Thrift Supervision policy, savings institutions must value securities available for sale at amortized cost for regulatory capital purposes. This means that in computing regulatory capital, savings institutions should add back any unrealized losses and deduct any unrealized gains, net of income taxes, on debt securities reported as a separate component of capital calculated according to generally accepted accounting principles.
At June 30, 2003, Willow Grove Bank exceeded all of its regulatory capital requirements, with tangible, core and risk-based capital ratios of 10.2%, 10.2% and 20.8%, respectively.
The Office of Thrift Supervision and the Federal Deposit Insurance Corporation generally are authorized to take enforcement action against a savings bank that fails to meet its capital requirements, which action may include restrictions on operations and banking activities, the imposition of a capital directive, a cease-and-desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, a savings bank that fails to meet its capital requirements is prohibited from paying any dividends.
Prompt Corrective Action. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements, including a leverage limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulator for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements.
Under the Federal Deposit Insurance Corporation Improvement Act an institution is deemed to be (a) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (b) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (c) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), (d) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less than 3.0%, and (e) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under specified circumstances, a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan which meets specified requirements with its appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. In addition, undercapitalized institutions are subject to various regulatory restrictions, and the appropriate federal banking agency also may take any number of discretionary supervisory actions.
At June 30, 2003, Willow Grove Bank was in the "well capitalized" category for purposes of the above regulations.
Safety and Soundness Guidelines. The Office of Thrift Supervision and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards may be required to submit compliance plans to their appropriate federal regulators. The Office of Thrift Supervision and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. Willow Grove Bank believes that it is in compliance with these guidelines and standards.
Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by savings institutions, which include cash dividends, stock repurchases and other transactions charged to the capital account of a savings institution to make capital distributions. A savings institution must file an application for Office of Thrift Supervision approval of the capital distribution if any of the following occur or would occur as a result of the capital distribution (1) the total capital distributions for the applicable calendar year exceed the sum of the institution's net income for that year to date plus the institution's retained net income for the preceding two years, (2) the institution would not be at least adequately capitalized following the distribution, (3) the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition, or (4) the institution is not eligible for expedited treatment of its filings. If an application is not required to be filed, savings institutions which are a subsidiary of a holding company (as well as certain other institutions) must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution.
Branching by Federal Savings Institutions. Office of Thrift Supervision policy permits interstate branching to the full extent permitted by statute (which is essentially unlimited). Generally, federal law prohibits federal savings institutions from establishing, retaining or operating a branch outside the state in which the federal institution has its home office unless the institution meets the IRS' domestic building and loan test (generally, 60% of a thrift's assets must be housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (a) the branch(es) result(s) from an emergency acquisition of a troubled savings institution (however, if the troubled savings institution is acquired by a bank holding company, does not have its home office in the state of the bank holding
company bank subsidiary and does not qualify under the IRS Test, its branching is limited to the branching laws for state-chartered banks in the state where the savings institution is located); (b) the law of the state where the branch would be located would permit the branch to be established if the federal savings institution were chartered by the state in which its home office is located; or (c) the branch was operated lawfully as a branch under state law prior to the savings institution's reorganization to a federal charter.
Furthermore, the Office of Thrift Supervision will evaluate a branching applicant's record of compliance with the Community Reinvestment Act of 1977. An unsatisfactory Community Reinvestment Act record may be the basis for denial of a branching application.
Community Reinvestment Act and the Fair Lending Laws. Savings institutions have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities, and failure to comply with the fair lending laws could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice.
Qualified Thrift Lender Test. All savings institutions are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. Under Section 2303 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, a savings institution can comply with the qualified thrift lender test by either qualifying as a domestic building and loan bank as defined in Section 7701(a)(19) of the Internal Revenue Code or by meeting the second prong of the qualified thrift lender test set forth in Section 10(m) of the Home Owner's Loan Act. A savings institution that does not meet the qualified thrift lender test must either convert to a bank charter or comply with the following restrictions on its operations: (a) the institution may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank; (b) the branching powers of the institution shall be restricted to those of a national bank; (c) the institution shall not be eligible to obtain any new advances from its Federal Home Loan Bank, other than special liquidity advances with the approval of the Office of Thrift Supervision; and (d) payment of dividends by the institution shall be subject to the rules regarding payment of dividends by a national bank. Upon the expiration of three years from the date the savings institution ceases to be a qualified thrift lender, it must cease any activity and not retain any investment not permissible for a national bank and immediately repay any outstanding Federal Home Loan Bank advances (subject to safety and soundness considerations).
Currently, the portion of the qualified thrift lender test that is based on Section 10(m) of the Home Owners' Loan Act rather than the Internal Revenue Code requires that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); stock issued by the Federal Home Loan Bank of Pittsburgh; and direct or indirect obligations of the Federal Deposit Insurance Corporation. Small business loans, credit card loans and student loans are also included without limitation as qualified investments. In addition, the following assets, among others, may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of loans for personal, family and household purposes (other than credit card loans and educational loans); and stock issued by Fannie Mae or Freddie Mac. Portfolio assets consist of total assets minus the sum of (a) goodwill and other intangible assets, (b) property used by the savings institution to conduct its business, and (c) liquid assets up to 20% of the institution's total assets. At June 30, 2003, approximately 92.4% of the portfolio assets of Willow Grove Bank were qualified thrift investments.
Federal Home Loan Bank System. Willow Grove Bank is a member of the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks that administer the home financing credit function of savings institutions. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e., advances) in accordance with policies and
procedures established by its board of directors. At June 30, 2003, Willow Grove Bank had $132.5 million of Federal Home Loan Bank advances.
As a member, Willow Grove Bank is required to purchase and maintain stock in the Federal Home Loan Bank of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of the members' aggregate amount of outstanding advances and 0.7% of the members' unused borrowing capacity. At June 30, 2003, Willow Grove Bank had $9.3 million in stock of the Federal Home Loan Bank of Pittsburgh, which was in compliance with this requirement.
The Federal Home Loan Banks are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of Federal Home Loan Bank dividends paid and could continue to do so in the future and could also result in the Federal Home Loan Banks imposing higher interest rates on advances to members. These contributions also could have an adverse effect on the value of Federal Home Loan Bank stock in the future.
Federal Reserve System. Federal Reserve Board regulations require all depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At June 30, 2003, Willow Grove Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the Office of Thrift Supervision.
Savings banks are authorized to borrow from a Federal Reserve Bank "discount window," but Federal Reserve Board regulations require savings banks to exhaust other reasonable alternative sources of funds, including Federal Home Loan Bank advances, before borrowing from a Federal Reserve Bank.
Affiliate Restrictions. Section 11 of the Home Owners' Loan Act provides that transactions between an insured subsidiary of a holding company and an affiliate thereof will be subject to the restrictions that apply to transactions between banks that are members of the Federal Reserve System and their affiliates pursuant to Sections 23A and 23B of the Federal Reserve Act.
Generally, Sections 23A and 23B and Office of Thrift Supervision regulations issued in connection therewith limit the extent to which a savings institution or its subsidiaries may engage in certain "covered transactions" with affiliates to an amount equal to 10% of the institution's capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. Section 23B applies to "covered transactions" and certain other transactions and requires that all such transactions be on terms and under circumstances that are substantially the same, or at least as favorable to the savings institution or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" is defined to include a loan or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. Section 23B transactions also apply to the provision of services and the sale of assets by a savings association to an affiliate.
In addition, under Office of Thrift Supervision regulations, a savings institution may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings institution may not purchase or invest in securities of an affiliate other than shares of a subsidiary; a savings institution and its subsidiaries may not purchase a low-quality asset from an affiliate; and covered transactions and certain other transactions between a savings institution or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each loan or extension of credit by a savings institution to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit.
The Office of Thrift Supervision regulation generally excludes all non-bank and non-savings institution subsidiaries of savings institutions from treatment as affiliates, except to the extent that the Office of Thrift Supervision or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulation also requires savings institutions to make and retain records that reflect affiliate transactions in reasonable detail, and provides that certain classes of savings institutions may be required to give the Office of Thrift Supervision prior notice of affiliate transactions.
Federal Securities Law
Our common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended, and under Office of Thrift Supervision regulations, and generally may not be deregistered for at least three years after the April 2002 Reorganization. We are subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act of 1934, as amended.
Sarbanes-Oxley Act of 2002
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the Sarbanes-Oxley Act restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client will require preapproval by the company's audit committee members. In addition, the audit partners must be rotated. The Sarbanes-Oxley Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Sarbanes-Oxley Act, counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.
Longer prison terms will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution ("FAIR") provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change.
The Sarbanes-Oxley Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company's "registered public accounting firm" ("RPAF"). Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a "financial expert" (as such term is defined by the SEC) and if not, why not. Under the Sarbanes-Oxley Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Sarbanes-Oxley Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statement's materially misleading. The Sarbanes-Oxley Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The Sarbanes-Oxley Act requires the RPAF that issues the audit report to attest to and report on management's assessment of the company's internal controls. In addition, the
Sarbanes-Oxley Act requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC.
TAXATION
Federal Taxation
General. We are subject to federal income taxation in the same general manner as other corporations with some exceptions listed below. The following discussion of federal taxation is only intended to summarize certain pertinent federal income tax matters and is not a comprehensive description of the applicable tax rules. Our federal income tax returns have been closed without audit by the Internal Revenue Service ("IRS") through 1995.
We will file a consolidated federal income tax return which includes the Bank. Accordingly, it is anticipated that any cash distributions made by us would be treated as cash dividends, and not as a non-taxable return of capital to stockholders for federal and state tax purposes.
Method of Accounting. For federal income tax purposes, we report our income and expenses on the accrual method of accounting and file our federal income tax return using a June 30 fiscal year end.
Bad Debt Reserves. The Small Business Protection Act of 1996 (the "1996 Act") eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995. Prior to the 1996 Act, the Bank was permitted to establish a reserve for bad debts and to make additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at taxable income. As a result of the 1996 Act, savings associations must use the specific chargeoff method in computing their bad debt deduction beginning with their 1996 federal tax return. In addition, federal legislation requires the recapture (over a six year period) of the excess of tax bad debt reserves at December 31, 1995 over those established as of December 31, 1987. The amount of the Bank's reserve subject to recapture as of June 30, 2003 is approximately $400,000.
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if the Bank failed to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Bank make certain non-dividend distributions or ceases to maintain a bank charter.
At June 30, 2003, the Bank's total federal pre-1988 reserve was approximately $6.2 million. The reserve reflects the cumulative effects of federal tax deductions for which no federal income tax provisions have been made.
Minimum Tax. The Code imposes an alternative minimum tax ("AMT") at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI"). The AMT is payable to the extent such AMTI is in excess of an exemption amount. Net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. We have not been subject to the AMT nor do we have any such amounts available as credits for carryover.
Net Operating Loss Carryovers. We may carry back net operating losses to the three preceding taxable years and forward to the succeeding 15 taxable years. This provision applies to losses incurred in taxable years beginning before August 6, 1997. For net operating losses in years beginning after August 5, 1997, such net operating losses can be carried back to the two preceding taxable years and forward to the succeeding 20 taxable years. At June 30, 2003, we had no net operating loss carryforwards for federal income tax purposes.
Corporate Dividends-Received Deduction. We may exclude from income 100% of dividends received from a member of the same affiliated group of corporations. The corporate dividends received deduction is 80% in the case of dividends received from corporations which a corporate recipient owns less than 80%, but at least 20%
of the distribution corporation. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received.
State and Local Taxation
Pennsylvania Taxation. We are subject to the Pennsylvania Corporate Net Income Tax and Capital Stock and Franchise Tax. The Corporation Net Income Tax rate for fiscal 2003 is 9.99% and is imposed on unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed at the rate of approximately 0.724% of a corporation's capital stock value, which is determined in accordance with a fixed formula based upon average net income and net worth.
The Bank is subject to tax under the Pennsylvania Mutual Thrift Institutions Tax Act (the "MTIT"), as amended to include thrift institutions having capital stock. Pursuant to the MTIT, the tax rate is 11.5%. The MTIT exempts the Bank from other taxes imposed by the Commonwealth of Pennsylvania for state income tax purposes and from all local taxation imposed by political subdivisions, except taxes on real estate and real estate transfers. The MTIT is a tax upon net earnings, determined in accordance with generally accepted accounting principles ("GAAP") with certain adjustments. The MTIT, in computing GAAP income, allows for the deduction of interest earned on state and federal obligations, while disallowing a percentage of a thrift's interest expense deduction in the proportion of interest income on those securities to the overall interest income of the Bank. Net operating losses, if any, thereafter can be carried forward three years for MTIT purposes.
Item 2.
Item 2. Properties
We operate from the following locations:
- ------------------------- (1) Includes adjacent nine-acre parcel that could be used for future expansion. (2) Includes expansion into second unit beginning July 2003. (3) Includes adjacent parcel of land with an existing structure. (3) Opened in January 2003.
Item 3.
