Item 1. Business
The Company is a Pennsylvania business corporation headquartered at 1240 Broadcasting Road, Wyomissing, Pennsylvania 19610. The Company was organized as a bank holding company on January 1, 1986. The Company's election with the Board of Governors of the Federal Reserve System to become a financial holding company became effective on February 7, 2002. The Company offers a wide array of financial services through its various subsidiaries. The Company's executive offices are located at 1240 Broadcasting Road, Wyomissing, Pennsylvania 19610.
At December 31, 2005, the Company had total assets of $965.8 million, total shareholders' equity of $94.8 million, and total deposits of $659.7 million.
The Bank
The Company's wholly-owned banking subsidiary is Leesport Bank ("Leesport Bank" or the "Bank"), a Pennsylvania chartered commercial bank. During the year ended December 31, 2000, the charters of The First National Bank of Leesport and Merchants Bank of Pennsylvania, both wholly-
owned banking subsidiaries of the Company at that time, were merged into a single charter under the name Leesport Bank. The First National Bank of Leesport was incorporated under the laws of the United States of America as a national bank in 1909. Leesport Bank operates in Berks, Schuylkill, Philadelphia, Delaware and Montgomery counties in Pennsylvania.
On October 1, 2004, the Company acquired 100% of the outstanding voting shares of Madison Bancshares Group, Ltd., the holding company for Madison Bank ("Madison"), a Pennsylvania state-chartered commercial bank and its mortgage banking division, Philadelphia Financial Mortgage Company ("PFM" or "Philadelphia Financial"). Madison and PFM are both now divisions of Leesport Bank. The transaction enhances the Bank's strong presence in Pennsylvania, particularly in the high growth counties of Berks, Philadelphia, Montgomery and Delaware.
At December 31, 2005, the Bank had the equivalent of 229 full-time employees.
Leesport Bank provides services to its customers through nineteen full service financial centers, which operate under Leesport Bank's name in Leesport, Blandon, Bern Township, Wyomissing, Breezy Corner, Hamburg, Birdsboro, Northeast Reading, Exeter Township, and Sinking Spring all of which are in Berks County, Pennsylvania. Leesport Bank also operates a financial center in Schuylkill Haven, which is located in Schuylkill County. Through its 2004 acquisition of Madison, Leesport Bank operates Madison division financial centers in Blue Bell, Conshohocken, Lansdale, Horsham, Oaks and Centre Square all of which are in Montgomery County, Pennsylvania. The Bank also operates Madison division branches in Fox Chase (northeast Philadelphia) in Philadelphia County, Pennsylvania and Strafford in Delaware County, Pennsylvania. The Bank also operates a limited service facility in Wernersville, Berks County, Pennsylvania. All full service facilities provide automated teller machine services. Each financial center, except the Wernersville and Breezy Corner locations, provide drive-in facilities.
Leesport Bank provides mortgage banking services to its customers through Philadelphia Financial through offices in Reading, Blue Bell, Camp Hill and Lancaster, which are located in Berks County Pennsylvania, Montgomery County Pennsylvania, Cumberland County Pennsylvania and Lancaster County Pennsylvania, respectively.
The Bank engages in full service commercial and consumer banking business, including such services as accepting deposits in the form of time, demand and savings accounts. Such time deposits include certificates of deposit, individual retirement accounts and Roth IRAs. The Bank's savings accounts include money market accounts, health savings accounts, club accounts, NOW accounts and traditional regular savings accounts. In addition to accepting deposits, the Bank makes both secured and unsecured commercial and consumer loans, finances commercial transactions, provides equipment lease and accounts receivable financing, makes construction and mortgage loans, including home equity loans. The Bank also provides small business loans and student loans. The Bank also provides other services including rents for safe deposit facilities.
In July 2005, the Company purchased a 25% equity position in First HSA, Inc. headed by Dr. William West, the Company began offering its customers Health Savings Accounts ("HSA"). At December 31, 2005, the Company has grown its HSA business to more than ten thousand accounts with approximately $14.7 million in deposits. The Company anticipates this business to grow rapidly as HSA accounts become a popular low cost vehicle for medical insurance. The Company believes its head start in this business will give it an advantage in raising deposits in 2006.
Subsidiary Activities
Effective February 13, 2003, both Leesport Wealth Management, Inc., an SEC-registered investment advisory business acquired in 1999 and Leesport Investment Group, Inc, which was formed in 1999 to purchase a securities brokerage business, were converted to limited liability companies, and became subsidiaries of the Company and no longer subsidiaries of the Bank. Effective January 1, 2005,
Leesport Investment Group, LLC merged into Leesport Wealth Management, LLC at which time Leesport Wealth Management, LLC changed its name to Madison Financial Advisors, LLC ("Madison Financial").
Madison Financial, which includes the acquisition of certain assets of First Affiliated Investment Group, an investment management and brokerage firm, as of September 1, 2002, are headquartered at 1240 Broadcasting Road, Wyomissing, Pennsylvania and collectively had 9 full-time employees at December 31, 2005.
Effective October 1, 2002, Essick & Barr, Inc., a Berks County based general insurance agency ("Essick & Barr") was converted to a limited liability company, and became a subsidiary of the Company and no longer a subsidiary of the Bank.
Essick & Barr, which includes The Boothby Group, a property and casualty and employee benefits insurance agency acquired as of October 1, 2002, offers a full line of personal and commercial property and casualty insurance as well as group insurance for businesses, employee benefit plans, and life insurance. Effective September 30, 2003, Essick & Barr acquired certain assets of CrosStates Insurance Consultants, Inc., a full service insurance agency that specializes in personal property and casualty insurance located in Langhorne, Pennsylvania. Effective January 1, 2005, CrosStates Insurance Consultants, Inc. changed its name to Madison Insurance Consultants. Essick & Barr is headquartered in Reading, Pennsylvania with sales offices at 108 South Fifth Street, Reading, Pennsylvania; 460 Norristown Road, Blue Bell, Pennsylvania, 1240 Broadcasting Road, Wyomissing, Pennsylvania; and 2300 E. Lincoln Highway, Langhorne, Pennsylvania. Essick & Barr had 69 full-time employees at December 31, 2005.
The Bank had two wholly-owned subsidiaries as of December 31, 2005: Leesport Realty Solutions, LLC, which was formed during 2000 to provide title insurance and other real estate related services to its customers through limited partnership arrangements with third parties involved in the real estate services industry; and Leesport Mortgage, LLC, a 60% owned subsidiary, which was jointly formed with a real estate company in May of 2002, to provide mortgage brokerage services, including, without limitation, any activity in which a mortgage broker may engage. It is operated as a permissible "affiliated business arrangement" within the meaning of the Real Estate Settlement Procedures Act of 1974.
Leesport Realty Solutions, LLC provides title insurance and other real estate related services to the Company's customers through limited partnership arrangements with unaffiliated third parties involved in the real estate services industry. At December 31, 2003, Leesport Realty Solutions, LLC had entered into four such arrangements as follows: Leesport Search and Settlement Solutions (70% equity interest); New Millennium Abstract (5% equity interest); Spectrum Settlement Agency (4% equity interest); and Benson Settlement Company (35% equity interest). The capital contributions of Leesport Realty Solutions, LLC in connection with the formation of each of the limited partnerships were not material. None of the limited partnership arrangements involves the use of a special purposes entity for financial accounting purposes or any off-balance sheet financing technique. Neither the Company nor any other affiliate of the Company nor Leesport Realty Solutions, LLC has any continuing contractual financial commitment to the limited partnerships beyond the amount of the initial capital contribution. At December 31, 2005, Leesport Realty Solutions, LLC had no full-time equivalent employees.
The Company also owns First Leesport Capital Trust I (the "Trust"), a Delaware statutory business trust formed on March 9, 2000, in which the Company owns all of the common equity. The Trust has outstanding $5 million of 107/8% fixed rate mandatory redeemable capital securities. These securities must be redeemed in March 2030, but may be redeemed on or after March 9, 2010 or earlier in the event that the interest expense becomes non-deductible for federal income tax purpose or if these securities no longer qualify as Tier I capital for the Company. In October, 2002 the Company entered
into an interest rate swap agreement that effectively converts the securities to a floating interest rate of six month LIBOR plus 5.25%. In June, 2003 the Company purchased a six month LIBOR cap to create protection against rising interest rates for the interest rate swap.
On September 26, 2002, the Company established Leesport Capital Trust II, a Delaware statutory business trust, in which the Company owns all of the common equity. Leesport Capital Trust II issued $10 million of mandatory redeemable capital securities carrying a floating interest rate of three month LIBOR plus 3.45%. These securities must be redeemed in September 2032, but may be redeemed on or after September 26, 2007 or earlier in the event that the interest expense becomes non-deductible for federal income tax purposes or if these securities no longer qualify as Tier I capital for the Company.
On June 26, 2003, Madison established Madison Statutory Trust I, a Connecticut statutory business trust. Pursuant to the purchase of Madison on October 1, 2004, the Company assumed Madison Statutory Trust I in which the Company owns all of the common equity. Madison Statutory Trust I issued $5 million of mandatory redeemable capital securities carrying a floating interest rate of three month LIBOR plus 3.10%. These securities must be redeemed in June 2033, but may be redeemed on or after September 26, 2008 or earlier in the event that the interest expense becomes non-deductible for federal income tax purposes or if the treatment of these securities is no longer qualified as Tier I capital for the Company.
Competition
The Company faces substantial competition in originating loans, in attracting deposits, and generating fee-based income. This competition comes principally from other banks, savings institutions, credit unions, mortgage banking companies and, with respect to deposits, institutions offering investment alternatives, including money market funds. Competition also comes from other insurance agencies and direct writing insurance companies. Due to the passage of landmark banking legislation in November 1999, competition may increasingly come from insurance companies, large securities firms and other financial services institutions. As a result of consolidation in the banking industry, some of the Company's competitors and their respective affiliates may enjoy advantages such as greater financial resources, a wider geographic presence, a wider array of services, or more favorable pricing alternatives and lower origination and operating costs.
Supervision and Regulation
General
The Company is registered as a bank holding company, which has elected to be treated as a financial holding company, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Act of 1956, as amended. As a bank holding company, the Company's activities and those of its bank subsidiary are limited to the business of banking and activities closely related or incidental to banking. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board, pursuant to such regulations, may require the Company to stand ready to use its resources to provide adequate capital funds to its bank subsidiary during periods of financial stress or adversity.
The Bank Holding Company Act prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank, or from merging or consolidating with another bank holding company, without prior approval of the Federal Reserve Board. Additionally, the Bank Holding Company Act prohibits the
Company from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business, unless such business is determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. The types of businesses that are permissible for bank holding companies to own were expanded by the Gramm-Leach-Bliley Act in 1999.
As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking Code, the Company is also subject to regulation and examination by the Pennsylvania Department of Banking.
The Company is under the jurisdiction of the Securities and Exchange Commission and of state securities commissions for matters relating to the offering and sale of its securities. In addition, the Company is subject to the Securities and Exchange Commission's rules and regulations relating to periodic reporting, proxy solicitation, and insider trading.
Regulation of Leesport Bank
Leesport Bank is a Pennsylvania chartered commercial bank, and its deposits are insured (up to applicable limits) by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is subject to regulation and examination by the Pennsylvania Department of Banking and by the FDIC. The Community Reinvestment Act requires Leesport Bank to help meet the credit needs of the entire community where Leesport Bank operates, including low and moderate income neighborhoods. Leesport Bank's rating under the Community Reinvestment Act, assigned by the FDIC pursuant to an examination of Leesport Bank, is important in determining whether the Bank may receive approval for, or utilize certain streamlined procedures in, applications to engage in new activities.
Leesport Bank is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of Leesport Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.
Capital Adequacy Guidelines
Bank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be "Tier 1 capital," consisting principally of common shareholders' equity, less certain intangible assets. The remainder ("Tier 2 capital") may consist of certain preferred stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, and a limited amount of the general loan loss allowance. The risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities.
In addition to the risk-based capital guidelines, the Federal Reserve Board requires a bank holding company to maintain a leverage ratio of a minimum level of Tier 1 capital (as determined under the risk-based capital guidelines) equal to 3% of average total consolidated assets for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 1% to 2% above the stated minimum. The Pennsylvania Department of Banking requires state chartered banks to maintain a 6% leverage capital level and 10% risk based capital, defined substantially the same as the federal regulations. The Bank is subject to almost identical capital requirements adopted by the FDIC.
Prompt Corrective Action Rules
The federal banking agencies have regulations defining the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a "well-capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings). The Company and the Bank each satisfy the criteria to be classified as "well capitalized" within the meaning of applicable regulations.
Regulatory Restrictions on Dividends
Dividend payments made by Leesport Bank to the Company are subject to the Pennsylvania Banking Code, the Federal Deposit Insurance Act, and the regulations of the FDIC. Under the Banking Code, no dividends may be paid except from "accumulated net earnings" (generally, retained earnings). The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends if they are not classified as well capitalized or adequately capitalized.
Under these policies and subject to the restrictions applicable to the Bank, the Bank had approximately $6.5 million available for payment of dividends to the Company at December 31, 2005, without prior regulatory approval.
FDIC Insurance Assessments
The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each depository institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-based assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. As of December 31, 2005, the Bank was well capitalized for purposes of calculating insurance assessments.
In 2005, the Bank Insurance Fund was fully funded at more than the minimum amount required by law. Accordingly, the 2005 Bank Insurance Fund assessment rates ranged from zero for those institutions with the least risk, to $0.27 for every $100 of insured deposits for institutions deemed to have the highest risk. The Bank is in the category of institutions that presently pay nothing for deposit insurance.
While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the Financing Corporation bonds. Beginning in 2000, commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds. The FDIC sets the Financing Corporation assessment rate every quarter. The Financing Corporation
assessment for the Bank (and all other banks) for the fourth quarter of 2005 is an annual rate of $.0134 for each $100 of deposits.
In February 2006, deposit insurance modernization legislation was enacted. The new law merges the BIF and SAIF into a single Deposit Insurance Fund, increases deposit insurance coverage for IRAs to $250,000, provides for the future increase of deposit insurance on all accounts by authorizing the FDIC to index the coverage to the rate of inflation, authorizes the FDIC to set the reserve ratio of the combined Deposit Insurance Fund at a level between 1.15% and 1.50%, and permits the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios. New deposit insurance assessment rates will not be known until the FDIC conducts extensive research and issues new assessment rates, expected by the fourth quarter of 2006. While the possible assessment rates are unknown, the FDIC has stated that it expects that all banks will be assessed some amount for deposit insurance based upon present expectations. Banks in existence prior to 1996 will receive a partial credit for past deposit insurance premiums paid, but the amount of the credit for a specific bank will not be known until new regulations implementing the assessments and the credits are adopted.
Other Legislation
The Gramm-Leach-Bliley Act, passed in 1999, dramatically changed certain banking laws. One of the most significant changes was that the separation between banking and the securities businesses mandated by the Glass-Steagall Act has now been removed, and the provisions of any state law that prohibits affiliation between banking and insurance entities have been preempted. Accordingly, the legislation now permits firms engaged in underwriting and dealing in securities, and insurance companies, to own banking entities, and permits bank holding companies (and in some cases, banks) to own securities firms and insurance companies. The provisions of federal law that preclude banking entities from engaging in non-financially related activities, such as manufacturing, have not been changed. For example, a manufacturing company cannot own a bank and become a bank holding company, and a bank holding company cannot own a subsidiary that is not engaged in financial activities, as defined by the regulators.
