Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 20549
FORM 10-K
--------------------------------------
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2003.
OR
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______ to _______.
Commission File Number 000-50426
KNBT Bancorp, Inc.
-----------------------------------------------------------------
(Name of Registrant as specified in its charter)
Pennsylvania 38-3681905
- ---------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
90 Highland Avenue, Bethlehem, Pennsylvania 18017
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 610-861-5000
Securities registered pursuant to Section 12 (b) of the Exchange Act:
None
Securities registered pursuant to Section 12 (g) of the Exchange Act:
Common Stock, $0.01 Par Value
-----------------------------
(Title of Class)
--------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ____ No __X__
The registrant had no shares of common equity outstanding on the last
business day of the registrant's most recently completed second fiscal quarter.
The registrant completed its initial public offering on October 31, 2003.
The number of shares of the Issuer's common stock, par value $0.01 per
share, outstanding as of March 19, 2004 was 30,529,450.
--------------------------------------
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of KNBT Bancorp's proxy statement to be filed in
connection with its 2004 Annual Meeting of Shareholders are incorporated by
reference in Part III of this Report. Other documents incorporated by reference
are listed in the Exhibit Index.
KNBT BANCORP, INC.
Form 10-K Table of Contents
Page
----
PART I
Item 1. Business........................................................................................... 1
Item 2. Properties......................................................................................... 31
Item 3. Legal Proceedings.................................................................................. 31
Item 4. Submission of Matters to a Vote of Security Holders................................................ 31
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Repurchases of Equity Securities................................................................... 32
Item 6. Selected Consolidated Financial Data............................................................... 33
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 34
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................................... 47
Item 8. Financial Statements and Supplementary Data........................................................ 48
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 82
Item 9A. Controls and Procedures............................................................................ 82
PART III
Item 10. Directors and Executive Officers of the Registrant................................................. 83
Item 11. Executive Compensation............................................................................. 83
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters........................................................................ 83
Item 13. Certain Relationships and Related Transactions..................................................... 83
Item 14. Principal Accounting Fees and Services............................................................. 83
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................... 84
Signatures ........................................................................................................ 86
KNBT BANCORP, INC.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION
In addition to historical information, this Annual Report on Form 10-K
includes certain "forward-looking statements," as defined in the Securities Act
of 1933 and the Securities Exchange Act of 1934, based on current management
expectations. KNBT's actual results could differ materially from those
management expectations. Such forward-looking statements include statements
regarding KNBT's intentions, beliefs or current expectations as well as the
assumptions on which such statements are based. Stockholders and potential
stockholders are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and that
actual results may differ materially from those contemplated by such
forward-looking statements. Factors that could cause future results to vary from
current management expectations include, but are not limited to, general
economic conditions, legislative and regulatory changes, monetary fiscal
policies of the federal government, changes in tax policies, rates and
regulations of federal, state and local tax authorities, changes in interest
rates, deposit flows, cost of funds, demand for loan products, demand for
financial services, difficulties in integrating the data processing or other
systems at its subsidiary savings bank, competition, changes in the quality or
composition of KNBT's loan and investment portfolios, changes in accounting
principles, policies or guidelines and other economic, competitive, governmental
and technological factors affecting KNBT's operations, markets, products,
services and fees. KNBT undertakes no obligation to update or revise any
forward-looking statements to reflect changed assumptions, the occurrence of
unanticipated events or changes to future operating results over time.
PART I
Item 1. Business
- ------ --------
General
- -------
KNBT Bancorp, Inc. is a Pennsylvania corporation and registered bank
holding company organized in 2003. KNBT's business consists primarily of being
the parent holding company for Keystone Nazareth Bank & Trust Company, a
Pennsylvania chartered savings bank. Keystone Nazareth Bank & Trust Company
(which we also refer to as the "Bank") is the stock-form successor to Keystone
Savings Bank upon the mutual-to-stock conversion of Keystone Savings Bank which
was completed on October 31, 2003. Concurrently with the mutual-to-stock
conversion, KNBT acquired, through a merger, First Colonial Group, Inc., the
parent bank holding company for Nazareth National Bank and Trust Company. On
October 31 2003, First Colonial Group was merged with and into KNBT and Nazareth
National Bank was merged with and into Keystone Nazareth Bank & Trust Company.
The mutual-to-stock conversion of Keystone Savings Bank and the mergers with
First Colonial and Nazareth National Bank also coincided with the completion of
the initial public offering of KNBT. KNBT sold approximately 20.2 million shares
of its common stock for an aggregate of $202.0 million to subscribers in its
offering, contributed approximately 1.6 million shares of common stock to the
recently created Keystone Nazareth Charitable Foundation, and issued an
additional 8.5 million shares to former shareholders of First Colonial in
exchange for their First Colonial shares.
Available Information
- ---------------------
KNBT is a public company and files annual, quarterly and current
reports, proxy statements and other information with the Securities and Exchange
Commission. KNBT's filings are available to the public at the SEC's website at
HTTP://www.sec.gov. Members of the public may also read and copy any document
that KNBT files at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You can request copies of these documents by writing to
the SEC and paying a fee for the copying cost. Please call the SEC at
1-800-SEC-0330 for more information about the operation of the public reference
room. In addition to the foregoing, the Company maintains a website of
www.KNBT.com. KNBT makes available on its Internet website copies of its Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K and any amendments to such documents as soon as reasonably practicable after
KNBT electronically files such material with, or furnishes such documents to,
the SEC.
-1-
Keystone Nazareth Bank & Trust Company
- --------------------------------------
The Bank is a stock savings bank incorporated in 2003 under the laws of
Pennsylvania and is a wholly-owned subsidiary of KNBT. The Bank is the successor
to Keystone Savings Bank, a Pennsylvania mutual savings bank that was organized
in 1925. The Bank has 41 full service offices with 19 located in Northampton
County, Pennsylvania, 16 in Lehigh County, Pennsylvania, five in Monroe County,
Pennsylvania and one in Carbon County, Pennsylvania. The Bank's office network
includes 14 full service in-store supermarket branch offices. The Bank has ATMs
in all but one of its banking offices and also maintains six off-site ATMs.
The Bank is primarily engaged in attracting deposits from the general
public and using those funds to invest in loans and securities. The Bank's
principal sources of funds are deposits, repayments of loans and mortgage-backed
securities, maturation of investments, funds provided from operations and funds
borrowed from outside sources such as the Federal Home Loan Bank ("FHLB") of
Pittsburgh. The Bank's deposit products include interest-bearing and
non-interest-bearing checking accounts, statement savings accounts, passbook
savings accounts, money-market accounts, club accounts, individual retirement
accounts and certificates of deposit. These funds are primarily used for the
origination of various loan types including single-family residential mortgage
loans, non-residential or commercial real estate mortgage loans, direct or
indirect consumer loans, such as home equity loans, automobile and recreational
vehicle loans and commercial business lines of credit, letters of credit and
term loans. Most of the Bank's commercial customers are small to medium in size
businesses operating in the Bank's market area.
The Bank also offers trust and wealth management services through its
trust department under the name KNBT Financial Advisors. These services include
acting as executor and trustee under wills and deeds, as guardian, custodian and
as trustee and agent for pension, profit sharing and other employee benefit
trusts as well as various investment, pension and estate planning services. The
market value of the funds held by the trust department was $312.4 million at
December 31, 2003.
The Bank offers a selection of investment and insurance products,
including equity securities, mutual funds and annuities, to its customers in its
branch offices. The Bank conducts such activities under the name KNBT Financial
Advisors. Such products are sold by registered representatives who are dual
employees of both the Bank and a third-party, registered broker-dealer. The
revenues received through the sale of these products amounted to $465,000,
$420,000 and $100,000 in 2003, 2002 and 2001, respectively.
The Bank has two wholly-owned subsidiaries, KLV, Inc. and KLVI, Inc.
KLV, Inc. is inactive. KLVI, Inc., a Delaware corporation, is a wholly-owned
subsidiary of the Bank formed in 1997 to hold and manage certain investment
securities.
The Bank is also a majority owner of Traditions Settlement Services,
LLC. Traditions was organized in May 2002 and provides real estate title and
settlement services.
Subsidiaries
- -------------
In addition to the Bank, KNBT's subsidiaries include KNBT Inv. I, KNBT
Inv. II and First Colonial Statutory Trust I.
In December 2003, KNBT established a wholly-owned subsidiary, KNBT Inv.
I, a Delaware corporation for the purpose of investing in various types of
securities. As of December 31, 2003, KNBT Inv. I, Inc. had total assets of
$10,000 of which all were in a non-interest bearing checking account.
KNBT Inv. II, Inc., formerly known as First C. G. Company, Inc., was
acquired on October 31, 2003 as part of KNBT's acquisition of First Colonial
Group, KNBT Inv. II, Inc. is a wholly-owned subsidiary of KNBT. KNBT Inv. II,
Inc. is a Delaware corporation established for the purpose of investing in
various
-2-
types of securities. As of December 31, 2003, KNBT Inv. II, Inc. had total
assets of $5.5 million of which $4.9 million was invested in equity securities
with most of the remaining assets in interest-bearing money market accounts.
First Colonial Statutory Trust I was acquired by KNBT on October 31,
2003 as a part of the merger with First Colonial Group, Inc. First Colonial
Statutory Trust I, a wholly-owned subsidiary of KNBT, was established in June
2002 and is a Connecticut business trust. This company was established for the
purpose of issuing $15.0 million of trust preferred securities. First Colonial
Statutory Trust I had total assets of $15.5 million at December 31, 2003.
Market Area and Competition
- ---------------------------
The Bank's market area consists of Lehigh, Northampton, Carbon and
Monroe counties, Pennsylvania. The greater Lehigh Valley area, which is in
eastern Pennsylvania approximately 60 miles north of Philadelphia, is anchored
by the cities of Bethlehem, Allentown and Easton. The combined population of
Lehigh and Northampton Counties is in excess of 600,000 and the market includes
a mix of urban, suburban and rural areas. Between 1990 and 2002, the combined
population of Lehigh and Northampton Counties grew by approximately 8.3%
compared to 3.4% for Pennsylvania as a whole. Major employers in the area
include Federal, State and local governments, local healthcare providers,
including Lehigh Valley Hospital and St. Luke's Hospital, Air Products &
Chemicals, PPL, Binney & Smith, Agere Systems and Mack Trucks.
The Bank faces significant competition in originating loans and
attracting deposits. This competition stems primarily from commercial banks,
other savings banks and savings associations and mortgage-banking companies.
Within the Bank's market area, more than 50 other banks, savings institutions
and credit unions are operating. Many of the financial service providers
operating in the Bank's market area are significantly larger, and have greater
financial resources, than the Bank. The Bank faces additional competition for
deposits from money market and other mutual funds, and from other non-depository
financial institutions such as brokerage firms and insurance companies.
Lending Activities
- ------------------
KNBT primarily extends loans to individuals and businesses in the
counties of Northampton, Lehigh, Monroe and Carbon, Pennsylvania. Historically,
KNBT's principal lending activity has been the origination of loans
collateralized by one-to four-family, or single-family, residential real estate
located in its market area. In addition, KNBT traditionally has been actively
involved in construction and land development loans, with an emphasis on
construction/permanent single-family residential mortgage loans and loans to
local homebuilders, and consumer loans, primarily home equity loans and lines of
credit. The securitization of some of its residential real estate loans and the
continuing sale of such loans has been a factor in reducing KNBT's historical
concentration in these types of loans. KNBT has increased its commercial lending
activities as a result of the merger and the additions to the commercial lending
staff.
KNBT's one-to four-family residential real estate loans amounted to
$332.0 million or 36.0% of the total loan portfolio at December 31, 2003. At
such date, commercial real estate loans amounted to $156.5 million or 17.0% of
the total portfolio, construction and land development loans were $112.7 million
or 12.2% of the total portfolio, commercial business loans were $39.0 million or
4.23% of the portfolio and consumer loans were $265.5 million or 28.8% of KNBT's
total loan portfolio.
-3-
Loan Portfolio Composition. The following table shows the composition
of the loan portfolio by type of loan at the dates indicated.
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31,
----------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------
Amount % Amount % Amount % Amount % Amount %
--------- -------- --------- --------- --------- ---------- -------- --------- --------- ---------
(dollars in thousands)
Real estate loans:
One-to four-family
residential (1) ..... $ 332,024 36.00% $ 361,842 59.34% $ 513,352 73.27% $ 509,188 73.20% $ 472,874 72.52%
Multi-family
residential ....... 14,197 1.54 5,377 0.88 3,823 0.55 4,020 0.58 3,607 0.55
Commercial real
estate ............ 156,563 16.97 29,385 4.82 12,839 1.83 6,715 0.97 3,442 0.54
Construction and
land development .. 112,684 12.22 59,363 9.74 54,092 7.72 59,687 8.58 63,404 9.72
--------- -------- --------- --------- --------- ---------- -------- --------- --------- ---------
Total real estate
loans ............... 615,468 66.73 455,967 74.78 584,106 83.36 579,610 83.33 543,327 83.33
Commercial
business loans ...... 38,978 4.23 10,050 1.65 4,399 0.63 4,166 0.60 3,535 0.54
State and political
subdivision loans ... 2,334 0.25 -- -- -- -- -- -- -- --
Consumer loans:
Home equity loans
and lines of credit 151,603 16.44 102,275 16.77 96,702 13.80 94,317 13.56 90,867 13.94
Automobile and other
vehicles .......... 102,256 11.09 31,956 5.24 5,887 0.84 8,901 1.28 7,906 1.21
Other ............... 11,682 1.26 9,500 1.56 9,572 1.37 8,585 1.23 6,407 0.98
--------- -------- --------- --------- --------- ---------- -------- --------- --------- ---------
Total consumer
loans ............... 265,541 28.79 143,731 23.57 112,161 16.00 111,803 16.07 105,180 16.13
--------- -------- --------- --------- --------- ---------- -------- --------- --------- ---------
Total loans ......... 922,321 100.00% 609,748 100.00% 700,666 100.00% 695,579 100.00% 652,042 100.00%
--------- ======== --------- ========= --------- ========== -------- ========= --------- =========
Less:
Undisbursed portion
of construction
loans in process .. (27,099) (24,263) (23,552) (28,972) (31,743)
Deferred loan fees .... (469) (3,236) (5,682) (6,163) (6,090)
Allowance for loan
losses .............. (7,910) (2,927) (3,386) (3,337) (3,101)
--------- --------- --------- -------- ---------
Net loans ............. $ 886,843 $ 579,322 $ 668,046 $ 657,107 $ 611,108
========= ========= ========= ======== =========
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Includes mortgage loans held-for-sale of $4.7 million at December 31, 2003
and $23.8 million at December 31, 2002. There were no mortgage loans
held-for-sale at December 31, 2001, 2000 or 1999.
-4-
Contractual Terms to Final Maturities. The following table shows the
scheduled contractual maturities of KNBT's loans as of December 31, 2003, before
giving effect to net items. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The amounts shown below do not take into account loan prepayments.
- ------------------------------------------------------------------------------------------------------------------------------------
State and
One-to Construction Commercial Political
Four-Family Multi-family Commercial and Land Business Subdivision Consumer
Residential Residential Real Estate Development Loans Loans Loans Total
------------ ----------- ------------ ------------ ----------- ----------- ------------ ---------
(dollars in thousands)
Amounts due after
December 31, 2003 in:
One year or less ........ $ 1,526 $ 326 $ 9,691 $ 87,858 $ 18,336 $ -- $ 15,946 $133,683
After one year through
three years .......... 3,152 728 7,919 23,259 3,452 -- 30,546 69,056
After three years through
five years .......... 14,493 101 16,013 148 3,315 443 94,786 129,299
After five years through
fifteen years ........ 103,948 6,090 67,489 1,419 7,797 1,891 122,307 310,941
After fifteen years ..... 208,905 6,952 55,451 -- 6,078 -- 1,956 279,342
-------- -------- -------- -------- -------- -------- -------- --------
Total ................ $332,024 $ 14,197 $156,563 $112,684 $ 38,978 $ 2,334 $265,541 $922,321
======== ======== ======== ======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------------------
The following table shows the amount of KNBT's loans at December 31,
2003, which are due after December 31, 2004 and indicates whether they have
fixed-rates of interest or which are floating or adjustable rates.
- -----------------------------------------------------------------------------------------------------
Floating or
Fixed-Rate Adjustable Rate Total
--------------- ----------------- --------------
(dollars in thousands)
One-to four-family residential ............ $ 303,741 $ 26,757 $ 330,498
Multi-family residential .................. 6,223 7,648 13,871
Commercial real estate .................... 83,259 63,613 146,872
Construction and land development ......... 4,473 20,353 24,826
Commercial business ....................... 12,219 8,423 20,642
State and political subdivisions .......... 2,152 182 2,334
Consumer .................................. 208,542 41,053 249,595
--------------- ----------------- --------------
Total .................................. $ 620,609 $ 168,029 $ 788,638
=============== ================= ==============
- -----------------------------------------------------------------------------------------------------
Loan Originations, Sales and Servicing. KNBT's lending activities are
subject to underwriting standards and loan origination procedures established by
its board of directors and management. KNBT relies on its staff of retail loan
representatives and commercial lenders to originate new loans. These employees
travel throughout KNBT's market area and meet with customers at their homes,
place of business or in the Bank's offices, to take loan applications. KNBT has
designated certain employees at each of its branch offices to take consumer loan
applications. KNBT has centralized its consumer and residential real estate
lending underwriting function and all new loans are received and underwritten by
staff at KNBT's main office.
KNBT's single-family residential mortgage loans generally are written
on standardized documents used by the Federal National Mortgage Association
("FNMA" or "Fannie Mae"). Historically, in its efforts to manage interest rate
risk, KNBT sells into the secondary market most of its newly originated
single-family residential mortgage loans which are agency eligible. KNBT sells
such newly originated loans on a loan-
-5-
by-loan or "flow" basis as the loans close. Excluding the effect of two loan
securitizations, KNBT sold an aggregate of $50.3 million and $37.2 million of
its newly originated single-family residential mortgage loans in the years ended
December 31, 2003 and 2002, respectively. At the time of sale, KNBT recognizes a
gain or loss on the sale based on the difference between the net proceeds
received and the carrying value of the loans sold. KNBT's net gains on sales of
residential mortgage loans were $246,000, $900,000 and $108,000 in 2003, 2002
and 2001, respectively. These gains are included in total non-interest income.
KNBT retains the right to continue to provide servicing for all loans sold. The
income from servicing is included in non-interest income as service fees.
At December 31, 2003, KNBT was servicing $228.0 million of residential
real estate loans it had previously sold. Due to the continuing low interest
rate environment and a higher level of loan repayments than originally
estimated, KNBT recognized impairments of its mortgage servicing rights of $1.1
million and $676,000 during the years ended December 31, 2003 and 2002,
respectively. Such impairments are recorded as non-interest expense.
In addition to loan sales, KNBT "securitized" $47.3 million and $115.3
million of seasoned, single-family residential mortgage loans in the years ended
December 31, 2003 and 2002, respectively. In such transactions, loans which did
not meet Fannie Mae's eligibility standards at the time of origination, due to
the lack of private mortgage insurance or other criteria, were able to be
securitized after being in KNBT's portfolio for certain stipulated periods of
time, generally 18 to 24 months. Securitization is the process of packaging and
transferring residential mortgage loans to issuers of mortgage-backed
securities, such as Fannie Mae, in return for mortgage-backed securities backed
by the mortgage loans which are transferred. As there is an active market for
mortgage-backed securities, they generally can be sold more readily than the
underlying loans in response to changes in interest rates or other factors. KNBT
retained all of the securities from its 2003 securitization and it sold $61.4
million of the $115.3 million securitization in 2002.
KNBT is limited in the amount of loans that it can make to any one
borrower. This amount is equal to 15% of Keystone Nazareth Bank & Trust
Company's unimpaired capital and surplus, or approximately $38.8 million at
December 31, 2003. KNBT has established a house limit of $25.0 million in loans
to any one borrower. KNBT's loans to one borrower have been within these limits.
-6-
The following table shows total loans originated, securitized, sold and
repaid at KNBT during the periods indicated.
- ------------------------------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------------
2003 2002 2001
--------- --------- ---------
(dollars in thousands)
Loan originations:
One-to four-family residential (1) .............. $ 135,325 $ 109,029 $ 100,204
Consumer ........................................ 131,989 114,188 58,784
Other (2) ....................................... 192,864 73,605 17,291
--------- --------- ---------
Total loan originations ..................... 460,178 296,822 176,279
Sales, securitizations and loan principal repayments:
Loans sold:
One-to four-family residential ................ 50,286 37,178 12,127
--------- --------- ---------
Total sold .................................. 50,286 37,178 12,127
Loans securitized:
Securitized and retained ...................... 47,251 53,897 --
Securitized and sold .......................... -- 61,438 --
--------- --------- ---------
Total securitized ........................... 47,251 115,335 --
--------- --------- ---------
Loans principal repayments ...................... 298,760 205,534 123,979
--------- --------- ---------
Total loans sold, securitized and
principal repayments .......................... 396,297 358,047 136,106
Decrease due to other items, net (3) ................ 27,568 27,499 29,234
Loans received in merger with First Colonial ........ 271,208 -- --
--------- --------- ---------
Net increase (decrease) in loans receivable ......... $ 307,521 $ (88,724) $ 10,939
========= ========= =========
- ------------------------------------------------------------------------------------------------------
(1) Includes loans originated for sale of $29.0 million in 2003, $61.0 million
in 2002 and $12.2 million in 2001.
(2) Consists of commercial real estate, construction and land development loans
and commercial business loans.
(3) Other items consist of loans in process, deferred fees and the allowance
for loan losses.
Single-Family Residential Mortgage Lending. A primary lending activity
of KNBT is the origination of loans secured by first mortgages on one-to
four-family residences in its market area. Traditionally, KNBT has been a
leading originator of single-family residential mortgage loans in Lehigh and
Northampton Counties, and the Bank expects to continue its single-family loan
origination efforts. At December 31, 2003, single-family residential mortgage
loans amounted to $332.0 million or 36.0% of KNBT's total loan portfolio which,
compares to $361.8 million of single-family residential mortgage loans at
December 31, 2002.
-7-
KNBT originates fixed-rate, fully amortizing mortgage loans with
maturities ranging between 10 and 30 years. Management establishes interest
rates charged on loans based on market conditions. KNBT also offers
adjustable-rate mortgage loans with terms of up to 30 years, with an interest
rate based on the one year Constant Maturity Treasury Bill index, which adjust
annually from the outset of the loan or which adjust manually after a three or
five year initial fixed period. Interest rate adjustments on such loans are
typically limited to no more than 2% during any adjustment period or 6% over the
life of the loan. Due to local market conditions and the current interest rate
environment, KNBT has originated few ARM loans during the past three years. At
December 31, 2003, 91.9% of KNBT's single-family residential mortgage loans
maturing after December 31, 2004 had fixed rates of interest and 8.1% had
adjustable interest rates.
KNBT underwrites one-to four-family residential mortgage loans with
loan-to-value ratios of up to 95%, provided that a borrower obtains private
mortgage insurance on loans that exceed 85% of the appraised value or sales
price, whichever is less, of the secured property. KNBT also requires that title
insurance, hazard insurance and, if appropriate, flood insurance be maintained
on all properties securing real estate loans. A licensed appraiser appraises all
properties securing one-to four-family first mortgage loans. Mortgage loans
originated by KNBT generally include a due-on-sale clause which provide the
contractual right to deem the loan immediately due and payable in the event the
borrower transfers ownership of the property without KNBT's consent. Due-on-sale
clauses are an important means of adjusting the yields of fixed-rate mortgage
loans in a portfolio and KNBT generally exercises its rights under these
clauses.
During 2003, KNBT's practice was to sell to Fannie Mae most of its
newly originated, agency eligible single-family residential mortgage loans with
interest rates of 6.5% or less. Such loans are sold on a non-recourse basis with
servicing retained. During the year ended December 31, 2003, KNBT, excluding
sales made as a part of its securitization, sold an aggregate of $50.3 million
and $37.2 million, respectively, of single-family residential mortgage loans.
Consumer Loans. At December 31, 2003, KNBT's consumer loans amounted to
$265.5 million or 28.8% of the total loan portfolio. KNBT's consumer loans are
comprised primarily of home equity loans and lines of credit and automobile and
recreational vehicle loans. KNBT also offers a variety of other consumer loans
including personal loans and lines of credit, home improvement loans and credit
card loans. At December 31, 2003, KNBT's home equity loans and lines of credit
amounted to $151.6 million or 16.4% of the total loan portfolio. Of such amount,
$112.8 million were loans and $38.8 million were lines of credit. In addition,
at such date the unadvanced portion of home equity lines of credit was $45.3
million. Home equity loans and lines of credit, like single-family residential
mortgage loans, are secured by the equity in the borrower's residence. However,
the Bank generally obtains a second mortgage position on a home equity loan or
line of credit. KNBT's home equity loans typically are structured as fixed-rate
fully amortizing loans with terms of up to 15 years and loan-to-value ratios,
when combined with any senior liens, of up to 100%. KNBT charges higher interest
rates for loan-to-value ratios exceeding 80%. KNBT's home equity lines of credit
have adjustable rates of interest which are indexed to the prime rate as
reported in The Wall Street Journal. Generally, the maximum loan-to-value ratio
on home equity lines of credit, including the outstanding amount of any first
mortgage loan, is 80%, however, larger loan-to-value loans are granted. A home
equity line of credit may be drawn down by the borrower for a period of five
years from the date of the loan agreement. During this period, the borrower has
the option of paying, on a monthly basis, either principal and interest or only
the interest.
KNBT's automobile and other vehicle loans amounted to $102.2 million at
December 31, 2003 and have increased significantly since the Bank commenced its
indirect automobile lending function in January 2002. The total automobile and
other vehicle loans includes, at December 31, 2003, $24.9 million of
recreational vehicle loans that were acquired from First Colonial in the merger.
Keystone originates indirect auto and recreational vehicle loans through a
network of dealers located in its market area and was actively doing business
with approximately 78 dealers at December 31, 2003. KNBT employed an experienced
indirect lender to head its program and has grown its dealer network by
emphasizing quality service and the development of long term relationships with
the owners and managers of dealerships.
KNBT makes indirect loans to purchase both new and used vehicles. The
loans have terms up to six years for loans secured by new and used autos and 15
years for loans secured by recreational vehicles. As of December 31, 2003,
approximately 20.0% of KNBT's indirect auto loans were secured by new cars,
54.0% were secured by used cars and 26.0% were secured by recreational vehicles.
KNBT originated $56.5 million and $32.9 million of indirect loans during 2003
and 2002, respectively.
To underwrite its indirect loans, KNBT reviews the credit history of
applicants and determines appropriate debt to income and loan to value ratios.
KNBT also believes that the quality of its indirect loan
-8-
portfolio is positively affected by its efforts to build and maintain
relationships with dealers who attract creditworthy customers. KNBT tries to
identify such dealers based on KNBT's knowledge of dealers in its market area.
Indirect auto and recreational vehicle lending entails greater risks
than owner-occupied residential mortgage lending. Although KNBT has not
experienced significant delinquencies in this portfolio to date, borrowers are
more likely to default on those loans than on a residential mortgage loan
secured by their primary residence. Moreover, automobiles and recreational
vehicles depreciate rapidly and, in the event of a default, principal loss as a
percentage of the loan balance depends upon the mileage and condition of the
vehicle at the time of repossession, over which KNBT has no control.