Item 3. Legal Proceedings
Brenda DiCicco v. Willow Grove Bank, (United States District Court, Eastern District of Pennsylvania). On October 11, 2002, a lawsuit was filed against Willow Grove Bank by Ms. DiCicco in her individual capacity as president and sole shareholder of ATS Products Corp. ("ATS") alleging eight causes of action related to a line of credit between the Bank and ATS. The complaint has since been amended to add Mr. Marcell and one present and one former employee of the Bank as defendants. The causes of action are: breach of contract, breach of oral contract, fraud, negligent misrepresentation, breach of fiduciary duty, unjust enrichment, conversion and negligence. The plaintiff seeks a multi-million dollar recovery for compensatory damages , punitive damages, attorney fees and costs. ATS previously filed suit against the Bank in the U.S. Bankruptcy Court averring similar causes of action. The Bank is vigorously defending the claims made by the plaintiff in both suits and believes that those claims are without merit.
Irvine Construction Co. v. Sklaroff, et al., (Court of Common Pleas of Montgomery County, Pennsylvania). On September 5, 2003, a lawsuit was filed against Willow Grove Bank and eight additional defendants by Irvine Construction Co., Inc., alleging thirteen causes of action related to an agreement for the construction of an office building. Eleven of such causes of action include the Bank as a defendant and are: breach of contract (two counts), unjust enrichment/equitable restitution (in the alternative), fraud, civil conspiracy (two counts), fraudulent transfer and aiding and abetting fraudulent transfers, constructive trust, abuse of process, and tortious interference with existing contractual relations (two counts). Four counts against the Bank seek damages in excess of $1.0 million, five counts seek damages in excess of $50,000, punitive damages and other relief, and two counts seek constructive relief. The Bank anticipates that it will vigorously defend the claims made by the plaintiff and believes that those claims are without merit .
Other than the above referenced litigation, the Company is involved in various legal proceedings occurring in the ordinary course of business. Management of the Company, based on discussions with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of the Company. There can be no assurance that any of the outstanding legal proceedings to which the Company is a party will not be decided adversely to the Company's interests and have a material adverse effect on the financial condition and operations of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is traded on the NASDAQ National Market (NASDAQ) under the symbol WGBC. Local newspapers listings include WillowG and WillGrvBcp. At September 22, 2003 there were 2,011 registered shareholders of record, not including the number of persons or entities whose stock is held in nominee or "street" name through various brokerage firms and banks. The following table shows the quarterly high and low trading prices of our stock and the amount of cash dividends declared per share for our past two fiscal years. Data prior to April 3, 2002 has been restated to reflect the 2.28019 exchange of shares of the former Willow Grove Bancorp, Inc for shares of the new Willow Grove Bancorp, Inc. stock.
Stock Price ----------- Cash dividends High Low per share ---- --- ---------
Quarter ended: June 30, 2003 $17.05 $14.63 $0.080 March 31, 2003 14.89 13.05 0.080 December 31, 2002 14.00 11.35 0.070 September 30, 2002 12.15 10.18 0.070
June 30, 2002 12.33 10.00 0.060 March 31, 2002 9.76 8.29 0.057 December 31, 2001 8.48 7.16 0.057 September 30, 2001 7.67 5.44 0.053
The information for all equity based and individual compensation arrangements is incorporated by reference from Item 12 hereof.
Item 6.
Item 6. Selected Financial Data
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(1) Data prior to April 3, 2002 has been adjusted for the 2.28019 exchange ratio in connection with the April 3, 2002 Reorganization and subscription offering. (2) Earnings per share data prior to January 1, 1999 is not applicable. (3) Data for June 30, 2001 is not meaningful. (4) For the fiscal years 2002, 2001, 2000 and 1999 includes dividends waived by the Mutual Holding Company of $1.1 million, $1.2 million, $1.0 million and $225,000, respectively.
Item 6. Selected Financial Data (continued)
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(5) The weighted average yield on interest-earning assets less the weighted average cost of interest-bearing liabilities. (6) This represents net interest income as a percentage of average interest-earning assets. (7) Non-performing assets equal non-accrual loans, troubled debt restructurings plus accruing loans 90 or more days past due and real estate owned. (8) Bank only.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is intended to assist in understanding our financial condition, and the results of operations for Willow Grove Bancorp, Inc., (the "Company") and its subsidiary Willow Grove Bank, (the "Bank") for the fiscal years ended June 30, 2003, 2002 and 2001. The information in this section should be read in conjunction with the Company's financial statements and the accompanying notes included elsewhere herein.
General
Our net income is primarily based upon our net interest income, which is the difference between the income earned on interest-earning assets and the interest paid on interest-bearing liabilities and the relative amount of our interest-earning assets to interest-earning liabilities. Non-interest income and expenses, the provision for loan losses and income tax expense also affect our results of operations.
Critical Accounting Policies
The following discussion and analysis of our financial condition and results of operations is based upon consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
In management's opinion, the most critical accounting policies affecting our consolidated financial statements are:
1. Evaluation of the allowance for loan losses. The determination of the allowance for loan losses involves significant judgments and assumptions by management which may have a material impact on the carrying value of net loans and, potentially, on the amount of net income we recognize from period to period. For a description of the methods we use to determine our allowance for loan losses, see "Results of Operations - Provision for Loan Losses."
2. Accrual and recognition of interest on loans. These policies involve significant judgments and assumptions by management which may have a significant impact on the amount of interest income recognized from period to period. For a description of our policies for recognizing interest income on loans, see Note 1 (Summary of Significant Accounting Policies) of our consolidated financial statements at and for the fiscal year ended June 30, 2003.
3. Realization of deferred income tax items. We include in our other assets a "net deferred tax asset" which is an estimate of net deferred tax assets and deferred tax liabilities. These estimates involve significant judgments and assumptions by management which may have a material effect on the carrying value of this asset for financial reporting purposes. For a more detailed description of these items and estimates, see Note 8 (Income Taxes) to our audited consolidated financial statements at and for the fiscal year ended June 30, 2003.
The Notes to Consolidated Financial Statements identify other significant accounting policies used in the development and presentation of our financial statements. This discussion and analysis, the significant accounting policies and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.
Changes in Financial Condition
General. Our total assets increased by $85.3 million, or 11.2%, to $845.1 million at June 30, 2003 compared to $759.8 million at June 30, 2002. This increase was primarily due to increases in cash and cash equivalents of $66.0 million, and securities available for sale ($37.2 million) and held to maturity ($3.3 million). These increases were
partially offset by a $30.1 million decrease in net loans receivable. The increase in total assets during the fiscal year ended June 30, 2003 was funded by a $56.9 million increase in deposits and a $34.7 million increase in borrowings from the Federal Home Loan Bank ("FHLB") of Pittsburgh.
Cash and Cash Equivalents. Cash and cash equivalents, which consist of cash on hand and in other banks in interest-earning and non-interest earning accounts, amounted to $98.0 million and $32.0 million at June 30, 2003 and 2002, respectively. The increase in cash and cash equivalents of $66.0 million or 206.5% was a result of the combination of increased loan prepayments associated with the continuing low interest rate environment as well as proceeds received from the sale of recently securitized single family residential mortgage loans and from the liquidation of our education loan portfolio. In the quarter ended June 30, 2003, the Company securitized and sold $30.7 million of single-family residential mortgage loans at a gain of $680,000. The loans securitized were on the Company's books at a premium and management believed that they had an increased likelihood of prepayment. As a part of its asset/liability management strategy, the Company used a portion of the proceeds from this sale of securities to repay $17.0 million of FHLB advances which had a weighted average interest rate of 5.29% and an average remaining term of 2.4 years. The Company also paid $1.4 million of prepayment penalties to the FHLB as part of this transaction which reduced its non-interest income in fiscal 2003. In addition, during the fiscal year ended June 30, 2003, the Company sold its $7.7 million portfolio of education loans at a gain of $440,000. The sale of the Company's education loan portfolio was due to its determination that the returns of such portfolio, which had an average interest yield of 3.6 %, were not sufficient in light of the administrative costs involved as well as the relatively limited growth in this sector of the Company's total loan portfolio. Cash and cash equivalents are available as a source of funds for originations of new loans and purchases of additional securities investments.
Securities Available for Sale. At June 30, 2003, we had securities that were classified available for sale ("AFS") totaling $291.9 million, compared to $254.7 million in AFS securities at June 30, 2002. The Company's AFS securities are comprised primarily of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, as well as US government agency securities, stock in the FHLB and certain equity securities. The increase in available for sale securities was part of the Company's investment strategy to increase its securities portfolio in light of relatively limited demand for originations of new loans at rates deemed acceptable to the Company. Securities classified as AFS are accounted for at fair value with unrealized gains and losses, net of tax, reflected as an adjustment to equity. Primarily as a result of interest rates remaining relatively the same, at June 30, 2003, we had unrealized gains on AFS securities of $3.0 million compared to unrealized gains on AFS securities of $3.0 million at June 30, 2002.
Securities Held to Maturity. At June 30, 2003, we had securities that were classified held to maturity totaling $17.3 million, compared to $14.0 million in held to maturity securities at June 30, 2002. Our held to maturity securities at June 30, 2003 and June 30, 2002 were comprised solely of municipal bonds. The increase in held to maturity securities was part of the Company's investment strategy to increase its municipal bond portfolio due to the tax advantages of municipal bonds. In January 2002 we changed the classification on our municipal bond portfolio from available for sale to held to maturity based upon our intention and our ability to hold these securities until their maturity. Held to maturity securities are carried at amortized cost, and assets transferred from available for sale to held to maturity are transferred at fair value.
Loans. Our net loan portfolio declined to $413.8 million at June 30, 2003 from $443.9 million at June 30, 2002. During the fiscal year ended June 30, 2003, new loan originations and purchases of $237.1 million were offset by loan repayments of $222.7 million and loan securitizations and sales of $43.5 million. This decrease in our net portfolio of $30.1 million, or 6.8%, was due primarily to a decline in our single-family residential mortgage loan portfolio. Our single-family residential mortgage loans amounted to $131.8 million, or 31.4% of our total loan portfolio, at June 30, 2003 compared to $181.5 million, or 40.4% of the total loan portfolio, at June 30, 2002. The $49.7 million, or 27.4%, decline in our single-family residential mortgage loans is primarily the result of the continuing low interest rate environment and accelerated prepayment levels as our customers refinanced their mortgage loans. The decrease in our single-family residential mortgage loans occurred despite new originations and purchases of $91.9 million of single-family residential mortgage loans in the year ended June 30, 2003. Other significant changes in the types of loans in our portfolio during the year ended June 30, 2003 were: an increase of $21.6 million (16.1%) in commercial real estate and multi-family residential mortgage loans; an increase of $6.9 million (23.5%) in construction mortgage loans; an increase of $1.5 million (7.8%) in commercial business loans; a $7.8 million (77.0%) decrease in consumer loans primarily related to the sale of $7.7 million of our education loan
portfolio; and a $2.0 million (2.7%) decrease in home equity loans. As of June 30, 2003, our single-family residential mortgage loans and home equity loans amounted to an aggregate of 48.8% of our total loans. In recent years we have increased our emphasis on commercial real estate and construction loans. Commercial real estate and multi-family residential loans amounted to 37.1% of loans, while construction loans amounted to 8.6% of the total loans at June 30, 2003. Commercial real estate and multi-family residential loans and construction loans generally have higher yields and shorter terms to maturity and/or repricing compared to single-family residential mortgage loans. However, commercial real estate and construction loans generally are considered to involve a higher degree of risk of loss compared to single-family residential mortgage loans. Our allowance for loan losses amounted to $5.3 million at June 30, 2003 representing a net increase of $686,000 (14.8%) from the allowance of $4.6 million at June 30, 2002.
Loans Held for Sale. Mortgage loans originated or purchased with the intention of being sold into the secondary market are classified as held for sale and are carried at the lower of cost or market value with any unrealized loss reflected in the statements of income. At June 30, 2003, $5.3 million of fixed-rate, single-family residential mortgages were classified as held for sale compared to $1.6 million in loans classified as held for sale at June 30, 2002. The increase of $3.7 million is related to increased secondary market activity as a result of the low interest rate environment. Since fiscal 2001, we have become more active in the residential mortgage loan secondary market in an attempt to take advantage of market opportunities and realize gains upon the sale of loans.
Intangible Assets. At June 30, 2003, the amount of our intangible assets totaled $1.0 million. This compares to $1.1 million at June 30, 2002. Our intangible assets include a core deposit intangible and an unidentified intangible asset, which represents the excess cost over fair value of assets acquired over liabilities assumed in a branch acquisition which occurred in 1994. The core deposit intangible is being amortized over a 12-year life. At June 30, 2003 the Company had goodwill of $848,000 which is periodically measured for impairment.