The legislation creates a new category of bank holding company called a "financial holding company." In order to avail itself of the expanded financial activities permitted under the law, a bank holding company must notify the Federal Reserve Board ("Federal Reserve") that it elects to be a financial holding company. A bank holding company can make this election if it, and all its bank subsidiaries, are well capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating, each in accordance with the definitions prescribed by the Federal Reserve and the regulators of the subsidiary banks. Once a bank holding company makes such an election, and provided that the Federal Reserve does not object to such election by such bank holding company, the financial holding company may engage in financial activities (i.e., securities underwriting, insurance underwriting, and certain other activities that are financial in nature as to be determined by the Federal Reserve) by simply giving a notice to the Federal Reserve within thirty days after beginning such business or acquiring a company engaged in such business. This makes the regulatory approval process to engage in financial activities much more streamlined than under prior law.
On February 7, 2002, the Company's election with the Board of Governors of the Federal Reserve System to become a financial holding company became effective.
The Sarbanes-Oxley Act of 2002 was enacted to enhance penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures under the federal securities laws. The Sarbanes-Oxley Act generally applies to all companies, including the Company, that file or are required to file periodic reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934, or the Exchange Act. The legislation includes provisions, among other things, governing the services that can be
provided by a public company's independent auditors and the procedures for approving such services, requiring the chief executive officer and chief financial officer to certify certain matters relating to the company's periodic filings under the Exchange Act, requiring expedited filings of reports by insiders of their securities transactions and containing other provisions relating to insider conflicts of interest, increasing disclosure requirements relating to critical financial accounting policies and their application, increasing penalties for securities law violations, and creating a new public accounting oversight board, a regulatory body subject to SEC jurisdiction with broad powers to set auditing, quality control and ethics standards for accounting firms. In connection with this legislation, the national securities exchanges and Nasdaq have adopted rules relating to certain matters, including the independence of members of a company's audit committee, as a condition to listing or continued listing. The Company does not believe that the application of these rules to the Company will have a material effect on its business, financial condition or results of operations.
The USA PATRIOT Act, enacted in direct response to the terrorist attacks on September 11, 2001, strengthens the anti-money laundering provisions of the Bank Secrecy Act. Many of the new provisions added by the Act apply to accounts at or held by foreign banks, or accounts of or transactions with foreign entities. While the Bank does not have a significant foreign business, the new requirements of the Bank Secrecy Act still require the Bank to use proper procedures to identify its customers. The Act also requires the banking regulators to consider a bank's record of compliance under the Bank Secrecy Act in acting on any application filed by a bank. As the Bank is subject to the provisions of the Bank Secrecy Act (i.e., reporting of cash transactions in excess of $10,000), the Bank's record of compliance in this area will be an additional factor in any applications filed by it in the future. To the Bank's knowledge, its record of compliance in this area is satisfactory.
The Fair and Accurate Credit Transaction Act was adopted in 2003. It extends and expands upon provisions in the Fair Credit Reporting Act, affecting the reporting of delinquent payments by customers and denials of credit applications. The revised act imposes additional record keeping, reporting, and customer disclosure requirements on all financial institutions, including the Bank. Also in late 2003, the Check 21 Act was adopted. This Act affects the way checks can be processed in the banking system, allowing payments to be converted to electronic transfers rather than processed as traditional paper checks.
Congress is often considering some financial industry legislation, and the federal banking agencies routinely propose new regulations. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future.
Essick & Barr and Madison Financial are subject to additional regulatory requirements. Essick & Barr is subject to Pennsylvania insurance laws and the regulations of the Pennsylvania Department of Insurance. The securities brokerage activities of Madison Financial are subject to regulation by the SEC and the NASD/SIPC, and Madison Financial is a registered investment advisor subject to regulation by the SEC.
Item 1A.
Item 1A. Risk Factors
Changes in interest rates could reduce our income, cash flows and asset values.
Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans
and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.
Economic conditions either nationally or locally in areas in which our operations are concentrated may adversely affect our business.
Deterioration in local, regional, national or global economic conditions could cause us to experience a reduction in deposits and new loans, an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, all of which could adversely affect our performance and financial condition. Unlike larger banks that are more geographically diversified, we provide banking and financial services locally. Therefore, we are particularly vulnerable to adverse local economic conditions.
Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance.
Despite our underwriting criteria, we may experience loan delinquencies and losses. In order to absorb losses associated with nonperforming loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit losses on those loans that are identified. We may be required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.
Competition may decrease our growth or profits.
We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service area. Our competitors may have greater resources, higher lending limits or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can.
In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions. As a result, those nonbank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.
We may be adversely affected by government regulation.
The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial loan officers. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
Failure to implement new technologies in our operations may adversely affect our growth or profits.
The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able properly or timely to anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the Federal Deposit Insurance Corporation, commonly referred to as the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is subject to the same market forces that affect the price of common stock in any company.
Our ability to pay dividends is limited by law and federal banking regulation.
Our ability to pay dividends to our shareholders largely depends on our receipt of dividends from Leesport Bank. The amount of dividends that Leesport Bank may pay to us is limited by federal laws and regulations. We also may decide to limit the payment of dividends even when we have the legal ability to pay them in order to retain earnings for use in our business.
Federal and state banking laws, our articles of incorporation and our by-laws may have an anti-takeover effect.
Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over us. Pennsylvania law also has provisions that may have an anti-takeover effect. In addition, our articles of incorporation and bylaws permit our board of directors to issue, without shareholder approval, preferred stock and additional shares of common stock that could adversely affect the voting power and other rights of existing common shareholders. These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a substantial premium over the current market price.
We plan to continue to grow rapidly and there are risks associated with rapid growth.
We intend to continue to expand our business and operations to increase deposits and loans. Continued growth may present operating and other problems that could adversely affect our business, financial condition and results of operations. Our growth may place a strain on our administrative, operational, personnel and financial resources and increase demands on our systems and controls. Our ability to manage growth successfully will depend on our ability to attract qualified personnel and maintain cost controls and asset quality while attracting additional loans and deposits on favorable terms, as well as on factors beyond our control, such as economic conditions and interest rate trends. If we grow too quickly and are not able to attract qualified personnel, control costs and maintain asset quality, this continued rapid growth could materially adversely affect our financial performance.
Our legal lending limits are relatively low and restrict our ability to compete for larger customers.
At December 31, 2005, our lending limit per borrower was approximately $10.8 million, or approximately 15% of our capital. Accordingly, the size of loans that we can offer to potential borrowers (without participation by other lenders) is less than the size of loans that many of our competitors with larger capitalization are able to offer. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We may engage in loan participations with other banks for loans in excess of our legal lending limits. However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and our customers.
If we are unable to identify and acquire other financial institutions and successfully integrate their acquired businesses, our business and earnings may be negatively affected.
Acquisition of other financial institutions is an important component of our growth strategy. The market for acquisitions remains highly competitive, and we may be unable to find acquisition candidates in the future that fit our acquisition and growth strategy.
Acquisitions of financial institutions involve operational risks and uncertainties, and acquired companies may have unforeseen liabilities, exposure to asset quality problems, key employee and customer retention problems and other problems that could negatively affect our organization. We may not be able to complete future acquisitions and, if completed, we may not be able to successfully integrate the operations, management, products and services of the entities that we acquire and
eliminate redundancies. The integration process may also require significant time and attention from our management that they would otherwise direct at servicing existing business and developing new business. Our failure to successfully integrate the entities we acquire into our existing operations may increase our operating costs significantly and adversely affect our business and earnings.
The market price for our common stock may be volatile.
The market price for our common stock has fluctuated, ranging between $28.40 and $20.52 per share during the 12 months ended December 31, 2005. The overall market and the price of our common stock may continue to be volatile. There may be a significant impact on the market price for our common stock due to, among other things, developments in our business, variations in our anticipated or actual operating results, changes in investors' or analysts' perceptions of the risks and conditions of our business and the size of the public float of our common stock. The average daily trading volume for our common stock as reported on NASDAQ was 3,839 shares during the twelve months ended March 3, 2006, with daily volume ranging from a low of zero shares to a high of 33,800 shares. There can be no assurance that a more active or consistent trading market in our common stock will develop. As a result, relatively small trades could have a significant impact on the price of our common stock.
Market conditions may adversely affect our fee based investment and insurance business.
The revenues of our fee based insurance business are derived primarily from commissions from the sale of insurance policies, which commissions are generally calculated as a percentage of the policy premium. These insurance policy commissions can fluctuate as insurance carriers from time to time increase or decrease the premiums on the insurance products we sell. Similarly, we receive fee based revenues from commissions from the sale of securities and investment advisory fees. In the event of decreased stock market activity, the volume of trading facilitated by Madison Financial Advisors, LLC will in all likelihood decrease resulting in decreased commission revenue on purchases and sales of securities. In addition, investment advisory fees, which are generally based on a percentage of the total value of an investment portfolio, will decrease in the event of decreases in the values of the investment portfolios, for example, as a result of overall market declines.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
The Company's principal office is located in the administration building at 1240 Broadcasting Road, Wyomissing, Pennsylvania.
Listed below are the locations of properties owned or leased by the Bank and its subsidiaries. Owned properties are not subject to any mortgage, lien or encumbrance.
Property Location
Leased or Owned
Corporate Office
1240 Broadcasting Road
Wyomissing, Pennsylvania
Leased
Leesport Operations Center
1044 MacArthur Road
Reading, Pennsylvania
Leased
North Pointe Financial Center
241 South Centre Avenue
Leesport, Pennsylvania
Leased
Northeast Reading Financial Center
1210 Rockland Street
Reading, Pennsylvania
Leased
Hamburg Financial Center
801 South Fourth Street
Hamburg, Pennsylvania
Leased
Bern Township Financial Center
909 West Leesport Road
Leesport, Pennsylvania
Leased
Wernersville Financial Center
1 Reading Drive
Wernersville, Pennsylvania
Leased
Breezy Corner Financial Center
3401-3 Pricetown Road
Fleetwood, Pennsylvania
Leased
Blandon Financial Center
100 Plaza Drive
Blandon, Pennsylvania
Leased
Wyomissing Financial Center
1199 Berkshire Boulevard
Wyomissing, Pennsylvania
Leased
Schuylkill Haven Financial Center
237 Route 61 South
Schuylkill Haven, Pennsylvania
Leased
Birdsboro Financial Center
350 West Main Street
Birdsboro, Pennsylvania
Leased
Exeter Financial Center
4361 Perkiomen Avenue
Reading, Pennsylvania
Leased
Sinking Spring Financial Center
4708 Penn Ave
Sinking Spring, Pennsylvania
Leased
Blue Bell Financial Center
The Madison Bank Building
1767 Sentry Parkway West
Blue Bell, Pennsylvania
Leased
Centre Square Financial Center
1380 Skippack Pike
Blue Bell, Pennsylvania
Leased
Conshohocken Financial Center
Plymouth Corporate Center
Suite 600
625 Ridge Pike
Conshohocken, Pennsylvania
Leased
Fox Chase Financial Center
8000 Verree Road
Philadelphia, Pennsylvania
Owned
Horsham Financial Center
100 Gibralter Road
Horsham, Pennsylvania
Leased
Lansdale Financial Center (Closing in March 2006)
Century Plaza Building
100 West Main Street
Lansdale, Pennsylvania
Leased
Oaks Financial Center
1232 Egypt Road
Oaks, Pennsylvania
Leased
Strafford Financial Center
600 West Lancaster Avenue
Strafford, Pennsylvania
Leased
Essick & Barr Insurance
108 South Fifth Street
Reading, Pennsylvania
Owned
The Boothby Group
Suite 103
460 Norristown Road
Blue Bell, Pennsylvania
Leased
Madison Insurance Consultants
2300 E. Lincoln Hwy
Suite 012
Langhorne, Pennsylvania
Leased
Philadelphia Financial Mortgage
Suite 220
1767 Sentry Parkway West
Blue Bell, Pennsylvania
Leased
Philadelphia Financial Mortgage
930 Red Rose Court
Lancaster, Pennsylvania
Leased
Philadelphia Financial Mortgage
3900 Trindle Road
Camp Hill, Pennsylvania
Leased
In the fourth quarter of 2004, the Company sold the North Point, Northeast Reading, Hamburg, Bern Township, Exeter and Sinking Spring financial centers and leased them back from the purchaser with a lease term of 20 years.
Essick & Barr shares offices in the Company's administration building located at 1240 Broadcasting Road, Wyomissing, Pennsylvania. Essick & Barr is charged a pro rata amount of the total lease expense.
Madison Financial also shares office space in the Company's administration building in Wyomissing as well as in The Boothby Group's office in Blue Bell and are accordingly charged a pro rata amount of the total lease expense.
Item 3.
Item 3. Legal Proceedings
A certain amount of litigation arises in the ordinary course of the business of the Company, and the Company's subsidiaries. In the opinion of the management of the Company, there are no proceedings pending to which the Company, or the Company's subsidiaries are a party or to which their property is subject, that, if determined adversely to the Company or its subsidiaries, would be material in relation to the Company's shareholders' equity or financial condition, nor are there any proceedings pending other than ordinary routine litigation incident to the business of the Company and its subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company or its subsidiaries by governmental authorities.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the Company's fiscal year ended December 31, 2005.
Item 4A. Executive Officers of the Registrant
Certain information, as of January 31, 2006, including principal occupation during the past five years, relating to each executive officer of the Company is as follows:
PART II
Item 5.
Item 5. Market For Common Equity and Related Shareholder Matters
As of December 31, 2005, there were 789 record holders of the Company's common stock. The market price of the Company's common stock for each quarter in 2005 and 2004 and the dividends declared on the Company's common stock for each quarter in 2005 and 2004 are set forth below.
Market Price of Common Stock
The Company's common stock is traded on the NASDAQ National Market under the symbol "FLPB." The following table sets forth, for the fiscal quarters indicated, the high and low bid and asked price per share of the Company's common stock, as reported on the NASDAQ National Market, and has been adjusted for the effect of the 5% stock dividend declared by the Board of Directors on December 15, 2004 with a record date of January 3, 2005 and distributed to shareholders on January 14, 2005:
Cash dividends on the Company's common stock have historically been payable on the 15th of January, April, July, and October.
The Company derives a significant portion of its income from dividends paid to it by the Bank. For a description of certain regulatory restrictions on the payment of dividends by the Bank to the Company, see "Business-Regulatory Restrictions on Dividends."
On May 20, 2004, the Company announced the extension of its stock repurchase plan, originally effective January 1, 2003, for the repurchase of up to 162,000 shares of the Company's common stock. During the fourth quarter of 2005, the Company repurchased 15,000 of its outstanding common stock. At December 31, 2005, the maximum number of shares that may yet be purchased under the stock repurchase plan was 95,513 shares.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial and other data and management's discussion and analysis of financial condition and results of operation set forth below and in Item 7
Item 7 hereof is derived in part from, and should be read in conjunction with, the consolidated financial statements and notes thereto contained elsewhere herein.
Earnings and cash dividends per share amounts reflect the 5% stock dividend declared by the Board of Directors on December 15, 2004 with a record date of January 3, 2005 and distributed to shareholders on January 14, 2005.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company is a financial services company. As of December 31, 2005, Leesport Bank, Essick & Barr, LLC, and Madison Financial Advisors, LLC were wholly-owned subsidiaries of the Company. As of December 31, 2005, Leesport Realty Solutions, LLC and Leesport Mortgage Holdings, LLC were wholly-owned, non-bank subsidiaries of Leesport Bank.
During 2000, Leesport Realty Solutions, LLC was formed as a subsidiary of Leesport Bank for the purpose of providing title insurance and other real estate related services to its customers through limited partnership arrangements with third parties involved in the real estate services industry.