Consumer loans entail greater risk than residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles and recreational vehicles. In these
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment. In addition, consumer loan
collections depend on the borrower's continuing financial stability, and thus
are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy.
Construction and Land Development Loans. KNBT has been an active
originator of construction and land development loans in its market area for
many years. At December 31, 2003, KNBT's construction and land development loans
amounted to $112.7 million or 12.2% of the total loan portfolio. KNBT's
construction lending includes both construction loans to individuals to
construct personal residences, which amounted to approximately $63.8 million at
December 31, 2003, and loans to building contractors and developers, which
amounted to approximately $13.0 million at December 31, 2003 and loans for
commercial real estate construction, which amounted to approximately $35.9
million at December 31, 2003. At December 31, 2003, the unadvanced portion of
construction loans in process amounted to $76.2 million.
KNBT's construction loans to individuals to build their residences
typically are structured as construction/permanent loans whereby there is one
closing for both the construction loan and the permanent financing. During the
construction phase, which typically lasts for six to nine months, employees of
KNBT make periodic inspections of the construction site and loan proceeds are
disbursed directly to the contractors as construction progresses. Typically,
disbursements are made in five draws during the construction period.
Construction loans require payment of interest only during the construction
phase and are structured to be converted to fixed-rate permanent loans at the
end of the construction phase. Prior to making a commitment to fund a
construction loan, KNBT requires an appraisal of the property by independent fee
appraisers or the Bank's in-house appraisers. The Bank's staff also reviews and
inspects each project prior to every disbursement of funds during the term of
the construction loan. Loan proceeds are disbursed based on a percentage of
completion.
KNBT also originates construction and site development loans to
contractors and builders primarily to finance the construction of single-family
homes and subdivisions and, to a lesser extent, the construction of commercial
development projects, and site development projects. Loans to finance the
construction of single-family homes and subdivisions are generally offered to
experienced builders in the Lehigh Valley with whom KNBT has an established
relationship. Residential development loans are typically offered with terms of
up to 24 months. The maximum loan-to-value limit applicable to these loans is
80% of the appraised post-construction value. Construction loan proceeds are
disbursed periodically in increments as construction progresses and as
inspection by KNBT's approved appraisers warrants. At December 31, 2003, KNBT's
largest construction and site development loan totaled $2.5 million and was
secured by a first mortgage lien. This loan was performing according to its
original terms at December 31, 2003. During 2003, KNBT estimates that the
average balance of its construction loans to contractors and developers was
approximately $4.7 million.
-9-
KNBT also makes construction loans for commercial development projects.
The projects include multi-family, apartment, industrial, retail and office
buildings. These loans generally have an interest-only phase during
construction, and generally convert to permanent financing when construction is
completed. Disbursement of funds is at the sole discretion of KNBT and is based
on the progress of construction. The maximum loan-to-value limit applicable to
these loans is 80% of the appraised post-construction value. KNBT's largest
commercial construction loan commitment to a single borrower was $15.7 million
at December 31, 2003 for a commercial construction development project located
within KNBT's primary market area. While this loan was performing in accordance
with all its terms at December 31, 2003, management has downgraded this loan on
its internal classification system and is closely monitoring it due to a
slowdown in the construction process as a result of inclement weather
conditions.
KNBT also originates land loans to local contractors and developers for
the purpose of improving the property, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 65% of the lower of the acquisition price or the appraised value
of the land, and have a term of up to two years with a floating interest rate
based on KNBT's internal base rate. KNBT's land loans are generally secured by
property in its primary market area. KNBT requires title insurance and, if
applicable, a hazardous waste survey reporting that the land is free of
hazardous or toxic waste.
Construction financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of
the initial estimate of the property's value at completion of construction
compared to the estimated cost, including interest, of construction and other
assumptions. Additionally, if the estimate of value proves to be inaccurate,
KNBT may be confronted with a project, when completed, having a value less than
the loan amount. KNBT has attempted to minimize these risks by generally
concentrating on residential construction loans in its market area to
contractors with whom it has established relationships.
Commercial Real Estate Loans and Multi-Family Residential Real Estate
Loans. At December 31, 2003, KNBT's commercial real estate loans amounted to
$156.6 million or 17.0% of the total loan portfolio. The amount of KNBT's
commercial real estate loans increased $127.2 million in 2003 from a total of
$29.4 million at year-end 2002. The merger with First Colonial accounted for
$52.0 million of this increase. KNBT's commercial real estate loans are secured
by mortgages on various commercial income producing properties and owner
occupied commercial buildings including office buildings, retail and industrial
properties. All of KNBT's commercial real estate loans are secured by properties
in Pennsylvania and substantially all are located in the Bank's primary market
area.
KNBT offers both adjustable-rate and fixed-rate commercial real estate
loans. Such loans typically have terms of 15 or 20 years with call options every
5 to 7 years. Loan-to-value ratios cannot exceed 85%, although they generally
are 80% or less, and a debt service coverage of 1.20 times or better generally
is required. Personal guarantees often are required.
KNBT performs more extensive diligence in underwriting commercial real
estate loans than loans secured by owner occupied one-to four-family residential
properties due to the larger loan amounts and the riskier nature of such loans.
KNBT attempts to understand and control the risk in several ways including
inspection of all such properties and the review of the overall financial
condition of the borrower, which may include, for example, the review of the
rent rolls and the verification of income. KNBT reviews a minimum of two years
of tax returns and financial statements of the borrower in its underwriting of
commercial real estate loans and these documents must be updated and provided to
the bank on annual basis. KNBT's commercial lending staff undertakes an
extensive credit review of each commercial real estate loan in excess of
$500,000 at least annually. KNBT's largest commercial real estate loan at
December 31, 2003, was a $7.9 million loan secured by commercial real estate in
KNBT's primary market area. Such loan was performing in accordance with its
terms at December 31, 2003.
Commercial real estate loans have interest rates which are generally
more sensitive to changes in market interest rates than residential real estate
loans. Commercial real estate loans, however, entail
-10-
significant additional credit risk as compared with one- to four-family
residential mortgage lending, as they typically involve larger loan balances
concentrated with single borrowers or groups of related borrowers. In addition,
the payment experience on commercial real estate loans secured by income
producing properties is typically dependent on the successful operation of the
related real estate project and thus may be more significantly impacted by
adverse conditions in the real estate market or in the economy generally.
At December 31, 2003, KNBT's multi-family residential mortgage loans
amounted to $14.2 million or 1.5% of the loan portfolio. Such loans are secured
by apartment buildings with five or more units. KNBT has not emphasized the
origination of multi-family residential mortgage loans but, when originated,
they are underwritten pursuant to the same policies and procedures as commercial
real estate loans.
Commercial Business Loans. KNBT's commercial business loans amounted to
$39.0 million or 4.2% of the total loan portfolio at December 31, 2003.
Commercial business loans have increased by $29.0 million since December 31,
2002 with $9.5 million of that increase resulting from the merger with First
Colonial. KNBT expects that its commercial loan portfolio will continue to grow.
KNBT's commercial business loans typically are to small to mid-sized
businesses with annual revenues generally not exceeding $100 million in its
market area and may be for working capital, equipment financing, inventory
financing or accounts receivable financing. Small business loans may have
adjustable or fixed rates and generally have terms of 5 years or less but may go
up to 10 years. KNBT's commercial business loans generally are secured by
equipment, machinery, real property or other corporate assets. In addition, KNBT
generally obtains personal guarantees from the principals of the borrower with
respect to all commercial business loans. KNBT's commercial loans structured as
advances are made upon perfected security interests in accounts receivable
and/or inventory. Generally KNBT will advance amounts up to 75% of accounts
receivable and 50% of the value of inventory.
At December 31, 2003, KNBT's largest commercial business loan was $5.8
million to a business located in KNBT's primary market area. Such loan was
performing in accordance with its terms at December 31, 2003.
Commercial business loans generally are deemed to involve a greater
degree of risk than single-family residential mortgage loans. Commercial
business lending is relatively new to KNBT and KNBT is attempting to
aggressively increase its originations of commercial business loans. KNBT
continues to hire experienced commercial loan officers and acquired additional
experienced commercial loan officers as a result of the merger. KNBT has
implemented policies and procedures for commercial business lending which are
deemed to be prudent.
Loan Approval Procedures and Authority. KNBT's Board of Directors
establishes its lending policies and procedures. KNBT's Loan Policy Manual is
reviewed on at least an annual basis by its Directors' Loan Committee and
management in order to propose modifications as a result of market conditions,
regulatory changes and other factors. Most modifications must be approved by the
Board of Directors of KNBT.
Various officers or combinations of officers of KNBT have the authority
within specifically identified limits to approve new loans. The largest
individual lending authority is $1.0 million. Amounts in excess of $1.0 million
up to $5.0 million must be approved by the Officers Loan Committee and amounts
in excess of $5.0 million up to $15.0 million must be approved by the Directors
Loan Committee. Loans in excess of $15.0 million must be approved by the Board
of Directors of KNBT.
Non-Performing Assets
On loans where the collection of principal or interest payments is
doubtful, the accrual of interest income ceases ("non-accrual" loans). On loans
90 days or more past due, as to principal and interest payments, KNBT's policy,
with certain limited exceptions, is to discontinue accruing additional interest
and reverse any interest currently accrued. On occasion, this action may be
taken earlier if the financial
-11-
condition of the borrower raises significant concern with regard to his/her
ability to service the debt in accordance with the terms of the loan agreement.
Interest income is not accrued on these loans until the borrower's financial
condition and payment record demonstrate an ability to service the debt.
Real estate that is acquired as a result of foreclosure is classified
as other real estate owned. Real estate is recorded at the lower of cost or fair
value less estimated selling costs. Costs associated with acquiring and
improving a foreclosed property are usually capitalized to the extent that the
carrying values does not exceed fair value less estimated selling costs. Holding
costs are charged to expense. Gains and losses on the sale of other real estate
owned are credited or charged to operations, as incurred.
The following table shows the amounts of KNBT's non-performing assets
defined as non-accruing loans, accruing loans 90 days or more past due and real
estate owned at the dates indicated. KNBT did not have troubled debt
restructurings at any of the dates indicated.
- -----------------------------------------------------------------------------------------------------------
At December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- ----------- ---------- ------------
(dollars in thousands)
Non-accruing loans ............... $1,720 $2,197 $1,752 $ 763 $1,103
Accruing loans 90 days
or more past due ............... 405 298 938 35 486
------ ------ ------ ------ ------
Total non-performing loans .. 2,125 2,495 2,690 798 1,589
Other real estate owned .......... 173 115 200 151 488
------ ------ ------ ------ ------
Total non-performing assets . $2,298 $2,610 $2,890 $ 949 $2,077
====== ====== ====== ====== ======
Total non-performing loans
as a percentage of loans, net . 0.24% 0.43% 0.40% 0.12% 0.26%
Total non-performing loans
as a percentage of total assets 0.11% 0.25% 0.29% 0.10% 0.21%
Total non-performing assets
as a percentage of total assets 0.12% 0.26% 0.31% 0.12% 0.27%
- -----------------------------------------------------------------------------------------------------------
The following table shows the effect non-accrual loans have had on
interest income from each of the periods indicated.
- -----------------------------------------------------------------------------------------------------------
Year ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- ----------- ---------- ------------
(dollars in thousands)
Interest which would have been
recorded at the original rate $ 50 $ 66 $ 81 $ 43 $ 69
Interest that was reflected
in income ......................... 60 45 40 26 34
------ ------ ------ ------ ------
Net impact on interest income ........ $ 10 $ (21) $ (41) $ (17) $ (35)
====== ====== ====== ====== ======
- -----------------------------------------------------------------------------------------------------------
KNBT measures impairment of a loan based on the present value of
expected future cash flows discounted at the loan's effective interest rate,
except that as a practical expedient, impairment may be measured based on a
loan's observable market price, or the fair value of the collateral if the loan
is collateral dependent. Regardless of the measurement method, a creditor must
measure impairment based on the fair value of the collateral when the creditor
determines that foreclosure is probable. SFAS
-12-
No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition
and Disclosures," allows creditors to use existing methods for recognizing
interest income on impaired loans.
KNBT identifies a loan as impaired when it is probable that interest
and principal will not be collected according to the contractual terms of the
loan agreement. The accrual of interest is discontinued on such loans and no
income is recognized until all recorded amounts of interest and principal are
recovered in full.
Loan impairment is measured by estimating the expected future cash
flows and discounting them at the respective effective interest rate or by
valuing the underlying collateral. The total principal amount of KNBT's impaired
loans was $217,000 at December 31, 2003. There were no impaired loans at
December 31, 2002. The recorded investment in these loans and the valuation for
credit losses related to loan impairment at December 31, 2003 were as follows:
- ---------------------------------------------------------------
At December 31, 2003
- ---------------------------------------------------------------
(dollars in thousands)
Principal amount of impaired loans .......... $ 217
Accrued interest ............................ 2
Deferred loan costs ......................... -
--------
219
Less valuation allowance
at December 31, ............................ 33
--------
$ 186
- ---------------------------------------------------------------
The activity in KNBT's allowance account for credit losses related to
impaired loans was as follows for the year ended December 31, 2003:
- ---------------------------------------------------------------
Year ended December 31, 2003
- ---------------------------------------------------------------
(dollars in thousands)
Valuation allowance at January 1, ............ $ -
Received in merger ........................... 33
Provision for loan impairment ................ -
Direct charge-offs ........................... -
Transfers from (to) unallocated reserve ...... -
--------
Valuation allowance
at December 31, ............................ $ 33
- ---------------------------------------------------------------
Total cash collected on impaired loans by KNBT during 2003 was $98,000,
of which $64,000 was credited to the principal balance outstanding on such loans
and $38,000 was credited to interest income. KNBT's valuation allowance for
impaired loans of $33,000 at December 31, 2003 is included in its "Allowance for
Loan Losses" which amounted to $7.9 million at December 31, 2003. KNBT had no
valuation allowance for impaired loans in 2002.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses. KNBT maintains the allowance at a level
believed, to the best of management's knowledge, to cover all known and inherent
losses in the portfolio that are both probable and reasonable to estimate at
each reporting date. Management reviews all loans which are delinquent 60 days
or more on a monthly basis and performs regular reviews of the allowance no less
than quarterly in order to identify those inherent losses and assess the overall
collection probability for the loan portfolio. Such reviews consist of a
quantitative analysis by loan category, using historical loss experience and
consideration of a series of qualitative loss factors. KNBT's evaluation process
includes, among other things, an analysis of delinquency trends, non-performing
loan trends, the level of charge-offs and recoveries, prior loss experience,
total loans outstanding, the volume of loan originations, the type, size and
geographic concentration of its loans, the value of collateral securing the
loan, the borrower's ability to repay and repayment performance, the number of
loans requiring heightened management oversight, local
-13-
economic conditions and industry experience. In addition, in establishing the
allowance for loan losses, KNBT's management considers a ten point internal
rating system for all loans originated by the Commercial Lending department. At
the time of origination, each commercial loan is assigned a rating based on the
assumed risk elements of the loan. Such risk ratings are periodically reviewed
by management and revised as deemed appropriate. As a result of this risk
assessment, management has identified $55.5 million of loans at December 31,
2003 which were performing in accordance with their terms but were deemed to
have certain weaknesses or increased levels of risk. Included in this amount is
one commercial construction loan in the amount of $15.7 million which was
performing in accordance with its terms but management believes has developed
certain credit weaknesses and an increased level of risk. The establishment of
the allowance for loan losses is significantly affected by management's judgment
and uncertainties and there is a likelihood that different amounts would be
reported under different conditions or assumptions. Various regulatory agencies,
as an integral part of their examination process, periodically review KNBT's
allowance for loan losses. Such agencies may require it to make additional
provisions for estimated loan losses based upon judgments different from those
of management. As of December 31, 2003, KNBT's allowance for loan losses was
0.89% of total loans receivable.
KNBT will continue to monitor and modify its allowances for loan losses
as conditions dictate. No assurances can be given that its level of allowance
for loan losses will cover all of the inherent losses on its loans or that
future adjustments to the allowance for loan losses will not be necessary if
economic and other conditions differ substantially from the economic and other
conditions used by management to determine the current level of the allowance
for loan losses.
The following table shows changes in KNBT's allowance for loan losses
during the periods presented.
- ------------------------------------------------------------------------------------------------------------------------------------
At or For the Year ended December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ----------- ------------- ------------- ---------
(dollars in thousands)
Allowance for loan losses, beginning of period $2,927 $3,386 $3,337 $3,101 $2,986
Reserve received in merger ................... 3,548 -- -- -- --
Provision for loan losses .................... 2,951 111 391 442 421
Charge-offs:
One-to four-family residential ......... 242 229 154 100 88
Multi-family ........................... -- -- -- -- 115
Commercial real estate ................. -- -- -- -- --
Construction and land development ...... -- -- -- -- --
Commercial business .................... 154 -- -- -- --
Consumer ............................... 1,207 394 224 146 108
------ ------ ------ ------ ------
Total charge-offs ................... 1,603 623 378 246 311
------ ------ ------ ------ ------
Recoveries on loans previously charged-off ... 87 53 36 40 5
------ ------ ------ ------ ------
Net loans charged-off ........................ 1,516 570 342 206 306
Allowance for loan losses, at December 31, ... $7,910 $2,927 $3,386 $3,337 $3,101
----------------------------------------------------------------------
Allowance for loan losses at year-end to:
Average loans .......................... 1.27% 0.47% 0.50% 0.52% 0.53%
Loans at year-end ...................... 0.89% 0.52% 0.50% 0.51% 0.50%
Non-performing loans ................... 388.28% 117.31% 125.87% 418.17% 195.15%
----------------------------------------------------------------------
-14-
The following table shows how KNBT's allowance for loan losses
has been allocated by type of loan at each of the dates indicated.
---------------------------------------------------------------------------------------------------------------
At December 31,
---------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
-------------------- --------------------- --------------------- --------------------- ---------------------
Loan Loan Loan Loan Loan
Category Category Category Category Category
Amount as a % Amount as a % Amount as a % Amount as a % Amount as a %
of of Total of of Total of of Total of of Total of of Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
---------- --------- ----------- --------- ------------ -------- ------------ -------- ----------- --------
(dollars in thousands)
One-to four-family
residential ..... $ 349 36.00% $ 1,086 59.34% $ 2,053 73.27% $2,291 73.20% $ 2,128 72.52%
Multi-family
residential ..... 4 1.54 33 0.88 35 0.55 48 0.58 36 0.55
Commercial real
estate .......... 2,745 16.97 145 4.82 39 1.83 43 0.97 5 0.54
Construction and
land development 683 12.22 451 9.74 291 7.72 106 8.58 102 9.72
Commercial
business ........ 712 4.23 500 1.65 464 0.63 115 0.60 22 0.54
State and political
subdivisions .... -- 0.25 -- -- -- -- -- -- -- --
Consumer .......... 2,673 28.79 590 23.57 303 16.00 123 16.07 150 16.13
Unallocated ....... 744 -- 122 -- 201 -- 611 -- 658 --
---------- --------- ----------- --------- ------------ -------- ------------ -------- ----------- --------
Total ......... $7,910 100.00% $2,927 100.00% $ 3,386 100.00% $ 3,337 100.00% $ 3,101 100.00%
========== ========= =========== ========= ============ ======== ============ ======== =========== ========
- ------------------------------------------------------------------------------------------------------------------------------------
Investment Activities
KNBT invests in securities pursuant to its Investment Policy. KNBT's
investment policy is designed primarily to maintain liquidity, to generate a
favorable return without incurring undue interest rate and credit risk, to
complement its lending activities, to manage the interest sensitivity of its
assets and liabilities and minimize KNBT's tax liability. KNBT also uses a
leverage investment strategy for the purpose of enhancing returns. Pursuant to
this strategy, KNBT has increased the size of its investment portfolio by
utilizing borrowings to support such investments.
At December 31, 2003, KNBT's investment securities amounted to $734.1
million or 37.8% of total assets at such date. At such date, there were $9.6
million in unrealized gains with respect to the investment securities portfolio
of KNBT, resulting in a net of tax unrealized gain of $6.3 million. The largest
component of KNBT's investment securities in recent periods has been
mortgage-backed securities, which amounted to $464.4 million or 63.2% of the
investment securities portfolio at December 31, 2003. In addition, KNBT invests
in municipal securities, corporate debt obligations, U.S. government and agency
obligations and other securities. In recent periods, KNBT has increased the
amount of its investment in municipal securities due to the tax advantage
provided. Under KNBT's investment policy, municipal bonds must be rated in the
top three investment rating categories at the time of purchase.
In order to achieve maximum flexibility with its investment securities,
all of KNBT's investment securities have been classified as available-for-sale,
pursuant to SFAS No. 115, for more than the past three years. This accounting
pronouncement requires a security to be classified as available-for-sale,
held-to-maturity, or trading, at the time of acquisition. Securities classified
as held-to-maturity must be purchased with the intent and ability to hold that
security until its final maturity, and can be sold prior to maturity only under
rare circumstances. Held-to-maturity securities are accounted for based upon the
historical cost of the security. Available-for-sale securities can be sold at
any time based upon needs or market conditions. Available-for-sale securities
are accounted for at fair value, with unrealized gains and
-15-
losses on these securities, net of income tax provisions, reflected in retained
earnings as accumulated other comprehensive income.
Currently, KNBT is not participating in hedging programs, interest rate
swaps, collars or other activities involving the use of off-balance sheet
financial derivatives. Also, KNBT does not purchase mortgage-backed derivative
instruments that would be characterized "high-risk" under Federal banking
regulations at the time of purchase, nor does it purchase corporate obligations
that are not rated investment grade.
KNBT's mortgage-backed securities include mortgage pass-through
certificates issued by the GNMA, FNMA and FHLMC as well as collateralized
mortgage obligations ("CMOs") issued by such agencies or private issuers.
Investments in mortgage-backed securities involve a risk that actual prepayments
will be greater than estimated prepayments over the life of the security, which
may require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby changing the net yield on such
securities. There is also reinvestment risk associated with the cash flows of
such securities or in the event such securities are redeemed by the issuer. In
addition, the market value of such securities may be adversely affected by
changes in interest rates.
Collateralized mortgage obligations are typically issued by a
special-purpose entity, in KNBT's case, private issuers or government agencies,
which may be organized in a variety of legal forms, such as a trust, a
corporation, or a partnership. Substantially all of the collateralized mortgage
obligations held in KNBT's portfolio consist of senior sequential tranches,
primarily investments in the first tranche of the collateralized mortgage
obligations. By purchasing senior sequential tranches, management attempts to
ensure the cash flow associated with such an investment. While non-agency
private issues are somewhat less liquid than collateralized mortgage obligations
issued by GNMA, Fannie Mae or Freddie Mac, they generally have a higher yield
than agency insured or guaranteed collateralized mortgage obligations, such
higher yield reflecting in part to lack of such guarantee or protection and,
thus, the potentially higher risk of loss or default associated with such
assets. KNBT's investment portfolio policy requires that all privately issued
CMOs be rated AAA by Standard & Poor's at the time of purchase.
-16-
The following table sets forth certain information relating to KNBT's
investment securities portfolio and FHLB stock at the dates indicated.
- -------------------------------------------------------------------------------------------------------------------------------
At December 31,
-------------------------------------------------------------------------------------------
2003 2002 2001
---------------------------- ---------------------------- -----------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-------------------------------------------------------------------------------------------
Debt Securities: .......... (dollars in thousands)
U.S. Government
and agency obligations .. $118,037 $120,380 $ 30,677 $ 31,075 $ 8,445 $ 8,437
Corporate securities ...... 15,068 15,637 34,053 35,172 36,937 38,153
Municipal obligations ..... 112,228 115,655 38,935 41,039 29,040 29,560
Mortgage-backed securities:
GNMA ................... 2,124 2,138 3,234 3,327 563 608
FHLMC .................. 83,737 83,985 17,963 18,348 3,063 3,140
FNMA ................... 224,802 227,538 73,743 76,101 6,845 6,867
Other .................. 150,645 150,697 83,449 84,174 64,849 65,101
---------- --------- ---------- --------- ---------- ---------
Total mortgage-backed
securities ............. 461,308 464,358 178,389 181,950 75,320 75,716
Other debt securities ..... -- -- -- -- 10 10
---------- --------- ---------- --------- ---------- ---------
Total debt securities .. 706,641 716,030 282,054 289,236 149,752 151,876
Equity Securities:
ARM fund .................. 4,939 4,880 4,939 4,914 4,938 4,909
Other equity securities ... 12,939 13,177 -- -- -- --
---------- --------- ---------- --------- ---------- ---------
Total equity securities 17,878 18,057 4,939 4,914 4,938 4,909
---------- --------- ---------- --------- ---------- ---------
Total investment securities $724,519 $734,087 $286,993 $294,150 $154,690 $156,785
---------- --------- ---------- --------- ---------- ---------
FHLB stock ................ 11,543 11,543 8,011 8,011 6,099 6,099
---------- --------- ---------- --------- ---------- ---------
Total investment securities
and FHLB stock .......... $736,062 $745,630 $295,004 $302,161 $160,789 $162,884
-------------------------------------------------------------------------------------------
-17-
The following table sets forth the amount of investment securities, at
amortized cost, which mature during each of the periods indicated and the
weighted average yields for each range of maturities at the dates indicated. No
tax-exempt yields have been adjusted to a tax-equivalent basis.
- ------------------------------------------------------------------------------------------------------------------------------------
Amounts at December 31, 2003, which mature in:
-----------------------------------------------------------------------------------------------------
Over One
One Weighted Year Weighted Over Five Weighted Over Weighted Weighted
year Average Through Average Through Average Ten Average Average
or Less Yield Five Years Yield Ten Years Yield Years Yield Total Yield
-----------------------------------------------------------------------------------------------------
(dollars in thousands)
Debt securities:
U.S. Government and
agency obligations ... $ 2,020 1.68% $ 61,339 3.04% $ 16,173 3.67% $ 38,505 4.13% $ 118,037 3.65%
Corporate securities .... 6,008 6.66 9,060 5.64 - - - - 15,068 6.05
Municipal obligations ... 102 4.85 2,123 3.98 27,745 4.33 82,258 4.63 112,228 4.54
Mortgage-backed
securities ........... - - 10,348 4.09 116,337 3.74 334,623 4.48 461,308 4.28
---------- --------- --------- --------- ----------- --------- ----------- -------- ---------- ------
Total debt securities . $ 8,130 5.40% $ 82,870 3.75% $160,255 3.84% $455,386 4.48% $ 706,641 4.26%
The following table sets forth the purchases, sales and principal
repayments of mortgage-backed securities, at amortized cost, for KNBT for the
periods indicated.
At or For the
Year Ended December 31,
-------------------------------------------
2003 2002 2001
--------- --------- ---------
(dollars in thousands)
Mortgage-backed securities at beginning of period ..... $ 178,389 $ 75,320 $ 44,521
Mortgage-backed securities acquired through merger
with First Colonial ................................ 151,584 -- --
Purchase price adjustment of mortgage-backed securities
acquired through merger with First Colonial ........ (2,309) -- --
Purchases ............................................. 333,675 140,911 53,160
Securitized and retained .............................. 47,251 53,897 --
Securitized and sold .................................. -- 61,438 --
Repayments ............................................ (218,339) (88,850) (22,403)
Sales ................................................. (25,495) (63,844) --
Amortizations of premiums and discounts, net .......... (3,448) (483) 42
--------- --------- ---------
Mortgage-backed securities at end of period ........... $ 461,308 $ 178,389 $ 75,320
========= ========= =========
Weighted average yield at end of period ............... 4.05% 5.85% 6.09%
- -----------------------------------------------------------------------------------------------------------
Sources of Funds
Deposits. Deposits are the primary source of KNBT's funds. KNBT offers
a variety of deposit accounts with a range of interest rates and terms. KNBT's
deposits consist of interest-bearing and non-interest-bearing checking accounts,
money market, savings and certificate of deposit accounts.