Deposits. Total deposits increased by $56.9 million, or 10.7%, to $586.6 million at June 30, 2003 compared to $529.8 million at June 30, 2002. At June 30, 2003, checking accounts totaled $121.1 million, representing an increase of $18.1 million or 17.6% compared to the balance of checking accounts at June 30, 2002 of $102.9 million. Savings accounts increased approximately $13.2 million, or 18.1% to $86.4 million at June 30, 2003 compared to $73.2 million at June 30, 2002, and money market accounts increased $31.5 million or 65.9% to $79.3 million at June 30, 2003 compared to $47.8 million at June 30, 2002. At June 30, 2003, certificates of deposit, which comprise the largest component of our deposit portfolio, amounted to $299.8 million or 51.1% of our deposit portfolio, a decrease of $6.0 million from $305.8 million or 57.7% of total deposits at June 30, 2002. We believe the changes in our deposit portfolio are due to our efforts to increase core deposit accounts and balances through targeted marketing as well as many depositor's unwillingness to extend the maturity of their certificate accounts into longer-term certificate of deposit accounts in the current low interest rate environment.
Federal Home Loan Bank Advances. We use advances from the FHLB of Pittsburgh as an additional source of funds to meet our loan demand, as leverage to fund certain revenue enhancing investment strategies and for other asset/liability management purposes. At June 30, 2003, the total amount of these borrowings outstanding was $132.6 million, which is a $34.7 million or 35.5% increase from the $97.8 million outstanding at June 30, 2002. During the fiscal year ended June 30, 2003 the average balance of FHLB advances was $129.6 million compared to $73.8 million in the year ended June 30, 2002. The maximum amount of borrowings at any month-end in fiscal 2003 was $139.1 million compared to $100.8 million in fiscal 2002. During the year ended June 30, 2003, the Company prepaid $17.0 million in FHLB advances. Of the total amount of borrowings outstanding, $63.1 million and $39.4 million were designated for use to fund revenue enhancement investment strategies at June 30, 2003 and 2002, respectively. Such revenue enhancement strategies consist primarily of using FHLB advances as leverage, that is, the Company obtains advances at a specified interest rate and then reinvests the proceeds into securities yielding a higher interest rate resulting in a net differential or "spread" for the Company which increases net interest income.
Stockholders' Equity. At June 30, 2003, our total stockholders' equity amounted to $117.1 million or 13.9% of assets compared to $124.4 million or 16.4% of assets at June 30, 2002. This decrease of $7.2 million, or 5.8% was primarily due to the repurchase of 657,000 shares of stock in the open market at an aggregate cost of $10.4 million under the Company's stock buyback program, the purchase of 256,000 shares of Company stock at an aggregate cost of $3.2 million for the Company's 2002 Recognition and Retention Plan ("RRP") Plan which were partially offset by $500,000 in plan amortization, and cash dividend payments of $3.1 million. These decreases were partially
offset by net income of $7.5 million for fiscal 2003. Other changes in stockholders' equity for the year ended June 30, 2003 were additional paid-in capital increasing $1.0 million to $83.5 million primarily as a result of director and employee stock option exercises, and a $26,000 change in comprehensive income, which was the result of the change in the unrealized market value of available for sale securities, and a decrease of $461,000 in unallocated shares held by Employee Stock Ownership Plan ("ESOP") primarily as a result of amortization related to the plan which is currently being amortized over 15 years.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents the average daily balances for various categories of assets and liabilities, and income and expense related to those assets and liabilities for the years ended June 30, 2003, 2002 and 2001. The table also shows the average yields and costs on interest-earning assets and interest-bearing liabilities for each of the fiscal years and at June 30, 2003. Loans receivable include non-accrual loans. To adjust nontaxable securities to a taxable equivalent, a 32.5%, 33.0% and 38.0% effective rate has been used for the fiscal years ending June 30, 2003, 2002, and 2001, respectively. The adjustment of tax exempt securities to a tax equivalent yield in the table below may be considered to include non-GAAP financial information. Management believes that it is a standard practice in the banking industry to present net interest margin, net interest rate spread and net interest income on a fully tax equivalent basis. Therefore, management believes, these measures provide useful information to investors by allowing them to make peer comparisons. A GAAP reconciliation also is included below.
Although management believes that the above mentioned non-GAAP financial measures enhance investors' understanding of the Company's business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliation of these non-GAAP financial measures from GAAP to non-GAAP is presented below.
Rate/Volume Analysis
The following table shows the effect of changing rates and volumes on net interest income for the years ended June 30, 2003 and 2002, compared to the prior fiscal year. Information provided shows the effect on net interest income of (1) rates (changes in rate multiplied times prior volume), (2) volume (changes in volume times prior rate) and (3) rate/volume (changes in rate times change in volume).
Results of Operations
General. Net income for the year ended June 30, 2003 was $7.5 million compared to $5.6 million and $157,000 for the years ended June 30, 2002 and 2001, respectively. Fiscal 2003 net income increased compared to fiscal 2002 primarily due to increased net interest income and non-interest income of $4.3 million and $1.0 million, respectively. These were partially offset by increases in non-interest expense of $2.7 million and income tax expense of $876,000. Provisions for loan losses aggregating $7.9 million, primarily related to two non-performing commercial business loans were the primary reason for the results for fiscal 2001.
Net Interest Income. Net interest income is determined by our interest rate spread (i.e., the difference between the average yields on interest-earning assets and the average rates paid on interest-bearing liabilities) and also the amount of interest-earning assets relative to interest-bearing liabilities. Our average interest rate spread for the years ended June 30, 2003, 2002 and 2001 was 2.91%, 2.89% and 2.59%, respectively. Our net interest margin (i.e., net interest income expressed as a percentage of average interest-earning assets) was 3.55%, 3.61% and 3.46% for the same three fiscal years. The changes in our interest spread have been due primarily to the fluctuations in market interest rates whereby rates on our interest-earning assets and interest-bearing liabilities changed by different amounts and at different times. In fiscal year 2003, the average cost of our interest-bearing liabilities decreased by 100 basis points from 4.01% during fiscal 2002 to 3.01% during fiscal 2003. This decrease was due primarily to the re-pricing of maturing certificates of deposits at lower rates. Because our certificates of deposit bear a stated interest for a specified term to maturity, there usually is a lagging effect on our cost of funds when market rates of interest change. When interest rates fall, as they have recently, we continue to pay the higher rate on certificates of deposit until their maturity at which time they are re-priced to approximate market conditions at the time of their maturity. During the fiscal year ended June 30, 2003, the average yield on our interest-earning assets declined by 98 basis points from 6.90% during fiscal 2002 to 5.92% during fiscal 2003. Average yields on both loans and securities decreased in fiscal 2003. The similar decline in our average cost of interest-bearing liabilities as compared to the slightly lesser decline in the average yield on our interest-earning assets caused our interest rate spread to increase by two basis point to 2.91% for fiscal 2003 from 2.89% in fiscal 2002. During fiscal 2002 compared to fiscal 2001, the average cost of our interest-bearing liabilities decreased faster than the decline in average yields on our interest-earning assets. This contributed to the increase of our spread from 2.59% in fiscal 2001 to 2.89% in fiscal 2002. Net interest margin for the fiscal year ended June 30, 2003 decreased by six basis points to 3.55% primarily due to the impact of the decline in yield on our interest-earning assets more than offsetting the increase in our ratio of interest-earning assets to interest-bearing liabilities. Average interest-earning assets increased by $138.4 million in fiscal 2003 compared to fiscal 2002, and were funded by increases in interest-bearing liabilities of $86.7 million and $55.7 million of non-interest-bearing liabilities and stockholders' equity. In fiscal 2002 compared to fiscal 2001, net interest margin increased 15 basis points, due primarily to increased net interest rate spread and the increase in the ratio of interest-earning assets to interest-bearing liabilities. The ratio of average interest-earning assets to average interest-bearing liabilities was 127.06%, 121.77%, and 120.93% for fiscal years 2003, 2002 and 2001, respectively.
For the fiscal year ended June 30, 2003, net interest income totaled $27.7 million compared to $23.4 million and $20.1 million in fiscal 2002 and 2001, respectively. The increase in fiscal 2003 compared to fiscal 2002 of $4.3 million or 18.6% was primarily due to increases in the amount of our average interest-earning assets compared to average interest-bearing liabilities and to a lesser degree decreases in rates paid on interest-bearing liabilities. In fiscal year 2002 compared to fiscal 2001, the increase in net interest income of $3.3 million or 16.4%, were primarily due to decreases in costs on average balances of interest-bearing liabilities greater than the decline in yields on average balances of interest-earning assets.
Interest Income. Interest income includes the interest earned on our various loans and securities, as well as yield adjustments for the premiums, discounts and deferred fees or costs recorded in connection with the acquisition of these assets. Our total interest income for the year ended June 30, 2003 was $46.4 million compared to $44.8 million and $44.3 million for fiscal 2002 and 2001, respectively.
The increase in interest income in fiscal 2003 compared to 2002 was $1.6 million, or 3.6%. This increase was primarily due to an increase of $108.9 million in the average balance of securities, which was partially offset by declining average yields on all of our interest-earning assets. During the year ended June 30, 2003 compared to the year ended June 30, 2002, the average balance of our loans receivable increased by $16.0 million. For fiscal 2003, the yield on average interest-earning assets dropped 98 basis points to 5.92% from 6.90% in fiscal 2002. The major
factors for this decline were the decrease in the average yield on loans, which decreased 61 basis points from 7.74% to 7.13%, and the increase in the average balance of securities outstanding together with a decline in the average yield earned on securities from 5.70% to 4.51%. These yield declines were the result of the current interest rate environment, which has accelerated loan repayments which have been reinvested in lower yielding assets.
The increase in interest income in fiscal 2002 compared to 2001 was $533,000, or 1.2%. This increase was primarily due to an increase of $49.7 million in the average balance of securities, which was partially offset by declining average yields on all our interest earning assets.
Interest Expense. Interest expense consists of the interest paid to our depositors on their interest-bearing deposit accounts with us, and to a lesser extent, interest paid on funds borrowed from the FHLB and certain escrow accounts. For the fiscal year ended June 30, 2003, our total interest expense was $18.7 million compared to $21.5 million and $24.2 million, for the fiscal years ended June 30, 2002 and 2001, respectively.
For the fiscal year ended June 30, 2003, interest expense decreased by $2.8 million, or 12.7% compared to the fiscal year ended June 30, 2002. This decrease was due to a $4.5 million decrease in interest paid on deposits primarily attributed to lower rates paid on our deposit accounts and a reduction in certificates of deposit as a percent of the total deposit portfolio, which was partially offset by a $1.8 million increase in interest expense on borrowed money due mostly to larger average balances of borrowings outstanding during the fiscal year. Compared to fiscal 2002, our average cost of deposits in fiscal 2003 decreased by 116 basis points from 3.78% to 2.62% while the average balance of interest-bearing deposits increased by $30.9 million from $458.9 million to $489.8 million. The average balance of borrowings outstanding during fiscal 2003 was $129.6 million compared to $73.8 million in fiscal 2002. The average cost of these borrowings for fiscal 2003 was 4.57% compared to 5.58% during fiscal 2002. The primary reason for the $2.7 million, or 11.4%, decrease in interest expense for the year ended June 30, 2002 compared to fiscal 2001, was due to a $3.0 million decrease in interest paid on deposit accounts which was partially offset by a $292,000 increase in interest expense on borrowed money. Our average cost of deposits declined 112 basis points to 3.78% during fiscal 2002 compared to 4.90% during fiscal 2001.
During fiscal year 2003, the average balance of our certificates of deposit ("CDs") decreased $6.6 million to $306.6 million, a 2.1% decrease compared to fiscal 2002. At June 30, 2003 and June 30, 2002, CDs made up 51.1% and 57.7%, respectively, of our total deposits. The average balance on our core deposit categories (interest and non-interest checking, savings and money market accounts) increased $43.9 million (22.2%) to $241.9 million during fiscal 2003 compared to an average balance of $198.0 million during fiscal 2002. Interest rates on core deposits are typically significantly less than rates paid on CDs. We believe that increasing our core deposits as a percentage of total deposits should decrease our weighted average cost of funds in a stable interest rate environment.
Provision for Loan Losses. We establish provisions for loan losses, which are charges to our operating results, in order to maintain our total allowance for losses at a level that we deem adequate to absorb known and unknown losses which are both probable and can be reasonably estimated. Our determination of the adequacy of the allowance is based upon the Company's regular review of credit quality and is based upon, but not limited to, the following factors: an evaluation of our loan portfolio, loss experience, current economic conditions, volume, growth, composition of the loan portfolio and other relevant factors. The amount of our allowance for loan loss is only an estimate and actual losses may vary from these estimates. We assess our allowance for loan loss at least quarterly and make any necessary adjustment to maintain our allowance for loss at a level deemed adequate. For the years ended June 30, 2003, 2002 and 2001, our provisions for loan losses were $1.0 million, $1.2 million and $7.9 million, respectively. In fiscal 2003, we charged-off a total of $391,000 of loans, consisting of $103,000 in commercial business loans, $284,000 in mortgage loans, and $4,000 in consumer loans.