In May 2002, the Company's subsidiary, Leesport Bank, jointly formed Leesport Mortgage, LLC with a real estate company. Leesport Mortgage, LLC was formed to provide mortgage brokerage services, including, without limitation, any activity in which a mortgage broker may engage. It is operated as a permissible "affiliated business arrangement" within the meaning of the Real Estate Settlement Procedures Act of 1974. Leesport Bank's initial investment was $15,000. In July 2004, Leesport Bank dissolved its investment with the real estate company.
On August 30, 2002, the Company completed its purchase of certain assets of First Affiliated Investment Group, an investment management and brokerage firm located in State College, Pennsylvania. In addition to cash payments payable to the shareholder of $175,000, the Company issued 9,460 shares of its common stock at a price of $18.50, resulting in an aggregate purchase price of $350,000 as of the closing date. Contingent payments to the shareholder totaling up to $300,000, payable in stock at the then current market values and/or cash, are based upon achieving certain annual revenue levels over the next three years.
On October 1, 2002, the Company completed its acquisition of 100% of the outstanding common stock of The Boothby Group, Inc., a full service insurance agency headquartered in Blue Bell, Pennsylvania. In addition to cash payments of $3.6 million, the Company issued 132,448 shares of its common stock at a price of $18.12 resulting in an aggregate purchase price of $6.2 million as of the closing date. Contingent payments payable to the five former shareholders totaling up to $1.6 million, payable in shares of the Company's common stock at the then current market values, are based on The Boothby Group division of Essick & Barr achieving certain annual revenue levels over the next five years.
On September 30, 2003, the Company completed its purchase of certain assets of CrosStates Insurance Consultants, Inc., a full service insurance agency that specializes in personal property and casualty insurance located in Langhorne, Pennsylvania. The Company made a cash payment of $1.0 million as of the closing date. Contingent payments payable to the former shareholder totaling up to $1.2 million, payable 50% in cash and 50% in shares of the Company's common stock at the then current market values, are based on the CrosStates Insurance division of Essick & Barr achieving certain levels of earnings over the next two years. Effective January 1, 2005, the CrosStates Insurance Consultants division changed its name to Madison Insurance Consultants.
On October 1, 2004, the Company acquired 100% of the outstanding voting shares of Madison Bancshares Group, Ltd., the holding company for Madison Bank ("Madison"), a Pennsylvania state-chartered commercial bank and its mortgage banking division, Philadelphia Financial. Madison has become a division of Leesport Bank. For each share of Madison common stock, the Company exchanged 0.6028 shares of Leesport common stock resulting in the issuance of 1,311,010 of Leesport common stock and a cash payment of $11,790. The total purchase price was $34.6 million. The value of the common shares issued was determined based on the average market price of Leesport common shares five days before and five days after the date of the announcement. In connection with the transaction, Madison paid cash of $7.1 million and recognized the expense for 699,122 Madison options and warrants outstanding at September 30, 2004. In addition, Madison paid cash of $2.3 million and recognized the expense for the termination of existing contractual arrangements.
Critical Accounting Policies
Disclosure of the Company's significant accounting policies is included in Note 1 to the consolidated financial statements. Certain of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by management. Additional information is contained in Management's Discussion and Analysis and the Notes to the Consolidated Financial Statements for the most sensitive of these issues. These include, the provision and allowance for loan losses, and revenue recognition for insurance activities, stock based compensation, and derivative financial instruments (see Notes 10 and 16), and purchase accounting, goodwill and intangible assets (Note 2). These discussions, analysis and 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.
Allowance for Loan Losses
The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to provide for known and inherent losses in the existing loan portfolio. Management's judgment is based on the evaluation of individual loans past experience, the assessment of current economic conditions, and other relevant factors. Loan losses are charged directly against the allowance for loan losses and recoveries on previously charged-off loans are added to the allowance.
Management uses significant estimates to determine the allowance for loan losses. Consideration is given to a variety of factors in establishing these estimates including current economic conditions, diversification of the loan portfolio, delinquency statistics, borrowers' perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant factors. Since the sufficiency of the allowance for loan losses is dependent, to a great extent on conditions that may be beyond our control, it is possible that management's estimates of the allowance for loan losses and actual results could differ in the near term. Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation. For example, a downturn in the local economy could cause increases in non-performing loans. Additionally, a decline in real estate values could cause some of our loans to become inadequately collateralized. In either case, this may require us to increase our provisions for loan losses, which would negatively impact earnings. Additionally, a large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively impact earnings. In addition, regulatory authorities, as an integral part of their examination, periodically review the allowance for loan losses. They may require additions to the allowance for loan losses based upon their judgments about information available to them at the time of examination. Future increases to our allowance for loan losses, whether due to unexpected changes in economic conditions or otherwise, could adversely affect our future results of operations.
Stock-Based Compensation
As permitted by Statement of Financial Accounting Standards ("SFAS") No. 123, the Company accounts for stock-based compensation in accordance with Accounting Principals Board Opinion ("APB") No. 25. Under APB No. 25, no compensation expense is recognized in the income statement related to any option granted under the Company's stock option plans. The pro forma impact to net income and earnings per share that would occur if compensation expense was recognized, based on the estimated fair value of the options on the date of the grant, is disclosed in the notes to the consolidated financial statements.
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity
instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. Statement 123(R) requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to the employees in the income statement. The revised Statement generally requires that an entity account for those transactions using the fair-value-based method, and eliminates the intrinsic value method of accounting in APB Opinion No. 25. "Accounting for Stock Issued to Employees," which was permitted under Statement No. 123, as originally issued.
The revised Statement requires entities to disclose information about the nature of the share-based payment transaction and the effects of those transactions on the financial statements. Statement No. 123(R) is effective for fiscal periods beginning after June 15, 2005. All public companies must use either the modified prospective or the modified retrospective transition method. The Company will adopt the modified prospective method. Using the modified prospective method, the Company estimates that total stock-based compensation expense, net of related tax effects, will be approximately $86,000 for the year ending December 31, 2006. Any additional impact that the adoption of this statement will have on our results of operations will be determined by share-based payments granted in future periods.
Goodwill
The Company has recorded goodwill of $11.0 million at December 31, 2005 related to Essick & Barr and Madison Financial. The Company performs its annual goodwill impairment test in the fourth quarter of each calendar year. A fair value is determined for the insurance services and investment services reporting segments. If the fair value of the reporting unit exceeds the book value, no write downs of goodwill is necessary. If the fair value is less than the book value, an additional test is necessary to assess the proper carrying value of goodwill. The Company determined that no impairment write-offs were necessary during 2005 and 2004.
Business unit valuation is inherently subjective, with a number of factors based on assumption and management judgments. Among these are future growth rates, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors and reporting unit performance could result in different assessments of the fair value and could result in impairment charges in the future.
Investment Securities Impairment Evaluation
Management evaluates securities for the other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Results of Operations
Net income for 2005 was $8.73 million or $1.71 per share diluted compared to $5.42 million or $1.36 per share diluted for 2004 and $4.95 million or $1.38 per share for 2003. These changes are a result of increasing net interest income after provision for loan losses and other income each year, net of increases in other expenses. Details regarding changes in each of these areas follow.
Included in net income for 2005 are severance costs of $445,000 associated with the March 2005 departure of the Company's Chairman, President and Chief Executive Officer. Included in net income
for 2004 are merger related costs of $899,000 associated with the Madison acquisition. Excluding these items, net income and earnings per share for 2005 and 2004 were as follows:
Return on average assets was 0.95% for 2005, 0.78% for 2004 and 0.84% for 2003. Return on average shareholders' equity was 9.36% for 2005, 8.69% for 2004 and 9.39% for 2003.
Net Interest Income
Net interest income is a primary source of revenue for the Company. This income results from the difference between the interest and fees earned on loans and investments and the interest paid on deposits to customers and other non-deposit sources of funds, such as repurchase agreements and borrowings from the Federal Home Loan Bank. Net interest margin is the difference between the gross (tax-effected) yield on earning assets and the cost of interest bearing funds as a percentage of earning assets. All discussion of net interest margin is on a fully taxable equivalent basis. Both net interest income and net interest margin are influenced by the frequency, magnitude and direction of interest rate changes and by product concentrations and volumes of earning assets and funding sources.
Net interest income increased to $30.3 million or 46.1% for the year ended December 31, 2005, compared to $20.8 million for 2004. The increase in net interest income during 2005 was primarily the result of an increase in average earning assets, due mainly to strong commercial and consumer loan growth, loans acquired from Madison and the targeted short-term interest rate, as established by the Federal Reserve Bank ("FRB"), increasing, which resulted in an increase in the prime rate from 5.25% at December 31, 2004, to 7.25% at December 31, 2005. Average loans increased by $198.7 million or 45.8% from 2004 to 2005. Management attributes the increase in organic loan growth to successful marketing initiatives and the favorable interest rate environment.
Interest expense increased during the year along with the overall growth in funding sources. The overall cost of funds increased from 2.38% in 2004 to 2.89% in 2005. Interest bearing deposit rates increased from 2.31% in 2004 to 2.62% in 2005. The increase in interest-bearing deposit rates was the result of both management pricing strategy as well as the effect of longer-term certificates of deposit that matured during the year and repriced at higher rates. Average interest bearing deposits increased $120.0 million or 30.3% from 2004 to 2005 due primarily to strong organic growth in deposits and deposits acquired from Madison. Total interest-bearing funding grew by $82.7 million and, combined with the growth in non-interest bearing deposits, provided all of the funding needed for the
$81.1 million in loan and investment security growth. The average rate paid on long-term borrowings has dropped steadily over the last three years, from 4.51% for the year ended 2003, to 3.34% for 2004, to 3.22% for 2005. Average long-term borrowings increased $11.0 million or 28.0% from 2004 to 2005. At year-end 2005, actual balances for federal funds purchased and long term debt were $66.2 million and $43.0 million, respectively compared to $36.1 million and $54.5 million at year-end 2004, respectively.
As a result of an increase in the commercial loan portfolio, an increase in the investment portfolio yield, increased non-interest bearing deposits, lower long-term borrowing costs and the increase in prime rate, the net interest margin increased to 3.82% in 2005 from 3.46% in 2004.
Other Income
Details of non-interest income follow:
The Company's primary source of other income for 2005 was commissions and other revenue generated through sales of insurance products through its insurance subsidiary, Essick & Barr. Revenues from insurance operations totaled $11.6 million in 2005 compared to $10.8 million in 2004 and $9.2 million in 2003. Revenues from broker and investment advisory commissions generated through Madison Financial, the Company's investment subsidiary, increased to $998,000 in 2005 from $528,000 in 2004 due to an increase in the sales staff facilitating increased sales of wealth management products offered through the branch network. Also, annuity and other insurance commissions generated by Madison Financial of $210,000, $309,000 and $112,000 are included in commissions and fees from insurance sales for the years 2005, 2004 and 2003, respectively.
The Company also relies on several other sources for its other income, including sales of newly originated mortgage loans and service charges on deposit accounts. The income recognized from mortgage banking activities was $5.4 million in 2005, $2.1 million in 2004 and $2.4 million in 2003. The increase in mortgage banking revenue from 2004 to 2005 is mainly attributable to increased volumes of mortgage loan originations and sales through the Company's mortgage banking division, Philadelphia Financial Mortgage Company. Also included in other income are net gains on other loan sales of $676,000 in 2005, $432,000 in 2004 and $269,000 in 2003 from the sale of $16.3 million, $8.5 million and $8.7 million, respectively, of fixed and adjustable rate portfolio residential mortgage loans, SBA loans and USDA loans. The increases in income from customer service fees reflect an expanded customer base, new products and services, the annual review of the fee pricing structure and the acquisition of Madison.
In September 2003, the Company recognized a non-recurring $3.1 million gain on the sale of three financial centers located in northern Schuylkill and Luzerne Counties. This sale reflects the strategic plan to build on the existing Berks County and growing southeastern Pennsylvania market areas.
Earnings on investment in life insurance represent the change in cash value of Bank Owned Life Insurance (BOLI) policies. The BOLI policies of the Company are designed to offset the costs of employee benefit plans. The investment in BOLI totaled $11.7 million and $11.4 million at December 31, 2005 and 2004. Earnings on BOLI are affected by fluctuations in interest rates and provide a tax-free return.
Other income includes dedit card network interchange income, merchant fee income, SBA service fee income and safe deposit box rentals, as well as, other miscellaneous income items. The most significant volume of income in this category is derived from ATM surcharge fees and interchange fees from the Bank's ATM network and from debit card transactions. These fees totaled $783,000 in 2005 which represents a 33.1% increase over 2004. Throughout the year, the Bank has initiated marketing campaigns to encourage its customers to use debit cards as a convenient alternative to traditional check transactions.
Other Expenses
Details of non-interest expense follow:
Non-interest expense consists primarily of costs associated with personnel, occupancy and equipment, data processing, marketing and professional fees. The Company's non-interest expense for the year ended December 31, 2005 totaled $41.3 million, representing an increase of $10.7 million or 35.1% as compared to 2004. Salaries and employee benefits, the largest component of non-interest expense, increased $5.9 million or 34.6% from 2004 to 2005. The increase in salaries and employee benefits from 2004 to 2005 was primarily the result of the acquisition of Madison, merit increases, continued growth of the Company, commissions paid on revenue generated from sales of insurance products through Essick & Barr and wealth management products through Madison Financial, as well as, higher benefits costs consistent with industry trends. Full-time equivalent (FTE) employees for the Company are 338, 332 and 230 for the years ended December 31, 2005, 2004 and 2003, respectively. The growth in FTE's from 2004 to 2005 was primarily the result of the acquisition of Madison and continued growth of the Company.
Total occupancy expense increased $1.9 million or 72.0% in 2005 primarily due to the lease expense related to the branch network and administrative office space acquired from Madison. Total equipment expense increased $552,000 or 28.0% in 2005 primarily due to the additional depreciation and software maintenance expense related to acquisition of Madison.
Total marketing expense increased $407,000 or 34.8% in 2005 primarily due to marketing campaigns for the introduction of new products and services, as well as, new marketing campaigns
targeting the Madison region. These marketing efforts coincide with a more cohesive and strategic branding approach designed to focus on our overall portfolio of banking, insurance and wealth management products and services. Our current marketing approach has contributed to increased visibility for the Company setting the stage for continued core franchise growth in the Reading and Philadelphia markets.
Total amortization of identifiable intangible assets increased $208,000 or 48.1% in 2005 as compared to 2004, total outside processing services increased $603,000 or 28.2% in 2005 as compared to 2004 and total insurance expense increased $95,000 or 17.8% in 2005 as compared to 2004. The increase in these costs is due primarily to the acquisition of Madison.
Other expense includes utility expense, postage expense, stationary and supplies expense, purchase accounting expense and OREO and foreclosure expense, as well as, other miscellaneous expense items. These costs totaled $3.9 million in 2005 which represents a 55.0% increase over 2004. Increases in other expenses were almost entirely related to the first full year of expenses associated with the acquisition of Madison in 2004.
Income Taxes
The effective income tax rate for the Company for the years ended December 31, 2005, 2004 and 2003 was 25.72%, 17.6% and 27.5%, respectively. The effective tax rate for 2005 increased from 2004 primarily because tax exempt income remained flat while income before income taxes increased. Included in the income tax provision is a federal tax benefit from our $5.0 million investment in an affordable housing, corporate tax credit limited partnership of $600,000 and $450,000, respectively, for the twelve months ended December 31, 2005 and 2004.
Financial Condition
The Company's total assets increased to $965.8 million at December 31, 2005, representing a growth rate of 10.1% from $877.4 million at December 31, 2004.
Cash and Securities Portfolio
Cash and balances due from banks increased to $29.1 million at December 31, 2005 from $24.1 million at December 31, 2004.