Total deposits increased to $1.3 billion at December 31, 2003, from
$771.8 million at December 31, 2002, a growth of $517.6 million or 67.1%. A
major factor in this growth was the acquisition of $512.1 million of deposits as
a result of the merger with First Colonial. Also contributing to the increase
-18-
in deposits were increases in savings, money market and checking products due to
the opening of new branches and KNBT's marketing programs. Total core deposits,
which are all deposits other than certificates of deposits increased by $359.2
million in 2003, $318.0 million of which were acquired through the merger. These
deposits totaled $741.7 million at December 31, 2003 and $382.6 million at
December 31, 2002. KNBT's core deposits were 57.5% and 49.6% of total deposits
at December 31, 2003 and 2002, respectively. Certificates of deposits increased
$158.4 million from $389.3 million at December 31, 2002 to $547.7 million at
December 31, 2003. The merger accounted for $194.0 million of the increase in
certificates of deposit.
The following table shows for KNBT the average balance of each type of
deposit and the average rate paid on each type of deposit for the periods
indicated.
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------------------------------------------------------------
2003 2002 2001
--------------------------------- ---------------------------------- ----------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Expense Rate Paid Balance Expense Rate Paid Balance Expense Rate Paid
--------------------------------- ---------------------------------- ----------------------------------
(dollars in thousands)
Savings ............... $182,548 $ 1,315 0.72% $111,689 $ 1,680 1.50% $ 97,778 $ 2,127 2.18%
Interest-bearing
checking ........... 102,506 298 0.29 81,609 466 0.57 76,090 846 1.11
Money market .......... 203,978 2,212 1.08 134,456 2,784 2.07 100,327 3,512 3.50
Certificates of deposit 409,003 12,168 2.98 417,073 18,169 4.36 447,171 25,679 5.74
-------- ------- ------- ------ ------- ------
Total interest-bearing
deposits ............ 898,035 15,993 1.78 744,827 23,099 3.10 721,366 32,164 4.46
Non-interest-bearing
deposits ............ 53,559 -- -- 28,881 -- -- 19,890 -- --
-------- ------- ------- ------ ------- ------
Total deposits ..... $951,594 $ 15,993 1.68% $773,708 $ 23,099 2.99% $741,256 $ 32,164 4.34%
======== ======= ==== ======= ====== ==== ======= ====== ======
The following table shows for KNBT deposit flows during the periods
indicated.
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
------------------------------------------------------------------
2003 2002 2001
-------------------- ------------------ -----------------
(dollars in thousands)
Deposits received in merger .................. $ 512,086 $ - $ -
Total deposits ............................... 10,938,793 4,352,478 2,616,347
Total withdrawals ............................ (10,947,524) (4,373,961) (2,586,937)
Interest credited ............................ 14,230 21,089 29,397
-------------------- ------------------ -----------------
Total increase (decrease) in deposits ... $ 517,585 $ (394) $ 58,807
==================== ================== =================
-19-
The following table shows for KNBT the amount of certificates of
deposit, by various interest rate categories and maturities, at the dates
indicated.
Balance at December 31, 2003
Maturing in the 12 Months Ending December 31,
-------------------------------------------------------------------------------------------
Certificates of Deposit: 2004 2005 2006 2007 2008 Thereafter Total
- ----------------------------------- ------------ ----------- ---------- ----------- --------- ------------ --------------
(dollars in thousands)
Less than 2% ...................... $ 171,421 $ 31,236 $ 2,743 $ - $ - $ 32 $ 205,432
2.00% - 2.99% ..................... 51,152 34,055 14,887 1,138 1,452 107 102,791
3.00% - 3.99% ..................... 54,229 34,589 18,305 8,328 12,367 118 127,936
4.00% - 4.99% ..................... 12,727 26,199 16,013 27,920 180 1,182 84,221
5.00% - 5.99% ..................... 9,364 1,807 2,241 13,543 133 20 27,108
6.00% - 6.99% ..................... 70 131 - 4 - - 205
7.00% or more .................... 1 - - - - - 1
------------ ----------- ---------- ----------- --------- ------------ --------------
Total certificates of deposit .. $ 298,964 $128,017 $54,189 $ 50,933 $14,132 $ 1,459 $ 547,694
============ =========== ========== =========== ========= ============ ==============
The following table shows the maturities of KNBT's certificates of
deposit of $100,000 or more at December 31, 2003 indicated by time remaining to
maturity.
Weighted
Maturing in Quarter Ending: Amount Average Rate
- ---------------------------------------- --------------- ---------------------
(dollars in thousands)
March 31, 2004 .......................... $ 5,522 1.98%
June 30, 2004 ........................... 11,291 2.27
September 30, 2004 ...................... 4,547 2.78
December 31, 2004 ....................... 5,604 2.16
After December 31, 2004 ................. 29,892 3.47
--------------- ---------------------
Total certificates of deposit with
balances of $100,000 or more ...... $56,856 2.90%
=============== =====================
Borrowings. KNBT, as part of its operating strategy, utilizes advances
from the Federal Home Loan Bank of Pittsburgh as an alternative to retail
deposits to fund its operations. These FHLB advances are collateralized
primarily by certain of KNBT's mortgage loans and mortgage-backed securities and
secondarily by its investment in capital stock of the Federal Home Loan Bank of
Pittsburgh. FHLB advances are made pursuant to several different credit
programs, each of which has it own interest rate and range of maturities. The
maximum amount that the Federal Home Loan Bank of Pittsburgh will advance to
member institutions, including KNBT, fluctuates from time to time in accordance
with the policies of the Federal Home Loan Bank. At December 31, 2003, KNBT had
$207.2 million in outstanding FHLB advances. At December 31, 2002, FHLB advances
totaled $113.5 million, which includes $20.0 million in short-term (overnight)
borrowings. KNBT had no other short-term (overnight) borrowings from the FHLB in
2003, 2002 and 2001.
The weighted average interest rates on KNBT's advances was 4.21% and
4.69% for the years ended December 31, 2003 and 2002, respectively.
-20-
The principal payments due on KNBT's long-term FHLB advances at
December 31, 2003 are as follows:
- ----------------------------------------------------------
FHLB Advances
Due In: At December 31, 2003
- ---------------------------- -----------------------
(dollars in thousands)
2004 $ 24,300
2005 20,000
2006 20,000
2007 61,626
2008 13,000
2009 and thereafter 68,227
-----------------
Total $ 207,153
=================
In addition to FHLB advances, KNBT's borrowings include securities sold
under agreements to repurchase ("repurchase agreements"). Repurchase agreements
are contracts for the sale of securities owned or borrowed by KNBT, with an
agreement to repurchase those securities at an agreed upon price and date. The
collateral for such repurchase agreements are U.S. Treasury and Agency
securities and municipal securities. At December 31, 2003, KNBT's securities
repurchase agreements amounted to $24.6 million and all of such borrowings were
short-term, having maturities of one year or less. KNBT's securities sold under
repurchase agreements totaled $8.9 million at December 31, 2002.
The following table shows certain information regarding KNBT's
repurchase agreements:
- ----------------------------------------------------------------------------------------------------
At or For the Year Ended December 31,
----------------------------------------------------
2003 2002 2001
---------------- --------------- ----------------
(dollars in thousands)
Repurchase Agreements:
Average balance outstanding .............. $ 11,931 $ 7,330 $ 2,431
Maximum amount outstanding at any
month-end during the period ........... $ 29,010 $10,051 $ 5,752
Balance outstanding at end of period ..... $ 24,550 $ 8,904 $ 5,752
Average interest rate during the period .. 1.10% 2.09% 3.79%
Weighted average interest rate at
end of period ......................... 0.64% 1.85% 2.49%
In conjunction with the merger with First Colonial, KNBT assumed the
$15.0 million of statutory trust debt held by First Colonial which were issued
to First Colonial Trust I, a wholly-owned Connecticut statutory business trust
subsidiary in June 2002. The Statutory Trust I issued $15.0 million in pooled
trust preferred securities. The subordinated debentures are the sole asset of
the statutory trust. The trust preferred securities are classified as long-term
debt for the financial statements, but are included as Tier I capital for
regulatory purposes. The interest rate on this security (4.62% at December 31,
2003) is variable, adjusting quarterly at three-month LIBOR plus 3.45%. The
interest is payable quarterly. The trust preferred securities mature in June
2007, or may be redeemed at any time in the event that the deduction of related
interest for federal income tax purposes is prohibited, treatment as Tier I
capital is no longer permitted, or certain other contingencies arise. The net
proceeds of the trust preferred securities have been used to support the
Company's growth and other general corporate purposes.
-21-
Regulation of KNBT Bancorp
Set forth below is a brief description of certain laws relating to the
regulation of KNBT Bancorp and Keystone Nazareth Bank & Trust Company. This
description does not purport to be complete and is qualified in its entirety by
reference to applicable laws and regulations.
General
The Bank as a Pennsylvania-chartered savings bank with deposits insured
by the Savings Association Insurance Fund administered by the Federal Deposit
Insurance Corporation, is subject to extensive regulation and examination by the
Pennsylvania Department of Banking and by the Federal Deposit Insurance
Corporation. The federal and state laws and regulations applicable to banks
regulate, among other things, the scope of their business, their investments,
the reserves required to be kept against deposits, the timing of the
availability of deposited funds and the nature and amount of and collateral for
certain loans. This regulatory structure also gives the federal and state
banking agencies extensive discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with respect
to the classification of assets and the establishment of adequate loan loss
reserves for regulatory purposes. The laws and regulations governing the Bank
generally have been promulgated to protect depositors and not for the purpose of
protecting shareholders.
Federal law provides the federal banking regulators, including the
Federal Deposit Insurance Corporation and the Federal Reserve Board, with
substantial enforcement powers. This enforcement authority includes, among other
things, the ability to assess civil money penalties, to issue cease-and-desist
or removal orders, and to initiate injunctive actions against banking
organizations and institution-affiliated parties, as defined. In general, these
enforcement actions may be initiated for violations of laws and regulations and
unsafe or unsound practices. Other actions or inactions may provide the basis
for enforcement action, including misleading or untimely reports filed with
regulatory authorities. Any change in such regulation, whether by the
Pennsylvania Department of Banking, the Federal Deposit Insurance Corporation,
the Federal Reserve Board or the United States Congress, could have a material
impact on KNBT and its operations.
KNBT is a bank holding company under the Bank Holding Company Act
subject to regulation and supervision by the Federal Reserve Board and by the
Pennsylvania Department of Banking. KNBT is required to file annually a report
of its operations with, and is subject to examination by, the Federal Reserve
Board and the Pennsylvania Department of Banking. This regulation and oversight
is generally intended to ensure that KNBT limits its activities to those allowed
by law and that it operates in a safe and sound manner without endangering the
financial health of its subsidiary bank.
KNBT has registered its common stock with the SEC under Section 12(g)
of the Securities Exchange Act of 1934. KNBT is subject to the proxy and tender
offer rules, insider trading reporting requirements and restrictions, and
certain other requirements under the Securities Exchange Act of 1934. KNBT has
listed its common stock on the Nasdaq Stock Market national market system. The
Nasdaq Stock Market listing requirements impose additional requirements on KNBT,
including, among other things, rules relating to corporate governance and the
composition and independence of its board of directors and various committees of
the board, such as the audit committee.
Bank Holding Company Act Activities and Other Limitations. Under the
Bank Holding Company Act, KNBT must obtain the prior approval of the Federal
Reserve Board before it may acquire control of another bank or bank holding
company, merge or consolidate with another bank holding company, acquire all or
substantially all of the assets of another bank or bank holding company, or
acquire direct or indirect ownership or control of any voting shares of any bank
or bank holding company if, after such acquisition, KNBT would directly or
indirectly own or control more than 5% of such shares.
Federal statutes impose restrictions on the ability of a bank holding
company and its non-bank subsidiaries to obtain extensions of credit from its
subsidiary bank, on the subsidiary bank's investments in the stock or securities
of the holding company, and on the subsidiary bank's taking of the holding
company's stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented
-22-
from engaging in certain tie-in arrangements in connection with any extension of
credit, lease or sale of property, or furnishing of services by the subsidiary
bank.
A bank holding company is required to serve as a source of financial
and managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, it is the policy of the
Federal Reserve Board that a bank holding company should stand ready to use
available resources to provide adequate capital to its subsidiary banks during
periods of financial stress or adversity and should maintain the financial
flexibility and capital-raising capacity to obtain additional resources for
assisting its subsidiary banks. A bank holding company's failure to meet its
obligations to serve as a source of strength to its subsidiary banks will
generally be considered by the Federal Reserve Board to be an unsafe and unsound
banking practice or a violation of the Federal Reserve Board regulations, or
both.
Non-Banking Activities. The business activities of KNBT, as a bank
holding company, are restricted by the Bank Holding Company Act. Under the Bank
Holding Company Act and the Federal Reserve Board's bank holding company
regulations, KNBT may only engage in, or acquire or control voting securities or
assets of a company engaged in:
o banking or managing or controlling banks and other subsidiaries
authorized under the Bank Holding Company Act; and
o any Bank Holding Company Act activity the Federal Reserve Board has
determined to be so closely related that it is incidental to banking
or managing or controlling banks.
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking including operating a mortgage
company, finance company, credit card company, factoring company, trust company
or savings association; performing certain data processing operations; providing
limited securities brokerage services; acting as an investment or financial
advisor; acting as an insurance agent for certain types of credit-related
insurance; leasing personal property on a full-payout, non-operating basis;
providing tax planning and preparation services; operating a collection agency;
and providing certain courier services. However, as discussed below, certain
other activities are permissible for a bank holding company that becomes a
financial holding company.
Financial Modernization. The Gramm-Leach-Bliley Act permits greater
affiliation among banks, securities firms, insurance companies, and other
companies under a new type of financial services company known as a "financial
holding company." A financial holding company essentially is a bank holding
company with significantly expanded powers. Financial holding companies are
authorized by statute to engage in a number of financial activities previously
not permissible for bank holding companies, including securities underwriting,
dealing and market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; and merchant banking activities. The act also
permits the Federal Reserve Board and the Treasury Department to authorize
additional activities for financial holding companies if they are "financial in
nature" or "incidental" to financial activities. A bank holding company may
become a financial holding company if each of its subsidiary banks is well
capitalized, well managed, and has at least a "satisfactory" Community
Reinvestment Act rating. A financial holding company must provide notice to the
Federal Reserve Board within 30 days after commencing activities previously
determined by statute or by the Federal Reserve Board and Department of the
Treasury to be permissible. KNBT has not submitted notice to the Federal Reserve
Board of its intent to be deemed a financial holding company. However, it is not
precluded from submitting a notice in the future should it wish to engage in
activities only permitted to financial holding companies.
Regulatory Capital Requirements. The Federal Reserve Board has adopted
capital adequacy guidelines pursuant to which it assesses the adequacy of
capital in examining and supervising a bank holding company and in analyzing
applications to it under the Bank Holding Company Act. The Federal Reserve
Board's capital adequacy guidelines for KNBT, on a consolidated basis, are
similar to those imposed on the Bank by the Federal Deposit Insurance
Corporation. Prompt corrective action provisions, however, are not applicable to
bank holding companies.
-23-
Restrictions on Dividends. KNBT's ability to declare and pay dividends
may depend in part on dividends received from the Bank. The Pennsylvania Banking
Code regulates the distribution of dividends by savings banks and states, in
part, that dividends may be declared and paid only out of accumulated net
earnings and may not be declared or paid unless surplus, retained earnings, is
at least equal to contributed capital. In addition, dividends may not be
declared or paid if the Bank is in default in payment of any assessment due the
Federal Deposit Insurance Corporation.
The Federal Reserve Board issued a policy statement in 1985 on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the holding company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earnings retention
that is consistent with the holding company's capital needs, asset quality and
overall financial condition. The Federal Reserve Board also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends. Furthermore, under the federal prompt corrective
action regulations, the Federal Reserve Board may prohibit a bank holding
company from paying any dividends if the holding company's bank subsidiary is
classified as "undercapitalized." See - "Regulation of the Bank" below.
Federal Securities Laws. KNBT is subject to the proxy and tender offer
rules, insider trading reporting requirements and restrictions, and certain
other requirements under the Securities Exchange Act of 1934.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into
law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to
address corporate and accounting fraud. In addition to the establishment of a
new accounting oversight board which will enforce auditing, quality control and
independence standards and will be funded by fees from all publicly traded
companies, the Sarbanes-Oxley Act restricts provision of both auditing and
consulting services by accounting firms. To ensure auditor independence, any
non-audit services being provided to an audit client requires pre-approval by
the company's audit committee members. In addition, the audit partners must be
rotated. The Sarbanes-Oxley Act requires chief executive officers and chief
financial officers, or their equivalent, to certify to the accuracy of periodic
reports filed with the SEC, subject to civil and criminal penalties if they
knowingly or willfully violate this certification requirement. In addition,
under the Sarbanes-Oxley Act, counsel are required to report evidence of a
material violation of the securities laws or a breach of fiduciary duty by a
company to its chief executive officer or its chief legal officer, and, if such
officer does not appropriately respond, to report such evidence to the audit
committee or other similar committee of the board of directors or the board
itself.
Longer prison terms now apply to corporate executives who violate
federal securities laws, the period during which certain types of suits can be
brought against a company or its officers has been extended, and bonuses issued
to top executives prior to restatement of a company's financial statements are
now subject to disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
"blackout" periods, and loans to company executives are restricted. In addition,
a provision directs that civil penalties levied by the SEC as a result of any
judicial or administrative action under the Sarbanes-Oxley Act be deposited to a
fund for the benefit of harmed investors. The Federal Accounts for Investor
Restitution ("FAIR") provision also requires the SEC to develop methods of
improving collection rates. The legislation accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers must also provide information for most changes in ownership in a
company's securities within two business days of the change.
The Sarbanes-Oxley Act also increases the oversight of, and codifies
certain requirements relating to audit committees of public companies and how
they interact with the company's "registered public accounting firm" ("RPAF").
Audit Committee members must be independent and are barred from accepting
consulting, advisory or other compensatory fees from the issuer. In addition,
companies must disclose whether at least one member of the committee is a
"financial expert," as such term is defined by the SEC, and if not, why not.
Under the Sarbanes-Oxley Act, a RPAF is prohibited from performing statutorily
mandated audit services for a company if such company's chief executive officer,
chief financial officer, comptroller, chief accounting officer or any person
serving in equivalent positions has been employed by such firm and participated
in the audit of such company during the one-year period preceding the audit
initiation date. The Sarbanes-Oxley Act also prohibits any officer or director
of a company or any other person acting under their direction from taking any
action to fraudulently influence, coerce,
-24-
manipulate or mislead any independent public or certified accountant engaged in
the audit of the company's financial statements for the purpose of rendering the
financial statement's materially misleading. The Sarbanes-Oxley Act also
required the SEC to prescribe rules requiring inclusion of an internal control
report and assessment by management in the annual report to shareholders. The
Sarbanes-Oxley Act requires the RPAF that issues the audit report to attest to
and report on management's assessment of the company's internal controls. In
addition, the Sarbanes-Oxley Act requires that each financial report required to
be prepared in accordance with, or reconciled to, generally accepted accounting
principles and filed with the SEC reflect all material correcting adjustments
that are identified by a RPAF in accordance with generally accepted accounting
principles and the rules and regulations of the SEC.
Regulation of The Bank
Pennsylvania Savings Bank Law. The Pennsylvania Banking Code contains
detailed provisions governing the organization, location of offices, rights and
responsibilities of directors, officers, and employees, as well as corporate
powers, savings and investment operations and other aspects of the Bank and its
affairs. The code delegates extensive rule-making power and administrative
discretion to the Pennsylvania Department of Banking so that the supervision and
regulation of state-chartered savings banks may be flexible and readily
responsive to changes in economic conditions and in savings and lending
practices.
The Pennsylvania Banking Code also provides that state-chartered
savings banks may engage in any activity permissible for a federal savings
association, subject to regulation by the Pennsylvania Department of Banking.
The Federal Deposit Insurance Act, however, will prohibit the Bank from making
new investments, loans, or becoming involved in activities as principal and
equity investments which are not permitted for national banks unless:
o the Federal Deposit Insurance Corporation determines the activity or
investment does not pose a significant risk of loss to the Savings
Association Insurance Fund; and
o the Bank meets all applicable capital requirements.
Accordingly, the additional operating authority provided to the Bank by the
Pennsylvania Banking Code is significantly restricted by the Federal Deposit
Insurance Act.
Insurance of Accounts. The deposits of the Bank are insured to the
maximum extent permitted by the Savings Association Insurance Fund, which is
administered by the Federal Deposit Insurance Corporation, and are backed by the
full faith and credit of the U.S. Government. As insurer, the Federal Deposit
Insurance Corporation is authorized to conduct examinations of, and to require
reporting by, insured institutions. It also may prohibit any insured institution
from engaging in any activity the Federal Deposit Insurance Corporation
determines by regulation or order to pose a serious threat to the Federal
Deposit Insurance Corporation. The Federal Deposit Insurance Corporation also
has the authority to initiate enforcement actions against savings institutions.
Under current Federal Deposit Insurance Corporation regulations,
Savings Association Insurance Fund-insured institutions are assigned to one of
three capital groups which are based solely on the level of an institution's
capital "well capitalized," "adequately capitalized" and "undercapitalized"
which are defined in the same manner as the regulations establishing the prompt
corrective action system discussed below. These three groups are then divided
into three subgroups which reflect varying levels of supervisory concern, from
those which are considered to be healthy to those which are considered to be of
substantial supervisory concern. The matrix so created results in nine
assessment risk classifications, with rates during the last six months of 2003
ranging from zero for well capitalized, healthy institutions, such as the Bank,
to 27 basis points for undercapitalized institutions with substantial
supervisory concerns.
In addition, all institutions with deposits insured by the Federal
Deposit Insurance Corporation are required to pay assessments to fund interest
payments on bonds issued by the Financing Corporation, a mixed-ownership
government corporation established to recapitalize the predecessor to the
Savings Association Insurance Fund. The assessment rate for the last quarter of
2003 was 0.152% of insured deposits and is adjusted quarterly. These assessments
will continue until the Financing Corporation bonds mature in 2019.
-25-
The Federal Deposit Insurance Corporation may terminate the deposit
insurance of any insured depository institution, including the Bank, if it
determines after a hearing that the institution has engaged or is engaging in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, order or any
condition imposed by an agreement with the Federal Deposit Insurance
Corporation. It also may suspend deposit insurance temporarily during the
hearing process for the permanent termination of insurance, if the institution
has no tangible capital. If insurance of accounts is terminated, the accounts at
the institution at the time of the termination, less subsequent withdrawals,
shall continue to be insured for a period of six months to two years, as
determined by the Federal Deposit Insurance Corporation. Management is aware of
no existing circumstances which would result in termination of the Bank's
deposit insurance.
Regulatory Capital Requirements. The Federal Deposit Insurance
Corporation has promulgated capital adequacy requirements for state-chartered
banks that, like the Bank, are not members of the Federal Reserve Board System.
The capital regulations establish a minimum 3% Tier 1 leverage capital
requirement for the most highly rated state-chartered, non-member banks, with an
additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively increases the minimum Tier
1 leverage ratio for such other banks to 4% to 5% or more. Under the Federal
Deposit Insurance Corporation's regulations, the highest-rated banks are those
that the Federal Deposit Insurance Corporation determines are not anticipating
or experiencing significant growth and have well diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and, in general, which are considered a strong banking organization,
rated composite 1 under the Uniform Financial Institutions Rating System. Tier
1, or leverage capital, is defined as the sum of common shareholders' equity,
including retained earnings, non-cumulative perpetual preferred stock and
related surplus, and minority interests in consolidated subsidiaries, minus all
intangible assets other than certain purchased mortgage servicing rights and
purchased credit card relationships.
The Federal Deposit Insurance Corporation's regulations also require
that state-chartered, non-member banks meet a risk-based capital standard. The
risk-based capital standard requires the maintenance of total capital, defined
as Tier 1 capital and supplementary (Tier 2) capital, to risk weighted assets of
8%. In determining the amount of risk-weighted assets, all assets, plus certain
off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based
on the risks the Federal Deposit Insurance Corporation believes are inherent in
the type of asset or item. The components of Tier 1 capital for the risk-based
standards are the same as those for the leverage capital requirement. The
components of supplementary (Tier 2) capital include cumulative perpetual
preferred stock, mandatory subordinated debt, perpetual subordinated debt,
intermediate-term preferred stock, up to 45% of unrealized gains on equity
securities and a portion of a bank's allowance for loan losses. Allowance for
loan losses includable in supplementary capital is limited to a maximum of 1.25%
of risk-weighted assets. Overall, the amount of supplementary capital that may
be included in total capital is limited to 100% of Tier 1 capital.
A bank that has less than the minimum leverage capital requirement is
subject to various capital plan and activities restriction requirements. The
Federal Deposit Insurance Corporation's regulations also provide that any
insured depository institution with a ratio of Tier 1 capital to total assets
that is less than 2.0% is deemed to be operating in an unsafe or unsound
condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and
could be subject to potential termination of deposit insurance.
The Bank is also subject to minimum capital requirements imposed by the
Pennsylvania Department of Banking on Pennsylvania chartered depository
institutions. Under the Pennsylvania Department of Banking's capital
regulations, a Pennsylvania bank or savings association must maintain a minimum
leverage ratio of Tier 1 capital, as defined under the Federal Deposit Insurance
Corporation's capital regulations, to total assets of 4%. In addition, the
Pennsylvania Department of Banking has the supervisory discretion to require a
higher leverage ratio for any institution or association based on inadequate or
substandard performance in any of a number of areas. The Pennsylvania Department
of Banking incorporates the same Federal Deposit Insurance Corporation
risk-based capital requirements in its regulations.
-26-
Prompt Correction Action. The following table shows the amount of
capital associated with the different capital categories set forth in the prompt
correction action regulations.
- -------------------------------------------------------------------------------------------------
Total Tier 1 Tier 1
Risk-Based Risk-Based Leverage
Capital Category Capital Capital Capital
- -------------------------------- -------------------- ------------------- ------------------
Well capitalized .................. 10% or more 6% or more 5% or more
Adequately capitalized ............ 8% or more 4% or more 4% or more
Undercapitalized .................. Less than 8% Less than 4% Less than 4%
Significantly undercapitalized .... Less than 6% Less than 3% Less than 3%
In addition, an institution is "critically undercapitalized" if it has
a ratio of tangible equity to total assets that is equal to or less than 2.0%.
Under specified circumstances, a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category, except that the
Federal Deposit Insurance Corporation may not reclassify a significantly
undercapitalized institution as critically undercapitalized.
An institution generally must file a written capital restoration plan
which meets specified requirements within 45 days of the date that the
institution receives notice or is deemed to have notice that it is
undercapitalized, significantly undercapitalized or critically undercapitalized.