At June 30, 2003, the amount of our allowance for loan losses was $5.3 million compared to $4.6 million at June 30, 2002. We believe that the allowance for loan losses at June 30, 2003 was appropriate given, among other things, the continuing growth of certain sectors of our loan portfolio and the inherent credit risk associated with our loan portfolio diversification into other than single-family residential loans. The percentage of the allowance for losses to loans increased to 1.27% at June 30, 2003 compared to 1.03% at June 30, 2002 and 0.94% at June 30, 2001.
We believe, to the best of our knowledge, that at such date the allowance for loan loss was adequate at June 30, 2003 and represents all known and inherent loses in the portfolio that are both probable and reasonably estimable, however, no assurance can be given as to the amount or timing of additional provisions for loan losses in the future as a result of potential increases in the amount of the Company's non-performing loans in the remainder of the Company's loan portfolio. Regulatory agencies, in the course of their regular examinations, review the allowance for loss and carrying value of non-performing assets. No assurance can be given that these agencies might not require changes to the allowance for losses in the future. Subsequent to June 30, 2003, the Company became aware that one of its largest commercial business credits became delinquent. This credit relationship consisted of two loans with an outstanding balances aggregating $953,000 as of August 31, 2003 and was 123 days delinquent. The Company is carefully monitoring these loans and understands that the borrower is experiencing financial difficulties. Management believes that certain additional provisions to loan losses may be necessary in the quarter ending September 30, 2003 due to these loans.
Non-Interest Income. Non-interest income is comprised of account service fees and charges, loan servicing fees, realized gains and losses on assets available or held for sale and increases in the cash surrender value of bank owned life insurance ("BOLI"). During fiscal 2003 the Company also recognized a loss on the disposition of borrowings which reduced its non-interest income. Total non-interest income for the years ended June 30, 2003, 2002, and 2001 was $3.5 million, $2.5 million and $1.8 million, respectively. The increase in non-interest income of $1.0 million or 41.9% for fiscal 2003 compared to fiscal 2002, was due primarily to realized gains on loans held for sale and securities available for sale and an increase in service fees and charges. Gains on sales of loans were $1.2 million in fiscal 2003 compared to $519,000 in fiscal 2002 while gains on available for sale securities were $1.7 million in fiscal 2003 compared to $310,000 in fiscal 2002. These increases were the result of our continuing efforts to sell a portion of the fixed-rate single-family loans we originate and re-positioning our securities portfolio in our efforts to meet our asset/liability management strategies. Other asset/ liability strategies incorporated during the fiscal year ended 2003 included the Company incurring costs of $1.4 million in penalties associated with the prepayment of $17.0 million in longer term FHLB advances averaging 5.29% with the intent of benefiting future periods. We had no such penalties in the prior year periods. During fiscal year 2002, we realized gains on sales of investments amounting to $437,000, but this was negatively impacted by a $93,000 adjustment on equity investments in accordance with SFAS 115 whereby unrealized losses deemed to be other than temporary are recorded as a realized loss. For the year ended June 30, 2003, non-interest income included $63,000 in increased cash surrender value of BOLI. The Company invested $5.0 million in BOLI in March 2003. BOLI is a bank owned life insurance policy on the selected group of employees which is used to help defray employee benefit costs. BOLI is recorded on the consolidated Statement of Financial Condition at its cash value and changes in the cash surrender value are recorded in non-interest income. BOLI income is tax-exempt.
Non-Interest Expense. The primary components of non-interest expense are compensation and employee benefits, occupancy and equipment expenses, data processing costs, deposit account services and a variety of other expenses. For the years ended June 30, 2003, 2002, and 2001, non-interest expense totaled $19.1 million, $16.3 million and $13.9 million, respectively. The primary reason for the increase in non-interest expenses in fiscal 2003 was due to a $2.4 million increase in compensation and employee benefits.
Compensation and benefits expenses totaled $11.9 million, $9.5 million and $8.0 million, respectively, for the fiscal years ended June 30, 2003, 2002, and 2001. Some of the factors affecting the increase in compensation and benefits include our continued efforts in opening new branches, increased costs to expand and support our lending function and costs of stock benefit plans that have increased due to the appreciation of our stock value and the full year impact of additional allocated shares in both the Employee Stock Option Plan ("ESOP") and the Recognition and Retention Plan ("RRP"). As part of the April 2002 Reorganization, 513,000 shares of our common stock were acquired by the 2002 ESOP trust and the related expense is being recognized over a 15-year period. ESOP associated benefit expense is based upon the market value of our stock at the time shares are released over the 15-year term. Due to the increased number of shares in the ESOP as well as increases in the market value of our common stock during fiscal 2003, our ESOP expense was $824,000 for June 30, 2003, compared to $338,000 and $138,000 for the years ended June 30, 2002 and 2001, respectively. During fiscal 2003, 236,468 shares were released from the 2002 RRP trust. Expenses relating to RRP grants were $500,000, $162,000 and $162,000 for fiscal years 2003, 2002 and 2001, respectively. In January 2003, we opened our fourteenth branch office in Philadelphia, Pennsylvania and we incurred full year expenses of $323,000 for our Holland branch office which we opened in April 2002. At June 30, 2003, we had 245 full and part-time employees compared to 238 at June 30, 2002.
Occupancy and furniture and equipment expenses were $2.5 million, $2.2 million and $1.8 million for the fiscal years ended June 30, 2003, 2002, and 2001, respectively. The $324,000 increase in fiscal 2003 compared to fiscal 2002 was primarily due to our branch expansion. Advertising expenses for fiscal 2003, 2002 and 2001 were $560,000, $567,000 and $404,000, respectively.
For the fiscal years ended June 30, 2003, 2002, and 2001, amortization of intangible assets was $104,000, $138,000 and $276,000, respectively; data processing expenses were $705,000, $666,000, and $563,000, respectively, deposit account service expenses were $822,000, $789,000, and $675,000, respectively, and professional fees were $456,000, $650,000 and $576,000, respectively. For the fiscal years ended June 30, 2003, 2002, and 2001, other expenses, which include miscellaneous operating items, were $1.8 million, $1.6 million and $1.4 million, respectively. Other expenses increased primarily due to our growth and diversification efforts.
Income Tax Provision/(Benefit). Expense for income taxes amounted to $3.6 million for the year ended June 30, 2003. This compares to a tax expense of $2.7 million, and tax benefit of $32,000 for the years ended June 30, 2001 and 2000, respectively. A significant reduction in pre-tax income caused by the large provisions for loan losses that were made in fiscal 2001 was the primary reason for the variances in our provision for income tax during that year. The effective tax rates for fiscal 2003, 2002 and 2001 were 32.53%, 33.00% and (26.00)%, respectively.
Liquidity and Commitments
Our primary sources of funds are from deposits, amortization of loans, loan and securities prepayments and repayments, interest income from mortgage-backed securities and other investments, and other funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. We also maintain excess funds in short-term, interest-bearing assets that provide additional liquidity. We have also utilized outside borrowings, primarily from the FHLB of Pittsburgh as an additional funding source.
We use our liquidity resources to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, and to meet operating expenses. At June 30, 2003, we had outstanding approved loan commitments totaling $29.0 million and certificates of deposit maturing within the next twelve months amounting to $195.5 million. Based upon historical experience, we anticipate that a significant portion of the maturing certificates of deposit will be reinvested in the Bank.
Due to the interest rate environment during the year ended June 30, 2003, we experienced increases in the amount of prepayments of loans and mortgage-backed securities as borrowers repaid higher rate loans and refinanced those loans at lower rates. We also experienced an increase in the amount of bonds with call provisions having those call provisions exercised by the issuer so that they could take advantage of a lower borrowing cost. These accelerated repayments have increased our liquidity.
We recently have also increased our use of borrowings from the FHLB of Pittsburgh as a cost effective means to obtain funds at varying maturities to implement some of our asset/liability strategies. Our outstanding borrowings from the FHLB of Pittsburgh have increased to $132.6 million at June 30, 2003 compared to $97.8 million at June 30, 2002. Under terms of our borrowing agreement with the FHLB of Pittsburgh, we pledge certain residential mortgage loans and mortgage-backed securities as well as our stock in the FHLB as collateral for these advances. At June 30, 2003, we had $290.6 million in additional borrowing capacity available from the FHLB of Pittsburgh.
We have not used, and currently are not intending to use, any significant off-balance sheet financing arrangement for liquidity or other purposes. Our financial assets with off-balance sheet risk are limited to our obligations to fund loans to borrowers pursuant to existing loan commitments. Additionally, we have not had any transactions, arrangements or other relationships with any unconsolidated, limited purpose entities that could affect our liquidity or capital resources, nor do we, or currently intend to, engage in trading commodity contracts.
We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.
Impact of Inflation and Changing Prices
The financial statements, accompanying notes, and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Most of our assets and liabilities are monetary in nature; therefore, the impact of interest rates has a greater impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure of Market Risk
Asset/Liability Management and Interest Rate Risk
The market value of assets and liabilities, as well as future earnings, can be affected by interest rate risk. Market values of financial assets have an inverse relationship to rates, i.e., when interest rates rise, the market value of many of the Company's assets declines and when rates fall, the market value of many of the Company's assets rise. The primary assets of the Company are loans to borrowers who often have the ability to prepay their loan. Therefore, in a falling rate environment, the increase in the market value of the Company's assets is limited by this option for the borrower to prepay the loan.
The ability to maximize net interest income is largely dependent upon the achievement of a positive interest spread that can be maintained during fluctuations in prevailing interest rates. Interest rate sensitivity gap ("gap") is a measure of the difference between interest-earning assets and interest-bearing liabilities that either mature or re-price within a specified time period. A gap is considered positive when the amount of interest-earning assets exceeds the amount of interest-bearing liabilities, and is considered negative when interest-bearing liabilities exceed interest-earning 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. During a period of falling interest rates, a negative gap would generally result in an increase in net interest income, and a positive gap would result in a decrease in net interest income. This is usually the case; however, interest rates on differing financial instruments will not always change at the same time or to the same extent.
The following gap table shows the amount as of June 30, 2003 of assets and liabilities projected to mature or re-price within various time periods. This table includes certain assumptions we have made that affect the rate at which loans will prepay and the duration of core deposits. Changes in interest rates may affect these assumptions which would impact our gap position.
At June 30, 2003, the ratio of the cumulative interest-earning assets maturing or re-pricing in one-year or less to interest-bearing liabilities maturing or re-pricing in one-year or less is 111.38%, which results in a cumulative one-year gap to total assets ratio of 3.54%.
We have adopted asset/liability management policies designed to quantify the interest rate risk caused by mismatches in the maturities and re-pricing of our interest-earning assets and interest-bearing liabilities. These interest rate risk and asset/liability management actions are taken under the guidance of the Asset/Liability Management Committee ("ALCO"). The ALCO's purpose is to communicate, coordinate and control asset/liability management consistent with our business plan and Board approved policies. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The ALCO meets at least quarterly and monitors the volume and mix of assets and funding sources taking into account the relative costs and spreads, the interest rate sensitivity gap and liquidity needs. The ALCO also reviews economic conditions and interest rate projections, current and projected liquidity needs and capital positions, anticipated changes in the mix of assets and liabilities, and interest rate exposure limits versus current projections pursuant to gap analysis and interest income simulations. At each meeting, the ALCO recommends changes in strategy as appropriate. Interest rate risk issues are also discussed by the Board of Directors
on a regular basis. Management meets weekly to monitor progress in achieving asset/liability targets approved by the Board, particularly the type and rate on asset generation and sources of funding.
In order to manage our assets and liabilities and improve our interest rate risk position, emphasis has been placed on the origination of assets with shorter maturities or adjustable rates such as commercial and multi-family real estate loans, construction loans, home equity loans and to a lesser extent commercial business loans. At the same time, other actions include attempts to increase our core deposits and the use of FHLB advances as additional sources of funds. We also classify a portion of the longer-term fixed rate loans we originate as held for sale. During the years ended June 30, 2003 and 2002, we sold long-term, generally 30 year, fixed rate single-family residential mortgage loans totaling $74.8 million and $77.8 million, respectively.
The ALCO regularly reviews interest rate risk by, among other things, examining the impact of alternative interest rate environments on net interest income and net portfolio value ("NPV"), and the change in NPV. NPV is the difference between the market value of assets and the market value of liabilities and off-balance sheet items under various interest rate scenarios. Sensitivity is the difference (measured in basis points) between the NPV to assets ratio at market rate and the NPV to assets ratio determined under each rate scenario. The ALCO monitors both the NPV and sensitivity according to guidelines established by the Office of Thrift Supervision ("OTS") in Thrift Bulletin 13A "Management of Interest Rate Risk, Investment Securities and Derivative Activities," and board approved limitations.
Presented below, as of June 30, 2003 and 2002, is an analysis of the interest rate risk position as measured by NPV and sensitivity based upon various rate scenarios. These values have been obtained from data submitted by the Bank to the OTS. The OTS performs scenario analysis to estimate current or base case economic value and estimates NPV that would result from instantaneous, parallel shifts of the yields on various financial instruments of plus and minus 100, 200 and 300 basis points. The model does not value new business activities. It only provides an estimate of economic value at a point in time and the economic value of the same portfolio under the above referenced interest rate scenarios.