The securities portfolio increased 9.6% to $188.7 million at December 31, 2005, from $172.2 million at December 31, 2004 primarily due to investment maturities and principal repayments reinvested into higher yielding securities. Securities are used to supplement loan growth as necessary, to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. To accomplish these ends, most of the purchases in the portfolio during 2005 and 2004 were of mortgage backed securities issued by US Government agencies. State and political subdivision securities were also purchased in 2005 to increase the yield of the portfolio.
The securities balance included a net unrealized loss on available for sale securities of $4.8 million and $393,000 at December 31, 2005 and 2004. The increase in interest rates over the past twelve months was primarily responsible for the reduction in the fair market value of the securities.
Loans
Loans increased to $654.2 million at December 31, 2005 from $596.3 million at December 31, 2004, an increase of $57.9 million or 9.7%. Management has targeted the commercial loan portfolio as a key to the Company's continuing growth. Specifically, the Company has a lending focus within the Reading and Philadelphia market areas targeting higher yielding commercial loans made to small and medium sized businesses. The acquisition of Madison in 2004, whose loan portfolio consisted of mainly commercial loans, underscores that focus as the commercial portfolio increased to $384.0 million at December 31, 2005, from $309.8 million at December 31, 2004, an increase of $74.2 million or 24.0%.
Loans secured by 1 to 4 family residential real estate decreased to $172.6 million at December 31, 2005, from $190.6 million as of December 31, 2004, a decrease of $18.0 million or 9.4%. Loans secured by multi-family residential real estate increased to $14.4 million at December 31, 2005, from $12.4 million as of December 31, 2004, an increase of $2.0 million or 15.9%. The overall decrease in residential real estate loans is due primarily to loan sales discussed previously with the proceeds used to fund higher yielding commercial loans.
Home equity lending products decreased to $83.2 million at December 31, 2005, from $83.5 million as of December 31, 2004. Consumer demand for these types of loans was hampered by steady increases in the prime rate. Despite the numerous increases in the prime rate throughout 2005, we were able to maintain our outstanding balances through successful marketing initiatives.
The loans held for sale category is composed of $16.6 million of mortgage loans committed for sale to other institutions and the secondary market as of December 31, 2005 versus $9.8 million as of December 31, 2004. The increase in loans held for sale is primarily due to new loan origination activity through Philadelphia Financial.
The sales of residential real estate loans in the secondary market reflect the Company's strategy of de-emphasizing the retention of long-term, fixed rate loans in the portfolio utilizing these loans sales to generate fees, improve interest-rate risk and fund growth in higher yielding assets.
Premises and Equipment
Premises and equipment, net of accumulated depreciation and amortization, decreased during 2005 to $7.8 million from $8.6 million at the end of 2004. The decrease in premises and equipment is due mainly to an increase in depreciation expense and amortization of leasehold improvements which totaled $1.7 million in 2005 and $1.4 million in 2004.
During 2004, the Company sold six branch locations with a net book value of $7.0 million and leased them back from the purchaser with a lease term of 20 years resulting in a gain of $712,000, which is being amortized into income over the term of the lease.
Goodwill and Identifiable Intangible Assets
Goodwill increased to $38.8 million from $38.2 million for the years ended December 31, 2005 and 2004, respectively. During 2005, the Company amended an asset purchase agreement to increase the payment to the seller by $600,000 which was recorded as goodwill and a liability payable to the seller. The details of this transaction are discussed later in Footnote 2. Identifiable intangible assets decreased to $5.2 million from $5.8 million for the years ended December 31, 2005 and 2004, respectively. The decrease in identifiable intangible assets is due mainly to an increase in amortization expense which totaled approximately $640,000 in 2005 and $432,000 in 2004.
Bank Owned Life Insurance
Bank owned life insurance increased $348,000 to $11.7 million at December 31, 2005 from $11.4 million at December 31, 2004. The increase in bank owned life insurance is due to tax exempt earnings credited in 2005.
Deposits and Borrowings
Total deposits increased by $47.4 million or 7.7% to $659.7 million at December 31, 2005 from $612.3 million at December 31, 2004.
Non-interest bearing deposits increased to $116.0 million at December 31, 2004, from $107.4 million at December 31, 2004, an increase of $8.6 million or 7.9%. The increase in non-interest
bearing deposits is primarily due to management's efforts to promote growth in these types of deposits, such as offering a free checking product, as a method to help reduce the overall cost of the Company's funds. Interest bearing deposits increased by $39.0 million or 7.7%, from $504.8 million at December 31, 2004 to $543.8 million at December 31, 2005. In 2005, our customer's preference was clearly weighted in favor of maintaining a more liquid investment position in anticipation of future increases in interest rates. In early 2005, we responded to our customers by introducing our Capital Growth Checking product which gave our customers the liquidity of a checking account at money market rates and by offering incentive rates for shorter term time deposits.
Borrowed funds from various sources are generally used to supplement deposit growth. Short-term borrowings, which were composed of federal funds purchased from the Federal Home Loan Bank ("FHLB") and other correspondent banks and securities sold under agreements to repurchase, were $135.7 million at December 31, 2005, and $88.9 million at December 31, 2004. This increase is primarily the result of funding needs generated by increased loan demand. Long-term borrowings, which consisted of advances from the FHLB, totaled $43.0 million and $54.4 million at December 31, 2005 and 2004, respectively.
Shareholders' Equity
Total common stock, surplus, retained earnings and accumulated other comprehensive loss increased by $3.9 million or 4.2% to $94.8 million at December 31, 2005 from $90.9 million at December 31, 2004. The increase for 2005 is primarily the result of net income of $8.7 million offset by cash dividends of $3.5 million.
Total shareholders' equity includes accumulated other comprehensive income, which includes an adjustment for the fair value of the Company's securities portfolio. This amount attempts to identify the impact to equity in the unlikely event that the Company's entire securities portfolio would be liquidated under current economic conditions. The amounts and types of securities held by the Company at the end of 2005, combined with current interest rates, resulted in a decrease in equity, net of taxes, of $3.0 million. This compares with a decrease to equity, net of taxes, of $392,000 at the end of 2004.
Interest Rate Sensitivity
Through the years, the banking industry has adapted to an environment in which interest rates have fluctuated dramatically and in which depositors have been provided with liquid, rate sensitive investment options. The industry utilizes a process known as asset/liability management as a means of managing this adaptation.
Asset/liability management is intended to provide for adequate liquidity and interest rate sensitivity by matching interest rate sensitive assets and liabilities and coordinating maturities and repricing characteristics on assets and liabilities.
Interest rate risk management involves managing the extent to which interest-sensitive assets and interest-sensitive liabilities are matched. Interest rate sensitivity is the relationship between market interest rates and earnings volatility due to the repricing characteristics of assets and liabilities. The Company's net interest income is affected by changes in the level of market interest rates. In order to maintain consistent earnings performance, the Company seeks to manage, to the extent possible, the repricing characteristics of its assets and liabilities.
One major objective of the Company when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Company's Asset/Liability Committee ("ALCO"), which is comprised of senior management and Board members. The ALCO meets quarterly to monitor the ratio of interest sensitive
assets to interest sensitive liabilities. The process to review interest rate risk management is a regular part of management of the Company. In addition, there is an annual process to review the interest rate risk policy with the Board of Directors which includes limits on the impact to earnings from shifts in interest rates.
To manage the interest rate sensitivity position, an asset/liability model called "gap analysis" is used to monitor the difference in the volume of the Company's interest sensitive assets and liabilities that mature or reprice within given periods. A positive gap (asset sensitive) indicates that more assets reprice during a given period compared to liabilities, while a negative gap (liability sensitive) has the opposite effect.
During October 2002, the Company entered into its first interest rate swap agreement with a notional amount of $5 million. This derivative financial instrument effectively converted fixed interest rate obligations of outstanding junior subordinated debt to variable interest rate obligations, decreasing the asset sensitivity of its balance sheet by more closely matching the Company's variable rate assets with variable rate liabilities. The Company considers the credit risk inherent in the contracts to be negligible.
Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities and to limit the exposure created by other interest rate swaps. In June of 2003, the Company purchased a six month LIBOR cap to create protection against rising interest rates for the above mentioned $5 million interest rate swap. The initial premium related to this interest rate cap was $102,000. At December 31, 2005 and 2004, the carrying and market values were approximately $38,000 and $102,000, respectively.
Also, the Company sells fixed and adjustable rate residential mortgage loans to limit the interest rate risk of holding longer-term assets on the balance sheet. In 2005, 2004 and 2003, the Company sold $8.9 million, $8.5 million and $8.7 million, respectively, of fixed and adjustable rate loans.
At December 31, 2005, the Company was in a negative one-year cumulative gap position. Commercial adjustable rate loans decreased $4.4 million or 1.8% from $238.2 million at December 31, 2004 to $233.8 million at December 31, 2005. Installment adjustable rate loans increased $3.2 million or 5.3% from $60.5 million at December 31, 2004 to $63.7 million at December 31, 2005. During 2005, the targeted short-term interest rate, as established by the FRB, increased which resulted in an increase in the prime rate from 5.25% at December 31, 2004, to 7.25% at December 31, 2005. The increase in interest rates throughout 2005 contributed to a slowdown in the refinance market effectively extending the maturities for fixed rate loans and investments. In order to augment the funding needs for new loan originations and investment security purchases, short-term borrowings, which include federal funds purchased and securities sold under agreements to repurchase, increased $46.8 million or 52.6% from $88.9 million at December 31, 2004 to $135.7 million at December 31, 2005. These factors contributed to the Company's negative one-year cumulative gap position. In 2006, the Company will continue its strategy to originate adjustable rate commercial and installment loans and use investment security cash flows and non-interest bearing and core deposits to reduce the overnight borrowings to maintain a more neutral gap position.
Interest Sensitivity Gap at December 31, 2005
(1)Includes gross of unrealized gains/losses on available for sale securities.
(2)Securities and loans are included in the earlier of the period in which interest rates were next scheduled to adjust or the period in which they are due.
(3)Demand and savings accounts are generally subject to immediate withdrawal. However, management considers a certain amount of such accounts to be core accounts having significantly longer effective maturities based on the retention experiences of such deposits in changing interest rate environments. Certain shortcomings are inherent in the method of analysis presented in the above table. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.
The Company also measures its sensitivity to interest rate movements through simulations of the effects of rate changes upon its net interest income. Interest rate movements of up 100, 200 and 300 basis points and down 100, 200 and 300 basis points, adjusted because of the current low rate
environment, were applied to the Company's interest earning assets and interest bearing liabilities as of December 31, 2005. The results of these simulations on net interest income for 2005 are as follows:
Economic value of shareholders' equity as a result of interest rate changes is presented in the following hypothetical table. This analysis estimates the projected change in the value of equity as of December 31, 2005 as a result of hypothetical interest rate movements. The results of the simulations in the up 100, 200 and 300 basis points categories reflect the balance sheet and interest rate environment changes as discussed above. The acquisition of Madison and the Company's plan to reduce its negative one-year cumulative gap position is expected to keep the economic value of shareholders' equity inside policy limits.
Capital
Federal bank regulatory agencies have established certain capital-related criteria that must be met by banks and bank holding companies. The measurements which incorporate the varying degrees of risk contained within the balance sheet and exposure to off-balance sheet commitments were established to provide a framework for comparing different institutions.
Other than Tier 1 capital restrictions on the Company's junior subordinated debt discussed later, the Company is not aware of any pending recommendations by regulatory authorities that would have a material impact on the Company's capital, resources, or liquidity if they were implemented, nor is the Company under any agreements with any regulatory authorities.
The adequacy of the Company's capital is reviewed on an ongoing basis with regard to size, composition and quality of the Company's resources. An adequate capital base is important for continued growth and expansion in addition to providing an added protection against unexpected losses.
An important indicator in the banking industry is the leverage ratio, defined as the ratio of common shareholders' equity less intangible assets, to average quarterly assets less intangible assets. The leverage ratio at December 31, 2005 was 8.16% compared to 7.98% at December 31, 2004. This decrease is primarily the result of an increase in disallowed goodwill and other intangible assets and the increase in average total assets primarily due to the acquisition of Madison. For 2005 and 2004, the ratios were above minimum regulatory guidelines.
As required by the federal banking regulatory authorities, guidelines have been adopted to measure capital adequacy. Under the guidelines, certain minimum ratios are required for core capital and total capital as a percentage of risk-weighted assets and other off-balance sheet instruments. For the Company, Tier I capital consists of common shareholders' equity less intangible assets plus the junior subordinated debt, and Tier II capital includes the allowable portion of the allowance for loan losses, currently limited to 1.25% of risk-weighted assets. By regulatory guidelines, the separate component of equity for unrealized appreciation or depreciation on available for sale securities is excluded from Tier I capital. In addition, federal banking regulating authorities have issued a final rule restricting the Company's junior subordinated debt to 25% of Tier I capital. Amounts of junior subordinated debt in excess of the 25% limit generally may be included in tier 2 capital. The final rule provides a five-year transition period, ending March 31, 2009.
The following table sets forth the Company's capital ratios.
Regulatory guidelines require that Tier I capital and total risk-based capital to risk-adjusted assets must be at least 4.0% and 8.0%, respectively.
Liquidity and Funds Management
Liquidity management ensures that adequate funds will be available to meet anticipated and unanticipated deposit withdrawals, debt servicing payments, investment commitments, commercial and consumer loan demand and ongoing operating expenses. Funding sources include principal repayments on loans and investment securities, sales of loans, growth in core deposits, short and long-term borrowings and repurchase agreements. Regular loan payments are a dependable source of funds, while the sale of loans and investment securities, deposit flows, and loan prepayments are significantly influenced by general economic conditions and level of interest rates.
At December 31, 2005, the Company maintained $29.1 million in cash and cash equivalents primarily consisting of cash and due from banks. In addition, the Company had $182.5 million in available for sale securities and $6.2 million in held to maturity securities. Cash and investment securities totaled of $217.8 million which represented 22.6% of total assets at December 31, 2005 compared to 22.4% at December 31, 2004.
The Company considers its primary source of liquidity to be its core deposit base, which includes non-interest-bearing and interest-bearing demand deposits, savings, and time deposits under $100,000. This funding source has grown steadily over the years through organic growth and acquisitions and
consists of deposits from customers throughout the financial center network. The Company will continue to promote the growth of deposits through its financial center offices. At December 31, 2005, approximately 59.1% of the Company's assets were funded by core deposits acquired within its market area. An additional 9.8% of the assets were funded by the Company's equity. These two components provide a substantial and stable source of funds.
Off-Balance Sheet Arrangements
The Company's financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments, at December 31, 2005 totaled $279.3 million. This consisted of $61.8 million in commercial real estate and construction loans, $51.7 million in home equity lines of credit, $156.6 million in unused business lines of credit and $9.2 million in standby letters of credit and the remainder in other unused commitments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. Any amounts actually drawn upon, management believes, can be funded in the normal course of operations. The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.
Contractual Obligations
The following table represents the Company's aggregate on and off balance sheet contractual obligations to make future payments.
Changes in Interest Income and Interest Expense
The following table sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate), and (2) changes in rate (changes in rate multiplied by average volume).
Analysis of Changes in Interest Income(1)(2)(3)
(1)Loan fees have been included in the change in interest income totals presented. Non-accrual loans have been included in average loan balances.
(2)Changes due to both volume and rates have been allocated in proportion to the relationship of the dollar amount change in each.
(3)Interest income on loans and securities is presented on a taxable equivalent basis.
Average Balances, Rates and Net Yield
The following table sets forth the average daily balances of major categories of interest earning assets and interest bearing liabilities, the average rate paid thereon, and the net interest margin for each of the periods indicated.
(1)Rates on loans and investment securities are reported on a tax-equivalent basis of 34%.