A federal banking agency must provide the institution with written notice of
approval or disapproval within 60 days after receiving a capital restoration
plan, subject to extensions by the agency. An institution which is required to
submit a capital restoration plan must concurrently submit a performance
guaranty by each company that controls the institution. In addition,
undercapitalized institutions are subject to various regulatory restrictions,
and the appropriate federal banking agency also may take any number of
discretionary supervisory actions.
At December 31, 2003, the Bank was deemed a well-capitalized
institution for purposes of the above regulations and as such is not subject to
the above-mentioned restrictions.
-27-
The following table provides a comparison of KNBT's and the Bank's
capital amounts, risk-based capital ratios and leverage ratios for the periods
indicated.
- -------------------------------------------------------------------------------------------------------------------------------
Capital Ratios Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- --------------------- -----------------------
at December 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Company, (consolidated) ........... $359,522 33.24% $ 86,535 8.00% N/A N/A
Bank .............................. $258,441 24.01% $ 86,123 8.00% $107,654 10.00%
Tier I Capital
(To risk-weighted assets)
Company, (consolidated) ........... $351,612 32.51% $ 43,268 4.00% N/A N/A
Bank .............................. $250,499 23.27% $ 43,062 4.00% $64,593 6.00%
Tier I Capital
(To average assets, leverage)
Company, (consolidated) ........... $351,612 19.39% $ 72,525 4.00% N/A N/A
Bank .............................. $250,499 13.42% $ 74,646 4.00% $93,307 5.00%
- ------------------------------------------------------------------------------------------------------------------------------
Capital Ratios Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- --------------------- -----------------------
at December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Total Capital
(To risk-weighted assets)
Bank .............................. $109,137 18.69% $ 46,702 8.00% $58,378 10.00%
Tier I Capital
(To risk-weighted assets)
Bank .............................. $106,210 18.19% $ 23,351 4.00% $35,027 6.00%
Tier I Capital
(To average assets, leverage)
Bank .............................. $106,210 10.78% $ 39,410 4.00% $49,263 5.00%
- --------------------------------------------------------------------------------------------------------------------------
Affiliate Transaction Restrictions. Federal laws strictly limit the
ability of banks to engage in transactions with their affiliates, including
their bank holding companies. Such transactions between a subsidiary bank and
its parent company or the non-bank subsidiaries of the bank holding company are
limited to 10% of a bank subsidiary's capital and surplus and, with respect to
such parent company and all such non-bank subsidiaries, to an aggregate of 20%
of the bank subsidiary's capital and surplus. Further, loans and extensions of
credit generally are required to be secured by eligible collateral in specified
amounts. Federal law also requires that all transactions between a bank and its
affiliates be on terms as favorable to the bank as transactions with
non-affiliates.
Federal Home Loan Bank System. The Bank is a member of the Federal Home
Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks.
Each Federal Home Loan Bank serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from funds deposited by
member institutions and proceeds from the sale of consolidated obligations of
the Federal Home Loan Bank
-28-
system. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the board of directors of the Federal Home Loan
Bank. At December 31, 2003, the Bank had $207.2 million in Federal Home Loan
Bank advances.
As a member, the Bank is required to purchase and maintain stock in the
Federal Home Loan Bank of Pittsburgh in an amount equal to the greater of 1% of
its aggregate unpaid residential mortgage loans, home purchase contracts or
similar obligations at the beginning of each year or 5% of its outstanding
advances from the Federal Home Loan Bank. At December 31, 2003, the Bank had
$11.5 million in stock of the Federal Home Loan Bank of Pittsburgh which was in
compliance with this requirement.
Federal Reserve Board System. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts, which are primarily checking and NOW
accounts, and non-personal time deposits. The balances maintained to meet the
reserve requirements imposed by the Federal Reserve Board may be used to satisfy
the liquidity requirements that are imposed by the Pennsylvania Department of
Banking. At December 31, 2003, the Bank was in compliance with these reserve
requirements.
Federal Taxation
General. KNBT and the Bank are subject to federal income taxation in
the same general manner as other corporations with some exceptions listed below.
The following discussion of federal, state and local income taxation is only
intended to summarize certain pertinent income tax matters and is not a
comprehensive description of the tax rules applicable to KNBT and the Bank.
Method of Accounting. For federal income tax purposes, KNBT reports
income and expenses on the accrual method of accounting and files its federal
income tax return on a calendar year basis.
Bad Debt Reserves. The Small Business Job Protection Act of 1996
eliminated the use of the reserve method of accounting for bad debt reserves by
savings associations, effective for taxable years beginning after 1995. Prior to
that time, KNBT was permitted to establish a reserve for bad debts and to make
additions to the reserve. These additions could, within specified formula
limits, be deducted in arriving at taxable income. As a result of the Small
Business Job Protection Act of 1996, savings associations must use the specific
charge-off method in computing their bad debt deduction beginning with their
1996 federal tax return. In addition, federal legislation required the recapture
over a six-year period of the excess of tax bad debt reserves at December 31,
1995 over those established as of December 31, 1987.
Taxable Distributions and Recapture. Prior to the Small Business Job
Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were
subject to recapture into taxable income if KNBT failed to meet certain thrift
asset and definitional tests. New federal legislation eliminated these savings
association related recapture rules. However, under current law, pre-1988
reserves remain subject to recapture should the Bank make certain non-dividend
distributions or cease to maintain a bank charter.
At December 31, 2003, KNBT's total federal pre-1988 reserve was
approximately $9.8 million. The reserve reflects the cumulative effects of
federal tax deductions by KNBT for which no federal income tax provisions have
been made.
Alternative Minimum Tax. The Internal Revenue Code imposes an
alternative minimum tax at a rate of 20% on a base of regular taxable income
plus certain tax preferences. The alternative minimum tax is payable to the
extent such alternative minimum tax income is in excess of an exemption amount.
Net operating losses, of which KNBT has none, can offset no more than 90% of
alternative minimum taxable income. Certain payments of alternative minimum tax
may be used as credits against regular tax liabilities in future years. KNBT had
a minimum tax credit carryover of $285,000 at December 31, 2003.
Net Operating Loss Carryovers. For net operating losses in tax years
beginning before August 6, 1997, KNBT may carry back net operating losses to the
three years preceding the loss year and then forward to fifteen years following
the loss years. For net operating losses in years beginning after August 5,
1997, net operating
-29-
losses can be carried back to the two years preceding the loss year and forward
to the 20 years following the loss year. At December 31, 2003, KNBT had no net
operating loss carry-forwards for federal income tax purposes.
Corporate Dividends-Received Deduction. KNBT may exclude from its
income 100% of dividends received from KNBT as a member of the same affiliated
group of corporations. The corporate dividends received deduction is 80% in the
case of dividends received from corporations which a corporate recipient owns
less than 80%, but at least 20% of the distribution corporation. Corporations
which own less than 20% of the stock of a corporation distributing a dividend
may deduct only 70% of dividends received.
State and Local Taxation
Pennsylvania Taxation. KNBT is subject to the Pennsylvania Corporate
Net Income Tax, Capital Stock and Franchise Tax. The Corporation Net Income Tax
rate for 2003 is 9.99% and is imposed on unconsolidated taxable income for
federal purposes with certain adjustments. In general, the Capital Stock and
Franchise Tax is a property tax imposed on a corporation's capital stock value
at a statutorily defined rate, such value being determined in accordance with a
fixed formula based upon average net income and net worth.
The Bank is subject to tax under the Pennsylvania Mutual Thrift
Institutions Tax Act, as amended to include thrift institutions having capital
stock. Pursuant to the Mutual Thrift Institutions Tax, the tax rate is 11.5%.
The Mutual Thrift Institutions Tax exempts Keystone from other taxes imposed by
the Commonwealth of Pennsylvania for state income tax purposes and from all
local taxation imposed by political subdivisions, except taxes on real estate
and real estate transfers. The Mutual Thrift Institutions Tax is a tax upon net
earnings, determined in accordance with generally accepted accounting principles
with certain adjustments. The Mutual Thrift Institutions Tax, in computing
income according to generally accepted accounting principles, allows for the
deduction of interest earned on state and federal obligations, while disallowing
a percentage of a thrift's interest expense deduction in the proportion of
interest income on those securities to the overall interest income of the Bank.
Net operating losses, if any, thereafter can be carried forward three years for
Mutual Thrift Institutions Tax purposes.
Employees
As of December 31, 2003, KNBT had approximately 649 employees of whom
141 were part-time. KNBT considers its relationship with its employees to be
good.
-30-
Item 2. Properties
- ------- ----------
KNBT does not own or lease any property. The Bank owns 20 properties
and leases 25 other properties. The principal office of KNBT is located at 90
Highland Avenue, Bethlehem, PA 18017. The book value of this office was $3.2
million at December 31, 2003.
The Bank also owns an operations and lending office at 236 Brodhead
Road, Bethlehem, PA 18017. This building was purchased in 2003 and had a book
value of $7.2 million at December 31, 2003. The Bank acquired an office building
at 3864 Adler Place, Bethlehem, PA 18017 as a part of the acquisition of First
Colonial. The Bank will continue to use this facility for general office space.
This building had a book value of $2.9 million at December 31, 2003.
In addition, the Bank owns 15 branch banking facilities and leases 25
other branch banking facilities. All of which are located within the Bank's
market area.
The Bank also owns a garage and parking lot in Nazareth, Pennsylvania
and a vacant lot which is available for a possible future branch in Easton,
Pennsylvania.
Item 3. Legal Proceedings
- ------ -----------------
From time-to-time, KNBT and the Bank are parties to routine litigation
incidental to their business.
Neither KNBT, the Bank nor any of their subsidiaries is subject to any
material legal proceedings, nor are any such proceedings known to be
contemplated by any governmental authorities.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
No matter was submitted to a vote of shareholders during the fourth
quarter of the fiscal year covered by this report.
-31-
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
KNBT Bancorp. Inc. common stock trades on the Nasdaq National Market
under the trading symbol "KNBT." At the close of business on December 31, 2003,
there were 3,641 shareholders of record.
The declaration and payment of dividends is at the sole discretion of
the Board of Directors, and their timing and amount will depend upon the Board
of Directors consideration of the earnings, financial condition, and capital
needs of KNBT and the Bank and certain other factors including restrictions
arising from Federal banking laws and regulations (see "Note P - Regulatory
Matters" in the "Notes to Consolidated Financial Statements"). As of December
31, 2003, no dividends had been paid or declared on KNBT common stock. KNBT
common shares were first sold in KNBT's initial public offering as a part of
Keystone Savings Bank's mutual-to-stock conversion on October 31, 2003 at the
offering price of $10.00 per share. KNBT's common stock began trading on Nasdaq
on November 3, 2003.
During the period of October 31, 2003 through December 31, 2003, bid
prices reported for KNBT's common stock was a high of $17.79 and a low of
$15.87. The last sale price on December 31, 2003 was $17.58.
KNBT did not sell any of its equity securities during 2003 that were
not registered under the Securities Act of 1933.
For information regarding KNBT's equity compensation plans see item 12.
-32-
Item 6. Selected Financial Data
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
As of and For the Year Ended December 31, 2003 (1) 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Summary of Income
Interest income ............................... $ 59,063 $ 59,479 $ 60,493 $ 57,603 $ 52,181
Interest expense .............................. 21,061 26,416 34,064 31,141 26,846
----------- ----------- ----------- ----------- -----------
Net interest income ........................... 38,002 33,063 26,429 26,462 25,335
Provision for loan losses ..................... 2,951 111 391 442 421
Total non-interest income ..................... 9,048 8,814 5,013 3,214 2,955
Total non-interest expense (2) ................ 55,119 24,568 19,613 17,999 16,372
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (benefit) ... (11,020) 17,198 11,438 11,235 11,497
Income taxes (benefit) ........................ (5,264) 5,188 3,326 3,718 3,898
----------- ----------- ----------- ----------- -----------
Net income (loss) (2) ....................... $ (5,756) $ 12,010 $ 8,112 $ 7,517 $ 7,599
=========== =========== =========== =========== ===========
Consolidated Balance Sheet Data
Total assets .................................. $ 1,940,801 $ 1,015,906 $ 922,045 $ 824,736 $ 773,953
Investment securities available-for-sale (3) .. 734,087 294,150 156,785 114,077 103,092
Loans receivable, net ......................... 882,166 555,526 668,046 657,107 611,108
Mortgage loans held-for-sale .................. 4,677 23,796 -- -- --
Deposits ...................................... 1,289,410 771,825 772,226 713,520 665,369
Securities sold under agreements to repurchase 24,550 8,904 5,752 -- --
FHLB advances ................................. 207,153 113,500 40,500 13,000 25,000
Guaranteed preferred beneficial interest in the
Company's subordinated debentures .......... 15,000 -- -- -- --
Shareholders' equity / retained eanings ....... 389,080 111,049 95,788 86,204 78,687
Book value per share .......................... 13.20 N/A N/A N/A N/A
Full service offices .......................... 41 19 16 16 15
Selected Consolidated Ratios
Net income (loss) to:
Average total assets ........................ (0.46)% 1.25 % 0.92 % 0.94 % 1.02 %
Average equity .............................. (3.58) 11.46 8.79 9.27 9.93
Net interest margin (4) ....................... 3.49 3.66 3.21 3.38 3.50
Efficiency ratio (5) .......................... 117.15 58.67 62.38 60.65 57.87
Equity to assets (6) .......................... 20.05 10.93 10.39 10.45 10.17
Tier 1 capital to average assets (leverage) (6) 19.39 10.78 10.50 10.45 9.97
Tier I risk-based capital ratio (6) ........... 32.51 18.19 17.09 16.99 16.67
Total risk-based capital ratio (6) ............ 32.24 18.19 17.71 17.65 17.34
(1) After the close of business on October 31, 2003, the Company completed the
mutual-to-stock conversion of the Bank and the related subscription stock
offering and the acquisition by merger of First Colonial Group, Inc. See
"Business - General" in Item 1.
(2) Included in the non-interest expenses for the year ended December 31, 2003
are a $16.1 million contribution to the Keystone Nazareth Charitable
Foundation and $5.7 million of merger and systems integration costs as a
result of the acquisition of First Colonial Group.
(3) KNBT has classified all of its investment securities as available-for-sale,
therefore there are no securities classified as trading or
held-to-maturity. (4) Calculated on a tax-equivalent basis.
(5) The calculation of the efficiency ratio for 2003 includes the effect of the
$16.1 million contribution to the Keystone Nazareth Charitable Foundation
and $5.7 million of merger and systems integration costs as a result of the
acquisition of First Colonial Group.
(6) Ratios for 2003 are for KNBT Bancorp. Ratios for 1999 - 2002 are for
Keystone Nazareth Bank & Trust Company (formerly Keystone Savings Bank).
-33-
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
General
- -------
The following presents a review of KNBT Bancorp's results of operations
and financial condition. This information should be read in conjunction with the
KNBT's consolidated financial statements and the accompanying notes to financial
statements. KNBT's consolidated earnings are derived primarily from the
operations of its wholly owned savings bank subsidiary, Keystone Nazareth Bank &
Trust Company, and its other subsidiaries
KNBT's results of operations depend, to a large extent, on net interest
income, which is the difference between the income earned on its loan and
investment portfolios and interest expense on deposits and borrowings. Results
of operations are also affected by fee income from its banking and non-banking
operations, provisions for loan losses, loan servicing and other non-interest
income. Non-interest expense primarily consists of compensation and employee
benefits, office occupancy and equipment expense, data processing, advertising
and business promotion and other expenses. KNBT's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities. Future changes in applicable law, regulations or
government policies may materially impact KNBT's financial condition and results
of operations.
Critical Accounting Policies, Judgments and Estimates
- -----------------------------------------------------
The accounting and reporting policies of KNBT conform with accounting
principles generally accepted in the United States of America and general
practices within the financial services industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and the assumptions that
affect the amounts reported in the financial statements and the accompanying
notes. Actual results could differ from those estimates.
KNBT considers that the determination of the allowance for loan losses
involves a higher degree of judgment and complexity than its other significant
accounting policies. The allowance for loan losses is calculated with the
objective of maintaining a reserve level believed by management to be sufficient
to absorb estimated probable credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, expected commitment usage, the amounts and
timing of expected future cash flows on impaired loans, mortgages, and general
amounts for historical loss experience. The process also considers economic
conditions, uncertainties in estimating losses and inherent risks in the loan
portfolio. All of these factors may be susceptible to significant change. To the
extent actual outcomes differ from management estimates, additional provisions
for loan losses may be required that would adversely impact earnings in future
periods.
KNBT recognizes deferred tax assets and liabilities for future tax
effects of temporary differences, net operating loss carry forwards and tax
credits. Deferred tax assets are subject to management's judgment based upon
available evidence that future realization is more likely than not. If
management determines that KNBT may be unable to realize all or part of net
deferred tax assets in the future, a direct charge to income tax expense may be
required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount. For further information, see "Note B - Summary of
Accounting Policies" in the "Notes to Consolidated Financial Statements",
included in Item 8 of this Form 10-K.
Goodwill, under SFAS No. 142, is subject to impairment testing at least
annually to determine whether write-downs of the recorded balances are
necessary. The Company tests for impairment based on the goodwill maintained at
each defined reporting unit. A fair value is determined for each reporting unit
based on at least one of three various market valuation methodologies. If the
fair values of the reporting units exceed their book values, no write-down of
recorded goodwill is necessary. If the fair value of the reporting unit is less,
an expense may be required on the Company's books to write down the related
goodwill to the proper carrying value. The Company
-34-
recorded goodwill and other identifiable intangible assets as a result of the
acquisition of First Colonial in October 2003. For further information, see
"Note B8 - Summary of Accounting Policies" in the "Notes to Consolidated
Financial Statements" included in Item 8 of this Form 10-K.
Operating Strategy
KNBT was organized in 2003 by Keystone Savings Bank as a part of its
mutual-to-stock conversion and to be the holding company for the Bank.
Historically, Keystone Savings Bank operated as a traditional savings bank
primarily providing single-family residential mortgage loans and a variety of
retail products and services to its customers.
Concurrent with the conversion on October 31, 2003, First Colonial
Group, Inc. was merged with and into KNBT and Nazareth National Bank and Trust
Company was merged into the Bank. Historically, Nazareth National Bank and Trust
Company was a full-service community commercial bank with full trust services.
Keystone Nazareth Bank & Trust Company is a Pennsylvania chartered stock savings
bank. Some of the Bank's key operating strategies and characteristics are
described below.
o A current branch network system with 41 branch offices located
throughout Lehigh, Northampton, Monroe and Carbon Counties,
Pennsylvania with consideration for additional branches in the future.
o Continuing to enhance operating systems and customer service and
convenience, including new computer software and hardware, an improved
internet banking system and new branch systems which are expected to
be operational during the second quarter of 2004.
o Strong deposit market share particularly in Northampton and Lehigh
Counties in which the Bank has the largest and second largest,
respectively, deposit market share. Overall, the Bank estimates that
it has the second largest deposit share in the Lehigh Valley.
o Focusing on increased lending to small to mid-sized businesses in the
greater Lehigh Valley, which sector is believed to be underserved.
o Continuing to develop as a "relationship bank" offering a broad array
of deposit and loan products as well as securities and insurance
products and trust and wealth management services.
o Leveraging capital efficiently through additional growth of loan and
investment portfolios.
Financial Performance Summary
KNBT had a net loss for 2003 of $5.8 million, which included one-time
charges aggregating $21.8 million (pre-tax) resulting from a $16.1 million
contribution to the Keystone Nazareth Charitable Foundation and $5.7 million of
merger related and systems integration related charges incurred in connection
with the First Colonial Group, Inc. and KNBT merger. KNBT's net income was $12.0
million and $8.1 million in 2002 and 2001, respectively.
KNBT's return on average assets was (0.46)% in 2003 as compared to
1.25% in 2002 and 0.92% in 2001. The return on average equity was (3.58)%,
11.46% and 8.79% in 2003, 2002 and 2001, respectively.
Total assets of KNBT were $1.9 billion at December 31, 2003 as compared
to $1.0 billion at year-end 2002, an increase of $924.9 million or 91.0%.
Included in this increase of total assets are $610.4 million of assets acquired
as a result of the merger with First Colonial. During 2003, total deposits grew
by $515.8 million or 66.8% to a year-end total of $1.3 billion. The merger
accounted for $512.1 million of this increase. Total deposits at December 31,
2002 were $771.8 million. Total loans amounted to $890.1 million and $558.5
million at December 31, 2003 and 2002, respectively. The loan increase in 2003
was $331.6 million. This increase included $272.2 million of loans acquired from
First Colonial in the merger.
The conversion of the Bank to a stock company resulted in the sale of
an aggregate of 20,201,188 shares of KNBT's common stock at a price of $10.00
per share for proceeds of $202.0 million. The capitalized expenses
-35-
for the conversion were $5.8 million resulting in net proceeds of $196.2
million. This sale was the principal factor in the $278.0 million increase in
shareholders' equity during 2003. An additional primary factor in the increase
in equity was the acquisition of First Colonial Group, Inc. through the issuance
of an aggregate of 8,545,855 common shares in exchange for the previously
outstanding shares of First Colonial. Total shareholders' equity was $389.1
million and $111.0 million at December 31, 2003 and 2002, respectively. Also
affecting the change in equity during 2003 was the establishment of an employee
stock ownership plan (ESOP) through the purchase of 949,845 shares of common
stock through a loan from KNBT to the ESOP in the amount of $16.1 million, the
release of 9,723 shares at their fair market value of $165,000, the contribution
of 1,616,095 shares of KNBT common stock to the Keystone Nazareth Charitable
Foundation which had a value of $16.1 million at the time of contribution, the
issuance of 56,259 shares of KNBT common stock pursuant to the exercise of stock
options for proceeds of $311,000, and the net loss of $5.8 million. The total
common shares outstanding at December 31, 2003 were 29,479,275 excluding the
unallocated shares held by the ESOP.
Analysis of Net Interest Income
Net interest income represents the difference between income on
interest-earnings assets and expense on interest-bearing liabilities. Net
interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them. Net interest income is the primary source of earnings for KNBT. Therefore,
changes in net interest income are important factors in KNBT's overall net
income.
Average Balances, Net Interest Income, and Yields Earned and Rates
Paid. The following table shows for the periods indicated the total dollar
amount of interest from average interest-earnings assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. The table
includes information adjusted to a tax equivalent yield basis for the Company's
tax-exempt investment securities. The presentation on a tax-equivalent basis may
be considered to include non-GAAP information. Management believes that it is a
standard industry practice in the banking industry to present such information
on a fully tax equivalent basis and that such information is useful to investors
in making peer comparisons. The tax-exempt adjustments and comparable GAAP
information also is included in the table.
-36-
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Comparative Statement Analysis
(dollars in thousands) For the Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ----------------------------- --------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
------------------------------- ----------------------------- --------------------------
Assets
Interest-Earning Assets
Interest-bearing balances with banks . $ 106,395 $ 1,028 0.97% $ 30,577 $ 408 1.33% $ 30,475 $ 1,011 3.32%
Investment securities
Taxable ........................... 345,048 13,334 3.86 241,475 13,272 5.50 113,261 7,332 6.47
Non-taxable (1) ................... 62,508 4,358 6.97 31,229 2,441 7.82 22,095 1,824 8.26
Loans receivable (2) (3) ............. 622,525 41,833 6.72 627,001 44,188 7.05 679,532 50,946 7.50
Allowance for loan losses ........... (3,447) - (3,021) - (3,676) -
------------- -------- ---------- --------- ---------- ---------
Net loans ............................ 619,078 41,833 6.76 623,980 44,188 7.08 675,856 50,946 7.54
------------- -------- ---------- --------- ---------- ---------
Total interest-earning assets ...... 1,133,029 60,553 5.34 927,261 60,309 6.50 841,687 61,113 7.26
Non-interest earning assets .......... 121,964 - - 33,531 - - 35,352 - -
------------- -------- -------- ---------- --------- ------- ---------- --------- ------
Total Assets,
Interest Income .................. $ 1,254,993 60,553 $960,792 60,309 $ 877,039 61,113
------------- -------- ---------- --------- ---------- ---------
Liabilities
Interest-Bearing Liabilities
Interest-bearing deposits
Demand deposits .................... $ 102,506 298 0.29 $ 81,609 466 0.57 $ 76,090 846 1.11
Money market deposits ............. 203,978 2,212 1.08 134,456 2,784 2.07 100,327 3,512 3.50
Savings deposits ................... 182,548 1,315 0.72 111,689 1,680 1.50 97,778 2,127 2.18
Certificates of deposit ........... 409,003 12,168 2.98 417,073 18,169 4.36 447,171 25,679 5.74
------------- -------- -------- --------- ---------- ------------------ --------- ------
Total interest-bearing deposits .. 898,035 15,993 1.78 744,827 23,099 3.10 721,366 32,164 4.46
Securities sold under agreements
to repurchase ...................... 11,931 131 1.10 7,330 155 2.11 2,431 94 3.87
FHLB advances ........................ 114,520 4,822 4.21 67,358 3,162 4.69 32,702 1,806 5.53
Guaranteed preferred beneficial
interests in Company's subordinated
debentures ......................... 2,507 115 4.59 - - - - - -
------------- -------- --------- ---------- ---------- ---------
Total interest-bearing liabilitites 1,026,993 21,061 2.05 819,515 26,416 3.22 756,499 34,064 4.50
Non-Interest-Bearing Liabilities
Non-interest-bearing deposits ........ 53,559 - - 28,881 - - 19,890 - -
Other liabilities .................... 13,832 - - 7,603 - - 8,356 - -
------------- -------- --------- ---------- ---------- ---------
Total Liabilities .................. 1,094,384 21,061 855,999 26,416 784,745 34,064
Shareholders' Equity/ ................ -
Retained Earnings .................. 160,609 - 104,793 - 92,294 -
------------- -------- --------- ---------- ---------- ---------
Total Liabilities & Shareholders'
Equity, Interest Expense ........... $ 1,254,993 21,061 $960,792 26,416 $ 877,039 34,064
------------- -------- --------- ---------- ---------- ---------
Net interest income tax
equivalent basis ...................... 39,492 33,893 27,049
-------- ---------- ---------
Net interest spread
Tax equivalent basis (4) ........... 3.29% 3.28% 2.76%
Effect of interest-free sources
used to fund earning assets ......... 0.20 0.37 0.45
-------- -------- ------
Net interest margin
tax equivalent basis (5) .............. 3.49 3.66 3.21
-------- -------- ------
Tax-exempt adjustment .................... (1,490) (830) (620)
---------- ---------- ---------
Net interest income and margin ........... $ 38,002 3.35% $33,063 3.57% $ 26,429 3.14%
========== ======== ========== ======== ========= ======
Average interest-earning assets
to average interest-bearing
liabilities ........................... 110.32% 113.15% 111.26%
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Includes Federal Home Loan Bank stock.
(2) The indicated interest income and average yields are presented on a taxable
equivalent basis. The taxable equivalent adjustments included above are $1.5
million, $830,000 and $620,000 for the years 2003, 2002 and 2001,
respectively. The effective tax rate used for the taxable equivalent
adjustment was 34%.
(3) Loan fees of $1.5 million, $1.2 million and $793,000 for the years 2003,
2002 and 2001, respectively, are included in interest income. Average loan
balances include non-accruing loans of $1.7 million, $2.2 million and $1.8
million and average loans held-for-sale of $3.1 million, $4.4 million and
none for the years 2003, 2002 and 2001, respectively.
(4) Net interest spread is the arithmetic difference between yield on
interest-earning assets and the rate paid on interest-bearing liabilities.