Estimated change in NPV and Sensitivity At June 30, 2003
Due to the level of current interest rates, no values are calculated for hypothetical rate scenarios of down 200 or down 300 basis points.
Estimated change in NPV and Sensitivity At June 30, 2002
The Bank's sensitivity in the plus 200 basis point rate scenario improved from negative 362 basis points at June 30, 2002 to negative 164 points at June 30, 2003. The primary reasons for this improvement were increases in the estimates of prepayments due to the general level of interest rates which shortened the projected lives of mortgage-related assets and also higher levels of cash and short-term investments.
NPV is more sensitive and may be more negatively impacted by rising interest rates than by declining rates. This occurs primarily because as rates rise, the market value of long-term fixed rate assets, like fixed rate mortgage loans, declines due to both the rate increase and slowing prepayments. When rates decline, these assets do not experience similar appreciation in value. This is due to the decrease in the duration of the asset resulting from the increase in prepayments.
Recent Accounting Pronouncements
Acquisitions of Certain Financial Institutions
In October 2002, the FASB issued Statement No. 147, Acquisitions of Certain Financial Institutions, which amends SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, SFAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets, and FASB Interpretation No. 9. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement No. 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5 of Statement No. 72 to recognize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to acquisitions within the scope of this Statement. In addition, this Statement amends Statement No. 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement No. 144 requires for other long-lived assets that are held and used.
Effective September 30, 2002 the Company adopted Statement No. 147 with retroactive application effective June 30, 2001. With the adoption of Statement No. 147 an adjustment to fiscal 2002 statements is included to eliminate the accumulated amortization associated with the retroactive adjustment. The results of this adjustment was an increase in income, for an average of $23,000, net of taxes, for each quarter and $92,000, net of taxes, for fiscal year ended June 30, 2002. The Company continues to conduct periodic impairment assessment of its goodwill. At June 30, 2003 the Company determined that its goodwill of $848,000 was not impaired and, correspondingly, no adjustment to earnings was required.
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FASB Interpretation No. 45)
Requires a guarantor to include disclosure of certain obligations, and if applicable, at the inception of the guarantee, recognize a liability for the fair value of other certain obligations undertaken in issuing a guarantee. Effective for financial statements ending March 31, 2003 and thereafter. The provisions of this Statement had no expected impact on earnings, financial condition or stockholders' equity.
Consolidation of Variable Interest Entities- an interpretation of ARB No. 51 (FASB Interpretation No. 46)
Clarifies the application of ARB No. 51 and applies immediately to any variable interest entities created after January 31, 2003 and to variable interest entities in which an interest is obtained after that date. Applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that is acquired before February 1, 2003. Applies to nonpublic enterprises as of the end of the applicable annual period. Requires that an enterprise review its degree of involvement in a variable interest entity to determine of it is the primary beneficiary of that entity. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Stock-Based Compensation
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123." This statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002. This Statement announces that "in the near future, the Board plans to consider whether it should propose changes to the U.S. standards on accounting for stock-based compensation." The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Amendments of Statement 133 on Derivative Instruments and Hedging Activities
In April 2003, the FASB issued SFAS No. 149, "Amendments of Statement 133 on Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including derivatives embedded in other contracts and hedging activities. This Statement amends Statement No. 133 for decisions made by the FASB as part of its Derivatives Implementation Group process. This Statement also amends Statement No. 133 to incorporate clarifications of the definition of a derivative. This Statement is effective for contracts entered into or modified and hedging relationships designated after June 30, 2003. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Some of the provisions of this Statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with the Board's proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the
issuer. For nonpublic entities, mandatorily redeemable financial instruments are subject to the provisions of this Statement for the first fiscal period beginning after December 15, 2003. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Selected Quarterly Financial Data
The following table presents selected quarterly operating data for the fiscal years ended June 30, 2003 and 2002. Per share data for periods prior to April 3, 2002 have been adjusted to reflect the effect of the exchange of 2.28019 shares of the former Willow Grove Bancorp, Inc. common stock for each share of our common stock as a result of the April 2002 Reorganization.
(Unaudited) For the quarter ended 6/30/03 3/31/03 12/31/02 9/30/02 -------- -------- -------- -------- (Dollars in thousands, except per share data)
Total interest income $ 10,674 $ 11,484 $ 12,034 $ 12,253 Total interest expense 4,366 4,524 4,783 5,073 Net interest income 6,308 6,960 7,251 7,180 Provision for loan losses 172 110 422 330 Total non-interest income 1,530 817 650 495 Total non-interest expense 5,047 4,787 4,632 4,592 Income tax expense 806 943 933 928 Net income $ 1,813 $ 1,937 $ 1,914 $ 1,825 Earnings per share Basic $ 0.18 $ 0.19 $ 0.19 $ 0.17 Diluted $ 0.17 $ 0.18 $ 0.18 $ 0.17
For the quarter ended 6/30/02 3/31/02 12/31/01 9/30/01 -------- -------- -------- -------- (Dollars in thousands, except per share data)
Total interest income $ 11,637 $ 10,649 $ 11,014 $ 11,518 Total interest expense 4.980 4,913 5,536 6,034 Net interest income 6,657 5,736 5,478 5,484 Provision for loan losses 118 100 620 374 Total non-interest income 406 561 958 536 Total non-interest expense 4,487 4,154 3,893 3,785 Income tax expense 817 655 641 621 Net income $ 1,641 $ 1,388 $ 1,282 $ 1,240 Earnings per share Basic $ 0.17 $ 0.13 $ 0.12 $ 0.11 Diluted $ 0.16 $ 0.13 $ 0.12 $ 0.11
Item 8.
Item 8. Financial Statements and Supplementary Data
Page ---- Management's Responsibility for Financial Reporting. 55 Independent Auditors' Report.................................. 56 Consolidated Statements of Financial Condition................ 57 Consolidated Statements of Income............................. 58 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income............................... 59 Consolidated Statements of Cash Flows......................... 60-61 Notes to Consolidated Financial Statements.................... 62-87
Willow Grove Bancorp, Inc.
MANAGEMENT REPORT
Financial Statements - -------------------- Willow Grove Bancorp, Inc. (the "Company") and its wholly owned subsidiary, Willow Grove Bank (the "Bank") are responsible for the preparation, integrity and fair presentation of its published financial statements as of June 30, 2003 and 2002 and for each of the years in the three-year period ended June 30, 2003. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and as such, include amounts, some of which are based on judgments and estimates of management.
Internal Control Over Financial Reporting - ----------------------------------------- Management of the Company and the Bank are responsible for establishing and maintaining effective internal control over financial reporting presented in conformity with both accounting principles generally accepted in the United States of America. The Bank's financial statements also are subject to regulations established by the Office of Thrift Supervision (the "OTS"). This internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Management assessed the Company and the Bank's internal control over financial reporting presented in conformity with both accounting principles generally accepted in the United States of America and, with respect to the Bank, OTS regulations and the instructions for the Thrift Financial Reports ("TFR") as of June 30, 2003. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of June 30, 2003, The Company and the Bank maintained effective internal control over financial reporting presented in conformity with generally accepted accounting principles and that the Bank's internal control over financial reporting was in compliance with the OTS regulations and TFR instructions.
Compliance With Laws And Regulations - ------------------------------------ Management assessed the Bank's compliance with the designated laws and regulations relating to safety and soundness. Based on this assessment, management believes that Willow Grove Bank complied, in all significant respects, with the designated laws and regulations relating to safety and soundness for the year ended June 30, 2003.
/s/ Frederick A. Marcell Jr. /s/ Christopher E. Bell - ------------------------------------- --------------------------------- President and Chief Executive Officer Senior Vice President and Chief Financial Officer
July 24, 2003
Independent Auditors' Report
To the Board of Directors and Stockholders of Willow Grove Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Willow Grove Bancorp, Inc. and subsidiary as of June 30, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended June 30, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Willow Grove Bancorp, Inc. and subsidiary as of June 30, 2003 and 2002 and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2003 in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP - --------------------------- Philadelphia, Pennsylvania July 24, 2003
Willow Grove Bancorp, Inc. Consolidated Statements of Financial Condition
See accompanying Notes to Consolidated Financial Statements
Willow Grove Bancorp, Inc. Consolidated Statements of Income
See accompanying Notes to Consolidated Financial Statements
See accompanying Notes to consolidated financial statements.
Willow Grove Bancorp, Inc. Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
Willow Grove Bancorp, Inc. Consolidated Statements of Cash Flows - Continued
See accompanying notes to consolidated financial statements.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Description of Business
Willow Grove Bancorp, Inc. (the "Company") provides a full range of banking services through its wholly-owned subsidiary, Willow Grove Bank (the "Bank" or "Willow Grove") which has 14 branches in Dresher, Willow Grove, Maple Glen, Warminster (2), Hatboro, Huntington Valley, Roslyn, Philadelphia (3 - Somerton, Rhawnhurst and Bustleton), North Wales, Southampton and Holland, Pennsylvania. All of the branches are full-service and offer commercial and retail banking products and services. These products include checking accounts (interest and non-interest bearing), savings accounts, certificates of deposit, business loans, real estate loans, and home equity loans. The Company is subject to competition from other financial institutions and other companies that provide financial services. The Company is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.
On April 3, 2002 Willow Grove Bank completed its reorganization from the two-tier mutual holding company form of organization to the stock form of organization (the "April 2002 Reorganization"). The former Willow Grove Bancorp, Inc. was a federally chartered mid-tier mutual holding company with approximately 56.9% of its stock being held by Willow Grove Mutual Holding Company and the remaining 43.1% being held by public shareholders. As part of the April 2002 Reorganization, the former Willow Grove Bancorp, Inc., the federal corporation was merged into Willow Grove Bank and the current Willow Grove Bancorp Inc., a Pennsylvania corporation was incorporated by the Bank for the purpose of becoming the holding company for the Bank. Willow Grove Bancorp, Inc., the new Pennsylvania corporation through a public subscription offering sold 6,414,125 shares of stock at $10.00 per share and issued 4,869,375 to the stockholders of Willow Grove Bancorp, Inc., the former federal corporation which represented an exchange of 2.28019 shares of its stock for each share of the former company. Willow Grove Bank is now the wholly-owned subsidiary of Willow Grove Bancorp, Inc., the Pennsylvania corporation. All per share data and information prior to April 3, 2002 refers to the former Willow Grove Bancorp, Inc., the federal corporation and has been restated to reflect the effect of the increased shares resulting from the share issuance and exchange in the April 2002 Reorganization. The stock has traded under the symbol "WGBC" for both the former federal corporation and the current Pennsylvania corporation.
In September 2000, Willow Grove Investment Corporation ("WGIC"), a Delaware corporation was formed as a wholly owned subsidiary of the Bank to conduct the investment activities of the Bank. In May 2003, Willow Grove Insurance Agency, LLC (the "Agency"), a Pennsylvania limited liability company was formed by the Bank to conduct permitted fixed rate annuity transaction activities for the Bank.
Basis of Financial Statement Presentation
The Company has prepared its accompanying consolidated financial statements in accordance with generally accepted accounting principles ("GAAP") as applicable to the banking industry. Certain amounts in prior years are reclassified for comparability to current year's presentation. Such reclassifications, when applicable have no effect on net income. The consolidated financial statements include the balances of the Company and its wholly owned subsidiary. All material inter-company balances and transactions have been eliminated in consolidation.
In preparing the consolidated financial statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenue and expense for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term include the determination of the allowance for loan losses.
Risks and Uncertainties
In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk, and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or re-price at different speeds, or on a different basis from its interest-earning assets. The Company's primary credit risk is the risk of default on the Company's loan portfolio that results from the borrower's inability to make contractually required payments. The
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Company's lending activities are concentrated in Pennsylvania. The largest concentration of the Company's loan portfolio is located in eastern Pennsylvania. The ability of the Company's borrowers to repay amounts owed is dependent on several factors, including the economic conditions in the borrower's geographic region and the borrower's financial condition. Market risk reflects changes in the value of collateral underlying loans, the valuation of real estate held by the Company, the valuation of loans held for sale, securities available for sale and mortgage servicing assets. The Company is subject to certain regulations as further described herein and in note 12. Compliance with regulations causes the Company to incur significant costs. In addition, the possibility of future changes to such regulations presents the risk that future costs will be incurred which may impact the Company.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents include cash and interest- bearing deposits with original maturities of three months or less.
The Company is required to maintain certain daily balances in accordance with Federal Reserve Bank requirements. The reserve balances maintained in accordance with such requirements at June 30, 2003 and 2002 were $7.9 million and $6.5 million, respectively. Such reserve requirements are satisfied through a combination of vault cash balances and sterile reserve deposits held at the Federal Home Loan Bank of Pittsburgh.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or market calculated on an aggregate basis, with any unrealized losses reflected in the statement of income. Loans transferred from loans held for sale to loans receivable are transferred at the lower of cost or market value at the date of transfer.