(2)Non-accrual loans have been included in average loan balances. Risk Elements
Non-performing loans, consisting of loans on non-accrual status, loans past due 90 days or more and still accruing interest, and renegotiated troubled debt increased to $6.3 million at December 31, 2005, an increase from $6.0 million at December 31, 2004. Generally, loans that are more than 90 days past due are placed on non-accrual status. As a percentage of total loans, non-performing loans represented .94% at December 31, 2005 and .99% at December 31, 2004. The allowance for loan losses represents 120.50% of non-performing loans at December 31, 2005, compared to 121.08% at December 31, 2004.
The Company continues to emphasize credit quality and believes that pre-funding analysis and diligent intervention at the first signs of delinquency will help to maintain these levels.
The following table is a summary of non-performing loans and renegotiated loans for the years presented.
At December 31, 2005, there was $2.2 million of commercial loans for which payments are current, but where the borrowers were experiencing significant financial difficulties, that were not classified as non-accrual.
The following summary shows the impact on interest income of non-accrual and restructured loans for the year ended December 31, 2005 (in thousands):
Provision and Allowance for Loan Losses
The provision for loan losses for 2005 was $1.5 million compared to $1.3 million in 2004 and $965,000 in 2003. The Company performs a review of the credit quality of its loan portfolio on a monthly basis to determine the adequacy of the allowance for possible loan losses. The Company experienced growth in the loan portfolio of 9.7% in 2005 and 66.8% in 2004. The allowance for loan losses at December 31, 2005 was $7.6 million, or 1.16% of outstanding loans, compared to $7.2 million or 1.22% of outstanding loans at December 31, 2004. The increase in the provision for loan losses for 2005 over 2004 is primarily a result of loan growth.
The allowance for loan losses is an amount that management believes to be adequate to absorb potential losses in the loan portfolio. Additions to the allowance are charged through the provision for loan losses. Management regularly assesses the adequacy of the allowance by performing an ongoing evaluation of the loan portfolio, including such factors as charge-off history, the level of delinquent loans, the current financial condition of specific borrowers, value of any collateral, risk characteristics in
the loan portfolio, and local and national economic conditions. Significant loans are individually analyzed, while other smaller balance loans are evaluated by loan category. Based upon the results of such reviews, management believes that the allowance for loan losses at December 31, 2005 was adequate to absorb credit losses inherent in the portfolio as of that date.
The following table presents a comparative allocation of the allowance for loan losses for each of the past five year-ends. Amounts were allocated to specific loan categories based upon management's classification of loans under the Company's internal loan grading system and assessment of near-term charge-offs and losses existing in specific larger balance loans that are reviewed in detail by the Company's internal loan review department and pools of other loans that are not individually analyzed. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future credit losses may occur.
Allocation of Allowance for Loan Losses
(In thousands except percentage data)
The unallocated portion of the allowance is intended to provide for possible losses that are not otherwise accounted for and to compensate for the imprecise nature of estimating future loan losses. Management believes the allowance is adequate to cover the inherent risks associated with the Company's loan portfolio. While allocations have been established for particular loan categories, management considers the entire allowance to be available to absorb losses in any category.
The following tables set forth an analysis of the Company's allowance for loan losses for the years presented.
Analysis of the Allowance for Loan Losses
(in thousands except ratios)
Loan Policy and Procedure
The Bank's loan policies and procedures have been approved by the Board of Directors, based on the recommendation of the Bank's President, Chief Lending Officer, Loan Review Officer, and the Risk Management Officer, who collectively establish and monitor credit policy issues. Application of the loan policy is the direct responsibility of those who participate either directly or administratively in the lending function.
The Bank's commercial lending officers originate loan requests through a variety of sources which include the Bank's existing customer base, referrals from directors and various networking sources (accountants, attorneys, and realtors), and market presence. Over the past several years, the Bank's commercial lending efforts have been significantly increased through (1) the hiring of experienced commercial lenders in the Bank's geographic markets, (2) the Bank's continued participation in community and civic events, (3) strong networking efforts, (4) local decision making, and (5) consolidation and other changes which are occurring with respect to other local financial institutions.
The Bank's commercial lenders have approval authority up to designated individual limits, along with joint lending authority up to $750,000. Loans in excess of $750,000 are presented to the Bank's Credit Committee, comprised of the President, Chief Lending Officer, Credit Manager, Loan Review Officer (non-voting), and selected commercial lenders. The Credit Committee can approve loans up to $2,500,000 and recommend loans to the Executive Loan Committee for approval up to approximately
$7,020,000 (which represents 65% of the Bank's legal lending limit of approximately $10,800,000). The Executive Loan Committee is composed of the President, Chief Financial Officer, Chief Lending Officer, Loan Review Officer (non-voting member) and selected Board members. Loans up to the Bank's legal lending limit are submitted to the Board for approval. The Bank has established an "in-house" lending limit of 80% of its legal lending limit and, at December 31, 2005, the Bank has no loan relationships in excess of its in-house limit.
The Bank has successfully implemented individual, joint, and committee level approval procedures which have monitored and solidified credit quality as well as provided lenders with a process that is responsive to customer needs.
The Bank manages credit risk in the loan portfolio through adherence to consistent standards, guidelines, and limitations established by the credit policy. The Bank's credit department, along with the loan officer, analyzes the financial statements of the borrower, collateral values, loan structure, and economic conditions, to then make a recommendation to the appropriate approval authority. Commercial loans generally consist of real estate secured loans, lines of credit, term, and equipment loans. The Bank's underwriting policies impose strict collateral requirements and normally will require the guaranty of the principals. For requests that qualify, the Bank will use Small Business Administration guarantees to improve the credit quality and support local small business.
The Bank's loan review officers/department conduct ongoing, independent reviews of all new loan relationships to ensure adherence to established policies and procedures, monitor compliance with applicable laws and regulations, and provide objective measurement statistics. The Bank's loan review officers/department submit quarterly reports to the Audit Committee and/or the Board on loan concentrations, large loan relationships, collateral and documentation exceptions, and relevant loan ratios pertaining to the Bank's loan loss reserves, delinquency, and other key asset quality ratios.
Loan Portfolio
The following table sets forth the Company's loan distribution at the periods presented:
Loan Maturities
The following table shows the maturity of commercial, financial and agricultural loans outstanding at December 31, 2005:
Maturity of Certificates of Deposit of $100,000 or More
The following table sets forth the amounts of the Bank's certificates of deposit of $100,000 or more by maturity date.
Securities Portfolio Maturities and Yields
The following table sets forth information about the maturities and weighted average yield on the Company's securities portfolio. Floating rate securities are included in the "Due in 1 Year or Less" bucket. Yields are not reported on a tax equivalent basis.
Securities Portfolio
The following table sets forth the amortized cost of the Company's investment securities at its last three fiscal year ends:
For purposes of financial reporting, available for sale securities are reflected at estimated fair value.
Average Deposits and Average Rates by Major Classification
The following table sets forth the average balances of the Bank's deposits and the average rates paid for the years presented.
Other Borrowed Funds
Other borrowings at December 31, 2005 consisted of overnight borrowings from the FHLB under a repurchase agreement, overnight borrowings from other correspondent financial institutions, and repurchase agreements with customers and other financial institutions. The borrowings are collateralized by certain qualifying assets of the Bank.
Federal funds purchased by the Bank were $66.2 million and $36.1 million at December 31, 2005 and 2004, respectively. The federal funds purchased typically mature in one day.
Information concerning the short-term borrowings is summarized as follows:
Dividends and Shareholders' Equity
The Company declared cash dividends in 2005 of $0.70 per share, and $0.65 per share in 2004.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The discussion concerning the effects of interest rate changes on the Company's estimated net interest income for the year ended December 31, 2005 set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Interest Rate Sensitivity" in Item 7 hereof, is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Leesport Financial Corp.
Wyomissing, Pennsylvania
We have audited the accompanying consolidated balance sheets of Leesport Financial Corp., and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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 consolidated financial position of Leesport Financial Corp. and its subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Leesport Financial Corp.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 10, 2006 expressed an unqualified opinion on management's assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting.
/s/ BEARD MILLER COMPANY LLP
Reading, Pennsylvania
March 10, 2006
LEESPORT FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
(Dollar amounts in thousands, except per share data)
See Notes to Consolidated Financial Statements.
LEESPORT FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2005, 2004 and 2003
(Amounts in thousands, except per share data)
See Notes to Consolidated Financial Statements.
LEESPORT FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2005, 2004 and 2003
(Dollar amounts in thousands, except share data)
See Notes to Consolidated Financial Statements.
LEESPORT FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2005, 2004 and 2003
(Amounts in thousands)
See Notes to Consolidated Financial Statements.
LEESPORT FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2005, 2004 and 2003
(Amounts in thousands)
See Notes to Consolidated Financial Statements.
1. Significant Accounting Policies
Principles of consolidation:
The consolidated financial statements include the accounts of Leesport Financial Corp. (the "Company"), a bank holding company, which has elected to be treated as a financial holding company, and its wholly-owned subsidiaries, Leesport Bank (the "Bank"), Essick & Barr, LLC ("Essick & Barr") and Madison Financial Advisors, LLC ("Madison Financial"). As of December 31, 2005, the Bank's wholly-owned subsidiaries were Leesport Realty Solutions, LLC and Leesport Mortgage Holdings, LLC. All significant intercompany accounts and transactions have been eliminated.
Nature of operations:
The Bank provides full banking services. Essick & Barr provides risk management services, employee benefits insurance and personal and commercial insurance coverage through multiple insurance companies. Madison Financial provides investment advisory and brokerage services. Leesport Realty Solutions, LLC provides title insurance and other real estate related services to the Company's customers through limited partnership arrangements with unaffiliated third parties involved in the real estate services industry. Leesport Mortgage Holdings, LLC provides mortgage brokerage services through its limited partnership agreements with unaffiliated third parties involved in the real estate services industry. First Leesport Capital Trust I, Leesport Capital Trust II and Madison Statutory Trust I are trusts formed for the purpose of issuing mandatory redeemable debentures on behalf of the Company. These trusts are wholly-owned subsidiaries of the Company, but are not consolidated for financial statement purposes. See "Junior Subordinated Debt" in footnote 10. The Company and the Bank are subject to the regulations of various federal and state agencies and undergo periodic examinations by various regulatory authorities.
Use of estimates:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets and the determination of other-than-temporary impairment on securities.
Significant group concentrations of credit risk:
Most of the Company's banking, insurance and wealth management activities are with customers located within Berks, Schuylkill, Philadelphia, Montgomery and Delaware Counties, as well as, within other southeastern Pennsylvania market areas. Note 4 details the Company's investment securities portfolio for both available for sale and held to maturity investments. Note 5 discusses the Company's loan concentrations. Although the Company has a diversified loan portfolio, its debtors' ability to honor contracts is influenced by the region's economy.
Reclassifications:
For comparative purposes, certain amounts in prior years' consolidated financial statements have been reclassified to conform to report classifications of the current year. The reclassifications had no effect on net income.
Presentation of cash flows:
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks and interest-bearing deposits in other banks.
Securities:
Debt securities that management has the positive ability and intent to hold to maturity are classified as held-to-maturity and recorded at amortized cost. Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are carried at fair value. Unrealized gains and losses are reported in other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Purchased premiums and discounts are recognized in interest income using a method which approximates the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Loans:
Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are stated at their outstanding unpaid principal balances, net of any deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. These amounts are generally being amortized over the contractual life of the loan. Discounts and premiums on purchased loans are amortized to income using the interest method over the expected lives of the loans.
The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on non-accrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.
Allowance for loan losses:
The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management's periodic evaluation of the adequacy of the allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful or substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value for that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Loans held for sale:
Mortgage loans originated and intended for sale in the secondary market at the time of origination are carried at the lower of cost or estimated fair value on an aggregate basis. The majority of all sales are made with 90 day recourse. At December 31, 2005 and 2004, there were $16.6 million and $9.8 million, respectively, of residential mortgage loans held for sale.
Rate lock commitments:
In March 2002, the Financial Accounting Standards Board determined that loan commitments related to the origination or acquisition of mortgage loans that will be held for sale must be accounted for as derivative instruments, effective for fiscal quarters beginning after April 10, 2002. Accordingly, the Company adopted such accounting on July 1, 2002.
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates. Fees received are included in the net gain or loss on sale of mortgage loans.
Foreclosed assets:
Foreclosed assets, which are recorded in other assets, include properties acquired through foreclosure or in full or partial satisfaction of the related loan.
Foreclosed assets are initially recorded at fair value, net of estimated selling costs, at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of carrying amount or fair value, less estimated costs to sell. Revenue and expense from operations and changes in the valuation allowance are included in other expense.
Premises and equipment:
Premises and equipment are stated at cost less accumulated depreciation. Depreciation expense is calculated principally on the straight-line method over the respective assets estimated useful lives as follows:.
Transfer of financial assets:
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Bank-owned life insurance:
The Bank invests in bank owned life insurance ("BOLI") as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees. The Bank is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies in the amount of $11.7 million and $11.4 million at December 31, 2005 and 2004, respectively. Income from the increase in cash surrender value of the policies is included in other income on the income statement.
Stock-based compensation:
At December 31, 2005, the Company had two stock-based compensation plans, which are described more fully in Note 12. The Company accounts for these stock option plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation" to stock-based compensation.
The fair value of options granted during 2005, 2004 and 2003 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
Loan servicing:
Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount.
Revenue recognition:
Insurance revenues are derived from commissions and fees. Commission revenues, as well as the related premiums receivable and payable to insurance companies, are recognized the later of the effective date of the insurance policy or the date the client is billed, net of an allowance for estimated policy cancellations. The reserve for policy cancellations is periodically evaluated and adjusted as necessary. Commission revenues related to installment premiums are recognized as billed. Commissions on premiums billed directly by insurance companies are generally recognized as income when received. Contingent commissions from insurance companies are generally recognized as revenue when the data necessary to reasonably estimate such amounts is obtained. A contingent commission is a commission paid by an insurance company that is based on the overall profit and/or volume of the business placed with the insurance company. Fee income is recognized as services are rendered.
Goodwill and other intangible assets:
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 revised the accounting for purchased intangible assets and, in general, requires that goodwill no longer be amortized, but rather that it be tested for impairment on an annual basis at the reporting unit level, which is either at the same level or one level below an operating segment. Other acquired intangible assets with finite lives, such as purchased customer accounts, are required to be amortized over their estimated lives. Prior to January 1, 2002, substantially all of the Company's goodwill was amortized using the straight line method over fifteen to twenty years. Other intangible assets are amortized using the straight line method over estimated useful lives of four to twenty years. The Company periodically assesses whether events or changes in circumstances indicate that the carrying amounts of goodwill and other intangible assets may be impaired.
Income taxes:
Deferred taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities in the financial statements and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the date of enactment.
Off-balance sheet financial instruments:
In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded in the consolidated balance sheets when they become receivable or payable.
Derivative financial instruments:
The Company maintains an overall interest rate risk-management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Company's goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. As a result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the derivative instruments that are linked to the hedged assets and liabilities. The Company views this strategy as a prudent management of interest rate sensitivity, such that earnings are not exposed to undue risk presented by changes in interest rates.
By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain in a derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a derivative contract is negative, the Company owns the counterparty and, therefore, it has no repayment risk. The Company minimizes the credit (or repayment) risk in the derivative instruments by entering into transactions with high quality counterparties.
Market risk is the adverse effect that a change in interest rates, currency, or implied volatility rates has on the value of a financial instrument. The Company manages the market risk associated with interest rate contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken. The Company periodically measures this risk by using value-at-risk methodology.