(5) Tax equivalent net interest margin is computed by dividing tax equivalent
net interest income by average interest-earning assets.
-37-
Rate Volume Analysis. The following table shows the extent to which
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities affected KNBT's interest income and expense during
the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in rate, which is the change in rate multiplied by prior year
volume, and (2) changes in volume, which is the change in volume multiplied by
prior year rate. The combined effect of changes in both rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
- ------------------------------------------------------------------------------------------------------------------------------------
2003 Compared to 2002 2002 Compared to 2001
---------------------------------------- ----------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------------------- ----------------------------------------
Total Total
Increase Increase
Rate Volume (Decrease) Rate Volume (Decrease)
----------- ------------ ---------------------------- ------------ ----------
(dollars in thousands)
Interest income:
Cash and cash equivalents ............ $ (392) $ 1,012 $ 620 $ (606) $ 3 $ (603)
Investment securities ................ (5,790) 7,769 1,979 (2,734) 9,291 6,557
Loans receivables, net ............... (2,009) (346) (2,355) (2,848) (3,910) (6,758)
-------- -------- -------- -------- -------- --------
Total interest-earning assets .... (8,191) 8,435 244 (6,188) 5,384 (804)
Interest expense:
Savings deposits ..................... (288) 120 (168) (441) 61 (380)
Checking deposits .................... (2,011) 1,439 (572) (1,923) 1,195 (728)
Money market deposits ................ (1,431) 1,066 (365) (749) 302 (447)
Certificates of deposit .............. (5,649) (352) (6,001) (5,782) (1,728) (7,510)
-------- -------- -------- -------- -------- --------
Total interest-bearing deposits .. (9,379) 2,273 (7,106) (8,895) (170) (9,065)
Securities sold under agreements
to repurchase .......................... (121) 97 (24) (122) 183 61
FHLB advances and other borrowings ....... (554) 2,214 1,660 (562) 1,918 1,356
Guaranteed preferred beneficial interests
in company's subordinated debentures ... -- 115 115 -- -- --
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities (10,054) 4,699 (5,355) (9,579) 1,931 (7,648)
Increase (decrease) in net
interest income ........................ $ 1,863 $ 3,736 $ 5,599 $ 3,391 $ 3,453 $ 6,844
======== ======== ======== ======== ======== ========
The net interest income, on a fully taxable equivalent basis, amounted
to $39.5 million for 2003, an increase of $5.6 million or 16.5% over $33.9
million in 2002. As shown in the "Rate/Volume Analysis" table, the increase in
net interest income in 2003 was attributable to higher net interest income of
$3.7 million due to changes in volume and $1.9 million due to changes in rates.
The volume-related change resulted primarily from increases in investment
securities and interest-bearing balances with banks reduced in part by a small
increase in loan receivables (see discussions on "Lending Activities"), an
increase in money market deposits, savings and demand deposits and FHLB advances
and other deposits. The rate-related change was primarily the result of the
decrease of interest earned on investment securities and loans being less than
the decrease of interest paid on deposits and debt.
The net interest income, on a fully taxable equivalent basis, in 2002
increased $6.8 million or 25.3% over the 2001 figure of $27.2 million. This
increase was the result of growth in investments and loans, reduced in part by
increases in time deposits and debt. Also affecting 2002 net income was the
decrease in interest rates earned on loans and investments being greater than
the decrease on the interest rates paid on deposits and debt.
The net interest margin, a measure of net interest income performance,
is determined by dividing net interest income by total interest-earning assets.
The net interest margin was 3.35% for 2003, 3.57% for 2002 and 3.14% for 2001.
The net interest margin on a tax equivalent basis was 3.49% for 2003,
-38-
3.66% for 2002 and 3.21% for 2001. The decrease in 2003 net interest margin was
primarily due to the non-interest-earning assets amounting to $124.6 million in
2003 as compared to $33.5 million in 2002. The interest spread is the difference
of interest earned on assets less the interest paid on deposits and debt. The
interest spread was 3.29%, 3.28% and 2.76% for 2003, 2002 and 2001,
respectively.
Provision for Loan Losses
The provision for loan losses is determined by management's review and
analysis of the loan portfolio. This evaluation process includes, among other
things, an analysis of delinquent and non-performing loans, the level of
charge-offs and recoveries, the value of collateral securing the loan, the
borrower's ability to repay, repayment performance and local economic
conditions. The valuation also takes into consideration performing loans that
may have certain weaknesses as identified by management in its review of loans.
A primary factor in the increased provision for 2003 as compared to 2002 was
$156.1 million or 395.9% increase in total commercial related loans. The
commercial loans acquired from First Colonial in the merger accounted for $61.5
million of this increase. An additional factor was the decision of management to
downgrade a performing $15.7 million commercial loan due to certain credit
weaknesses. The provision for loan losses amounted to $3.0 million for the year
ended December 31, 2003 as compared to $111,000 in 2002. The increase of $2.8
million was the result of management's ongoing evaluation of risk elements in
KNBT's loan portfolio. The provision in 2001 was $391,000. Net charge-offs were
$1.5 million, $570,000, and $342,000 in 2003, 2002, and 2001, respectively. For
more information see "Business - Lending Activities - Non-Performing Assets" in
Item 1.
Non-Interest Income
Non-interest income increased in 2003 by $234,000 or 2.7% to a total of
$9.0 million from $8.8 million in 2002. This increase was primarily the result
of an increase in the fees earned on deposit services of $414,000 or 11.4%. Fees
on deposit services amounted to $4.0 million in 2003 and $3.6 million in 2002.
This increase was the result of a higher number of deposit accounts and the
acquisition of new accounts due to the merger. Other non-interest operating
income increased in 2003 over 2002 by $1.5 million or 123.8%. The other
non-interest operating income was $2.8 million and $1.2 million in 2003 and
2002, respectively. This increase was the result of higher loan fees including
mortgage servicing fees and increases in other fee based services. Also
contributing to higher non-interest income were increases of $45,000 in
brokerage services revenues, and $80,000 in earnings on bank owned life
insurance ("BOLI"). The revenues from brokerage services were $465,000 in 2003
and $420,000 in 2002. The earnings on the bank owned life insurance were $1.5
million and $1.4 million in 2003 and 2002, respectively. KNBT began earning
revenues from trust operations in November 2003 when trust powers were obtained
and the trust accounts were acquired due to the merger with First Colonial. The
trust revenues for the last two months of 2003 amounted to $279,000.
The increases in non-interest income were offset in part by a $1.5
million decrease in the net gains on the sale of investment securities and by a
$654,000 decrease in the gains on the sale of residential real estate loans.
During 2003, KNBT had total net losses of $249,000 on the sales of $25.5 million
of securities available-for-sale compared to total net gains of $1.2 million in
2002 on the sales of $63.8 million of securities available-for-sale. The losses
in 2003 were due to the sale of some lower yielding and longer term securities.
The gains on the sale of residential real estate loans were $246,000 in 2003 and
$900,000 in 2002.
Non-interest income increased $3.8 million or 75.8% from $5.0 million
in 2001 to $8.8 million in 2002. Non-interest income increased from 2001 to 2002
as a result of increases in the net gains on the sales of investment securities
of $1.2 million, increases in earnings on bank owned life insurance of $536,000,
increases in the net gains on the sale of loans of $792,000, increased fees for
deposit services of $923,000 and increased non-interest operating income of
$63,000.
Non-Interest Expense
Non-interest expense increased to $55.1 million in 2003 from $24.6
million in 2002, a $30.5 million or 124.4% increase. The major factors in this
increase were the $16.1 million contribution to KNBT's new
-39-
charitable foundation and $5.7 million of expenses related to the merger and
subsequent integration of systems and operations at the Bank. The merger and
integration expenses included such items as severance agreements, supplies,
customer communication, data processing upgrades and other costs. Compensation
and benefits expense increased by $5.4 million or 41.0%. These expenses were
$18.6 million and $13.2 million in 2003 and 2002, respectively. Contributing to
the increase in compensation and employee benefit expense were normal salary
increases, additional staff required for the new branches added in 2003, the
addition of 245 employees as a result of the merger with First Colonial, staff
increases in the lending and trust divisions and a benefit expense of $165,000
for the ESOP. Occupancy expense increased from $3.1 million in 2002 to $4.6
million in 2003, an increase of $1.5 million or 48.0%. The higher occupancy
expense was the result of the addition of new branches, the purchase and
renovation of a new operations center and additional facilities acquired in the
merger. All other expense items including advertising, data processing,
professional services, supplies, postage, FDIC insurance premiums, impairment of
mortgage servicing rights and all other items totaled $10.1 million in 2003 as
compared to $8.3 million in 2002. This was an increase of $1.8 million or 21.9%.
These increases were principally due to the growth of the Company and the
merger.
Non-interest expense in 2002 increased $5.0 million or 25.3% over 2001.
Total non-interest expenses were $24.6 million in 2002 and $19.6 million in
2001. The increase in compensation and employee benefit expense from 2001 to
2002 was $2.8 million or 26.9%. Occupancy expenses in 2002 were $467,000 or
17.8% higher than in 2001. All other non-interest expenses grew in 2002 as
compared to 2001 by $1.7 million or 25.6% in 2002 over 2001. In addition to
normal salary increases, compensation increased as the result of the addition of
new branches in 2002. Also in 2002, compared to 2001, the Company's benefit
expense increased due to a $793,000 increase in retirement expenses related to
the multiple employer defined benefit pension plan, matching contributions to
the Company's 401k plan and the funding of the supplemental executive retirement
plans for certain executive officers.
Income Tax Expense (Benefit)
KNBT had an income tax benefit of $5.3 million for the year ended
December 31, 2003. The income tax expense in 2002 amounted to $5.2 million. The
tax benefit in 2003 was the result of a net operating loss for the year. The
income tax expense in 2001 was $3.3 million. KNBT's effective Federal tax rate
was a benefit of (47.8)% for the year ended December 31, 2003 compared to an
effective tax rate of 30.2% for the year ended December 31, 2002 and 29.1% for
the year ended December 31, 2001.
Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. KNBT's market risk arises primarily from the interest rate risk which
is inherent in its lending and deposit taking activities. To that end,
management actively monitors and manages interest rate risk exposure. In
addition to market risk, KNBT's primary risk is credit risk on its loan
portfolio. KNBT attempts to manage credit risk through its loan underwriting and
oversight policies. See "Lending Activities".
KNBT and the Bank operate as a community banking institution primarily
in the counties of Northampton, Lehigh, Monroe and Carbon, Pennsylvania. As a
result of its location and nature of operations, the Company is not subject to
foreign currency exchange or commodity price risk. The Bank makes real estate
and other loans primarily in the counties adjacent to its operations and thus is
subject to risks associated with those local economies. The Bank holds a
concentration of one-to four-family residential real estate loans (36.0% of
total loans) and consumer/installment loans (28.8% of total loans) in its loan
portfolio. Loans for automobiles and other vehicles represent 38.5% of the
consumer/installment loans and 11.1% of total loans. The Bank's loans are
subject to interest and economic risks. The Bank also originates residential
real estate loans for sale in the secondary market. Such loans are identified as
"Mortgage Loans Held-for-Sale" on the Company's balance sheet and are subject to
interest rate risk (see discussion on "Loan Origination, Sales and Servicing").
The Company does not own any trading assets and does not have any hedging
transactions in place such as interest rate swaps (see discussions on
"Investment Activities").
-40-
Interest Rate Sensitivity
Interest rate sensitivity is a measure of the extent to which net
interest income would change due to changes in the level of interest rates.
The principal objective of KNBT's interest rate risk management
function is to evaluate the interest rate risk embedded in certain balance sheet
accounts, determine the level of risk appropriate, given its business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. Through
such management, KNBT seeks to reduce the exposure of its operations to changes
in interest rates. KNBT monitors interest rate risk as such risk relates to its
operating strategies. KNBT has established an Asset/Liability Committee,
responsible for reviewing its asset/liability policies and interest rate risk
position. The Asset/Liability Committee meets on a quarterly basis. The extent
of the movement of interest rates is an uncertainty that could have a negative
impact on future earnings of KNBT.
KNBT primarily has utilized the following strategies in its efforts to
manage interest rate risk:
o It has emphasized originations for portfolio of shorter term loans,
particularly construction loans, commercial loans and consumer loans;
o It has been an active seller in the secondary market of its newly
originated, agency eligible long-term fixed-rate residential mortgage
loans and it securitized an aggregate of $47.3 million of
single-family residential mortgage loans in 2003 and $115.3 million in
2002;
o It has invested in securities with relatively short anticipated lives,
generally three to five years.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset
and liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2003, KNBT's cumulative one-year interest rate
gap, which is the difference between the amount of interest-earning assets
maturing or repricing within one year and interest-bearing liabilities maturing
or repricing within one year, as a percentage of total assets, was a positive
13.77%. A gap is considered positive when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities. A gap is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. During a period of rising
interest rates, a negative gap would tend to affect adversely net interest
income while a positive gap would tend to result in an increase in net interest
income. Conversely, during a period of falling interest rates, a negative gap
would tend to result in an increase in net interest income while a positive gap
would tend to affect adversely net interest income.
The following table sets forth the amounts of KNBT's interest-earning
assets and interest-bearing liabilities outstanding at December 31, 2003, which
are expected, based upon certain assumptions, to reprice or mature in each of
the future time periods shown, commonly termed, the GAP Table. Except as stated
below, the amount of assets and liabilities shown which reprice or mature during
a particular period were determined in accordance with the earlier of term to
repricing or the contractual maturity of the asset or liability. The table sets
forth an approximation of the projected repricing of assets and liabilities at
December 31, 2003, on the basis of contractual maturities, anticipated
prepayments, and scheduled rate adjustments within a three-month period and
subsequent selected time intervals. The loan amounts in the table reflect
principal balances expected to be repaid and/or repriced as a result of
contractual amortization and anticipated prepayments of adjustable-rate loans
and fixed-rate loans, and as a result of contractual rate adjustments on
adjustable-rate loans. Annual prepayment rates for adjustable-rate and
fixed-rate single-family and multi-family mortgage loans are assumed to range
from 14% to 32%. The annual prepayment rate for mortgage-backed securities is
assumed to range from 14% to 32%. Money market deposit accounts, savings
accounts and interest-bearing checking accounts are assumed to have annual rates
of withdrawal, or "decay rates," of 20%, 15% and 15%, respectively.
-41-
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
More than More than More than More than
3 Months 3 Months 6 Months 1 Year 3 Years More than
or Less to 6 Months to 1 Year to 3 Years to 5 Years 5 Years Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
(dollars in thousands)
Interest-earning assets (1):
Deposits at other institutions $ 85,422 $ -- $ -- $ -- $ -- $ -- $ 85,422
Debt investment securities ... 31,515 40,677 85,379 224,021 140,991 193,626 716,209
Loans receivable (2) ......... 287,766 76,607 139,187 292,449 114,979 11,333 922,321
Equity securities ............ -- -- -- -- -- 29,421 29,421
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total interest-earning
assets .................. $ 404,703 $ 117,284 $ 224,566 $ 516,470 $ 255,970 $ 234,380 $ 1,753,373
=========== =========== =========== =========== =========== =========== ===========
Cumulative total interest-
earning assets ............. $ 404,703 $ 521,987 $ 746,553 $ 1,263,023 $ 1,518,993 $ 1,753,373 $ 1,753,373
=========== =========== =========== =========== =========== =========== ===========
Interest-bearing
liabilities:
Savings deposits ............. $ 8,847 $ 8,847 $ 17,694 $ 66,352 $ 66,353 $ 53,083 $ 221,176
Interest-bearing
checking deposits ......... 6,550 6,550 13,100 49,126 49,126 39,297 163,749
Money market deposits ........ 11,976 11,976 23,953 95,808 95,808 -- 239,521
Certificates of deposit ...... 82,521 72,871 145,742 181,254 37,285 28,021 547,694
FHLB advances and other
borrowings .............. 47,708 6,458 14,316 49,266 64,823 64,132 246,703
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing
liabilities ........... $ 157,602 $ 106,702 $ 214,805 $ 441,806 $ 313,395 $ 184,533 $ 1,418,843
=========== =========== =========== =========== =========== =========== ===========
Cumulative total interest-
bearing liabilities .......... $ 157,602 $ 264,304 $ 479,109 $ 920,915 $ 1,234,310 $ 1,418,843 $ 1,418,843
=========== =========== =========== =========== =========== =========== ===========
Interest-earning assets
less interest-bearing
liabilities .................. $ 247,101 $ 10,582 $ 9,761 $ 74,664 $ (57,425) $ 49,847 $ 334,530
=========== =========== =========== =========== =========== =========== ===========
Cumulative interest-rate
sensitivity gap (3) .......... $ 247,101 $ 257,683 $ 267,444 $ 342,108 $ 284,683 $ 334,530
=========== =========== =========== =========== =========== ===========
Cumulative interest-rate
gap as a percentage
of total assets at
December 31, 2003 ............ 12.73% 13.27% 13.77% 17.62% 14.66% 17.23%
Cumulative interest-
earning assets as a
percentage of
cumulative interest-
bearing liabilities at
December 31, 2003 ............ 256.79% 197.49% 155.82% 137.15% 123.06% 123.58%
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Interest-earning assets are included in the period in which the balances
are expected to be redeployed and/or repriced as a result of anticipated
prepayments, scheduled rate adjustment and contractual maturities.
(2) For purposes of the gap analysis, loans receivable includes non-performing
loans, gross of the allowance for loan losses, undisbursed loan funds and
deferred loan fees.
(3) Interest-rate sensitivity gap represents the difference between net
interest-earning assets and interest-bearing liabilities.
-42-
KNBT BANCORP, INC.
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, 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 may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates both on a short-term basis and
over the life of the asset. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Finally, the ability of many borrowers
to service their adjustable-rate loans may decrease in the event of an interest
rate increase.
KNBT's interest rate sensitivity is monitored by management through the
use of models that generate estimates of the change in its net portfolio value
("NPV") and net interest income ("NII") over a range of interest rate scenarios.
NPV is the present value of expected cash flows from assets, liabilities, and
off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is
defined as the NPV in that scenario divided by the market value of assets in the
same scenario. KNBT also analyzes potential changes to NII for a twelve-month
period under rising and falling interest rate scenarios. The following table
sets forth KNBT's NPV and NII as of December 31, 2003 and reflects the changes
to NPV and NII as a result of immediate and sustained changes in interest rates
as indicated.
- ------------------------------------------------------------------------------------------------------------
Net Portfolio Value
at December 31, 2003 Net Interest Income for 2004
------------------------------------- -------------------------------------
Percent Change Percent Change
from from
Rate Scenario Amount Base Case Amount Base Case
- ------------------------------ -------------- -------------------- -------------------------------------
(dollars in thousands)
+300 basis point rate shock .... $ 366,674 (13.5%) $ 69,110 4.7%
+200 basis point rate shock .... 390,100 (8.0%) 68,850 4.3%
+100 basis point rate shock .... 409,860 (3.3%) 68,298 3.5%
Static - base case ............ 423,908 -- 66,010 --
- -100 basis point rate shock ... 410,745 (3.1%) 59,448 (9.9%)
- -200 basis point rate shock ... 398,318 (6.0%) 53,119 (19.5%)
- -300 basis point rate shock ... 387,533 (8.6%) 48,424 (26.6%)
- ------------------------------------------------------------------------------------------------------------
Liquidity
KNBT's primary sources of funds are from deposits, amortization of
loans, loan prepayments and the maturity of loans, mortgage-backed securities
and other investments, and other funds provided from operations. While scheduled
payments from the amortization of loans and mortgage-backed securities and
maturing investment securities are relatively predictable sources of funds,
deposit flows and loan prepayments can be greatly influenced by general interest
rates, economic conditions and competition. KNBT also maintains excess funds in
short-term, interest-bearing assets that provide additional liquidity and also
utilizes outside borrowings, primarily from the Federal Home Loan Bank of
Pittsburgh, as an additional funding source.
KNBT uses its liquidity to fund existing and future loan commitments,
to fund maturing certificates of deposit and demand deposit withdrawals, to
invest in other interest-earning assets, and to meet operating expenses. In
addition to cash flow from loan and securities payments and prepayments as well
as from sales of available-for-sale securities and mortgage loans, KNBT has
significant borrowing capacity available to fund liquidity needs. KNBT has
increased its utilization of FHLB borrowings in recent years as a cost efficient
addition to deposits as a source of funds. The average balance of FHLB
borrowings was $114.5 million, $67.4 million and $32.7 million for the years
ended December 31, 2003, 2002, and 2001, respectively. To date KNBT borrowings
have consisted primarily of advances from the Federal Home Loan Bank of
Pittsburgh.
-43-
KNBT has not used, and has no intention to use, any significant
off-balance sheet financing arrangements for liquidity purposes. Its primary
financial instruments with off-balance sheet risk are limited to loan servicing
for others, obligations to fund loans to customers pursuant to existing
commitments and commitments to sell mortgage loans. In addition, KNBT had not
had, and has no intention to have, any significant transactions, arrangements or
other relationships with any unconsolidated, limited purpose entities that could
materially affect its liquidity or capital resources. KNBT has not, and does not
intend to, trade in commodity contracts.
KNBT anticipates that it will continue to have sufficient funds and
alternative funding sources to meet its current commitments.
KNBT's contractual obligations as of December 31, 2003 are as follows:
Contractual Obligations
At December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------
Payments Due by Period:
-------------------------------------------------------------------
Less Than More Than
Total 1 Year 1-3 Years 3-5 Years 5 Years
- -------------------------------------- -------------- ---------------- --------------- ---------------- ---------------
(dollars in thousands)
Federal Home Loan Bank debt ........... $ 207,153 $ 24,300 $ 40,000 $ 74,626 $ 68,227
Trust preferred securities ............ 15,000 - - - 15,000
Operating leases ...................... 10,545 1,317 2,166 1,361 5,701
Severance agreements .................. 1,220 1,028 192 - -
Deferred directors' fees and
officer compensation ............... 2,691 98 104 112 2,377
-------------- ---------------- --------------- ---------------- ---------------
Total obligations ..................... $ 236,609 $ 26,743 $ 42,462 $ 76,099 $ 91,305
============== ================ =============== ================ ===============
Off-Balance-Sheet Obligations
KNBT is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the balance sheet. KNBT's
exposure to credit loss in the event of non-performance by the other party to
the financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual notional amount of those instruments.
KNBT uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments (see Note N of the
"Notes to Consolidated Financial Statements").
KNBT's contingent liabilities and commitments as of December 31, 2003
are as follows:
- --------------------------------------------------------------------------------------------------------------------------
Contingent Liabilities and Commitments
At December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------
Less Than More Than
Total 1 Year 1-3 Years 3-5 Years 5 Years
- -------------------------------------- -------------- ---------------- --------------- ---------------- ---------------
(dollars in thousands)
Lines of credit ....................... $ 139,105 $ 71,364 $ 12,230 $ 29,450 $ 26,061
Standby letters of credit ............. 15,297 7,795 7,448 54 --
Other commitments to make loans ....... 130,802 110,848 5,251 456 14,247
-------------- ---------------- --------------- ---------------- ---------------
Total ................................. $ 285,204 $ 190,007 $ 24,929 $ 29,960 $ 40,308
============== ================ =============== ================ ===============
-44-
Impact of Inflation and Changing Prices. The financial statements,
accompanying notes, and related financial data of KNBT presented herein have
been prepared in accordance with generally accepted accounting principals, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in purchasing power of money
over time due to inflation. The impact of inflation is reflected in the
increased cost of operations. Most of KNBT's assets and liabilities are monetary
in nature: therefore, the impact of interest rates has a greater impact on its
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services.
Conversion from Mutual to Stock Form and Capital Resources
On October 31, 2003 KNBT completed its sale of common stock. KNBT sold
20,201,188 shares of common stock at a price of $10.00 per share for total
proceeds of $202.0 million. The capitalized expenses for the conversion were
$5.8 million resulting in net proceeds of $196.2 million. Concurrent with the
conversion KNBT established the Keystone Nazareth Charitable Foundation with a
contribution of 1,616,095 shares of KNBT common stock to the Foundation.
Also concurrent with the conversion, KNBT acquired First Colonial on
October 31, 2003. KNBT issued 8,545,855 shares of common stock to the
shareholders of First Colonial in exchange for their First Colonial shares (see
"Merger with First Colonial Group").
In connection with the conversion, KNBT also established the ESOP. The
ESOP purchased 949,845 shares in the market at an average price of $17.01 per
share for a total cost of $16.1 million. In December, 2003, 9,723 KNBT common
shares were allocated to the plan participants at their fair value of $164,000.
At December 31, 2003 KNBT had 29,479,275 total common shares
outstanding. This number does not include 940,122 unallocated shares held in the
ESOP. The average shares outstanding for 2003 (months of November and December,
only) excluding unallocated ESOP shares, was 28,502,462.
KNBT's total shareholders' equity was $389.1 million at December 31,
2003 as compared to $111.0 million at December 31, 2002. This was an increase of
$278.1 million or 250.4%. The increase in shareholders' equity was the result of
net proceeds from the stock offering of $196.2 million, the issuance of $85.5
million of KNBT common stock to former First Colonial shareholders in the
merger, the contribution of $16.1 million of KNBT common stock to the Keystone
Nazareth Charitable Foundation, the change in unrealized gain on investment
securities, net of deferred taxes of $1.6 million, net proceeds from the
exercise of stock options of $311,000 and the allocation in KNBT's ESOP of 9,723
shares of stock with a fair market value of $165,000. These increases were
partially offset by KNBT's net loss from operations in 2003 of $5.8 million and
the purchase of shares of common stock for the ESOP of $16.1 million.
The Company and the Bank are subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to met
minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Additional
information relating to the Company's and Bank's capital requirements and
capital ratios can be found in Note P of the "Notes to Consolidated Financial
Statements."
Merger with First Colonial Group
On October 31, 2003, KNBT acquired First Colonial Group, Inc. (First
Colonial) and its subsidiaries, Nazareth National Bank and Trust Company, First
C.G. Company, Inc. and First Colonial Statutory Trust I. First Colonial Group
was merged into KNBT and Nazareth National Bank and Trust Company was merged
into the Bank to form Keystone Nazareth Bank & Trust Company.
-45-
At October 31, 2003 First Colonial had $610.4 million in assets. Under
the terms of the merger, each outstanding share of First Colonial common stock
was converted to 3.7 shares of KNBT common stock, resulting in the issuance of
8,545,855 shares of KNBT's common stock in the merger. First Colonial had a
stock option plan which had options to acquire 218,417 shares of First
Colonial's common stock at October 31, 2003. Pursuant to the terms of the merger
agreement, these options were converted at the 3.7 exchange rate to options to
acquire 808,157 shares of KNBT's common stock.
The merger transaction was accounted for under the purchase method of
accounting. The results of operations include the operation acquired from First
Colonial for the period October 31, 2003 through December 31, 2003. More
information is available in KNBT's reports on Form 8-K dated January 14, 2004,
December 23, 2003 and November 3, 2003 each filed with the SEC, and in KNBT's
registration statement on Form S-1 filed with the SEC on June 6, 2003.
New Accounting Pronouncements
The Bank adopted FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees including Indirect Guarantees of Indebtedness of
Others," on January 1, 2003. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Bank has financial and performance
letters of credit. Financial letters of credit require the Bank to make payment
if the customer's financial condition deteriorates, as defined in the
agreements. FIN 45 applies prospectively to guarantees the Bank issues or
modifies subsequent to December 31, 2002. The required disclosures are included
in these financial statements.