Securities
The Company divides its securities portfolio into two segments: (a) held to maturity and (b) available for sale. Securities in the held to maturity category are carried at cost, adjusted for amortization of premiums and accretion of discounts, using the level yield method, based on the Company's intent and ability to hold the securities until maturity. Marketable securities included in the available for sale category are carried at fair value, with unrealized gains or losses which are temporary in nature, net of taxes, reflected as an adjustment to equity. Unrealized losses which are other than temporary in nature are reflected in the statement of operations. The fair value of marketable securities for sale is determined from publicly quoted market prices. Securities available for sale which are not readily marketable, which include Federal Home Loan Bank of Pittsburgh stock, are carried at cost which approximates liquidation value. Premiums and discounts on securities are amortized/accreted using the interest method.
At the time of purchase, the Company makes a determination of whether or not it will hold the securities to maturity, based upon an evaluation of the probability of future events. Securities, which the Company believes may be involved in interest rate risk, liquidity, or other asset/liability decisions, which might reasonably result in such securities not being held to maturity, are classified as available for sale. If securities are sold, a gain or loss is determined by the specific identification method and is reflected in the operating results in the period the trade occurs.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level we believe is adequate to cover known and inherent losses in the loan portfolio that are both probable and reasonable to estimate at each reporting date. Our determination of the adequacy of the allowance is based upon an evaluation of the portfolio, loss experience, current economic conditions, volume, growth, composition of the portfolio, and other relevant factors. With the expansion of our lending activities into commercial real estate, business and other consumer loans in recent years, we consider industry-wide loss experience in our process when we determine the adequacy of our allowance for loan losses. We believe that due to the changing mix of our loan portfolio and our relative lack of historical loss experience with these types of loans, considering loan loss data from other banking institutions with loan portfolios similar to ours and in a similar geographic setting will provide us with a more representative approach to evaluating the credit risks
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
in our loan portfolio. During the year ended June 30, 2001, based upon a more detailed stratification of the loan portfolio, we modified the formulas we use to calculate the allowance on various loan types. In some cases, such as business lending and home equity lending where the combined LTV exceeds 80%, the percentage used to calculate the allowance was increased. In other cases, such as single-family first mortgage lending with LTVs below 60%, the percentage used was decreased. The overall effect of this modification did not materially impact the amount of the allowance for loan loss. During the fiscal year ended June 30, 2002 we modified the methodology for calculating the allowance for loan loss based upon the guidance provided by the SEC and the Federal Financial Institutions Examination Council ("FFIEC"). We continue to use historical loss factors for each loan type and for loans that we consider higher risk for all but single-family mortgage loans and guaranteed consumer loans, we now add a component for factors that may not be included in the historical loss calculation. This component establishes a range for factors such as, but not limited to, delinquency trends, asset classification trends and current economic conditions. Management then assesses these conditions and establishes, to the best of its ability, the allowance for loan loss from within the range calculated, based upon the facts known at that time. At June 30, 2003, our allowance for loan loss was in the lower quartile of the range established by this methodology. The result of this change in methodology is to allocate the entire allowance for loan loss to specific loan types, whereas prior methodology had an unallocated component. The change in methodology does not imply that any portion of the allowance for loan loss is restricted, but the allowance for loan loss applies to the entire loan portfolio.
Mortgage Servicing Rights
The Company recognizes mortgage servicing rights as assets, regardless of how such assets were acquired. Impairment of mortgage servicing rights is assessed based upon a fair market valuation of those rights on a disaggregated basis. Impairment, if any, is recognized in the statement of income. There was no impairment in the mortgage servicing rights for the years ended June 30, 2003, 2002 and 2001 (see note 5).
Loans, Loan Origination Fees, and Uncollected Interest
Loans are recorded at cost, net of unearned discounts, deferred fees, and allowances. Discounts or premiums on purchased loans are amortized using the interest method over the remaining contractual life of the portfolio, adjusted for actual prepayments. Loan origination fees and certain direct origination costs are deferred and amortized over the contractual life of the related loans using the level yield method.
Interest receivable on loans is accrued to income as earned. Non-accrual loans are loans on which the accrual of interest has ceased because the collection of principal or interest payments is determined to be doubtful by management. It is the policy of the Company to discontinue the accrual of interest and reverse any accrued interest when principal or interest payments are delinquent more than 90 days (unless the loan principal and interest are determined by management to be fully secured and in the process of collection), or earlier if the financial condition of the borrower raises significant concern with regard to the ability of the borrower to service the debt in accordance with the terms of the loan. Interest income on such loans is not accrued until the financial condition and payment record of the borrower demonstrates the ability to service the debt.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and amortization. The Company computes depreciation and amortization using the straight-line method over the estimated useful lives of the assets which range from three to 40 years. Significant renovations and additions are capitalized. Leasehold improvements are depreciated over the shorter of the useful lives of the assets or the related lease term. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
Intangible Assets
Intangible assets include a core deposit intangible and an unidentified intangible asset, which represents the excess cost over fair value of assets acquired over liabilities assumed in a branch acquisition which occurred in 1994. The
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
core deposit intangible is being amortized to expense over a twelve-year life. The carrying amount of intangible assets at June 30, 2003 and 2002 is net of accumulated amortization of $3.1 million and $3.0 million, respectively.
Income Taxes
Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
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, see Note 2 (Earnings Per Share). 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 and unvested common stock awards. Common stock equivalents which are considered antidilutive are not included for the purposes of this calculation. At June 30, 2003 there were no antidilutive shares.
Stock Options
The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, as permitted by statement No. 123, "Accounting for Stock-Based Compensation". As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Statement No. 123 requires entities which continue to apply the provisions of APB Opinion No. 25 to provide pro-forma earnings per share disclosures for stock option grants made in 1995 and subsequent years as if the fair value based method defined in Statement No. 123 had been applied, see Note 9 (Benefit Plans).
Recent Accounting Pronouncements
Acquisitions of Certain Financial Institutions
In October 2002, the FASB issued Statement No. 147, Acquisitions of Certain Financial Institutions, which amends SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, SFAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets, and FASB Interpretation No. 9. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement No. 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5 of Statement No. 72 to recognize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to acquisitions within the scope of this Statement. In addition, this Statement amends Statement No. 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement No. 144 requires for other long-lived assets that are held and used.
Effective September 30, 2002 the Company adopted Statement No. 147 with retroactive application effective June 30, 2001. With the adoption of Statement No. 147 an adjustment to fiscal 2002 statements is included to eliminate the accumulated amortization associated with the retroactive adjustment. The results of this adjustment was an increase in income, for an average of $23,000, net of taxes, for each quarter and $92,000, net of taxes, for fiscal year ended June 30, 2002. The Company continues to conduct periodic impairment assessment of its goodwill. At June 30, 2003 the Company determined that its goodwill of $848,000 was not impaired and, correspondingly, no adjustment to earnings was required.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FASB Interpretation No. 45)
Requires a guarantor to include disclosure of certain obligations, and if applicable, at the inception of the guarantee, recognize a liability for the fair value of other certain obligations undertaken in issuing a guarantee. Effective for financial statements ending March 31, 2003 and thereafter. The provisions of this Statement had no expected impact on earnings, financial condition or stockholders' equity.
Consolidation of Variable Interest Entities- an interpretation of ARB No. 51 (FASB Interpretation No. 46)
Clarifies the application of ARB No. 51 and applies immediately to any variable interest entities created after January 31, 2003 and to variable interest entities in which an interest is obtained after that date. Applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that is acquired before February 1, 2003. Applies to nonpublic enterprises as of the end of the applicable annual period. Requires that an enterprise review its degree of involvement in a variable interest entity to determine of it is the primary beneficiary of that entity. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Stock-Based Compensation
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123." This statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002. This Statement announces that "in the near future, the Board plans to consider whether it should propose changes to the U.S. standards on accounting for stock-based compensation." The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Amendments of Statement 133 on Derivative Instruments and Hedging Activities
In April 2003, the FASB issued SFAS No. 149, "Amendments of Statement 133 on Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including derivatives embedded in other contracts and hedging activities. This Statement amends Statement No. 133 for decisions made by the FASB as part of its Derivatives Implementation Group process. This Statement also amends Statement No. 133 to incorporate clarifications of the definition of a derivative. This Statement is effective for contracts entered into or modified and hedging relationships designated after June 30, 2003. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Some of the provisions of this Statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with the Board's proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. For nonpublic entities, mandatorily redeemable financial instruments are subject to the provisions of this Statement for the first fiscal period beginning after December 15, 2003. The provisions of this Statement have no expected impact on earnings, financial condition or stockholders' equity.
(2) Earnings Per Share
For the years ended June 30, 2003, 2002 and 2001 earnings per share, basic and diluted, were $0.75 and $0.71, $0.53 and $0.52, and $0.01 and $0.01, respectively.
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations.
- -------------------------
(1) Data prior to April 3, 2002 adjusted for a 2.28019 exchange ratio in connection with the April 3, 2002 Reorganization and subscription offering.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(3) Securities
Securities at June 30, 2003 and 2002 consisted of the following:
Proceeds from the sales of securities available for sale for the years ended June 30, 2003, 2002, and 2001 were $66.0 million, $23.6 million and $30.1 million, respectively. Gross gains of $1.8 million, $437,000 and $260,000 were realized in fiscal 2003, 2002 and 2001 respectively. There were no gross losses in fiscal 2003 compared to gross losses of $34,000 and $17,000 in fiscal 2002 and 2001, respectively. Additionally, we recognized losses of $48,000, $93,000 and $258,000 in fiscal 2003, 2002 and 2001, respectively, resulting from other than temporary declines in values of certain equity securities.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Accrued interest receivable on securities amounted to $1.6 million and $2.0 million at June 30, 2003 and 2002, respectively.
The amortized cost and estimated fair value of securities available for sale at June 30, 2003, by contractual maturity, are shown below.
The Company must maintain ownership of specified amounts of stock as a member of the Federal Home Loan Bank of Pittsburgh ("FHLB"). The Company's ownership of FHLB stock was $9.3 million and $5.0 million as of June 30, 2003 and 2002, respectively.
For mortgage-backed securities, expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay the obligation with or without call or prepayment penalties. Of the Company's $78.2 million U.S. government agency securities, $52.5 million are callable within one year.
As described in note 10, certain securities available for sale are maintained to collateralize advances from the FHLB.
(4) Loans
Loans receivable as of June 30, 2003 and 2002 consisted of the following:
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
June 30, 2003 June 30, 2002 ------------- ------------- (Dollars in thousands) Mortgage loans: Single-family $ 131,821 $ 181,454 Multi-family & commercial real estate 155,892 134,294 Construction 36,191 29,306 Home equity 72,990 75,016 ------------- ------------- Total mortgage loans 396,894 420,070 Consumer loans 2,324 10,081 Commercial business loans 20,549 19,067 ------------- ------------- Total loans receivable 419,767 449,218
Allowance for loan losses (5,312) (4,626) Deferred loan fees (656) (737) ------------- ------------- Loans receivable, net $ 413,799 $ 443,855 ============= =============
Included in loans receivable are loans on non-accrual status in the amounts of $1.7 million, $4.0 million and $3.6 million at June 30, 2003, 2002 and 2001, respectively. Interest income that would have been recognized on such non-accrual loans during the years ended June 30, 2003, 2002 and 2001, had they been current in accordance with their original terms was $127,000, $257,000, and $695,000, respectively.
As of June 30, 2003, 2002 and 2001, the Company had impaired loans with a total recorded investment of $1.9 million, $3.4 million and $3.2 million, respectively, and an average recorded investment for the years ended June 30, 2003, 2002 and 2001 of $476,000, $1.8 million and $8.5 million, respectively. Cash of $124,000, $134,000 and $648,000 was collected on these impaired loans during the years ended June 30, 2003, 2002 and 2001, respectively. Interest income of $9,000, $80,000 and $366,000 was recognized on such loans during the years ended June 30, 2003, 2002 and 2001, respectively. As of June 30, 2003, 2002 and 2001, there were no recorded investments in impaired loans for which there was a related specific allowance for credit losses.
The following is a summary of the activity in the allowance for loan losses for the years ended June 30, 2003, 2002 and 2001:
For the year ended June 30, ------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- (Dollars in thousands)
Balance, beginning of the period $ 4,626 $ 4,313 $ 3,905 Provisions for loan losses 1,034 1,212 7,856 Charge-offs (391) (954) (7,449) Recoveries 43 55 1 ----------- ----------- ----------- Balance, end of the period $ 5,312 $ 4,626 $ 4,313 =========== =========== ===========
(5) Mortgage Servicing Activity
A summary of mortgage servicing rights activity follows:
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
For the year ended June 30, ------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- (Dollars in thousands)
Balance, beginning of the period $ 221 $ 340 $ 127 Originated servicing rights 179 -- 350 Amortization (180) (119) (137) ----------- ----------- ----------- Balance, end of the period $ 220 $ 221 $ 340 =========== =========== ===========
At June 30, 2003, 2002 and 2001, the Company serviced loans for others of $68.1 million, $58.3 million, and $91.5 million, respectively. Loans serviced by others for the Company as of June 30, 2003, 2002 and 2001 were $29.4 million, $28.9 million, and $6.9 million, respectively.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(6) Deposits
Deposit balances by type consisted of the following at June 30, 2003, and 2002:
- ------------------------ (1) Deposit balances in excess of $100,000 are not federally insured.