During 2002, the Company entered into an interest rate swap to convert its fixed rate long-term debt to floating rate debt. Both the interest rate swap and the related debt are recorded on the balance sheet at fair value through adjustments to interest expense. For the years ended December 31, 2005, 2004 and 2003, the ineffective portion of the fair value hedge was minimal.
During 2003, the Company also entered into an interest rate cap agreement to limit its exposure to the variable rate interest achieved through the interest rate swap. The interest rate cap was not designated as a cash flow hedge and thus, it is carried on the balance sheet in other assets at fair value through adjustments to interest expense.
Derivatives use for the Company consists of an interest rate cap and an interest rate swap entered into in 2003 and 2002, respectively to in effect convert fixed rate capital debentures into variable rate. The Company has designated its interest rate swap as a fair value hedge as defined in SFAS No. 133. Because the critical term of the interest rate swap matches the terms of the trust preferred securities, the swap qualifies for "short-cut method" accounting treatment under SFAS No. 133.
Advertising:
Advertising costs are expensed as incurred.
Earnings per common share:
Basic earnings per common share is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is calculated by adjusting the weighted average number of shares of common stock outstanding to include the effect of stock options, if dilutive, using the treasury stock method.
The number of common shares outstanding as of December 31, 2004 and all references to the weighted-average number of common shares outstanding and per share amounts reflect the 5% stock dividend declared by the Board of Directors on December 15, 2004 with a record date of January 3, 2005 and distributed to shareholders on January 14, 2005. The 5% stock dividend resulted in 236,874 shares and cash paid of $11,790 on 349.2 fractional shares.
The Company's calculation of earnings per share for the years ended December 31, 2005, 2004, and 2003 is as follows:
Comprehensive income:
Accounting principles generally require that recognized revenue, expense, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
The components of other comprehensive loss and related tax effects were as follows:
Segment reporting:
The Bank acts as an independent community financial services provider which offers traditional banking and related financial services to individual, business and government customers. Through its branch and automated teller machine networks, the Bank offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of other financial services. Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial and retail operations of the Bank. As such, discrete financial information is not available and segment reporting would not be meaningful. See Note 18 for a discussion of insurance operations, investment advisory and brokerage operations and mortgage banking operations.
Recently issued accounting standards:
In January 2003, the FASB's Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investors" ("EITF 03-1"), and in March 2004, the EITF issued an update. EITF 03-1 addresses the meaning of other-than-temporary impairment and its application to certain debt and equity securities. EITF 03-1 aids in the determination of impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff's recommendations were to nullify the guidance on the determination of whether an investment is impaired as set forth in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the meaning of other-than-temporary impairment. Instead, the staff recommends entities recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115.
In July 2005, the FASB issued a proposed interpretation of FAS 109, "Accounting for Income Taxes," to clarify certain aspects of accounting for uncertain tax positions, including issues related to
the recognition and measurement of those tax positions. Management is currently in the process of determining the impact of adoption of the interpretation as proposed on the Company's consolidated financial statements.
In June 2005, the EITF reached a consensus on Issue No. 05-6, "Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination" ("EITF 05-6"). This guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are reasonably assured at the date of the business combination or purchase. This guidance is applicable only to leasehold improvements that are purchased or acquired in reporting periods beginning after June 29, 2005. The Company is evaluating the impact, if any, of EITF 05-6 on its consolidated financial statements.
In October 2005, the FASB issued FASB Staff Position FAS 13-1 ("FSP FAS 13-1"), which requires companies to expense rental costs associated with ground or building operating leases that are incurred during a construction period. As a result, companies that are currently capitalizing these rental costs are required to expense them beginning in its first reporting period beginning after December 15, 2005. FSP FAS 13-1 is effective for our Company as of the first quarter of fiscal 2006. Management has evaluated the provisions of FSP FAS 13-1 and do not believe that its adoption will have a material impact on the Company's financial condition or results of operations.
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) replaces Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt the new standard using a modified prospective method and may elect to restate prior periods using the modified retrospective method. Under the modified prospective method, companies are required to record compensation cost for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method. Under the modified retrospective method, companies record compensation costs for prior periods retroactively through restatement of such periods using the exact pro forma amounts disclosed in the companies' footnotes. Also, in the period of adoption and after, companies record compensation cost based on the modified prospective method.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No. 107"), "Share-Based Payment," providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of SFAS No. 123(R) on January 1, 2006.
On April 14, 2005, the Securities and Exchange Commission ("SEC") adopted a new rule that amends the compliance dates for Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). Under the new rule, the Company is required to adopt SFAS No. 123R in the first annual period beginning after September 15, 2005. Using the modified prospective method, the Company estimates that total stock-based compensation expense, net of related tax effects, will be approximately $86,000 for the year ending December 31, 2006. Any additional impact will be determined by share-based payments granted in future periods.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations-an interpretation of SFAS No. 143," ("FIN 47"). This Interpretation provides clarification with respect to the timing of liability recognition for legal obligations associated with the retirement of tangible long-lived assets when the timing and/or method of settlement of the obligation are conditional on a future event. FIN 47 is effective for all fiscal years ending after December 15, 2005 (December 31, 2005, for calendar-year companies). Retrospective application for interim financial information is permitted but is not required. Early adoption of this Interpretation is encouraged. We do not expect the adoption of FIN 47 to materially impact our condensed consolidated financial statements.
In May 2005, FASB issued SFAS 154, "Accounting Changes and Error Corrections." The Statement requires retroactive application of a voluntary change in accounting principle to prior period financial statements unless it is impracticable. SFAS 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS 154 replaces APB Opinion 20, "Accounting Changes," and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS 154 will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Management currently believes that adoption of the provisions of SFAS 154 will not have a material impact on the Company's consolidated financial statements.
In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004. The Company adopted the provisions of SOP 03-3 on January 1, 2005 and it did not have a material effect on the Company's consolidated financial statements.
2. Acquisitions and Divesture
On October 1, 2004, the Company acquired 100% of the outstanding voting shares of Madison Bancshares Group, Ltd., the holding company for Madison Bank ("Madison"), a Pennsylvania state-chartered commercial bank. Madison has become a division of Leesport Bank. The transaction enhances the Company's strong presence in Pennsylvania, particularly in the high growth counties of Berks, Philadelphia, Montgomery and Delaware. The results of Madison's operations have been included in the consolidated financial statements since the date of acquisition.
Under the terms of the merger, each share of Madison common stock was exchanged for 0.6028 shares of Leesport common stock resulting in the issuance of 1,311,010 of Leesport common stock and a cash payment of $11,790. The total purchase price was $34.6 million. The value of the common shares issued was determined based on the average market price of Leesport common shares five days before and five days after the date of the announcement. In connection with the transaction, Madison paid cash of $7.1 million and recognized the expense for 699,122 Madison options and warrants outstanding at September 30, 2004. In addition, Madison paid cash of $2.3 million and recognized the expense for the termination of existing contractual arrangements.
The $28.2 million of goodwill was assigned to our banking and financial services segment. None of the goodwill is expected to be deductible for tax purposes.
The following represents the unaudited pro forma results of the ongoing operations for Leesport Financial Corp. and Madison as though the acquisition of Madison had occurred at the beginning of each period shown. The unaudited pro forma information, however, is not necessarily indicative of the results that would have resulted had the acquisition occurred at the beginning of the periods presented, nor is it necessarily indicative of future results.
On September 30, 2003, the Company acquired certain assets of CrosStates Insurance Consultants, Inc. ("CrosStates"), a full service insurance agency that specializes in personal and casualty insurance headquartered in Langhorne, Pennsylvania. CrosStates has become a division of the Company's Essick & Barr, LLC insurance agency. As a result of this acquisition, Essick & Barr, LLC expanded its retail and commercial insurance presence in southeastern Pennsylvania counties. The results of CrosStates' operations have been included in the consolidated financial statements since October 1, 2003.
The Company paid cash of $1.0 million for CrosStates on September 30, 2003 and recorded a liability of $1.4 million, payable to the shareholder of CrosStates in cash and stock at the then current market value. This liability is included in other liabilities. After the first and second years following the acquisition, $1.0 million and $0.4 million, respectively, will be paid to the former shareholder of CrosStates. On October 1, 2004, the Company paid the shareholder of CrosStates $500,000 in cash and $500,000 in fair market value of the Company's stock. Also, there are contingent payments totaling up to $1.2 million, payable to the former shareholder in cash and stock at the then current market value based on CrosStates achieving certain annual revenue levels through September 30, 2005. On March 17, 2005, the Company and the seller amended the asset purchase agreement to increase the payment to the seller in the second year following the acquisition of CrosStates to $1.0 million. The $0.6 million increase was recorded as goodwill and a liability payable to the seller in stock at the then current market value. Under the amended agreement, the total potential amount of contingent payments was correspondingly reduced from $1.2 million to $0.6 million.
In accordance with the provisions of SFAS No. 142, the Company continues to amortize other intangible assets over the estimated remaining life of each respective asset. Amortizable intangible assets were composed of the following:
The changes in the carrying amount of goodwill for the years ended December 31, 2005 and 2004 are as follows:
In 2005, the Company recognized an additional net operating loss carry-forward of approximately $467,000 related to the Madison acquisition. This transaction resulted in an increase in deferred taxes and a decrease in goodwill.
On September 5, 2003, the Company finalized an agreement with The Legacy Bank, Harrisburg, Pennsylvania, to sell its three most northern financial centers-Shenandoah, located in northern Schuylkill County, and Drums and Hazleton, located in Luzerne County. Included in the results for 2003 is the gain of $3,073,000 on the sale to The Legacy Bank of these financial centers. Included in the sale were approximately $59.5 million in deposits and related accrued interest and loans of approximately $24 million and other assets of approximately $1.0 million.
3. Restrictions on Cash and Due from Banks
The Federal Reserve Bank requires the Bank to maintain average reserve balances. For the years 2005 and 2004, the average of these daily reserve balances approximated $3.8 million and $3.5 million, respectively.
4. Securities Available For Sale and Securities Held to Maturity
The amortized cost and estimated fair values of securities held to maturity and securities available for sale were as follows at December 31, 2005 and 2004:
Equity securities include restricted stock in the FHLB of $6.1 million and $5.8 million at December 31, 2005 and 2004, respectively. The FHLB requires the Company to maintain a certain amount of FHLB stock according to a predetermined formula. The stock is carried at cost.
The following table shows the gross unrealized losses and fair value of securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005 and 2004:
There were 172 securities in the less than twelve month category and 57 securities in the twelve month or more category. The Company has the ability to hold these securities until maturity or market price recovery. Management believes that the unrealized losses represent temporary impairments of the securities.
A. U.S. Government agencies and corporations. The unrealized losses on the Company's investments in obligations of U S Government agencies were caused by interest rate increases. The Company purchased those investments at par or at a discount relative to their face amount and the contractual cash flows are guaranteed by an agency of the U S Government. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005.
B. Federal Agency and Corporate Mortgage-Backed Securities. The unrealized losses on the Company's investments in federal agency and corporate mortgage-backed securities were caused by interest rate increases. The Company purchased those securities at a price relative to the market at the time of the purchase, and the contractual cash flows of those investments are guaranteed either by an agency of the U S Government or the corporate entity. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the
Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005.
C. Other Securities. The Company's unrealized loss on investments in other securities relates to $3.0 million investment in financial services industry company notes. The unrealized losses are caused by (a) decreases in profitability and near-term profit forecasts by industry analysts resulting from competitive pricing pressure in the auto manufacturing industry and (b) interest rate increases. The contractual terms of those investments do not permit the companies to settle the securities at a price less than the amortized cost of the investment. While the credit rating for certain issues have decreased during the period, the Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005.
D. Equity Securities. The Company's investments in marketable equity securities primarily consist of investments in preferred stock in a U S government sponsored enterprise ($4.5 million of the fair value and $314,000 of the total unrealized losses in equity security investments) and the common stock of companies in the financial services industry ($2.7 million of the total fair value and where there is a $126,000 net gain). Within the Company's equity securities portfolio is (1) a $4.85 million investment in FHLMC 5.1% Series perpetual preferred stock. The unrealized losses are caused by (a) questions concerning the operating structure of the company, especially in the areas of financial reporting and management control and (b) interest rate increases. Perpetual preferred stock is an equity security that is junior to the entity's debt obligations but senior to common stock. The preferred stock pays quarterly dividends at the above stated fixed rate, and while it does not have a stated maturity date the issuer has the right to retire securities through redemption provisions. FHLMC is a U S government-sponsored enterprise and the Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investment. Because the market value is attributable to operational scrutiny and changes in interest rates and not credit quality, and the Company has the ability and intent to hold those investments until a recovery of fair value, which may be at redemption, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005. (2) A $141,000 investment in FNMA common stock (1.7% of the fair value and 16.8% of the total unrealized losses in the equity security investments). The government sponsored enterprise has experienced recent growth and is working through its accounting issues and feels optimistic about the near-term prospects. Based on that information and the Company's ability and intent to hold those investments for a reasonable time period sufficient for a recovery of fair value, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005.
December 31, 2004:
During 2004, the Bank transferred $4,196,000 of securities from securities available for sale to securities held to maturity. The securities were transferred at their fair value on the date of transfer which was $164,000 more than the amortized cost of the securities. This difference was reflected as a component of accumulated other comprehensive income and is being amortized over the period to maturity of the respective securities. At December 31, 2005, this difference has been completely amortized.
The amortized cost and fair value of securities as of December 31, 2005, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because certain securities may be called or prepaid without penalty.
Securities with a carrying amount of $153.0 million and $113.0 million at December 31, 2005 and 2004, respectively, were pledged to secure securities sold under agreements to repurchase, public deposits and for other purposes as required or permitted by law.
The following gross gains and losses were realized on sales of securities available for sale in 2005, 2004 and 2003:
5. Loans
The components of loans were as follows:
Changes in the allowance for loan losses were as follows:
The recorded investment in impaired loans not requiring an allowance for loan losses was $6.2 million at December 31, 2005 and $5.9 million at December 31, 2004. The recorded investment in impaired loans requiring an allowance for loan losses was $2.2 million and $2.4 million at December 31, 2005 and 2004, respectively. At December 31, 2005 and 2004, the related allowance for loan losses associated with those loans was $1.4 million and $1.4 million, respectively. For the years ended December 31, 2005, 2004 and 2003, the average recorded investment in these impaired loans was $8.1 million, $5.6 million and $5.8 million, respectively; and the interest income recognized on impaired loans was $356,000 for 2005, $236,000 for 2004 and $287,000 for 2003.
Loans on which the accrual of interest has been discontinued amounted to $5,567,000 and $2,918,000 at December 31, 2005 and 2004 respectively. Loan balances past due 90 days or more and still accruing interest but which management expects will eventually be paid in full, amounted to $606,000 and $2,965,000 at December 31, 2005 and 2004.
6. Loan Servicing
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balance of these loans as of December 31, 2005 and 2004 was $29.1 million and $33.5 million, respectively.
The balance of capitalized servicing rights included in other assets at December 31, 2005 and 2004, was $685,000 and $443,000, respectively. The fair value of these rights was $685,000 and $443,000, respectively. The fair value of servicing rights was determined using a 9.0 percent discount rate for 2005 and 2004.
The following summarizes mortgage servicing rights capitalized and amortized:
7. Premises and Equipment
Components of premises and equipment were as follows:
In the second quarter of 2005, the Company sold a parcel of land located in Luzerne County, Pennsylvania. The proceeds of the sale were approximately $163,000. The Company recognized a gain of approximately $19,000 on the transaction.
In the fourth quarter of 2004, the Company sold six branch locations and leased them back from the purchaser with a lease term of 20 years. The proceeds of the sale were $7.7 million. The gain on the transaction was $712,000 and will be amortized over the 20 year lease term.