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin 51, Consolidated Financial Statements, to
certain entities in which voting rights are not effective in identifying the
investor with the controlling financial interest. An entity is subject to
consolidation under FIN 46 if the investors either do not have sufficient equity
at risk for the entity to finance its activities without additional subordinated
financial support, are unable to direct the entity's activities, or are not
exposed to the entity's losses or entitled to its residual returns ("variable
interest entities"). Variable interest entities within the scope of FIN 46 will
be required to be consolidated by their primary beneficiary. The primary
beneficiary of a variable interest entity is determined to be the party that
absorbs a majority of the entity's expected losses, receives a majority of its
expected returns, or both. Management has determined that First Colonial
Statutory Trust I qualifies as a variable interest entity under FIN 46. First
Colonial Statutory Trust I issued mandatorily redeemable preferred stock to
investors and loaned the proceeds to the Company. First Colonial Statutory Trust
I holds, as its sole asset, subordinated debentures issued by the Company in
2002. First Colonial Statutory Trust I is currently included in the Company's
consolidated balance sheet and statements of operations. The Company has
evaluated the impact of FIN 46 and concluded it should continue to consolidate
First Colonial Statutory Trust I as of December 31, 2003, in part due to its
ability to call the preferred stock prior to the mandatory redemption date and
thereby benefit from a decline in required dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to certain
variable interest entities by March 31, 2004. The Company plans to adopt the
provisions under the revised interpretation in the first quarter of 2004. FIN
46(R) will require KNBT to deconsolidate First Colonial Statutory Trust I as of
March 31, 2004. FIN 46(R) precludes consideration of the call option embedded in
the preferred stock when determining if the Company has the right to a majority
of First Colonial Statutory Trust I expected residual returns. Accordingly, the
Company will deconsolidate First Colonial Statutory Trust I at the end of the
first quarter, which will result in an increase in outstanding debt by $464,000.
The banking regulatory agencies have not issued any guidance that would change
the regulatory capital treatment for the trust-preferred securities issued by
First Colonial Statutory Trust I based on the adoption of FIN 46(R). However, as
additional interpretations from the banking regulators related to entities such
as First Colonial Statutory Trust I become available, management will reevaluate
its potential impact to its Tier I capital calculation under such
interpretations.
-46-
In October 2003, the AICPA issued SOP 03-3, "Accounting for Loans or
Certain Debt Securities Acquired in a Transfer." SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the Bank
will be unable to collect all contractually required payments receivable. SOP
03-3 is effective for loans acquired in fiscal years beginning after December
31, 2004. Early adoption is permitted. Management is currently evaluating the
provisions of SOP 03-3 and does not anticipate its adoption to have a material
affect on the Bank's financial position or results of operations.
The Bank adopted EITF 03-1, "The Meaning of Other than Temporary
Impairment and Its Application to Certain Investments," as of December 31, 2003.
EITF 03-1 includes certain disclosures regarding quantitative and qualitative
disclosures for investment securities accounted for under FAS 115, Accounting
for Certain Investments in Debt and Equity Securities, that are impaired at the
balance sheet date, but an other-than-temporary impairment has not been
recognized. The disclosure under EITF 03-1 are required for financial statements
for years ending after December 15, 2003 and are included in these financial
statements.
Item 7.A Quantitative and Qualitative Disclosure About Market Risks
- -------- ----------------------------------------------------------
Information with respect to quantitative and qualitative disclosure is
contained in Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
-47-
Item 8. Financial Statements and Supplementary Data
- ------- -------------------------------------------
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
KNBT Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of KNBT
Bancorp, Inc. (and previously Keystone Savings Bank) and subsidiaries as of
December 31, 2003 and 2002, and the related consolidated statements of income,
changes in shareholders' equity and cash flows for each of the three years in
the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of KNBT
Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
January 31, 2004
-48-
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------
(dollars in thousands) At December 31,
---------------------------------------
2003 2002
- ----------------------------------------------------------------------------------------------------
ASSETS
Cash and Due From Banks .......................... $ 53,555 $ 33,535
Interest-Bearing Deposits With Banks ............. 85,422 52,758
----------- -----------
Cash and Cash Equivalents ...................... 138,977 86,293
Investment Securities Available-for-Sale ......... 734,087 294,150
Federal Home Loan Bank of Pittsburgh Stock ....... 11,543 8,011
Mortgage Loans Held-for-Sale ..................... 4,677 23,796
Loans ............................................ 890,076 558,453
Less: Allowance for Loan Losses ................. (7,910) (2,927)
----------- -----------
Net Loans ...................................... 882,166 555,526
Bank Owned Life Insurance ........................ 57,849 26,334
Premises and Equipment, Net ...................... 35,867 12,178
Accrued Interest Receivable ...................... 7,645 4,964
Goodwill and Other Intangible Assets ............. 47,448 912
Other Assets ..................................... 20,542 3,742
----------- -----------
TOTAL ASSETS ................................... $ 1,940,801 $ 1,015,906
=========== ===========
LIABILITIES
Deposits ......................................... $ 1,289,410 $ 771,825
Securities Sold Under Agreements to Repurchase ... 24,550 8,904
Advances from the Federal Home Loan Bank ......... 207,153 113,500
Guaranteed Preferred Beneficial Interest in the
Company's Subordinated Debentures .............. 15,000 --
Accrued Interest Payable ......................... 3,218 711
Other Liabilities ................................ 12,390 9,917
----------- -----------
TOTAL LIABILITIES .............................. 1,551,721 904,857
----------- -----------
SHAREHOLDERS' EQUITY
Preferred Stock, no par
Authorized: 20,000,000 shares ................. -- --
Common Stock, Par Value $0.01 a share ............ 295 --
Authorized: 100,000,000 shares
Issued and Outstanding:
29,479,275 shares at Dec. 31, 2003 and None at
Dec. 31, 2002
Additional Paid-In Capital ....................... 297,887 --
Retained Earnings ................................ 100,570 106,326
Unallocated Common Stock Held
by Employee Stock Ownership Plan ............... (15,987) --
Accumulated Other Comprehensive Income ........... 6,315 4,723
----------- -----------
TOTAL SHAREHOLDERS' EQUITY ....................... 389,080 111,049
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ....... $ 1,940,801 $ 1,015,906
=========== ===========
See accompanying notes to consolidated financial statements.
-49-
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------
(dollars in thousands)
Year Ended December 31,
-----------------------------------
2003 2002 2001
-------- -------- --------
INTEREST INCOME
Loans, including fees ............................... $ 41,823 $ 44,188 $ 50,946
Investment Securities ............................... 16,212 14,883 8,536
Other Interest ...................................... 1,028 408 1,011
-------- -------- --------
Total Interest Income ........................... 59,063 59,479 60,493
-------- -------- --------
INTEREST EXPENSE
Deposits ............................................ 15,993 23,099 32,164
Securities Sold Under Agreements to Repurchase ...... 131 155 94
Advances from the Federal Home Loan Bank ............ 4,822 3,162 1,806
Trust-Preferred Securities .......................... 115 -- --
-------- -------- --------
Total Interest Expense .......................... 21,061 26,416 34,064
-------- -------- --------
NET INTEREST INCOME .................................... 38,002 33,063 26,429
Provision for Loan Losses ........................... 2,951 111 391
-------- -------- --------
Net Interest Income After Provision
for Loan Losses ................................... 35,051 32,952 26,038
-------- -------- --------
NON-INTEREST INCOME
Trust Revenue ....................................... 279 -- --
Brokerage Services Revenue .......................... 465 420 100
Deposit Service Charges ............................. 4,042 3,628 2,705
Bank Owned Life Insurance ........................... 1,515 1,435 899
Net Gains ( Losses) on Sales of Investment Securities (249) 1,202 35
Net Gains on Sales of Residential Mortgage Loans .... 246 900 108
Non-Interest Operating Income ....................... 2,750 1,229 1,166
-------- -------- --------
Total Non-Interest Income ....................... 9,048 8,814 5,013
-------- -------- --------
NON-INTEREST EXPENSES
Compensation and Employee Benefits .................. 18,633 13,217 10,414
Net Occupancy and Equipment Expense ................. 4,599 3,086 2,619
Professional Fees ................................... 1,083 868 419
Advertising ......................................... 350 840 728
Data Processing ..................................... 2,124 1,712 1,603
Impairment of Mortgage Servicing Rights ............. 1,068 676 236
Contributions to Charitable Foundation .............. 16,161 -- --
Merger-Related Expenses ............................. 5,652 -- --
Other Operating Expenses ............................ 5,449 4,169 3,594
-------- -------- --------
Total Non-Interest Expenses ..................... 55,119 24,568 19,613
-------- -------- --------
Income (Loss) Before Income Taxes (Benefit) ............ (11,020) 17,198 11,438
Income Taxes (Benefit) ................................. (5,264) 5,188 3,326
-------- -------- --------
NET INCOME (LOSS) ...................................... $ (5,756) $ 12,010 $ 8,112
======== ======== ========
PER SHARE DATA
Net Income - Basic .................................. N/M N/A N/A
======== ======== ========
Net Income - Diluted ................................ N/M N/A N/A
======== ======== ========
See accompanying notes to consolidated financial statements.
-50-
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) Accumulated
Common Additional Unallocated Other
Common Stock Paid-In Retained ESOP Comprehensive
Shares Value Capital Earnings Shares Income Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2000 ................... - $ - $ - $ 86,204 $ - $ 732 $ 86,936
2001
Comprehensive Income
Net Income ................................ 8,112 8,112
Other Comprehensive Income Net of Taxes ... 740 740
--------------
Total Comprehensive Income ................... 8,852
------------------------------------------------------------------------------------
Balance at December 31, 2001 ................. - - - 94,316 - 1,472 95,788
2002
Comprehensive Income
Net Income ................................ 12,010 12,010
Other Comprehensive Income Net of Taxes ... 3,251 3,251
--------------
Total Comprehensive Income ................... 15,261
------------------------------------------------------------------------------------
Balance at December 31, 2002 ................. - - - 106,326 - 4,723 111,049
2003
Comprehensive Loss
Net Loss .................................. (5,756) (5,756)
Other Comprehensive Income Net of Taxes
and Reclassification Adjustments ....... 1,592 1,592
--------------
Total Comprehensive Loss (4,164)
Proceeds from Sale of Common Stock, Net ...... 20,201,188 202 196,059 196,261
Shares in merger with First Colonial ......... 8,545,855 85 85,374 85,459
Issuance of Common Stock
to Charitable Foundation .................. 1,616,095 16 16,145 16,161
Purchase of Shares for ESOP .................. (949,845) (9) (16,152) (16,161)
Unallocated ESOP Shares Committed to Employees 9,723 (1) 165 164
Shares Issued upon Exercise of Stock Options . 56,259 1 310 311
------------------------------------------------------------------------------------
Balance at December 31, 2003 ................. 29,479,275 $ 295 $ 297,887 $ 100,570 $ (15,987) $ 6,315 $ 389,080
- -----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
-51-
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) Year Ended December 31,
--------------------------------------------
2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net (Loss) Income ......................................................... $ (5,756) $ 12,010 $ 8,112
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by (Used in) Operating Activities:
Provision for Loan Losses ........................................... 2,951 111 391
Depreciation and Amortization ....................................... 3,180 1,317 1,137
Amortization (Accretion) of Security Premiums and Discounts, Net .... 3,630 (521) 82
Loss on Disposition of Fixed Assets ................................. -- 99 --
Gain (Loss) on Sale of Other Real Estate Owned ...................... 31 28 10
Loss (Gain) on Sales of Investment Securities ....................... 249 (1,202) (35)
Gains on the Sales of Mortgage Loans ................................ (246) (900) (108)
Mortgage Loans Originated for Sale .................................. (29,043) (60,974) (12,127)
Mortgage Loan Sales ................................................. 50,286 37,178 12,127
Contribution to Charitable Foundation ............................... 16,161 -- --
Changes in Assets and Liabilities:
Decrease (Increase) in Accrued Interest Receivable .................. 283 (1,805) (1,063)
(Increase) Decrease in Other Assets ................................. (5,849) (4,113) 1,667
Increase (Decrease) in Other Liabilities and Accrued Interest Payable 5,760 2,842 (1,973)
--------- --------- ---------
Net Cash Provided by (Used in) Operating Activities ......................... 41,637 (15,930) 8,220
--------- --------- ---------
INVESTING ACTIVITIES
Proceeds from Calls and Maturities of Securities Available-for-Sale ......... 264,030 104,037 46,102
Proceeds from Sales of Securities Available-for-Sale ........................ 28,540 63,844 1,625
Purchase of Securities Available-for-Sale ................................... (462,963) (184,848) (89,818)
Purchase of Federal Home Loan Bank of Pittsburgh Stock ...................... (3,531) (1,912) (394)
Purchase of Bank Owned Life Insurance ....................................... (31,515) (4,000) (20,000)
Net Increase in Loans ....................................................... (62,542) (1,915) (11,330)
Purchase of Premises and Equipment .......................................... (13,138) (1,376) (2,208)
Proceeds from Sale of Other Real Estate Owned ............................... 556 791 337
Cash and Cash Equivalents Acquired through Merger ........................... 45,616 -- --
--------- --------- ---------
Net Cash Used in Investing Activities ....................................... (234,947) (25,379) (75,686)
--------- --------- ---------
FINANCING ACTIVITIES
Net Increase (Decrease) in Deposits ......................................... 5,499 (394) 58,807
Net (Decrease) Increase in Repurchase Agreements ............................ (2,113) 3,152 4,123
Proceeds from Long-Term Debt ................................................ 92,300 73,000 30,500
Payments on Long-Term Debt .................................................. (30,103) -- (3,000)
Purchase of ESOP Shares ..................................................... (16,161) -- --
Proceeds from Issuance of Common Stock ...................................... 196,261 -- --
Proceeds from the Exercise of Stock Options ................................. 311 -- --
--------- --------- ---------
Net Cash Provided by Financing Activities ................................... 245,994 75,758 90,430
--------- --------- ---------
Increase in Cash and Cash Equivalents ....................................... 52,684 34,449 22,964
Cash and Cash Equivalents, January 1, ....................................... 86,293 51,844 28,880
--------- --------- ---------
Cash and Cash Equivalents, December 31, ..................................... $ 138,977 $ 86,293 $ 51,844
========= ========= =========
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Year for
Income Taxes ........................................................ $ 3,165 $ 4,075 $ 3,450
========= ========= =========
Interest on Deposits, Advances and Other Borrowed Money ............. $ 18,554 $ 26,344 $ 33,956
========= ========= =========
Supplemental Disclosure of Non-cash Activities
Mortgage Loan Securitizations ....................................... $ 47,250 $ 115,335 $ --
========= ========= =========
Reclassification of Loans Receivable to Other Real Estate Owned ..... $ 473 $ 998 $ 342
========= ========= =========
See accompanying notes to consolidated financial statements
-52-
KNBT BANCORP, INC.
KNBT BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All dollar amounts presented in the tables are in thousands, except per share
data.)
NOTE A - ORGANIZATION
KNBT Bancorp, Inc. ("KNBT" or the "Company") is the holding company of
Keystone Nazareth Bank & Trust Company ("the Bank"), KNBT Inv. I, Inc ("Inv.
I"), KNBT Inv. II, Inc. ("Inv. II"), and First Colonial Statutory Trust I
("Statutory Trust I"). The Bank is an independent community Pennsylvania
chartered stock savings bank. The Bank provides retail and commercial banking
and trust and brokerage services through its 41 offices in Northampton, Lehigh,
Monroe and Carbon counties in northeastern Pennsylvania.
On October 31, 2003, Keystone Savings Bank converted and reorganized
from a Pennsylvania mutual savings bank into a stock chartered savings bank
holding company structure pursuant to a Plan of Conversion (the "Plan"). Under
the terms of the Plan, Keystone Savings Bank changed its name to Keystone
Nazareth Bank & Trust Company, became a wholly-owned subsidiary of KNBT Bancorp,
Inc. and received 50% of the net proceeds from the initial public offering of
KNBT Bancorp, Inc.'s common stock. KNBT Bancorp, Inc. is a Pennsylvania
corporation and a registered bank holding company.
KNBT Bancorp, Inc. sold 20,201,188 shares of its common stock to the
public at $10.00 per share. In addition, KNBT Bancorp, Inc. contributed
1,616,095 shares to Keystone Nazareth Charitable Foundation. KNBT Bancorp, Inc.
received net proceeds of $196.2 million. The number of shares of common stock
sold and the price for such shares was determined by the Board of Directors
based upon an appraisal of Keystone Savings Bank made by an independent
appraisal firm.
Upon completion of the Plan, a "liquidation account" was established in
an amount equal to the total equity of Keystone Savings Bank as of the latest
practicable date prior to the conversion. The liquidation account was
established to provide a limited priority claim to the assets of Keystone
Savings Bank to eligible account holders and supplemental eligible account
holders, as defined in the Plan, who continue to maintain deposits in Keystone
Savings Bank after the Reorganization. In the unlikely event of a complete
liquidation of Keystone Savings Bank, and only in such event, each eligible
account holder and supplemental eligible account holder would receive a
liquidation distribution, prior to any payment to the holder of the Bank's
common stock. This distribution would be based upon each eligible account
holder's and supplemental account holders proportionate share of the then total
remaining qualifying deposits.
The Bank competes with other banking and financial institutions in its
primary market communities, including financial institutions with resources
substantially greater than its own. Commercial banks, savings banks, savings and
loan associations, credit unions and money market funds actively compete for
savings and time deposits and for various types of loans. Such institutions, as
well as consumer finance and insurance companies, may be considered competitors
of the Bank with respect to one or more of the services it renders.
KNBT and the Bank are subject to regulations of certain state and
Federal agencies and, accordingly, they are periodically examined by those
regulatory agencies. As a consequence of the extensive regulation of commercial
banking activities, the Bank's business is particularly susceptible to being
affected by state and Federal legislation and regulation which may have the
effect of increasing the cost of doing business.
-53-
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
The accounting and reporting policies of KNBT conform to accounting
principles generally accepted in the United States of America and predominant
practices within the banking industry. The accompanying consolidated financial
statements include the accounts of KNBT and its wholly-owned subsidiaries, the
Bank, Inv. I, Inv. II, Statutory Trust I, the Bank's wholly-owned subsidiary
KLVI and the Bank's majority-owned subsidiary, Traditions Settlement Services.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the balance sheets and revenues and
expenditures for the periods. Therefore, actual results could differ
significantly from those estimates.
The principal estimates that are particularly susceptible to
significant change in the near term relate to the allowance for loan losses and
the evaluation of impairment of goodwill. The evaluation of the adequacy of the
allowance for loan losses includes an analysis of the individual loans and
overall risk characteristics and size of the different loan portfolios, and
takes into consideration current economic and market conditions, the capability
of specific borrowers to pay specific loan obligations, as well as current loan
collateral values. However, actual losses on specific loans, which also are
encompassed in the analysis, may vary from estimated losses.
2. Cash and Cash Equivalents
For reporting cash flows, cash and cash equivalents include cash and
due from banks and interest-bearing deposits with banks. The Company maintains
cash deposits in other depository institutions that occasionally exceed the
amount of deposit insurance available. Management periodically assesses the
financial condition of these institutions and believes that the risk of any
possible credit loss is minimal. Interest-bearing deposits in other financial
institutions consist of short-term investments generally having maturities of
less than 30 days.
3. Investment Securities
KNBT accounts for its investment securities in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities". This
standard requires, among other things, that debt and equity securities
classified as available for sale be reported at fair value, with unrealized
gains and losses excluded from earnings and reported in a separate component of
shareholders' equity, net of income taxes and reclassification adjustments.
Investment securities expected to be held for an indefinite period of
time are classified as available for sale and are stated at fair value. Gains or
losses on the sales of securities available for sale are recognized upon
realization utilizing the specific identification method.
KNBT follows SFAS No. 133 as amended by SFAS No 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133, as
amended requires that entities recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. KNBT did not have any derivative instruments as of
December 31, 2003 and 2002.
KNBT adopted EITF 03-1, "The Meaning of Other than Temporary Impairment
and Its Application to Certain Investments" as of December 31, 2003. EITF 03-1
includes certain disclosures regarding quantitative and qualitative disclosures
for investment securities accounted for under SFAS 115, that are impaired at the
balance sheet date, but an other-than-temporary impairment has not been
recognized. The disclosures under EITF 03-1 are required for financial
statements for years ending after December 15, 2003 and are included in these
financial statements.
-54-
4. Mortgage Loans Held-for-Sale
Mortgage loans originated and intended for sale in the secondary market
are carried at the lower of aggregate cost or estimated fair value. Gains and
losses on the sales of loans are also accounted for in accordance with SFAS No.
134, "Accounting for Mortgage Securities Retained after the Securitizations of
Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise". This statement
requires that an entity engaged in mortgage banking activities classify the
retained mortgage-backed security or other interest, which resulted from the
securitizations of a mortgage loan held-for-sale based upon its ability and
intent to sell or hold these investments.
KNBT follows SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," which revised the
standards for accounting for the securitizations and other transfers of
financial assets and collateral. Transfers of financial assets for which KNBT
has surrendered control of the financial assets are accounted for as sales to
the extent that consideration other than beneficial interests in the transferred
assets is received in exchange. Retained interest in a sale or securitization of
financial assets are measured at the date of transfer by allocating the previous
carrying amount between the assets transferred and based on the relative
estimated fair values. The fair values of retained debt securities are generally
determined through reference to independent pricing information. The fair values
of retained servicing rights and any other retained interests are determined
based on the present value of expected future cash flows associated with those
interests and by reference to market prices for similar assets.
KNBT adopted SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," on July 1, 2003. Implementation issue C13,
"When a Loan Commitment Is Included in the Scope of Statement 133" is included
in SFAS No. 149. SFAS No. 149 amends SFAS No. 133 to add a scope exception for
borrowers (all commitments) and lenders (all commitments except those relating
to mortgage loans that will be held for sale). Statement 149 also amends
paragraph SFAS No. 133 to require a lender to account for loan commitments
related to mortgage loans that will be held for sale as derivatives. SFAS No.
149 is effective for contracts entered into or modified after June 30, 2003.
KNBT periodically enters into commitments with its customers, which it intends
to sell in the future. KNBT's commitments to extend credit for loans intended
for resale were not material at December 31, 2003.
5. Loans and Allowance for Loan Losses
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and reduced by an allowance for loan losses. Interest on loans
accrues and is credited to operations based upon the principal amounts
outstanding. The allowance for loan losses is established through a provision
for loan losses charged to operations. Loans are charged against the allowance
for loan losses when management believes that the collectibility of the
principal is unlikely.
Interest is discontinued when, in the opinion of management, the
collectibility of such interest becomes doubtful. A loan is generally classified
as nonaccrual when the loan is 90 days or more delinquent. Loan origination fees
and certain direct origination costs are deferred and amortized over the life of
the related loans as an adjustment to the yield on loans receivable in a manner
which approximates the interest method.
The allowance for loan losses is maintained at an amount management
deems adequate to cover estimated losses. In determining the level to be
maintained, management evaluates many factors, including current economic
trends, industry experience, historical loss experience, industry loan
concentrations, the borrowers' ability to repay and repayment performance, and
estimated collateral values. In the opinion of management, the present allowance
is adequate to absorb future loan losses which are foreseeable and reasonably
estimable. While management uses the best information available to make such
evaluations, future adjustments to the allowance may be necessary based on
changes in economic conditions or any of the other factors used in management's
determination. In addition, various
-55-
regulatory agencies, as an integral part of their examination process,
periodically review KNBT's allowance for losses on loans. Such agencies may
require KNBT to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
Charge-offs to the allowance are made when the loan is transferred to real
estate owned or some other determination of impairment is made.
KNBT accounts for its impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118,
"Accounting by Creditors of a Loan - Income Recognition and Disclosures." This
standard requires that a creditor measure impairment based on the present value
of expected future cash flows discounted at the loan's observable market price,
or the fair value of the collateral if the loan is collateral dependent.
Regardless of the measurement method, a creditor must measure impairment based
on the fair value of the collateral when the creditor determines that
foreclosure is probable.
FASB Interpretation FIN No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantee, Including Indirect Guarantees of Indebtedness of
Others," requires certain disclosures effective for the year ended December 31,
2002 regarding the nature of the guarantee, the maximum potential amount of
future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. Significant guarantees that have been entered
into by KNBT include standby and performance letters of credit. The adoption of
FIN No. 45 did not have a material impact on the consolidated financial
statements.
In October 2003, the AICPA issued SOP 03-3, "Accounting for Loans or
Certain Debt Securities Acquired in a Transfer". SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the Bank
will be unable to collect all contractually required payments receivable. SOP
03-3 is effective for loans acquired in fiscal years beginning after December
31, 2004. Early adoption is permitted. Management is currently evaluating the
provisions of SOP 03-3 and does not anticipate its adoption will have a material
affect on KNBT's consolidated financial position or results of operations.
6. Premises and Equipment
Premises and equipment are carried at cost less accumulated
depreciation, and include expenditures for new facilities, major betterments and
renewals. Expenditures of maintenance and repairs are charged to expense as
incurred. Depreciation is computed using the straight-line method based upon the
estimated useful lives of the related assets.
On January 1, 2002, KNBT adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. The adoption of this statement did
not have an impact on the financial condition or results of operations of the
Company.
7. Other Real Estate Owned
Real estate acquired through foreclosure is classified as other real
estate owned ("OREO"). OREO is carried at the lower cost (lesser of carrying
value of loan or fair value at date of acquisition) or fair value less estimated
costs to sell. Any reductions in value, at or prior to the dates the real estate
is considered foreclosed, is charged to the allowance for loan losses. Any
subsequent reductions in value are charged through earnings. Costs relating to
the development or improvement of the property are capitalized; holding costs
are charged to expense.
8. Goodwill and Intangible Assets
KNBT adopted SFAS No. 142, "Goodwill and Intangible Assets" on January
1, 2002. This statement modifies the accounting for all purchased goodwill and
intangible assets. SFAS No. 142
-56-
includes requirements to test goodwill and indefinite lived intangible assets
for impairment rather than amortize them. KNBT has tested the goodwill included
on its consolidated balance sheet as of December 31, 2003 and has determined
that it was not impaired as of such date.
Intangible assets are comprised of core deposit intangibles and
goodwill acquired in business combinations. KNBT's goodwill is the result of its
acquisition of First Colonial Group in October 2003. The balance of goodwill at
December 31, 2003 was $28.8 million. Core deposit intangibles of $17.1 million
(net of accumulated amortization of $364,000) at December 31, 2003 are being
amortized over the estimated useful lives of the existing deposit base of 8
years using a method which approximates the interest method.
9. Income Taxes
Under the liability method deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities as measured by the enacted tax rates which will be in
effect when these temporary differences are estimated to reverse. Deferred tax
expense is the result of changes in deferred tax assets and liabilities.
10. Advertising
The Company expenses advertising costs as incurred.
11. Stock Based Compensation
KNBT acquired the stock option plans previously maintained by First
Colonial Group, Inc. as a part of the merger. KNBT's stock option plans are
accounted for under SFAS No. 123, "Accounting for Stock-Based Compensation."
This standard contains a fair value-based method for valuing stock-based
compensation which measures compensation cost at the grant date based on the
fair value of the award. Compensation is then recognized over the service
period, which is usually the vesting period. Alternatively, the standard permits
entities to continue accounting for employee stock options and similar
instruments under APB Opinion No. 25. Entities that continue to account for
stock options using APB Opinion No. 25 are required to make pro forma
disclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS No. 123 had been applied. KNBT's stock
option plans are accounted for under APB Opinion No. 25. KNBT did not have any
unvested stock options at December 31, 2003.