While certificates of deposit are frequently renewed at maturity rather than paid out, a summary of certificates of deposit by contractual maturity and rate at June 30, 2003 is as follows:
Year ending (Dollars in thousands) - --------------------- ---------------------- June 30, 2004 $ 195,504 June 30, 2005 69,916 June 30, 2006 12,160 June 30, 2007 13,436 June 30, 2008 3,208 Thereafter 5,570 --------------------- $ 299,794 =====================
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Interest expense on deposits for the years ended June 30, 2003, 2002 and 2001 consisted of the following:
For the year ended June 30, -------------------------------------- 2003 2002 2001 ---------- ---------- ---------- (Dollars in thousands) Savings accounts $ 923 $ 1,175 $ 1,102 Checking accounts 1,317 1,346 1,464 Certificates of deposit 10,569 14,810 17,806 ---------- ---------- ---------- Total $ 12,809 $ 17,331 $ 20,372 ========== ========== ==========
(7) Property and Equipment
Amounts charged to operating expense for depreciation for the years ended June 30, 2003, 2002 and 2001 amounted to $959,000, $883,000 and $723,000, respectively.
For the year ended June 30, --------------------------- 2003 2002 ----------- ----------- (Dollars in thousands) Depreciable life ---------------- Land $ 1,424 $ 1,423 Buildings nxnxnnxx 15 to 40 years 5,822 5,513 Furniture, fixtures and equipment 3 to 7 years 5,576 5,078 ----------- ----------- Total 12,822 12,014 Accumulated depreciated (6,458) (5,499) ----------- ----------- Property and equipment, net $ 6,364 $ 6,515 =========== ===========
(8) Income Taxes
The Small Business Job Protection Act of 1996, enacted on August 20, 1996, provides for the repeal of the tax bad debt deduction computed under the percentage of taxable income method. Upon repeal, the Company is required to recapture into income, over a six-year period, the portion of its tax bad debt reserves that exceeds its base year reserves (i.e., tax reserves for tax years beginning before 1988). The base year tax reserves, which may be subject to recapture if the Company ceases to qualify as a bank for federal income tax purposes, are restricted with respect to certain distributions. The Company's total tax bad debt reserves at June 30, 2003 are approximately $6.6 million, of which $6.2 million represents the base year amount and $400,000 is subject to recapture. The Company has previously recorded a deferred tax liability for the amount to be recaptured; therefore, this recapture does not impact the statement of income.
Income tax expense (benefit) for the years ended June 30, 2003, 2002 and 2001 consisted of the following:
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Current Deferred Total ------- -------- ------- (Dollars in thousands) For the year ended June 30, 2003 Federal $ 3,925 $ (417) $ 3,508 State 102 -- 102 ------- ------- ------- Total $ 4,027 $ (417) $ 3,610 ======= ======= =======
For the year ended June 30, 2002 Federal $ 2,988 $ (304) $ 2,684 State 6 -- 6 ------- ------- ------- Total $ 2,994 $ (304) $ 2,690 ======= ======= =======
For the year ended June 30, 2001 Federal $ 203 $ (244) $ (41) State 9 -- 9 ------- ------- ------- Total $ 212 $ (244) $ (32) ======= ======= =======
The expense (benefit) for income taxes differed from that computed at the statutory federal corporate rate for the years ended June 30, 2003, 2002 and 2001 as follows:
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Significant deferred tax assets and liabilities of the Company as of June 30, 2003 and 2002 are as follows:
June 30, ------------------------ 2003 2002 --------- --------- (Dollars in thousands)
Impairment reserves $ 113 $ 97 Deferred loan fees 171 250 Retirement plan reserves 452 398 Employee benefits 427 255 Intangible asset amortization 223 330 Capital loss carryover -- -- Charitable contributions -- -- Uncollected interest 53 50 Book bad debt reserves 1,806 1,573 Unrealized loss on available for sale securities -- -- Other, net 16 16 --------- --------- Gross deferred tax assets 3,261 2,969 --------- --------- Tax bad debt reserves -- -- Tax bad debt reserves in excess of base year (138) (275) Prepaid expenses (15) (15) Originated mortgage servicing rights (75) (75) Investment in Joint Venture (1) -- Gain on transfer of AFS securities (5) -- Unrealized gain on available for sale securities (1,158) (1,124) Depreciation (121) (69) --------- --------- Gross deferred tax liabilities (1,513) (1,558) --------- --------- Net tax deferred asset $ 1,748 $ 1,411 ========= =========
During the year ended June 30, 2003. the Company recorded deferred tax liabilities of $44,000 related to the adoption of FAS 147. The realizability of deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that the Company will realize the benefits of these deferred tax assets.
(9) Benefit Plans
The Company has a money purchase pension plan to which the Company contributes for all eligible employees. During the first six months of the fiscal year ended June 30, 2003, this contribution was 7.50% of their base salary and during the second six months, this contribution was 5.0% of their base salary. The expense of such plan was $229,000, $301,000, and $269,000 for the years ended June 30, 2003, 2002 and 2001, respectively.
The Company also has a 401(k) plan which covers all eligible employees and permits them to make certain contributions to the plan on a pretax basis. Employees are permitted to contribute up to 15% of salary to this plan. The Company matches fifty cents for every dollar contributed up to 10% of salary. The expense of such plan was $170,000, $158,000 and $134,000 for the years ended June 30, 2003, 2002 and 2001, respectively.
Effective June 30, 1998, the Company adopted non-qualified supplemental retirement plans for the Company's Board of Directors (the "Directors' Plan") and for the Company's president (the "President's Plan"). The Directors' Plan provides for fixed annual payments to qualified directors for a period of ten years from retirement. Benefits to
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
be paid accrue at the rate of 20% per year on completion of six full years of service, with full benefit accrual at ten years of service. At the time these plans were adopted credit was given for past service. The President's Plan provides for payments for a period of ten years beginning at retirement based on a percentage of annual compensation not to exceed an established cap. Full benefits become accrued at age 68 with partial vesting prior thereto. Both plans provide for full payments in the event of a change in control of the Company. The costs of each of the Directors' Plan and President's Plan were $150,000 and $60,000, $120,000 and $60,000, and $60,000 and $60,000 for fiscal years ended 2003, 2002 and 2001, respectively. The Directors' Plan and President's Plan are intended to be, and are, unfunded.
ESOP
In December 23, 1998, the Company adopted an ESOP. The ESOP borrowed $1.8 million from the Company and used the funds to purchase 408,769 shares (179,270 shares pre-exchange) of the Company's common stock. The loan has an interest rate of 7.75% and has an amortization schedule of 15 years. The April 2002 Reorganization resulted in an additional ESOP loan of $5.1 million to purchase an additional 513,130 shares of the Company's common stock issued in the Reorganization. This loan has an interest rate of 4.75% and an amortization schedule of 15 years. Shares purchased are held in a suspense account for allocation among the participants as the loans are repaid. Contributions to the ESOP and shares released from the loan collateral will be in an amount proportional to repayment of the ESOP loans. Shares are allocated to participants based on compensation as described in the ESOP, in the year of allocation. At June 30, 2003, there were 127,162 ESOP shares allocated to participants, representing a fair value of $2.2 million, in addition, there were 30,730 shares committed to be released. The Company recorded compensation expense of $824,000, $338,000, and $138,000 for the ESOP for the years ended June 30, 2003, 2002 and 2001, respectively.
RRP
Pursuant to the 1999 Recognition and Retention Plan and Trust Agreement (the "1999 RRP"), the Company acquired 204,384 shares (89,635 shares pre-exchange) at a cost of $929,000. Pursuant to the terms of the agreement, all 204,384 shares have been awarded to directors and management from the 1999 RRP Trust. As of June 30, 2003, 109,803 granted shares were vested pursuant to the terms of the 1999 Plan. In fiscal 2003, the Company adopted the 2002 Recognition and Retention Plan and Trust Agreement (the "2002 RRP"), and acquired 256,565 shares at a cost of $2.2 million. Pursuant to the terms of the 2002 RRP 222,468 shares have been awarded to directors and management, none of which were vested at June 30, 2003.
At June 30, 2003, the deferred cost of unearned 1999 and 2002 RRP shares totaled $513,000 and is recorded as a charge against stockholders' equity. Compensation expense on 1999 and 2002 RRP shares granted is recognized ratably over the five year vesting period in an amount which totals the market price of the Company's stock at the date of grant. The Company recorded compensation expense of $500,000, $162,000 and $162,000 related to both these plans for the years ended June 30, 2003, 2002 and 2001, respectively.
Stock Option Plan
The stockholders of the Company approved a stock option plan in fiscal 2000 (the "1999 Plan") for officers, directors and certain employees of the Company and its subsidiaries. Pursuant to the terms of the 1999 Plan, the number of common shares reserved for issuance is 510,963 (224,087 shares pre-exchange) of which 11,400 options remain unawarded. Additionally the stockholders of the Company approved a stock option plan in fiscal 2003 (the "2002 Plan") for officers, directors and certain employees of the Company and its subsidiaries. Pursuant to the terms of the 2002 Plan, the number of common shares reserved for issuance is 641,412 of which 93,992 remain unawarded at June 30, 2003. All options were granted with an exercise price equal to fair market value at the date of grant and expire in 10 years from the date of grant. All stock options granted vest over a five year period commencing on the first anniversary of the date of grant.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
A summary of the status of the 1999 and 2002 Plans as of June 30, 2003 and changes during the year is presented below:
SFAS No 123, "Accounting for Stock-based Compensation" encourages, but does not require, the adoption of fair-value accounting for stock-based compensation to employees. The Company, as permitted, has elected not to adopt the fair value accounting provisions of SFAS 123, and has instead continued to apply APB Opinion 25 and related interpretations in accounting for the 1999 and 2002 Plans and to provide the required proforma disclosures for SFAS No. 123. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
For the year ended June 30, -------------------------------------- 2003 2002 2001 ---------- ---------- ---------- (Dollars in thousands, except per share data) Net income As reported $ 7,489 $ 5,551 $ 157 Pro-forma 7,276 5,443 62
Basic earnings per share As reported $0.75 $0.53 $0.01 Pro-forma $0.73 $0.52 $0.01
Diluted earnings per share As reported $0.71 $0.52 $0.01 Pro-forma $0.69 $0.51 $0.01
Dividend yield 2.67% 2.75% n/a Volatility 21.70% 27.74% n/a Expected term 7.5 years 7.5 years n/a Risk-free interest rate 3.88% 4.41% n/a
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
The following table summarizes all stock options outstanding for the 1999 and 2002 Plans as of June 30, 2003, segmented by range of exercise prices:
Total outstanding options at June 30, 2003 Range of exercisable prices $3.97 to $15.88 Number outstanding 935,706 Weighted average remaining contractual life 8.52 years Weighted average exercise price $9.94
Exercisable options at June 30, 2003 Number outstanding 123,800 Weighted average exercise price $4.98
(10) Federal Home Loan Bank Advances
Under terms of its collateral agreement with the FHLB, the Company maintains otherwise unencumbered qualifying assets (principally qualifying 1-4 family residential mortgage loans and U.S. government agency, and mortgage-backed securities) in the amount of at least as much as its advances from the FHLB. The Company's FHLB stock is also pledged to secure these advances.
At June 30, 2003, such advances have contractual maturities as follows:
Amount Weighted outstanding average rate ----------- ------------ (dollars in thousands) Due by: June 30, 2004 $ 18,706 1.67% June 30, 2005 13,403 3.32 June 30, 2006 8,820 3.65 June 30, 2007 24,123 4.26 June 30, 2008 5,005 3.68 Thereafter 62,500 4.47 ----------- Total $ 132,557 3.84% ===========
At June 30, 2003, $70.5 million of the above advances were callable at the direction of the FHLB within certain parameters, of which $56.5 million could be called within one year.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(11) Commitments and Contingencies
At June 30, 2003 and 2002, the Company was committed to fund loans as follows:
June 30, ------------------------- 2003 2002 ---------- ---------- (Dollars in thousands)
Loans with fixed interest rates $ 16,936 $ 11,090 Loans with variable interest rates 12,072 29,082 ---------- ---------- Total commitments to fund loans $ 29,008 $ 40,172 ========== ==========
Financial Instruments With Off-Balance Sheet Risk
In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. At June 30, 2003 the Company is committed to the funding of first mortgage loans of approximately $17.4 million, construction loans of approximately $7.6 million, commercial business loans of approximately $3.0 million, and commercial real estate loans of $ 1.0 million.