Certain facilities and equipment are leased under various operating leases. Rental expense for these leases was $3,215,000, $1,633,000 and $1,100,000 for the years ended December 31, 2005, 2004
and 2003, respectively. Future minimum rental commitments under non-cancelable leases as of December 31, 2005 were as follows:
8. Deposits
The components of deposits were as follows:
At December 31, 2005, the scheduled maturities of time deposits were as follows (in thousands):
9. Borrowings and Other Obligations
At December 31, 2005 and 2004, the Bank had purchased federal funds from the Federal Home Loan Bank totaling $66.2 million and $36.1 million, respectively.
During 2003, the Bank entered into securities sold under agreements to repurchase totaling $25 million with terms ranging from 1 to 3 years and interest rates ranging from 1.34% to 2.60%. During 2004, the Bank entered into securities sold under agreements to repurchase totaling $5 million with terms of 2 years and at interest rates of 2.84%. During 2005, the Bank entered into securities sold under agreements to repurchase totaling $30 million. These securities sold under agreements to repurchase have a 5 year term, carry a variable interest rate tied to the three month LIBOR rate minus 75 basis points ranging from 3.62% to 3.78%, and, in 2006, may either convert to a fixed rate loan or may be called. Total borrowings under these repurchase agreements were $45.0 million and $25.0 million at December 31, 2005 and 2004, respectively.
These repurchase agreements are treated as financings with the obligations to repurchase securities sold reflected as a liability in the balance sheet. The dollar amount of securities underlying the agreements remains recorded as an asset, although the securities underlying the agreements are delivered to the broker who arranged the transactions. In certain instances, the brokers may have sold, loaned, or disposed of the securities to other parties in the normal course of their operations, and have agreed to deliver to the Company substantially similar securities at the maturity of the agreement. The broker/dealers who participated with the Company in these agreements are primarily broker/dealers reporting to the Federal Reserve Bank of New York. Securities underlying sales of securities under repurchase agreements consisted of investment securities that had an amortized cost of $52.0 million and a market value of $50.3 million at December 31, 2005.
At December 31, 2005, the securities sold under agreements to repurchase consisted of the following:
In addition, the Bank enters into agreements with bank customers as part of cash management services where the Bank sells securities to the customer overnight with the agreement to repurchase them at par. Securities sold under agreements to repurchase generally mature one day from the transaction date.
The securities underlying the agreements are under the Bank's control. The outstanding customer balances and related information of securities sold under agreements to repurchase are summarized as follows:
Long-term debt consisted of the following:
(1)These notes contain a convertible option that allows the FHLB, at quarterly intervals, to change the note to an adjustable-rate advance at three-month LIBOR (4.54% at December 31, 2005) plus 14 to 16 basis points. If the note is converted, the option allows the Bank to put the funds back to the FHLB at par. The year/year refers to the maturity of the note (in years) and the term until the first convertible date.
Contractualmaturities of long-term debt at December 31, 2005 were as follows (in thousands):
The Bank has a maximum borrowing capacity with the Federal Home Loan Bank of approximately $216.3 million, of which $109.2 million was outstanding at December 31, 2005. Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.
On September 30, 2003, the Bank prepaid $40.9 million of fixed rate, high cost Federal Home Loan Bank (FHLB) advances in order to improve future net interest income. The FHLB advances were replaced with lower cost borrowings and certificates of deposits. The Bank expensed prepayment fees of $2,482,000 associated with this transaction.
On December 29, 2003, the Bank entered into a limited partner subscription agreement with Midland Corporate Tax Credit XVI Limited Partnership, where the Bank will receive special tax credits and other tax benefits. The Bank subscribed to a 6.2% interest in the partnership, which is subject to an adjustment depending on the final size of the partnership at a purchase price of $5 million. This investment is included and recorded in other assets as of December 31, 2005 and 2004 and is not guaranteed; therefore, it will be accounted for in accordance with Statement of Position (SOP) 78-9, "Accounting for Investments in Real Estate Ventures" using the equity method. This agreement was accompanied by a payment of $1,675,000 and a non-interest bearing promissory note payable of $3,325,000. The balance of the $1,050,000 non-interest bearing promissory note payable included in other liabilities at December 31, 2004 was paid on January 1, 2005.
The Company has entered into a contract with a provider of information systems services for the supply of such services through April 2011. The Company is required to make minimum annual payments as follows, whether or not it uses the services:
Total expenditures during 2005 and 2004 in connection with the contract were $1,485,000 and $1,118,000, respectively.
The Company is also party to legal actions that are routine and incidental to its business. In management's opinion, the outcome of these matters, individually or in the aggregate, will not have a material effect on the financial statements of the Company.
10. Junior Subordinated Debt
First Leesport Capital Trust I, a Delaware statutory business trust, was formed on March 9, 2000 and is a wholly-owned subsidiary of the Company. The Trust issued $5 million of 107/8% fixed rate capital trust pass-through securities to investors. First Leesport Capital Trust I purchased $5 million of fixed rate junior subordinated deferrable interest debentures from Leesport Financial Corp. The debentures are the sole asset of the Trust. The terms of the junior subordinated debentures are the same as the terms of the capital securities. The obligations under the debentures constitute a full and unconditional guarantee by Leesport Financial Corp. of the obligations of the Trust under the capital securities. The capital securities are redeemable by Leesport Financial Corp. on or after March 9, 2010, at stated premiums, or earlier if the deduction of related interest for federal income taxes is prohibited, classification as Tier 1 Capital is no longer allowed, or certain other contingencies arise. The capital securities must be redeemed upon final maturity of the subordinated debentures on March 9, 2030. In October 2002, the Company entered into an interest rate swap agreement with a notional amount of $5 million that effectively converts the securities to a floating interest rate of six month LIBOR plus 5.25% (9.16% at December 31, 2005). In June, 2003, the Company purchased a six month LIBOR cap with a rate of 5.75% to create protection against rising interest rates for the above mentioned $5 million interest rate swap. Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities and to limit the exposure created by other interest rate swaps.
On September 26, 2002, the Company established Leesport Capital Trust II, a Delaware statutory business trust, in which the Company owns all of the common equity. Leesport Capital Trust II issued $10 million of mandatory redeemable capital securities carrying a floating interest rate of three month LIBOR plus 3.45% (7.79% at December 31, 2005). These debentures are the sole assets of the Trusts. The terms of the junior subordinated debentures are the same as the terms of the capital securities. The obligations under the debentures constitute a full and unconditional guarantee by Leesport Financial Corp. of the obligations of the Trust under the capital securities. These securities must be redeemed in September 2032, but may be redeemed on or after November 7, 2007 or earlier in the event that the interest expense becomes non-deductible for federal income tax purposes or if the treatment of these securities is no longer qualified as Tier I capital for the Company.
On June 26, 2003, Madison established Madison Statutory Trust I, a Connecticut statutory business trust. Pursuant to the purchase of Madison on October 1, 2004, the Company assumed Madison Statutory Trust I in which the Company owns all of the common equity. Madison Statutory Trust I issued $5 million of mandatory redeemable capital securities carrying a floating interest rate of three month LIBOR plus 3.10% (7.62% at December 31, 2005). These debentures are the sole assets of the Trusts. The terms of the junior subordinated debentures are the same as the terms of the capital securities. The obligations under the debentures constitute a full and unconditional guarantee by Leesport Financial Corp. of the obligations of the Trust under the capital securities. These securities must be redeemed in June 2033, but may be redeemed on or after September 26, 2008 or earlier in the event that the interest expense becomes non-deductible for federal income tax purposes or if the treatment of these securities is no longer qualified as Tier I capital for the Company.
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" which was revised in December 2003. This Interpretation provides guidance for the consolidation of variable interest entities (VIEs). First Leesport Capital Trust I, Leesport Capital Trust II and Madison Statutory Trust I (the "Trusts") each qualify as a variable interest entity under FIN 46. The Trusts issued mandatory redeemable preferred securities (Trust Preferred Securities) to third-party investors and loaned the proceeds to the Company. The Trusts hold, as their sole assets, subordinated debentures issued by the Company.
FIN 46 required the Company to deconsolidate First Leesport Capital Trust I and Leesport Capital Trust II from the consolidated financial statements as of March 31, 2004 and to deconsolidate Madison Statutory Trust I as of December 31, 2004. There has been no restatement of prior periods. The impact of this deconsolidation was to increase junior subordinated debentures by $20,150,000 and reduce the mandatory redeemable capital debentures line item by $20,150,000 which had represented the trust preferred securities of the trust. The Company's equity interest in the trust subsidiaries of $538,000, which had previously been eliminated in consolidation, is now reported in "Other assets" as of December 31, 2005 and 2004. For regulatory reporting purposes, the Federal Reserve Board has indicated that the preferred securities will continue to qualify as Tier 1 Capital subject to previously specified limitations, until further notice. If regulators make a determination that Trust Preferred Securities can no longer be considered in regulatory capital, the securities become callable and the Company may redeem them. The adoption of FIN 46 did not have an impact on the Company's results of operations or liquidity.
11. Employee Benefits
The Company has an Employee Stock Ownership Plan (ESOP) to provide its employees with future retirement plan assistance. The ESOP invests primarily in the Company's common stock. Contributions to the Plan are at the discretion of the Board of Directors. For the years ended December 31, 2005, 2004 and 2003, $233,000, $285,000 and $217,000, respectively, was accrued to provide for contribution of shares to the Plan. During 2005, 2004 and 2003 respectively, 11,369 shares, 10,018 shares and 9,348 shares were purchased on behalf of the ESOP.
The Company has a 401(k) Salary Deferral Plan. This plan covers all eligible employees who elect to contribute to the Plan. An employee who has attained 18 years of age and has been employed for at least 30 calendar days is eligible to participate in the Plan effective with the next quarterly enrollment period. Employees become eligible for the Company contribution to the Salary Deferral Plan at each future enrollment period upon completion of one year of service. The Company contributes 100% of the first three percent of eligible employees' annual salary deferral and 50% of the next four percent of salary deferred. Contributions from the Company vest to the employee over a five year schedule. The annual expense included in salaries and employee benefits representing the expense of the Company's
contribution was $661,000, $462,000, and $335,000 for the years ended December 31, 2005, 2004, and 2003, respectively.
The Company has entered into deferred compensation agreements with certain directors and a salary continuation plan for certain key employees. At December 31, 2005 and 2004, the present value of the future liability for these plans was $1,388,000 and $1,484,000, respectively. To fund the benefits under these agreements, the Company is the owner and beneficiary of life insurance policies on the lives of certain directors and employees. These bank-owned life insurance policies had an aggregate cash surrender value of $11.7 million and $11.4 million at December 31, 2005 and 2004, respectively. For the years ended December 31, 2005, 2004 and 2003, ($22,000), $360,000 and $236,000, respectively, was charged to expense in connection with these agreements.
Leesport Financial Corp. has a non-compensatory Employee Stock Purchase Plan (ESPP). Under the ESPP, employees of the Company who elect to participate are eligible to purchase common stock at prices up to a 15 percent discount from the market value of the stock. The ESPP does not allow the discount in the event that the purchase price would fall below the Company's most recently reported book value per share. The ESPP allows an employee to make contributions through payroll deduction to purchase common shares up to 15 percent of annual compensation. The total number of shares of common stock that may be issued pursuant to the ESPP is 275,625. As of December 31, 2005, a total of 23,479 shares have been issued under the ESPP.
12. Stock Option Plans and Shareholders' Equity
The Company has an Employee Stock Incentive Plan (ESIP) that covers all officers and key employees of the Company and its subsidiaries and is administered by a committee of the Board of Directors. The total number of shares of common stock that may be issued pursuant to the ESIP is 441,525. The option price for options issued under the Plan must be at least equal to 100% of the fair market value of the common stock on the date of grant and shall not be less than the stock's par value. Options granted under the Plan have a various vesting periods ranging from immediate up to 5 years, 20% exercisable not less than one year after the date of grant, but no later than ten years after the date of grant in accordance with the vesting. Vested options expire on the earlier of ten years after the date of grant, three months from the participant's termination of employment or one year from the date of the participant's death or disability. As of December 31, 2005, a total of 58,698 shares have been issued under the ESIP.
The Company has an Independent Directors Stock Option Plan (IDSOP). The total number of shares of common stock that may be issued pursuant to the IDSOP is 110,381. The Plan covers all directors of the Company who are not employees and former directors who continue to be employed by the Company. The option price for options issued under the Plan will be equal to the fair market value of the Company's common stock on the date of grant. Options are exercisable from the date of grant and expire on the earlier of ten years after the date of grant, three months from the date the participant ceases to be a director of the Company or the cessation of the participant's employment, or twelve months from the date of the participant's death or disability. As of December 31, 2005, a total of 14,313 shares have been issued under the IDSOP.
Stock option transactions under the Plans, as adjusted for the 5% stock dividend in 2004, were as follows:
Options available for grant at December 31, 2005 were 133,608.
On May 20, 2004, the Company announced the extension of its stock repurchase plan, originally effective January 1, 2003, for the repurchase of up to 162,000 shares of the Company's common stock. At December 31, 2005, the maximum number of shares that may yet be purchased under the plan is 95,513.
13. Income Taxes
The components of income tax expense were as follows:
Reconciliation of the statutory federal income tax expense computed at 34% to the income tax expense included in the consolidated statements of income is as follows:
The federal income tax provision includes $126,000, $117,000 and $97,000 in 2005, 2004 and 2003, respectively, of federal income taxes related to gains on the sale of securities.
Net deferred tax assets consisted of the following components:
The Company has approximately $4.8 million of federal net operating loss carryovers from the acquisition of Madison, which will expire in 2024. The utilization of these losses is subject to annual limitation under Section 382 of the Internal Revenue Code. The Company has approximately $6.7 million of state net operating loss carryovers which will expire in 2024.
14. Transactions with Executive Officers and Directors
The Bank has had banking transactions in the ordinary course of business with its executive officers and directors and their related interests on the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with others. At December 31, 2005 and 2004, these persons were indebted to the Bank for loans totaling $8.96 million and $9.64 million, respectively. During 2005, $55,000 thousand of new loans were made and repayments totaled $740,000.
15. Regulatory Matters and Capital Adequacy
The Company and the Bank are 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 their financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification 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 Company and the Bank to maintain minimum amounts and ratios of total and tier I capital (as defined in the regulations) to risk-weighted assets, and of tier I capital to average assets. Management believes, as of December 31, 2005, that the Company and the Bank meet all minimum capital adequacy requirements to which they are subject.
As of December 31, 2005, the most recent notification from the Bank's primary regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed its category.
The Company's and the Bank's actual capital amounts and ratios are presented below:
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. At December 31, 2005, the Bank had approximately $6.5 million available for payment of dividends to the Company. Loans or advances are limited to 10 percent of the Bank's capital stock and surplus on a secured basis. At December 31, 2005 and 2004, respectively, the Bank had no secured loans outstanding to the Company.
As of December 21, 2005, the Company had declared a $.18 per share cash dividend for shareholders of record on January 3, 2005, payable January 13, 2006. As of December 15, 2004, the Company had declared a $.16 per share cash dividend for shareholders of record on January 3, 2005, payable January 14, 2005.
In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements.
16. Financial Instruments with Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet investments.
A summary of the Bank's financial instrument commitments is as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.
Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future
payments required under the corresponding guarantees. The current amount of the liability as of December 31, 2005 and 2004 for guarantees under standby letters of credit issued is not material.