12. Employee Benefit Plans
KNBT has certain employee benefit plans covering substantially all
employees. KNBT expenses such costs as incurred. KNBT follows SFAS No. 132, as
revised in December 2003, "Employers' Disclosures about Pensions and Other
Post-retirement Benefits." SFAS No. 132 revised employers' disclosures about
pension and other post-retirement benefit plans. It requires additional
information about changes in the benefit obligation and the fair values of plan
assets. It also standardized the requirements for pensions and other
post-retirement benefit plans to the extent possible, and illustrates combined
formats for the presentation of pension plan and other post-retirement benefit
plan disclosures.
In November 2003, KNBT established an Employee Stock Ownership Plan
("ESOP") covering all eligible employees as defined by the ESOP. The ESOP is a
tax-qualified plan designed to invest primarily in KNBT's common stock that
provides employees with the opportunity to receive a KNBT-funded retirement
benefit based primarily on the value of KNBT's common stock. KNBT accounts for
its ESOP in accordance with Statement of Position ("SOP") 93-6, "Employer's
Accounting for Employee Stock Ownership Plans", issued by the Accounting
Standards Division of the American Institute of Certified Public Accountants
("AICPA").
To purchase KNBT's common stock, the ESOP borrowed $16.1 million from
KNBT to purchase 949,845 shares of KNBT common stock in the market. The ESOP
loan is being repaid principally from the
-57-
Bank's contributions to the ESOP over a period of up to 30 years. Dividends
declared on common stock held by the ESOP and not allocated to the account of a
participant can be used to repay the loan. Compensation expense is recognized in
accordance with SOP 93-6. The number of shares released annually is based upon
the ratio that the current principal and interest payment bears to the current
and all remaining scheduled future principal and interest payments.
All shares that have not been released for allocation to participants
are held in a suspense account by the ESOP for future allocation as the loan is
repaid. Unallocated common stock purchased by the ESOP is recorded as a
reduction of stockholders' equity at cost.
13. Bank Owned Life Insurance (BOLI)
KNBT has purchased Bank Owned Life Insurance policies ("BOLI"). BOLI
involves the purchasing of life insurance by the corporation on a chosen group
of employees. The proceeds are used to help defray employee benefit costs. KNBT
is the owner and beneficiary of the policies. The Company originally invested
$20.0 million in BOLI in 2001 and made additional BOLI investments of $4.0
million in 2002 and $30.0 million in 2003. BOLI is recorded on the consolidated
balance sheets at its cash surrender value and changes in the cash surrender
value are recorded in non-interest income. BOLI income is tax-exempt.
14. Trust Assets and Revenue
Assets held by the Trust Department of the Bank in fiduciary or agency
capacities for its customers are not included in the accompanying consolidated
balance sheets since such assets are not assets of KNBT. Operating revenue and
expenses of the Trust Department are included under their respective captions in
the accompanying consolidated statements of income and are recorded on the
accrual basis.
15. Per Share Information
KNBT follows the provisions of SFAS No. 128, "Earnings Per Share".
Basic earnings per share excludes dilution and is computed by dividing income
available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. Earnings per share
were not meaningful in 2003, as KNBT did not complete its initial public
offering until October 31, 2003. KNBT did not have any shares outstanding in
2002 and 2001.
16. Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires KNBT to disclose the estimated fair value of their assets and
liabilities considered to be financial instruments. Financial instruments
requiring disclosure consist primarily of cash and cash equivalents, investment
securities, loans, deposits and borrowings.
17. Segment Information
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," defines how operating segments are determined and requires
disclosures of certain financial and descriptive information about KNBT's
operating segments. Management has determined that KNBT has one operating
segment and, accordingly, one reportable segment, "Community Banking." All of
KNBT's activities are interrelated, and each activity is dependent and assessed
based on how each of the activities of KNBT supports the others. For example,
consumer and residential mortgage lending is dependent upon the ability of KNBT
to fund itself with retail deposits and other borrowings and to manage interest
rate and credit risk. All significant operating decisions are based upon
analysis of KNBT as one operating segment.
-58-
18. Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," includes net income as
well as certain other items which result in a change to equity during the
period.
The income tax effects allocated to comprehensive income for the years
ended December 31, 2003, 2002, 2001 were as follows:
- --------------------------------------------------------------------------------------------------
Year ended December 31, 2003
----------------------------------------------------
Tax
Before tax benefit Net of tax
amount (expense) amount
- --------------------------------------------------------------------------------------------------
(dollars in thousands)
Unrealized Gains on Securities:
Unrealized holding gains arising
during period ............................ $ 2,162 $ (734) $ 1,428
Less reclassification adjustment for
net realized losses ...................... 249 85 154
---------------- ---------------- ---------------
Other comprehensive income, net .............. $ 2,411 $ (819) $ 1,592
- --------------------------------------------------------------------------------------------------
Year ended December 31, 2002
----------------------------------------------------
Tax
Before tax benefit Net of tax
amount (expense) amount
- --------------------------------------------------------------------------------------------------
(dollars in thousands)
Unrealized Gains on Securities:
Unrealized holding gains arising
during period ............................ $ 6,266 $ (2,222) $ 4,044
Less reclassification adjustment for
net realized gains ....................... (1,202) (409) (793)
---------------- ---------------- ---------------
Other comprehensive income, net ............. $ 5,064 $ (1,813) $ 3,251
- --------------------------------------------------------------------------------------------------
Year ended December 31, 2001
----------------------------------------------------
Tax
Before tax benefit Net of tax
amount (expense) amount
- --------------------------------------------------------------------------------------------------
(dollars in thousands)
Unrealized Gains on Securities:
Unrealized holding gains arising
during period ............................ $ 938 $ (174) $ 764
Less reclassification adjustment for
net realized gains ....................... (35) (11) (24)
---------------- ---------------- ---------------
Other comprehensive income, net .............. $ 903 $ (163) $ 740
- --------------------------------------------------------------------------------------------------
19. Statement of Cash Flows
KNBT considers cash, due from banks and Federal funds sold as cash
equivalents for the purposes of the Consolidated Statements of Cash Flows.
-59-
20. Variable Interest Entities
In January 2003, FASB Interpretation 46 ("FIN 46"), "Consolidation of
Variable Interest Entities" was issued. FIN 46 clarifies the application of
Accounting Research Bulletin 51, "Consolidated Financial Statements", to certain
entities in which voting rights are not effective in identifying the investor
with the controlling financial interest. An entity is subject to consolidation
under FIN 46 if the investors either do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support, are unable to direct the entity's activities, or are not exposed to the
entity's losses or entitled to its residual returns ("variable interest
entities"). Variable interest entities within the scope of FIN 46 were required
to be consolidated by their primary beneficiary. The primary beneficiary of a
variable interest entity is determined to be the party that absorbs a majority
of the entity's expected losses, receives a majority of its expected returns, or
both.
Management has determined that First Colonial Statutory Trust I
qualifies as a variable interest entity under FIN 46. First Colonial Statutory
Trust I issued mandatorily redeemable preferred stock to investors and loaned
the proceeds to KNBT. First Colonial Statutory Trust I holds, as its sole asset,
subordinated debentures issued by KNBT in 2002. First Colonial Statutory Trust I
is currently included in KNBT's consolidated balance sheet and statements of
income. KNBT has evaluated the impact of FIN 46 and concluded it should continue
to consolidate First Colonial Statutory Trust I as of December 31, 2003, in part
due to its ability to call the preferred stock prior to the mandatory redemption
date and thereby benefit from a decline in required dividend yields.
Subsequent to the issuance of FIN 46, the FASB issued a revised
interpretation, FIN 46(R), the provisions of which must be applied to certain
variable interest entities by March 31, 2004. KNBT plans to adopt the provisions
under the revised interpretation in the first quarter of 2004. FIN 46(R) will
require KNBT to deconsolidate First Colonial Statutory Trust I as of March 31,
2004. FIN 46(R) precludes consideration of the call option embedded in the
preferred stock when determining if KNBT has the right to a majority of First
Colonial Statutory Trust I's expected residual returns. Accordingly, KNBT will
deconsolidate First Colonial Statutory Trust I at the end of the first quarter,
which will result in an increase in outstanding debt by $464,000. The banking
regulatory agencies have not issued any guidance that would change the
regulatory capital treatment for the trust-preferred securities issued by First
Colonial Statutory Trust I based on the adoption of FIN 46(R). However, as
additional interpretations from the banking regulators related to entities such
as First Colonial Statutory Trust I become available, management will reevaluate
its potential impact to its Tier I capital calculation under such
interpretations.
21. Reclassifications
Certain reclassifications of prior years' amounts have been made to
conform to the 2003 presentation.
-60-
NOTE C - STOCK CONVERSION AND MERGER
On October 31, 2003, KNBT and the Bank completed mergers with First
Colonial Group and its subsidiary Nazareth National Bank and Trust Company,
respectively. Under the terms of the merger agreement, which was the result of
arms-length negotiation, each of the shares of First Colonial stock was
exchanged for 3.7 shares of KNBT common stock for a total issuance of 8,545,855
shares of common stock. Based on management's assessment of the anticipated
benefits of the acquisition, including enhanced market share and expansion of
its banking franchise, KNBT entered into the merger agreement and proceeded with
its acquisition of First Colonial Group. First Colonial stock options
outstanding at the date of acquisitions were converted into 808,157 options to
purchase KNBT shares of common stock and were fully vested at the time of the
merger. The transaction was accounted for under the purchase method of
accounting and KNBT's results of operations include First Colonial's results
from October 31, 2003 (date of acquisition) through December 31, 2003. The
acquisition resulted in the recording of approximately $45.9 million of goodwill
and other intangible assets.
The following condensed consolidated balance sheet of First Colonial Group,
Inc. discloses the amounts assigned to each major asset and liability caption at
the acquisition date, October 31, 2003.
- --------------------------------------------------------------------------------------------------
(dollars in thousands)
Assets
Cash and due from banks .................................................... $ 45,616
Investment securities ...................................................... 271,784
Net loans .................................................................. 272,270
Fair value allocated to premises and equipment ............................. 4,408
Goodwill and core deposit intangible asset ................................. 46,442
Other assets ............................................................... 26,368
---------
Total Assets ............................................................ $ 666,888
=========
Liabilities
Total deposits ............................................................. $(512,086)
Borrowings ................................................................. (64,215)
Other liabilities .......................................................... (5,128)
---------
Total Liabilities Assumed ............................................... (581,429)
---------
Net assets acquired ..................................................... $ 85,459
=========
- --------------------------------------------------------------------------------------------------
The following represents the unaudited pro forma financial information of
KNBT as if the acquisition occurred on the first date of the periods indicated.
The pro forma information should be read in conjunction with the related
historical information and is not necessarily indicative of the results that
would have been attained had the transaction actually taken place.
- --------------------------------------------------------------------------------
For The Year Ended
December 31,
---------------------------------------------------
2003 2002 2001
--------------- --------------- -------------
(dollars in thousands)
Interest Income ........... $ 83,713 $ 89,009 $ 90,528
Interest Expense .......... 33,896 38,826 48,033
--------------- --------------- -------------
Net Interest Income ....... 49,817 50,183 42,495
Provision for Loan Losses . 4,001 1,652 971
Non-interest Income ....... 14,761 15,721 10,620
Non-interest Expense ...... 77,911 43,834 37,671
Net (Loss) Income ......... $(9,901) $ 20,333 $ 10,339
- --------------------------------------------------------------------------------
-61-
NOTE D - INVESTMENT SECURITIES
The amortized cost, unrealized gains and losses, and fair value of
KNBT's investment securities available-for-sale are as follows:
- ------------------------------------------------------------------------------------------------------------------------
At December 31, 2003
-------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- ---------------- ----------------- -----------------
(dollars in thousands)
U. S. Government and agencies ........... $ 118,037 $ 2,442 $ (99) $ 120,380
Obligations of states and political
subdivisions ......................... 112,228 3,584 (157) 115,655
Mortgaged-backed securities
GNMA ................................. 2,124 14 - 2,138
FHLMC ................................ 83,737 1,016 (768) 83,985
FNMA ................................. 224,802 5,597 (2,861) 227,538
Other CMOs ........................... 150,645 628 (576) 150,697
----------------- ---------------- ----------------- -----------------
Total mortgage-backed securities .. 461,308 7,255 (4,205) 464,358
Corporate and other debt securities ..... 15,068 569 - 15,637
ARM fund ................................ 4,939 - (59) 4,880
Equity securities ....................... 12,939 272 (34) 13,177
----------------- ---------------- ----------------- -----------------
Total investment securities ............. $ 724,519 $ 14,122 $ (4,554) $ 734,087
================= ================ ================= =================
- ------------------------------------------------------------------------------------------------------------------------
At December 31, 2002
-------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- ---------------- ----------------- -----------------
(dollars in thousands)
U. S. Government and agencies ........... $ 30,677 $ 398 $ - $ 31,075
Obligations of states and political
subdivisions ......................... 38,935 2,148 (44) 41,039
Mortgaged-backed securities
GNMA ................................. 3,234 93 - 3,327
FHLMC ................................ 17,963 390 (5) 18,348
FNMA ................................. 73,743 2,382 (24) 76,101
Other CMOs ........................... 83,449 862 (137) 84,174
----------------- ---------------- ----------------- -----------------
Total mortgage-backed securities .. 178,389 3,727 (166) 181,950
Corporate and other debt securities ..... 34,053 1,132 (13) 35,172
ARM fund 4,939 - (25) 4,914
----------------- ---------------- ----------------- -----------------
Total investment securities ............. $ 286,993 $ 7,405 $ (248) $ 294,150
================= ================ ================= =================
- ------------------------------------------------------------------------------------------------------------------------
The amortized cost and fair value of KNBT's investment and
mortgage-backed securities available-for-sale at December 31, 2003, by
contractual maturity, are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
-62-
- ---------------------------------------------------------------------------------------------
Available-for-sale
at December 31, 2003
-------------------------------------------
Amortized Fair
Cost Value
----------------- ------------------
(dollars in thousands)
Investment Securities
Due in one year or less ....................... $ 8,130 $ 8,220
Due after one year through five years ......... 72,522 73,384
Due after five years through ten years ........ 43,918 45,102
Due after ten years ........................... 120,763 124,966
----------------- ------------------
245,333 251,672
----------------- ------------------
Mortgage-backed securities ....................... 461,308 464,358
ARM fund ......................................... 4,939 4,880
Equity securities ................................ 12,939 13,177
----------------- ------------------
Total ......................................... $ 724,519 $ 734,087
================= ==================
- ---------------------------------------------------------------------------------------------
Gross gains of $146,000 and losses of $395,000 were realized on sales
of investment securities classified as available-for-sale during the year ended
December 31, 2003. Gross gains of $1.2 million were realized on sales of
investment securities classified as available-for-sale for the year ended
December 31, 2002. There were no gross losses realized on the sale of investment
securities in 2002. Gross gains of $37,000 and losses of $2,000 were realized on
sales of investment securities classified as available-for-sale for the year
ended December 31, 2001.
As of December 31, 2003 and 2002, securities having a book value of
$63.8 million and $15.5 million were pledged to secure public deposits,
outstanding advances and for other purposes as required by law.
The following table indicates the length of time individual securities
have been in a continuous unrealized loss position at December 31, 2003.
- ----------------------------------------------------------------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
---------------------------- ----------------------------- ------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Losses Value Losses Value Losses
- ---------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
U.S. Government & agencies ........ $ 12,100 $ (99) $ - $ - $ 12,100 $ (99)
Obligations of states and
political subdivisions .......... 17,303 (157) - - 17,303 (157)
Total mortgage-backed securities .. 297,021 (4,176) 7,318 (29) 304,339 (4,205)
--------------- ----------- -------------- ------------ ---------------- -------------
Subtotal, debt securities ......... 326,424 (4,432) 7,318 (29) 333,742 (4,461)
--------------- ----------- -------------- ------------ ---------------- -------------
ARM funds ......................... - - 4,879 (59) 4,879 (59)
Equity securities ................. 1,669 (34) - - 1,669 (34)
--------------- ----------- -------------- ------------ ---------------- -------------
Total temporarily
impaired securities ............. $ 328,093 $(4,466) $ 12,197 $ (88) $ 340,290 $(4,554)
=============== =========== ============== ============ ================ =============
- ----------------------------------------------------------------------------------------------------------------------------------
Management has reviewed the securities listed in the above table and
believes all unrealized losses to be temporary. The unrealized losses are due
primarily to changes in market interest rates and
-63-
other temporary changes in market conditions. As of December 31, 2003, KNBT held
645 different securities of which 186 were in an unrealized loss position.
NOTE E - LOANS
A summary of KNBT's loans receivable follows:
- --------------------------------------------------------------------------------
At December 31,
-----------------------------
2003 2002
--------- ---------
(dollars in thousands)
Real Estate
Residential .................. $ 346,221 $ 367,219
Construction ................. 112,684 59,363
Commercial ................... 156,563 29,385
--------- ---------
Total real estate ......... 615,468 455,967
Consumer loans .................. 265,541 143,731
Commercial (non real estate) .... 38,978 10,050
States and political subdivisions 2,334 --
--------- ---------
Total gross loans ......... 922,321 609,748
Less:
Mortgage loans held-for-sale . (4,677) (23,796)
Loans in process ............. (27,099) (24,263)
Deferred fees ................ (469) (3,236)
--------- ---------
Total loans ............... 890,076 558,453
Less: Allowance for loan losses (7,910) (2,927)
--------- ---------
Total net loans ........... $ 882,166 $ 555,526
========= =========
- --------------------------------------------------------------------------------
The Bank makes loans to its directors and executive officers. These
loans were made in the ordinary course of business and on substantially the same
terms and conditions as those with other borrowers.
An analysis of the 2003 activity of these loans follows:
- ---------------------------------------------------------
(dollars in thousands)
Balance, January 1, 2003 .......... $ 659
Acquired from merger
with First Colonial ....... 1,728
New loans .................... 1,631
Repayments ................... (411)
---------------
Balance, December 31, 2003 ........ $ 3,607
- ---------------------------------------------------------
-64-
KNBT's non-performing loans are as follows:
- ---------------------------------------------------------------------------------------------------------
At December 31,
------------------------------------------------------------
2003 2002 2001
----------------- ------------------ -------------------
(dollars in thousands)
Non-accrual loans ......................... $ 1,720 $ 2,197 $ 1,752
Accruing loans 90 days or more past due ... 405 298 938
----------------- ------------------ -------------------
Total non-performing loans ................ $ 2,125 $ 2,495 $ 2,690
================= ================== ===================
Interest income not recognized on
non-accrual loans ....................... $ 50 $ 66 $ 81
================= ================== ===================
KNBT's recorded investment in impaired loans was $217,000 at December
31, 2003. KNBT did not have any impaired loans at December 31, 2002 and 2001.
The valuation allowance for loan losses related to impaired loans is a part of
the allowance for loan losses and was $33,000 at December 31, 2003. The average
impaired loan balance for the year ended December 31, 2003 was $217,000. KNBT
received principal payments of $64,000 on impaired loans in 2003. Income on
impaired loans is recognized by KNBT on a cash basis. KNBT recognized income of
approximately $34,000 on impaired loans in 2003. There were no principal
payments and no income recognized on impaired loans in 2002 and 2001.
Activity in the allowance for loan losses is as follows:
Year ended December 31,
------------------------------------------------------------
2003 2002 2001
----------------- ------------------ -------------------
(dollars in thousands)
Balance, beginning of year ................ $ 2,927 $ 3,386 $ 3,337
Acquisition of First Colonial ............. 3,548 - -
Provision charged to operations ........... 2,951 111 391
Loans charged-off ......................... (1,603) (623) (378)
Recoveries of loans previously charged-off 87 53 36
----------------- ------------------ -------------------
Balance, end of year ...................... $ 7,910 $ 2,927 $ 3,386
================= ================== ===================
NOTE F - PREMISES AND EQUIPMENT
KNBT's premises and equipment are summarized as follows:
At December 31,
Estimated -----------------------------------------
useful lives 2003 2002
----------------- ----------------- ------------------
(dollars in thousands)
Land ...................................... Indefinite $ 3,624 $ 1,829
Buildings and leasehold
improvements ........................... 30-50 years 25,923 10,559
Furniture and fixtures .................... 3-10 years 16,279 11,210
Purchase accounting adjustment ............ 20 years 4,379 -
----------------- ------------------
50,205 23,598
Less accumulated depreciation
and amortization ....................... (14,338) (11,420)
----------------- ------------------
$ 35,867 $ 12,178
================= ==================
- ----------------------------------------------------------------------------------------------------------
-65-
Construction in process of approximately $5.9 million is included in
the balances in the previous table on premises and equipment and will not be
depreciated until it is put in service.
Depreciation expense was $1.8 million, $1.3 million and $1.1 million
for the years ended December 31, 2003, 2002 and 2001. As a result of the merger
with First Colonial, the premises and equipment of First Colonial were marked to
fair value which resulted in an intangible amount of $4.4 million. Amortization
of $29,000 for this intangible asset was recorded for the year ended December
31, 2003. The intangible related to the buildings and leasehold improvements is
being amortized over a 20-year period.
NOTE G - ASSET SECURITIZATIONS AND CAPITALIZED SERVICING ASSETS
1. Asset Securitization
In 2003, KNBT securitized approximately $47.3 million of one-to
four-family residential mortgage loans in a guaranteed mortgage securitization
with the Federal National Mortgage Association ("FNMA"). KNBT recognized no gain
or loss on the transaction as it retained all of the resulting securities. All
of the resulting securities were classified as investment securities
available-for-sale. In 2002, KNBT securitized approximately $115.3 million of
one-to four-family residential mortgage loans in a guaranteed mortgage
securitization with the FNMA. KNBT sold $61.4 million to various investors and
recognized a gain of $1.2 million on the transaction. The remaining $53.9
million of loans securitized were retained by KNBT and classified as investment
securities available-for-sale. No gain or loss was recognized on the securities
retained. KNBT retained the servicing rights on all of the loans securitized and
allocated $736,000 of the carrying value of the loans to be capitalized
servicing assets.
At December 31, 2003, and December 31, 2002, KNBT's retained securities
had an aggregate amortized cost of $49.0 million and $44.1 million an aggregate
estimated fair value of $50.8 million and $46.0 million. The estimated fair
values were obtained from independent pricing sources and management does not
anticipate that a hypothetical adverse change from expected pricing assumptions
would have a significant impact on the fair value of the subordinated retained
securities. During the years ended December 31, 2003 and 2002, KNBT received
$46.1 million and $12.2 million, respectively, in principal and interest
payments on the retained securities and $106,000 and $24,000 in servicing fees
from FNMA. At December 31, 2003, KNBT held $346.2 million of residential
mortgage loans, $4.2 million of which were past due 30 days or more. KNBT had
$81,000 in credit losses on residential real estate loans during the period
ended December 31, 2003. At December 31, 2002, KNBT held $362.0 million of
residential mortgage loans, $3.5 million of which were past due 30 days or more.
KNBT had $33,000 in credit losses during the period ended December 31, 2002.
2. Capitalized Servicing Assets
Changes in capitalized servicing assets were as follows:
- ----------------------------------------------------------------------------------------------
Year ended December 31,
-----------------------------------------------------------
2003 2002 2001
--------------- --------------- ---------------
(dollars in thousands)
Balance, beginning ................ $ 911 $ 567 $ 701
Acquired from First Colonial ...... 662 - -
Amortizations ..................... (1,068) (287) (114)
Sales ............................. 416 1,020 102
Valuation allowance ............... 119 (389) (122)
--------------- --------------- ---------------
Ending balance, net ............... $ 1,040 $ 911 $ 567
=============== =============== ===============
- ----------------------------------------------------------------------------------------------
-66-
NOTE H - DEPOSITS
KNBT's deposits are as follows:
At December 31,
----------------------------------
2003 2002
--------------- -------------
(dollars in thousands)
Non-interest bearing deposits ......... $ 117,270 $ 33,872
Interest-bearing checking deposits .... 163,749 84,164
Savings and club deposits ............. 221,176 115,289
Money market deposits ................. 239,521 149,225
Time deposits ......................... 490,838 343,749
Time deposits $100,000 or more ........ 56,856 45,526
--------------- -------------
$ 1,289,410 $ 771,825
=============== =============
Maturities of time deposits at December 31, 2003 are as follows:
- ---------------------------------------------------
(dollars in thousands)
2004 ................. $ 298,964
2005 ................. 128,017
2006 ................. 54,189
2007 ................. 50,933
2008 ................. 14,132
2009 and Thereafter .. 1,459
------------------
$ 547,694
==================
- ---------------------------------------------------
NOTE I - BORROWINGS
1. Federal Home Loan Bank (FHLB) Advances
Federal Home Loan Bank ("FHLB") advances at December 31, 2003 and
December 31, 2002 totaled $207.2 million and $113.5 million, respectively. The
December 31, 2002 total of $113.5 million includes $20.0 million of short-term
(overnight) borrowings. KNBT had no short-term (overnight) borrowings from the
FHLB at December 31, 2003. The advances are collateralized by FHLB stock and
otherwise unencumbered qualified assets. The fair value of such collateral for
these advances totaled approximately $821.7 million at December 31, 2003 and
$547.4 million at December 31, 2002. These advances had a weighted average
interest rate of 4.21% and 4.69% for the years ended December 31, 2003 and 2002,
respectively. Advances are made pursuant to several different credit programs
offered from time to time by the FHLB.
KNBT's outstanding FHLB borrowings at December 31, 2003 mature as
follows:
- --------------------------------------------------------
(dollars in thousands)
2004 ......................... $ 24,300
2005 ......................... 20,000
2006 ......................... 20,000
2007 ......................... 61,626
2008 ........................ 13,000
2009 and Thereafter ......... 68,227
-------------------
$ 207,153
===================
- -------------------------------------------------------
-67-
2. Securities Sold Under Agreements to Repurchase
KNBT, pursuant to a designated cash management agreement, utilizes
securities sold under agreements to repurchase as vehicles for customers' sweep
and term investment products. Securitization under these cash management
agreements are in U.S. Treasury and Agency Securities and obligations of states
and political subdivisions securities.
These securities are held in a third party custodian's account,
designated by the Bank under a written custodial agreement that explicitly
recognizes KNBT's interest in the securities.
KNBT's details of securities sold under agreements to repurchase are as
follows:
- -------------------------------------------------------------------------------------------------
Year ended December 31,
----------------------------------------------
2003 2002 2001
----------------- --------------- ----------
(dollars in thousands)
Average balance outstanding ........................ $ 11,931 $ 7,330 $ 2,431
Maximum amount outstanding any
month-end during the period ..................... $ 29,010 $ 10,051 $ 5,752
Balance outstanding at end of period ............... $ 24,550 $ 8,904 $ 5,752
Average interest rate during the period ............ 1.10% 2.09% 3.79%
Weighted-average interest rate at end of period .... 0.64% 1.85% 2.49%
3. Guaranteed Preferred Beneficial Interest in KNBT's Subordinated Debenture
As a result of the merger with First Colonial, the Company also
acquired First Colonial Statutory Trust I (the "Statutory Trust I") and assumed
its debt. Statutory Trust I is a wholly-owned Connecticut statutory business
trust subsidiary of the Company organized for the sole purpose of issuing trust
preferred securities that are fully and unconditionally guaranteed by KNBT. On
June 26, 2002, First Colonial issued $15.0 million of subordinated debentures to
Statutory Trust I and the Statutory Trust I issued $15.0 million in pooled trust
preferred securities. The subordinated debentures are the sole asset of the
Statutory Trust. The trust preferred securities are classified as long-term debt
for the financial statements, but are included as Tier I capital for regulatory
purposes. The interest rate on this security (4.62% at December 31, 2003) is
variable, adjusting quarterly at the three-month LIBOR rate plus 3.45%. The
interest is payable quarterly. The trust preferred securities mature in June
2007, or may be redeemed at any time in the event that the deduction of related
interest for federal income tax purposes is prohibited, treatment as Tier I
capital is no longer permitted or certain other contingencies arise. The net
proceeds of the trust preferred securities have been used to support the
Company's growth and expansion and for other general corporate purposes.