The Company uses the same credit policies in extending commitments as it does for on-balance sheet instruments. The Company attempts to control its exposure to loss from these agreements through credit approval processes and monitoring procedures. Commitments to extend credit are generally issued for one year or less and may require payment of a fee. The total commitment amounts do not necessarily represent future cash disbursements, as many of the commitments expire without being drawn upon. The Company may require collateral in extending commitments, which may include cash, accounts receivable, securities, real or personal property, or other assets. For those commitments which require collateral, the value of the collateral generally equals or exceeds the amount of the commitment.
Concentration of Credit Risk
The Company offers residential and construction real estate loans as well as commercial and consumer loans. The Company's lending activities are concentrated in Pennsylvania. The largest concentration of the Company's loan portfolio is located in eastern Pennsylvania. The ability of the Company's borrowers to repay amounts owed is dependent on several factors, including the economic conditions in the borrower's geographic region and the borrower's financial condition.
Legal Proceedings
Brenda DiCicco v. Willow Grove Bank, (United States District Court, Eastern District of Pennsylvania). On October 11, 2002, a lawsuit was filed against Willow Grove Bank by Ms. DiCicco in her individual capacity as president and sole shareholder of ATS Products Corp. ("ATS") alleging eight causes of action related to a line of credit between the Bank and ATS. The complaint has since been amended to add Mr. Marcell and one present and one former employee of the Bank as defendants. The causes of action are: breach of contract, breach of oral contract, fraud, negligent misrepresentation, breach of fiduciary duty, unjust enrichment, conversion and negligence. The plaintiff seeks a multi-million dollar recovery for compensatory damages, punitive damages, attorney fees and costs. ATS previously filed suit against the Bank in the U.S. Bankruptcy Court averring similar causes of action. The Bank is vigorously defending the claims made by the plaintiff in both suits and believes that those claims are without merit.
Irvine Construction Co. v. Sklaroff, et al., (Court of Common Pleas of Montgomery County, Pennsylvania). On September 5, 2003, a lawsuit was filed against Willow Grove Bank and eight additional defendants by Irvine Construction Co., Inc., alleging thirteen causes of action related to an agreement for the construction of an office building. Eleven of such causes of action include the Bank as a defendant and are: breach of contract (two counts), unjust enrichment/equitable restitution (in the alternative), fraud, civil conspiracy (two counts), fraudulent transfer and aiding and abetting fraudulent transfers, constructive trust, abuse of process, and tortuous interference with
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
existing contractual relations (two counts). Four counts against the Bank seek damages in excess of $1.0 million, five counts seek damages in excess of $50,000, punitive damages and other relief, and two counts seek constructive relief. Willow Grove Bank anticipates that it will vigorously defend the claims made by the plaintiff and believes that those claims are without merit .
Other than the above referenced litigation, the Company is involved in various legal proceedings occurring in the ordinary course of business. Management of the Company, based on discussions with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of the Company. There can be no assurance that any of the outstanding legal proceedings to which the Company is a party will not be decided adversely to the Company's interests and have a material adverse effect on the financial condition and operations of the Company.
Other Commitments
In connection with the operation of fourteen of its banking offices and an operations center, the Company leases certain office space. The leases are classified as operating leases, with rent expense of $692,000, $577,000 and $485,000 for the years ended June 30, 2003, 2002 and 2001, respectively. Minimum payments over the remainder of the lease are summarized as follows:
Minimum lease payments ---------------------- (Dollars in thousands) Year ended: June 30, 2004 $ 634 June 30, 2005 549 June 30, 2006 529 June 30, 2007 499 Thereafter 449 ----------- Total $ 2,660 ===========
(12) Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain certain minimum amounts and ratios (set forth in the table below). Management believes that the Bank meets, as of June 30, 2003, all capital adequacy requirements to which it is subject.
As of June 30, 2003 the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
The Bank's actual capital amounts and ratios are presented in the following table.
The Bank is not under any agreement with the regulatory authorities nor is it aware of any current recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on liquidity, capital resources, or operations of the Bank.
(13) Fair Value of Financial Instruments
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
The Company's methods for determining the fair value of its financial instruments as well as significant assumptions and limitations are set forth below.
Limitations
Estimates of fair value are made at a specific point in time, based upon, where available, relevant market prices and information about the financial instrument. Such estimates do not include any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. For a substantial portion of the Company's financial instruments, no quoted market exists. Therefore, estimates of fair value are necessarily based on a number of significant assumptions (many of which involve events outside the control of management). Such assumptions include assessments of current economic condition, perceived risks associated with these financial instruments and their counterparties, future expected loss experience, and other factors. Given the uncertainties surrounding these assumptions, the reported fair values represent estimates only and, therefore, cannot be compared to the historical accounting model. Use of different assumptions or methodologies is likely to result in significantly different fair value estimates.
The estimated fair values presented neither include nor give effect to the values associated with the Company's banking or other businesses, existing customer relationships, branch banking network, property, equipment, goodwill, or certain tax implications related to the realization of unrealized gains or losses. The fair value of non-interest-bearing demand deposits, savings and NOW accounts, and money market deposit accounts is equal to the carrying amount because these deposits have no stated maturity. This approach to estimating fair value excludes the significant benefit that results from the low-cost funding provided by such deposit liabilities, as compared to alternative sources of funding. As a consequence, this presentation may distort the actual fair value of a banking organization that is a going concern.
The following methods and assumptions were used to estimate the fair value of each major classification of financial instruments at June 30, 2003 and 2002:
Cash and Cash Equivalents, Accrued Interest Receivable, Deposits with No Stated Maturity, and Accrued Interest Payable
These financial instruments have carrying values that approximate fair value.
Securities Available for Sale
Current quoted market prices were used to determine fair value.
Loans
Fair values were estimated for portfolios of loans with similar financial characteristics. Loans were segregated by type and each loan category was further segmented by fixed and adjustable-rate interest terms. The estimated fair value of the segregated portfolios was calculated by discounting cash flows based on estimated maturity and prepayment speeds using estimated market discounted rates that reflected credit and interest risk inherent in the loans. The estimate of the maturities and prepayment speeds was based on the Company's historical experience. Cash flows were discounted using market rates adjusted for portfolio differences.
Loans Available for Sale
The fair value of mortgage loans originated and intended for sale in the secondary market is based on contractual cash flows using current market rates, calculated on an aggregate basis.
Certificates of Deposit
Fair value was estimated by discounting the contractual cash flows using current market rates offered in the Company's market area for deposits with comparable terms and maturities.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
FHLB Advances
Fair value was estimated using discounted cash flow analysis based on the Company's current incremental borrowing rate for similar types of borrowing arrangements.
Commitments to Extend Credit
The majority of the Company's commitments to extend credit carry current interest rates if converted to loans. Because commitments to extend credit are generally unassignable by either the Company or the borrower, they only have value to the Company and the borrower. The estimated fair value approximates the recorded deferred fee amounts.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
The carrying amounts and estimated fair values of the Company's financial instruments, including off-balance sheet financial instruments, were at June 30, 2003 and 2002:
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(14) Comprehensive Income (Loss)
The tax effects allocated to each component of "Other comprehensive income" are as follows:
(15) Dividend Policy
The Company's ability to pay dividends is dependent, in part, upon its ability to obtain dividends from the Bank. The future dividend policy of the Company is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial conditions, cash needs, and general business conditions. Holders of common stock will be entitled to receive dividends as and when declared by the Board of Directors of the Company out of funds legally available for that purpose. Such payment, however, will be subject to the regulatory restrictions set forth by the OTS. In addition, OTS regulations provides that, as a general rule, a financial institution may not make a capital distribution if it would be undercapitalized after making the capital distribution.
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
(16) Parent Company Financial Information (Willow Grove Bancorp, Inc.)
Condensed Statement of Financial Condition
Condensed Statement of Income
Willow Grove Bancorp, Inc. Notes to Consolidated Financial Statements
Condensed Statement of Cash Flows
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and regulations and are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference from pages 3-5 and page 15 of the definitive proxy statement of the Company for the Annual Meeting of Stockholders to be held on November 12, 2003, which will be filed within 120 days of June 30, 2003 ("Definitive Proxy Statement").
Item 11.
Item 11. Executive Compensation
The information required herein is incorporated by reference from pages 7 to 12 of the Definitive Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required herein is incorporated by reference from pages 13 to 15 of the Definitive Proxy Statement.
Equity Compensation Plan Information
The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of June 30, 2003.
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(1) Includes 312,779 shares granted to directors and employees as of June 30, 2003 and held in the recognition plan trust.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from page 11 of the Definitive Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required under Item 9 (e) of Schedule 14A of Regulation S-K is incorporated by reference from page 16 of the Definitive Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents Filed as Part of this Report. ---------------------------------------
(1) The following financial statements are incorporated by reference from Item 8 hereof:
Independent Auditors' Report Consolidated Statements of Financial Condition Consolidated Statements of Income Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements
(2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index.
Exhibit Index -------------
2.1 Plan of Conversion and Agreement and Plan of Reorganization (1) 3.1 Articles of Incorporation of Willow Grove Bancorp, Inc. (1) 3.2 Bylaws of Willow Grove Bancorp, Inc. (1) 4.0 Form of Stock Certificate of Willow Grove Bancorp, Inc. (1)
10.1 Form of Employment Agreement entered into between Willow Grove Bank and Frederick A. Marcell, Jr. (2) 10.2 Form of Employment Agreement entered into between Willow Grove Bank and each of Joseph M. Matisoff, Christopher E. Bell, Thomas M. Fewer and John T. Powers (2) 10.3 Supplemental Executive Retirement Agreement (2) 10.4 Non-Employee Directors Retirement Plan (3) 10.5 1999 Stock Option Plan (4) 10.6 1999 Recognition and Retention Plan and Trust Agreement (4) 10.7 Amended Directors and Officers Incentive Compensation Plan (5) 10.8 2002 Stock Option Plan (6) 10.9 2002 Recognition and Retention Plan and Trust Agreement (6) 21.0 Subsidiaries of the Registrant - Reference is made to "Item 1. Business Subsidiaries" for the required information 23.0 Consent of KPMG LLP 31.1 Section 302 Certification of the Chief Executive Officer 31.2 Section 302 Certification of the Chief Financial Officer 32.1 Section 906 Certification of the Chief Executive Officer 32.2 Section 906 Certification of the Chief Financial Officer
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(1) Incorporated by reference from the Company's Registration Statement on Form S-1 filed on December 14, 2001, as amended, and declared effective on February 11, 2002 (Registration No. 333-75106).
(2) Incorporated by reference from the registration statement on Form S-1 filed by the Company's predecessor, a federal corporation also known as Willow Grove Bancorp, Inc. (the "Mid-Tier") on September 18, 1998, as amended, and declared effective on November 12, 1998 (Registration No. 333-63737).
(3) Incorporated by reference from the Company's Form 10-Q for the quarter ended September 30, 2002, filed with the SEC on November 14, 2002 (SEC File No. 000-49706)
(4) Incorporated by reference from the Definitive Proxy Statement on Schedule 14A filed by the Mid-Tier on June 23, 1999 (SEC File No. 000-25191).
(5) Incorporated by reference from the Company's Form 10-K for the fiscal year ended June 30, 2002, filed with the SEC on September 30, 2002 (SEC File No. 000-49706).
(6) Incorporated by reference from the Company's Definitive Proxy Statement on Schedule 14A filed on October 9, 2002 (SEC File No. 000-49706).
(b) Reports on Form 8-K
(1) On April 23, 2003, the Company furnished a Form 8-K that included a press release announcing third quarter results and the declaration of an cash dividend.
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.
Willow Grove Bancorp, Inc.
By: /s/ Frederick A. Marcell Jr. -------------------------------------------- Frederick A. Marcell Jr. President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Lewis W. Hull September 23, 2003 - ----------------------------------------------- Lewis W. Hull Director
/s/ Charles F. Kremp, 3rd September 23, 2003 - ----------------------------------------------- Charles F. Kremp 3rd Director
/s/ William W. Langan September 23, 2003 - ----------------------------------------------- William W. Langan Chairman of the Board
/s/ Rosemary C. Loring September 23, 2003 - ----------------------------------------------- Rosemary C. Loring Director
/s/ Frederick A. Marcell Jr. September 23, 2003 - ----------------------------------------------- Frederick A. Marcell Jr. Director, President and Chief Executive Officer
/s/ A. Brent O'Brien September 23, 2003 - ----------------------------------------------- A. Brent O'Brien Director
/s/ Samuel H. Ramsey, III September 23, 2003 - ----------------------------------------------- Samuel H. Ramsey, III Director
/s/ William B. Weihenmayer September 23, 2003 - ----------------------------------------------- William B. Weihenmayer Director
/s/ Christopher E. Bell September 23, 2003 - ----------------------------------------------- Christopher E. Bell Senior Vice President and Chief Financial Officer (principal financial officer)