During October 2002, the Company entered into an interest rate swap agreement with a notional amount of $5 million. This derivative financial instrument effectively converted fixed interest rate obligations of outstanding mandatory redeemable capital debentures to variable interest rate obligations, decreasing the asset sensitivity of its balance sheet by more closely matching the Company's variable rate assets with variable rate liabilities. The Company considers the credit risk inherent in the contracts to be negligible. This swap has a notional amount equal to the outstanding principal amount of the related trust preferred securities, together with the same payment dates, maturity date and call provisions as the related trust preferred securities.
Under the swap, the Company pays interest at a variable rate equal to six month LIBOR plus 5.25%, adjusted semiannually (9.16% at December 31, 2005), and the Company receives a fixed rate equal to the interest that the Company is obligated to pay on the related trust preferred securities (107/8%). The Company has designated its interest rate swap as a fair value hedge as defined in SFAS No. 133. Because the critical terms of the interest rate swap match the terms of the trust preferred securities, the swap qualifies for "short-cut method" accounting treatment under SFAS No. 133.
The estimated fair value of the interest rate swap agreement represents the amount the Company would have expected to receive (pay) to terminate such contract. At December 31, 2005 and 2004, the estimated fair value of the interest rate swap agreement was ($93,000) and ($34,000), respectively, and was offset by a decrease in the fair value of the related trust preferred security. The swap agreement exposes the Company to market and credit risk if the counterparty fails to perform. Credit risk is equal to the extent of a fair value gain on the swap. The Company manages this risk by entering into the transaction with high quality counterparties.
During the years ended December 31, 2005, 2004 and 2003, the Company recognized amounts received or receivable under the agreement of $113,000, $200,000 and $209,000, which was recorded as a reduction of interest expense on the trust preferred securities.
Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities and to limit the exposure created by other interest rate swaps. In June, 2003 the Company purchased a six month LIBOR cap to create protection against rising interest rates for the above mentioned $5 million interest rate swap. The initial premium related to this interest rate cap was $102,000. At December 31, 2005 and 2004, the carrying and market values were approximately $38,000 and $102,000, respectively.
17. Fair Value of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amount the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful.
The following methods and assumptions were used to estimate the fair values of the Company's financial instruments at December 31, 2005 and 2004:
Cash and cash equivalents:
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.
Securities:
Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans and loans held for sale:
For variable-rate and adjustable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. For fixed-rate loans, fair values are estimated using quoted market prices, when available, or discounted cash flows, at interest rates currently offered for loans with similar terms to borrowers of similar credit quality.
Mortgage servicing rights:
The fair value of mortgage servicing rights is based on observable market prices when available or the present value of expected future cash flows when not available.
Interest rate swap and cap:
The fair value of the interest rate swap and interest rate cap agreements are based on the net present value of expected future cash flows and are heavily dependent on interest rate assumptions over the remaining term of the agreements.
Deposit liabilities:
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings and certain types of money market accounts) are considered to be equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits.
Securities sold under agreements to repurchase and federal funds purchased:
The carrying amounts of these borrowings approximate their fair values.
Long-term debt:
The fair value of long-term debt is calculated based on the discounted value of contractual cash flows, using rates currently available for borrowings with similar maturities.
Junior subordinated debt:
The fair value of these debentures is calculated based on the discounted value of contractual cash flows, using rates currently available.
Accrued interest receivable and payable:
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Off-balance sheet instruments:
Fair values for the off-balance sheet instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.
The estimated fair values of the Company's financial instruments as of December 31, 2005 and 2004 were as follows:
18. Segment and Related Information
The Company's insurance operations, investment operations and mortgage banking operations are managed separately from the traditional banking and related financial services that the Company also offers. The mortgage banking operation offers residential lending products and generates revenue primarily through gains recognized on loan sales. The insurance operation provides coverage for commercial, individual, surety bond, and group and personal benefit plans. The investment operation provides services for individual financial planning, retirement and estate planning, investments, corporate and small business pension and retirement planning. Effective January 1, 2005, Leesport Investment Group, LLC merged into Leesport Wealth Management, LLC. Leesport Wealth Management, LLC changed its name to Madison Financial Advisors, LLC.
During the second quarter of 2005, the Company changed the composition of its reportable segments, which resulted in the mortgage banking operations being included as a separate segment. The segment was previously included in the banking and financial services segment. The Company has restated the corresponding items of segment information for earlier periods.
Segment information for 2005, 2004 and 2003 is as follows (in thousands):
Income (loss) before income taxes, as presented above, does not reflect referral and management fees of approximately $580,000, $1,577,000 and $110,000 that the mortgage banking operation, insurance operation and the brokerage and investment operation, respectively, paid to the Company during 2005. For 2004, referral and management fees of approximately $1,608,000 and $146,000 were paid by the insurance operation and brokerage and investment operation, respectively. Referral and management fees of approximately $1,226,000 and $142,000 were paid by the insurance operation and the brokerage and investment operation, respectively, in 2003.
19. Leesport Financial Corp. (Parent Company Only) Financial Information
STATEMENTS OF CONDITION
STATEMENTS OF INCOME
STATEMENTS OF CASH FLOWS
20. Quarterly Data (Unaudited)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
The Company's management, with the participation of the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of December 31, 2005. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer conclude that the Company's disclosure controls and procedures are effective as of such date.
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. The Company's management, with the participation of the Company's principal executive officer and principal financial officer, has evaluated the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, the Company's management concluded that our internal control over financial reporting was effective as of December 31, 2005.
There have been no material changes in the Company's internal control over financial reporting during the fourth quarter of 2005 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005, has been audited by Beard Miller Company LLP, an independent registered public accounting firm, as stated in its attestation report which is included herein.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting. An adequate system of internal control over financial reporting encompasses the processes and procedures that have been established by management to:
•Maintain records that, in reasonable detail, accurately reflect the company's transactions
•Provide reasonable assurance that the transactions are recorded as necessary to permit preparation of the financial statement and footnote disclosures in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of managements and the directors of the Corporation
•Provide reasonable assurance regarding the prevention of unauthorized acquisition, use, or disposition of the Corporation's assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of the Corporation's internal control over financial reporting based on the criteria in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation under the criteria in Internal Control- Integrated Framework, management concluded that internal control over financial reporting was effective as of December 31, 2005. Furthermore, during the conduct of its assessment, management identified no material weakness in its financial reporting control system.
The Board of Directors of Leesport Financial Corp., through its Audit Committee, provides oversight to managements' conduct of the financial reporting process. The Audit Committee, which is composed entirely of independent directors, is also responsible to recommend the appointment of independent public accountants. The Audit Committee also meets with management, the internal audit staff, and the independent public accountants throughout the year to provide assurance as to the adequacy of the financial reporting process and to monitor the overall scope of the work performed by the internal audit staff and the independent public accountants.
The consolidated financial statements of Leesport Financial Corp. have been audited by Beard Miller Company LLP, an independent registered public accounting firm, who was engaged to express an opinion as to the fairness of presentation of such financial statements. In connection therewith, Beard Miller Company LLP is required to issue an attestation report on management's assessment of internal control over financial reporting and, in addition, is required to form its own opinion as to the effectiveness of those controls. Their opinion on the fairness of the financial statement presentation, and their attestation and opinion on internal controls over financial reporting are included herein.
/s/ ROBERT D. DAVIS Robert D. Davis
President and
Chief Executive Officer
/s/ EDWARD C. BARRETT Edward C. Barrett
Executive Vice President and
Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Leesport Financial Corp.
We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Leesport Financial Corp. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Leesport Financial Corp.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Leesport Financial Corp. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Leesport Financial Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Leesport Financial Corp. and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2005, and our report dated March 10, 2006 expressed an unqualified opinion.
/S/ BEARD MILLER COMPANY LLP
Reading, Pennsylvania
March 10, 2006
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information relating to directors and executive officers of the Registrant is incorporated herein by reference to the information disclosed under the captions "MATTER NO. 1-ELECTION OF DIRECTORS-Director Information; Corporate Governance; Board of Directors and Committee Meetings; Other Director and Executive Officer Information" included in the Registrant's Proxy Statement for the Annual meeting of Shareholders to be held on April 18, 2006.
Item 11.
Item 11. Executive Compensation
The information relating to executive compensation and directors' compensation is incorporated herein by reference to the information disclosed under the captions "MATTER NO. 1-ELECTION OF DIRECTORS-Director Compensation; Executive Compensation; and Executive Officer Agreements" included in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 2006.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder
Matters
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the information disclosed under the caption "MATTER NO. 1-ELECTION OF DIRECTORS-Directors-Beneficial Ownership by Directors and Executive Officers" and "ADDITIONAL INFORMATION" included in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 2006.
The following table provides certain information regarding securities issued or issuable under the Company's equity compensation plans as of December 31, 2005.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information relating to certain relationships and related transactions is incorporated herein by reference to the information disclosed under the caption "MATTER NO. 1-ELECTION OF DIRECTORS-Other Director and Executive Officer Information" included in the Registrant's proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 2006.
Item 14.
Item 14. Principal Accounting Fees and Services
The information relating to principal accounting fees and services is incorporated herein by reference to the information under the caption "MATTER NO. 1-ELECTION OF DIRECTORS-Audit and Other Fees" included in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 2006.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)1. Financial Statements.
Consolidated financial statements are included under Item 8 of Part II of this Form 10-K.
(a)2. Financial Statement Schedules.
Financial statement schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto.
(b) Exhibits
EXHIBIT INDEX
Exhibit No.
Description
3.1
Articles of Incorporation of Leesport Financial Corp. (incorporated by reference to Exhibit 3.1 of the Registrant's Amended Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2003).
3.2
Bylaws of Leesport Financial Corp. (incorporated by reference to Exhibit 3.1 of the Registrant's Current Report on Form 8-K filed November 18, 2005).
4.1
Form of Rights Agreement, dated as of September 19, 2001, between Leesport Financial Corp. and American Stock Transfer & Trust Company as Rights Agent (incorporated by reference to Exhibit 4.1 of Registrant's Registration Statement on Form 8-A, dated October 1, 2001).
10.1
Employment Agreement, dated September 19, 2005, among Leesport Financial Corp., Leesport Bank and Robert D. Davis, (incorporated herein by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K/A filed September 22, 2005).*
10.2
Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-QSB for the quarter ended June 30, 1996).*
10.3
Deferred Compensation Plan for Directors (incorporated herein by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-QSB for the quarter ended June 30, 1996).*
10.4
Non-Employee Director Compensation Plan (incorporated by reference to Exhibit 10.1 to Registrant's Registration Statement No. 333-37452 on Form S-8).*
10.5
1998 Employee Stock Incentive Plan, as amended (incorporated by reference to Exhibit 99.1 to Registrant's Registration Statement No. 333-108130 on Form S-8).*
10.6
1998 Independent Directors Stock Option Plan, as amended (incorporated by reference to Exhibit 99.1 to Registrant's Registration Statement No. 333-108129 on Form S-8).*
10.7
Employment Agreement, dated September 17, 1998, among Leesport Financial Corp., Inc., Essick & Barr, Inc. and Charles J. Hopkins, as amended (incorporated herein by reference to Exhibit 10.4 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2002).*
10.8
Change in Control Agreement, dated February 11, 2004 among Leesport Financial Corp., Leesport Bank and Edward C. Barrett (incorporated by reference to Exhibit 10.9 of Registrant's Form 10-K for the year ended December 31, 2003).
10.9
Change in Control Agreement, dated February 11, 2004 among Leesport Financial Corp., Leesport Bank and Stephen A. Murray (incorporated by reference to Exhibit 10.9 of Registrant's Form 10-K for the year ended December 31, 2004).
10.10
Change in Control Agreement, dated February 11, 2004 among Leesport Financial Corp., Leesport Bank and Jenette L. Eck (incorporated by reference to Exhibit 10.10 of Registrant's Form 10-K for the year ended December 31, 2004).
10.11
Employment Agreement, dated as of April 16, 2004 among Leesport Financial Corp., Leesport Bank and Vito A. DeLisi (incorporated by reference to Exhibit 10.10 of the Registrant's Registration Statement No. 333-116331 on Form S-4).*
10.12
Amendment to Employment Agreement dated as of December 23, 2005, among Leesport Financial Corp., Leesport Bank and Vito A. DeLisi (incorporated by reference to Exhibit 10.2 of the Registrant's Current Report on Form 8-K filed December 28, 2005).*
10.13
Agreement and Plan of Merger, dated as of April 16, 2004, between Leesport Financial Corp. and Madison Bancshares Group, Ltd. (incorporated by reference to Exhibit 99.1 of the Registrant's Form 8-K, dated April 20, 2004).
10.14
Letter Agreement, dated as of March 17, 2005, between Leesport Financial Corp., Leesport Bank and Raymond H. Melcher, Jr. (incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K/A filed March 24, 2005.
No statement setting forth the computation of per share earnings is included because such computation is reflected clearly in the financial statements set forth in response to Item 8 of this Report.
Subsidiaries of Leesport Financial Corp.
23.1
Consent of Beard Miller Company LLP.
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1
Section 1350 Certification of Chief Executive Officer.
32.2
Section 1350 Certification of Chief Financial Officer.
*Denotes a management contract or compensatory plan or arrangement.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 10,
LEESPORT FINANCIAL CORP.
By:
/s/ ROBERT D. DAVIS Robert D. Davis
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ ROBERT D. DAVIS Robert D. Davis
President and Chief Executive Officer, Director (Principal Executive Officer)
March 10, 2006
/s/ EDWARD C. BARRETT Edward C. Barrett
Chief Financial Officer (Principal Financial and Accounting Officer)
March 10, 2006
/s/ JAMES H. BURTON James H. Burton
Director
March 10, 2006
/s/ PATRICK J. CALLAHAN Patrick J. Callahan
Director
March 10, 2006
/s/ CHARLES J. HOPKINS Charles J. Hopkins
Director
March 10, 2006
/s/ PHILIP E. HUGHES, JR. Philip E. Hughes, Jr.
Director
March 10, 2006
/s/ ANDREW J. KUZNESKI, JR. Andrew J. Kuzneski, Jr.
Vice Chairman of the Board; Director
March 10, 2006
/s/ M. DOMER LEIBENSPERGER M. Domer Leibensperger
Director
March 10, 2006
/s/ FRANK C. MILEWSKI Frank C. Milewski
Director
March 10, 2006
/s/ MICHAEL J. O'DONOGHUE Michael J. O'Donoghue
Director
March 10, 2006
/s/ HARRY J. O'NEILL III Harry J. O'Neill III
Director
March 10, 2006
/s/ KAREN A. RIGHTMIRE Karen A. Rightmire
Director
March 10, 2006
/s/ MICHAEL L. SHOR Michael L. Shor
Director
March 10, 2006
/s/ ALFRED J. WEBER Alfred J. Weber
Chairman of the Board; Director
March 10, 2006
INDEX
PART I FORWARD LOOKING STATEMENTS
PART II
Item 5. Market For Common Equity and Related Shareholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Interest Sensitivity Gap at December 31, 2005
Allocation of Allowance for Loan Losses (In thousands except percentage data)
Analysis of the Allowance for Loan Losses (in thousands except ratios)
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
LEESPORT FINANCIAL CORP. CONSOLIDATED BALANCE SHEETS December 31, 2005 and 2004 (Dollar amounts in thousands, except per share data)
LEESPORT FINANCIAL CORP. CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2005, 2004 and 2003 (Amounts in thousands, except per share data)
LEESPORT FINANCIAL CORP. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 2005, 2004 and 2003 (Dollar amounts in thousands, except share data)
LEESPORT FINANCIAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2005, 2004 and 2003 (Amounts in thousands)
LEESPORT FINANCIAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2005, 2004 and 2003 (Amounts in thousands)
STATEMENTS OF CONDITION
STATEMENTS OF INCOME
STATEMENTS OF CASH FLOWS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Item 9B. Other Information
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
EXHIBIT INDEX
SIGNATURES