-68-
NOTE J - INCOME TAXES
The components of KNBT's income taxes were as follows for the years
ended:
- ---------------------------------------------------------------------------
Year ended December 31,
-------------------------------------------------------
2003 2002 2001
-------------- --------------- ---------------
(dollars in thousands)
Current:
Federal ........ $ 1,249 $ 5,232 $ 3,280
State .......... - 128 (56)
-------------- --------------- ---------------
1,249 5,360 3,224
Deferred:
Federal ........ (6,513) (172) 102
-------------- --------------- ---------------
$(5,264) $ 5,188 $ 3,326
============== =============== ===============
The reconciliation of KNBT's tax computed at the statutory rate is as
follows:
Year ended December 31,
-------------------------------------------------------
2003 2002 2001
-------------- --------------- --------------
(dollars in thousands)
Tax (benefit) expense at statutory rate of 35% . $(3,857) $ 6,019 $ 3,888
Increase (decrease) resulting from:
Tax-exempt income ........................... (1,565) (1,036) (657)
State tax expense, net federal benefit ...... - 84 19
Other, net .................................. 158 121 76
-------------- --------------- --------------
Income tax (benefit) expense ............. $(5,264) $ 5,188 $ 3,326
============== =============== ==============
Deferred tax assets and liabilities consist of the following:
- -------------------------------------------------------------------------------
At December 31,
------------------------
2003 2002
------- -------
(dollars in thousands)
Deferred tax assets:
Deferred compensation .......................... $ 1,268 $ 773
Allowance for loan losses ...................... 2,344 1,025
Investment acquisition adjustment .............. 2,081 --
Charitable contribution ........................ 5,540 --
Other .......................................... 584 286
------- -------
11,817 2,084
Deferred tax liabilitites:
Fixed assets ................................... 2,057 819
Core deposit intangible ........................ 5,995 --
Mortgage servicing rights ...................... 111 412
Unrealized gains on securities avalable-for-sale 3,253 2,434
------- -------
11,416 3,665
------- -------
Net deferred tax (liability) ................ $ 401 $(1,581)
======= =======
-69-
As a result of the acquisition of First Colonial, KNBT computed a
deferred tax asset of $9.7 million and deferred tax liabilities of $7.5 million
for the core deposit intangible and the step up of the fixed assets acquired.
KNBT will not be required to recapture approximately $9.8 million of its tax bad
debt reserve attributable to bad debt deductions taken prior to 1988, as long as
the Bank continues to operate as a bank under federal tax law and does not use
the reserve for any other purpose. In accordance with SFAS No. 109, KNBT has not
recorded any deferred tax liability on this portion of its tax bad debt reserve.
The tax that would be paid if KNBT ultimately was required to recapture that
portion of the reserve would amount to approximately $3.4 million.
NOTE K - RETIREMENT PLANS
1. Defined Benefit Plans
KNBT participates in a multiple employer defined benefit pension plan,
which covers substantially all employees with 1,000 hours of service during the
plan year. Benefits are generally based on years of service and the highest
average compensation of five consecutive years of employment. It is the
Company's policy to fund the amount which satisfies the statutory requirements
under the Employee Retirement Income Security Act. KNBT's contributions to the
multiple employee pension plan for the years ended December 31, 2003, 2002, and
2001 were approximately $816,000, $529,000 and $239,000, respectively. In
October 2003, KNBT froze the future accrual of benefits under the defined
benefit pension plan. KNBT will continue to contribute to this plan for benefits
accrued prior to October 2003.
2. Defined Contribution Plan
KNBT also has a 401(k) plan which covers substantially all employees.
Employees may elect to defer 1% to 20% of their compensation per year. KNBT will
match 50% of the contributions up to 6% of compensation per year. KNBT's
contributions to the 401(k) plan totaled approximately $306,000, $222,000 and
$167,000 for the years ended December 31, 2003, 2002, and 2001 respectively.
3. Employee Stock Ownership Plan
KNBT established an ESOP in November 2003 for all eligible employees as
defined by the ESOP. KNBT accounts for its ESOP in accordance with SOP 93-6,
"Employers' Accounting for Employee Stock Ownership Plans." The ESOP borrowed
$16.1 million from KNBT to purchase 949,845 shares of KNBT common stock in the
market at an average price of $17.01 per share.
Under SOP 93-6, unearned ESOP shares are not considered outstanding and
are shown as a reduction of shareholders' equity as unearned compensation.
Dividends on unallocated ESOP shares are considered to be compensation expense.
KNBT will recognize compensation cost equal to the fair value of the ESOP shares
during the periods in which they become committed to be released. To the extent
that the fair value of KNBT's ESOP shares differs from the cost of such shares,
this differential will be credited to equity. KNBT will receive a tax deduction
equal to the cost of the shares released. As the loan is internally leveraged,
the loan receivable from the ESOP to KNBT is not reported as an asset nor is the
debt of the ESOP shown as a Company liability. Dividends on allocated shares are
expected to be used to pay the ESOP debt. The ESOP compensation expense for 2003
was $165,000, which is the fair value of the shares released in 2003 as provided
by SOP 93-6. At December 31, 2003, the ESOP had a total of 949,845 of KNBT's
common stock, of which 940,122 were unallocated and 9,723 were allocated. The
fair value of the unreleased ESOP shares, using the closing quoted market price
of $17.58 per share at year end, was approximately $16.5 million at December 31,
2003.
4. Post-Retirement Benefit
KNBT, as a part of the merger, assumed First Colonial's post-retirement
benefit plan that covers certain First Colonial retired employees. This plan
generally provides medical insurance benefits to a group of previously qualified
retirees and spouses who were 60 years of age or older on January 1, 1992 and
who have retired after attaining age 65. This plan is unfunded. As permitted by
SFAS No. 106, the
-70-
Company elected to delay the recognition of this transition obligation by
aggregating $308,000, which arose from adopting SFAS No. 106, and amortizing
this amount on a straight-line basis over 20 years.
The components of the net periodic post-retirement benefit cost are as
follows:
- -------------------------------------------------------------
Post-Retirement Plan
Year Ended December 31, 2003
- -------------------------------------------------------------
(dollars in thousands)
Interest cost ..................... $ 8
Amortization of transition
obligation ...................... 15
Amortization of unrecognized gain . (8)
-----------------
Net periodic benefit cost ......... $ 15
=================
- -------------------------------------------------------------
The assumptions used to develop the net periodic post-retirement
benefit cost are as follows:
- --------------------------------------------------------
At December 31, 2003
- --------------------------------------------------------
Discount rate ..................... 6.50%
Medical care cost
trend rate ...................... 7.00%
The medical care cost trend used in the actuarial computation
ultimately is reduced to 7.0% in the year 2003 and 6.0% in 2005 and subsequent
years. This was accomplished using 0.5% decrements through the year 2005 and
later.
The table of actuarially computed plan assets and benefit obligations
for KNBT is presented below.
- ---------------------------------------------------------------------
Post-Retirement Plan
For the Year Ended December 31, 2003
- ---------------------------------------------------------------------
(dollars in thousands)
Change in benefit obligation:
Benefit obligation assumed from merger
with First Colonial ........................ $ 163
Service cost ................................. --
Interest cost ................................ 8
Actual gain .................................. --
Change due to change in experience ........... (31)
Change due to change in assumption ........... --
Benefits paid ................................ (16)
-----
Benefits obligation at end of year ........... $ 124
=====
Change in plan assets:
Fair value of plan assets at beginning of year $ --
Actual return on plan assets ................. --
Employer contribution ........................ --
Benefits paid ................................ --
-----
Fair value of plan assets at end of year ..... --
Funded status ................................ (124)
Unrecognized net transition obligation ....... 139
Unrecognized net gain ........................ (83)
-----
Accrued benefit cost ......................... $ (68)
=====
-71-
The effect of a one percentage point increase in each future year's
assumed medical care cost trend rate, holding all other assumptions constant,
would have been to increase the accumulated post-retirement benefit obligation
by $8,224 and the net post-retirement benefit cost by $502. Decreasing the
assumed health care cost trend rates by one percentage point in each year would
decrease the accumulated post-retirement benefit obligation by $7,508 and the
net post-retirement benefit cost by $458.
Health care benefits are provided to certain retired employees. The
cost of providing these benefits was approximately $17,000 in 2003.
5. Directors' Deferred Plan
KNBT, as part of the merger, assumed the First Colonial directors'
deferred plan involving certain former directors of First Colonial. The plan
requires defined annual payments for five to fifteen years beginning at age 65
or death. The annual benefit is based upon the amount deferred plus interest.
KNBT has recorded the deferred compensation liabilities using the present value
method.
The following table sets forth the changes in benefit obligations and
plan assets of the directors' deferred plan.
Actuarial present value of benefit obligations is as follows:
- -------------------------------------------------------------------------------------------
Directors' Deferred Plan
At December 31 2003
- -------------------------------------------------------------------------------------------
(dollars in thousands)
Change in benefit obligation:
Benefit obligation assumed from merger with First Colonial ....... $ 389
Service cost ..................................................... --
Interest cost .................................................... 25
Change due to change in assumptions .............................. 10
Change due to plan amendment ..................................... --
Actual (gain) loss ............................................... (11)
Benefits paid .................................................... (53)
-----
Benefits obligation at end of year ............................... $ 360
=====
Change in plan assets:
Fair value of plan assets received from merger with First Colonial $ --
Actual return on plan assets ..................................... --
Employer contribution ............................................ 53
Benefits paid .................................................... (53)
-----
Fair value of plan assets at end of year ......................... --
Funded status .................................................... (360)
Unrecognized net transition asset ................................ --
Unrecognized net actuarial (gain) loss ........................... 31
Unrecognized prior service cost .................................. --
Adjustment to recognize
additional minimum liability ................................... (31)
-----
Accrued benefit cost ............................................. $(360)
=====
- -------------------------------------------------------------------------------------------
-72-
The weighted-average assumed discount rates used in determining the
actuarial present value of the projected benefit obligation were 6.5% in 2003.
The weighted-average expected long-term rate of return on assets was 9.0% for
2003.
- ------------------------------------------------------------
Directors' Deferred Plan
Year ended December 31, 2003
- ------------------------------------------------------------
(dollars in thousands)
Service cost ............................ $ -
Interest cost ........................... 25
Net amortization and
deferral of prior service costs ....... -
---------------
Net Periodic Benefit Cost ............... $ 25
===============
6. Deferred Compensation Plans
KNBT maintains two deferred compensation plans. One of these plans was
acquired through KNBT's acquisition of First Colonial. These deferred
compensation arrangements permit the directors and certain executive officers to
defer director's fees or salary, as the case may be, and other compensation at
the election of the participants. At December 31, 2003, there were $223,000 in
accumulated balances for Keystone's directors (compared to $138,000 at December
31, 2002) and $224,000 in accumulated balances for former First Colonial
directors under the acquired First Colonial plan for an aggregate of $467,000.
The weighted-average earnings for directors in these plans in 2003 was 4.3%
under the Keystone plan and 1.3% under the former First Colonial plan. The
weighted-average earnings for director's deferred accounts was 4.7% in 2002.
Deferred fees will be paid out when the participant retires or as otherwise
provided by the plan agreements. Selected executive officers also are permitted
to defer compensation. The plan includes all funds that were previously
identified as the executive supplemental retirement plan. At December 31, 2003
and 2002, the balance accumulated for executive officers was approximately $1.7
million and $934,000, respectively. The weighted-average earnings on these
deferred funds for executive officers was 2.0% in 2003 and 0.5% in 2002. These
deferred amounts will be paid out when the executive retires or as otherwise
provided by the plan agreement.
NOTE L - STOCK OPTIONS
KNBT assumed the First Colonial stock option plans on October 31, 2003
pursuant to the merger agreement. Outstanding options to acquire 218,417 shares
of First Colonial common stock were converted to options to acquire 808,157
common shares of the Company's stock at the exchange ratio of 3.7 shares of
KNBT's stock for each share of First Colonial's stock. All of the outstanding
options acquired were fully vested prior to the merger date. There were no
options awarded after the merger date.
-73-
A summary of the stock option plans as of December 31, 2003 and changes
during the year follows:
- ----------------------------------------------------------------------------
Stock Option Plans
Year Ended December 31, 2003
- ----------------------------------------------------------------------------
Weighted
Average
Exercise
Shares Price
---------------- --------------
Outstanding at beginning of year .......... - $ -
Acquired from merger with First Colonial .. 808,157 5.62
Granted ................................... - -
Exercised ................................. (56,259) 5.51
Expired ................................... - -
Outstanding at end of year ................ 751,898 $ 5.63
The following table summarizes information concerning the Company's
stock option plans outstanding at December 31, 2003:
- -------------------------------------------------------------------------------------------------------------------------------
Options outstanding Options exercisable
- ------------------------------------------------------------------------------------- --------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life (years) Price Exercisable Price
- ------------------------------------------ ----------------- ----------------- --------------- ------------------
$2.35 - $3.14 ...... 10,938 0.8 $ 3.07 10,938 $ 3.07
$3.14 - $3.92 ...... 10,930 5.1 $ 3.81 10,930 $ 3.81
$3.92 - $4.70 ...... 115,923 6.6 $ 4.26 115,923 $ 4.26
$4.70 - $5.49 ...... 45,554 4.1 $ 5.02 45,554 $ 5.02
$5.49 - $6.27 ...... 394,816 7.7 $ 5.69 394,816 $ 5.69
$6.27 - $7.06 ...... 125,333 8.3 $ 6.44 125,333 $ 6.44
$7.06 - $7.84 ...... 48,404 2.9 $ 7.84 48,404 $ 7.84
------------------ ---------------
751,898 751,898
================== ===============
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of assets
and liabilities considered to be financial instruments. For KNBT, as for most
financial institutions, the majority of its assets and liabilities are
considered financial instruments as defined in SFAS No. 107. However, many such
instruments lack an available trading market as characterized by a willing buyer
and willing seller engaging in an exchange transaction. Therefore, KNBT had to
use significant estimations and present value calculations to prepare this
disclosure, as required by SFAS No. 107. Accordingly, the information presented
below does not purport to represent the aggregate net fair value of KNBT.
Changes in the assumptions or methodologies used to estimate fair
values may materially affect the estimated amounts. Also, management is
concerned that there may not be reasonable comparability between institutions
due to the wide range of permitted assumptions and methodologies in the absence
of active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
-74-
Estimated fair values have been determined by KNBT using what
management believes to be the best available data and an estimation methodology
suitable for each category of financial instruments. The estimated methodologies
used, the estimated fair values, and recorded book balances at December 31, 2003
and 2002 are set forth below.
For cash and due from banks and interest-bearing deposits with banks,
the recorded book values of approximately $139.0 million and $86.3 million are
deemed to approximate fair values at December 31, 2003 and 2002, respectively.
The estimated fair values of investment and mortgage-backed securities
are based on quoted market prices, if available. If quoted market prices are not
available, the estimated fair values are based on quoted market prices of
comparable instruments. The fair values of loans are estimated on a discounted
cash flow analysis using interest rates currently offered for loans with similar
terms to borrowers of similar credit quality. The carrying value of accrued
interest is deemed to approximate fair value.
- -----------------------------------------------------------------------------------------------------------------
At December 31,
----------------------------------------------------------------------------
2003 2002
----------------------------------- -----------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------------------------- -----------------------------------
(dollars in thousands)
Investment and mortgage-backed
securities ....................... $ 734,087 $ 734,087 $ 294,150 $ 294,150
Federal Home Loan Bank
of Pittsburgh stock .............. $ 11,543 $ 11,543 $ 8,011 $ 8,011
Loans receivable .................... $ 886,843 $ 889,262 $ 558,453 $ 580,363
Mortgage loans held-for-sale ........ $ 4,677 $ 4,677 $ 23,796 $ 23,796
The estimated fair values of demand deposits (i.e., interest-bearing
and non-interest-bearing checking accounts, passbook savings and certain types
of money market accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). The carrying
amounts of variable-rate, fixed-term money market accounts and certificates of
deposit approximate their fair values at the reporting date. The fair values of
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered to a schedule of
aggregated expected monthly time deposit maturities. The carrying amount of
accrued interest payable approximates its fair value.
- -------------------------------------------------------------------------------------------------
At December 31,
--------------------------------------------------------------
2003 2002
---------------------------- ----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------------------- ----------------------------
(dollars in thousands)
Time deposits ............ $547,697 $562,174 $389,179 $393,111
Securities sold under
agreements to repurchase $ 24,550 $ 24,550 $ 8,904 $ 8,904
Advances from the
Federal Home Loan Bank . $207,153 $212,082 $113,500 $120,334
The guaranteed preferred beneficial interest in KNBT's subordinated
debt had a carrying value of $15.0 million at December 31, 2003. The interest on
this debt is tied to LIBOR and changes quarterly. The estimated fair value at
December 31, 2003 was $15.0 million.
-75-
The fair value of commitments to extend credit is estimated based on
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based on the amount of unearned fees plus the estimated
cost to terminate the letters of credit. Fair values of unrecognized financial
instruments including commitments to extend credit and the fair value of letters
of credit are considered immaterial.
NOTE N - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
KNBT is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheet. KNBT's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit and standby letters of credit is represented by the contractual
amount of those instruments. KNBT uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
KNBT had the following approximate off-balance-sheet financial
instruments whose contract amounts represent credit risk.
- ---------------------------------------------------------------------------------------------
At December 31,
-----------------------------------
2003 2002
- --------------------------------------------------------------------------------------------
(dollars in thousands)
Commitments to extend credit Lines of credit:
Commercial loans .................................. $ 86,664 $48,880
Home equity secured by mortgage ................... 45,341 26,590
Unsecured consumer including credit card .......... 7,100 8,712
---------------- ----------------
Total lines of credit .......................... 139,105 84,182
Letters of credit .................................... 15,297 3,366
Other loan commitments:
Commercial loans unsecured ........................ 14,580 -
Residential mortgages ............................. 55,583 19,007
Other mortgages ................................... 51,758 1,663
Consumer (auto, personal) ......................... 8,881 -
---------------- ----------------
Total other loan commitments ................... 130,802 20,670
---------------- ----------------
Total commitments to extend credit ...................... $ 285,204 $108,218
================ ================
- --------------------------------------------------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. KNBT evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by KNBT upon extension of credit, is based on management's
credit evaluation of the customer. Collateral held varies but may include
guarantees, personal or commercial real estate, accounts receivable, inventory
and equipment.
-76-
Standby letters of credit are conditional commitments issued by KNBT to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support contracts entered into by customers. Most guarantees
extend for one year. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
KNBT holds collateral to support these commitments. The Bank had standby letters
of credit of $15.3 million and $3.4 million at December 31, 2003 and 2002,
respectively. These letters of credit expire as follows: $7.6 million in 2004,
$7.4 million in 2005 through 2006, and $54,000 in 2007.
A substantial amount of KNBT's loans are secured by real estate in the
Northampton, Lehigh, Monroe, and Carbon counties of northeastern Pennsylvania.
Loans purchased from other financial institutions or participation in loans
originated by other financial institutions constitute less than 1% of the
Company's loans outstanding. Accordingly, KNBT's primary concentration of credit
risk is related to the real estate market in the four county areas and the
ultimate collectibility of this portion of KNBT's loan portfolio is susceptible
to changes in economic conditions in that area.
NOTE O - LEASE COMMITMENTS
The Bank has entered into several noncancellable operating lease
agreements for its branch banking facilities. The Bank is responsible for
pro-rata operating expense escalations. The approximate minimum annual rental
payments at December 31, 2003 under these leases are as follows:
- -------------------------------------------------
(dollars in thousands)
2004 .................. $ 1,317
2005 .................. 1,177
2006 .................. 989
2007 .................. 734
2008 .................. 627
2009 and Thereafter ... 5,701
------------------
$ 10,545
==================
- -------------------------------------------------
Lease expense for the years ended December 31, 2003, 2002 and 2001 was
$769,000, $474,000, and $339,000, respectively.
NOTE P - REGULATORY MATTERS
KNBT is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators that, if undertaken, could have a direct material effect on KNBT's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, KNBT and the Bank must meet specific
capital guidelines that involve quantitative measures of KNBT's and the Bank's
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. KNBT's and the Bank's capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
KNBT's ability to declare and pay dividends may depend in part on
dividends received from the Bank. The Pennsylvania Banking Code regulates the
distribution of dividends by savings banks and states, in part, that dividends
may be declared and paid only out of accumulated net earnings and may not be
declared or paid unless surplus, retained earnings, is at least equal to
contributed capital. In addition, dividends may not be declared or paid if the
Bank is in default in payment of any assessment due the Federal Deposit
Insurance Corporation.
The Federal Reserve Board issued a policy statement on the payment of
cash dividends by the bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding
-77-
company should pay cash dividends only to the extent that the holding company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earnings retention that is consistent with the holding company's
capital needs, asset quality and overall financial condition.
Quantitative measures established by regulations to ensure capital
adequacy require KNBT and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). As of December 31, 2003, KNBT and the
Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2003, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as "well-capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"adequately capitalized" the Bank must maintain minimum total risk-based, Tier I
risk-based and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed in the institution's category.
The following table provides a comparison of KNBT's and Bank's capital
amounts, risk-based capital ratios and leverage ratios for the periods
indicated.
- -----------------------------------------------------------------------------------------------------------------------------------
Capital Ratios Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------- ------------------------------ ---------------------------------
at December 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
KNBT, (consolidated) ......... $ 359,522 33.24% $86,535 8.00% N/A N/A
Bank ......................... $ 258,441 24.01% $86,123 8.00% $ 107,654 10.00%
Tier I Capital
(To risk-weighted assets)
KNBT, (consolidated) ......... $ 351,612 32.51% $43,268 4.00% N/A N/A
Bank ......................... $ 250,499 23.27% $43,062 4.00% $ 64,593 6.00%
Tier I Capital
(To average assets, leverage)
KNBT, (consolidated) ......... $ 351,612 19.39% $72,525 4.00% N/A N/A
Bank ......................... $ 250,499 13.42% $74,646 4.00% $ 93,307 5.00%
- -----------------------------------------------------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------- ------------------------------ ---------------------------------
at December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Bank ......................... $ 109,137 18.69% $46,702 8.00% $ 58,378 10.00%
Tier I Capital
(To risk-weighted assets)
Bank ......................... $ 106,210 18.19% $23,351 4.00% $ 35,027 6.00%
Tier I Capital
(To average assets, leverage)
Bank ......................... $ 106,210 10.78% $39,410 4.00% $ 49,263 5.00%
- -----------------------------------------------------------------------------------------------------------------------------------
-78-
NOTE Q - QUARTERLY FINANCIAL DATA (Unaudited)
The following represents summarized quarterly financial data of KNBT,
which, in the opinion of management, reflects all adjustments (comprising only
normal recurring accruals) necessary for a fair presentation. Per share data is
not included because no shares were issued prior to November 2003.
- -------------------------------------------------------------------------------------------------------------------------
Quarterly Financial Data (Unaudited)
Three Months Ended
- -------------------------------------------------------------------------------------------------------------------------
2003 Dec. 31 Sept. 30 June 30 March 31
- -------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest income ......................... $18,153 $13,193 $13,578 $14,139
Interest expense ........................ 6,110 4,657 4,991 5,303
Net interest income ..................... 12,043 8,536 8,587 8,836
Provision for loan losses ............... 2,095 468 326 62
Non-interest income ..................... 2,447 2,018 2,401 2,182
Non-interest expense .................... 33,213 7,852 7,148 6,906
Income (loss) before income taxes ....... (20,819) 2,234 3,514 4,050
Net income (loss) ....................... (13,087) 1,756 2,626 2,949
- -------------------------------------------------------------------------------------------------------------------------
2002 Dec. 31 Sept. 30 June 30 March 31
- -------------------------------------------------------------------------------------------------------------------------
Interest income ......................... $14,667 $15,164 $14,721 $14,927
Interest expense ........................ 5,821 6,521 6,919 7,155
Net interest income ..................... 8,846 8,643 7,802 7,772
Provision (recovery) for loan losses .... 58 301 197 (445)
Non-interest income ..................... 2,544 1,964 1,663 2,643
Non-interest expense .................... 7,589 6,079 5,718 5,182
Income before income taxes .............. 3,743 4,227 3,550 5,678
Net income .............................. 2,496 3,017 2,601 3,896
- -------------------------------------------------------------------------------------------------------------------------
-79-
NOTE R - KNBT BANCORP, INC.
(PARENT COMPANY ONLY)
- -------------------------------------------------------------------------------------------------------
Condensed Balance Sheet
December 31, 2003
- -------------------------------------------------------------------------------------------------------
(dollars in thousands)
Assets
Cash and due from banks .................................................... $ 3
Interest-bearing deposits with banks ....................................... 94,477
---------------------
Total cash and cash equivalents ........................................ 94,480
Loans receivable ........................................................... 15,920
Investment in banking subsidiary ........................................... 302,897
Investment in other subsidiaries ........................................... 5,706
Other assets ............................................................... 7,380
---------------------
Total Assets ........................................................... $ 426,383
=====================
Liabilities
Long-term ESOP debt ........................................................ $ 15,920
Guaranteed beneficial interest in the Company's subordinated debentures .... 15,464
Other liabilities .......................................................... 5,919
---------------------
Total Liabilities ...................................................... 37,303
Shareholder's Equity .......................................................... 389,080
---------------------
Total Liability and Shareholder's Equity ................................... $ 426,383
=====================
- -------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Condensed Statement of Operations
For the Year Ended December 31, 2003
- --------------------------------------------------------------------------------------------------------
(dollars in thousands)
Income
Interest on deposits with banks ............................................ $ 264
Interest on ESOP loan ...................................................... 96
Statutory trust income ..................................................... 5
--------------------
Total Income ........................................................... 365
--------------------
Expenses
Interest on long-term ESOP debt ............................................ 96
Interest on trust preferred securities ..................................... 120
Contribution to charitable foundation ...................................... 16,161
Other expenses ............................................................. 80
--------------------
Total Expenses ......................................................... 16,457
--------------------
Loss before tax benefit and equity in undistributed net earnings of subsidiaries (16,092)
Income tax benefit ......................................................... (5,632)
--------------------
Loss before equity in undistributed net earnings of subsidiaries ........... (10,460)
Equity in undistributed net earnings of subsidiaries ....................... 4,704
--------------------
Net Loss ............................................................... $ (5,756)
====================
- --------------------------------------------------------------------------------------------------------
-80-
- ---------------------------------------------------------------------------------------------------------------
Condensed Statement of Cash Flows
For the Year Ended December 31, 2003
- ---------------------------------------------------------------------------------------------------------------
Operating Activities (dollars in thousands)
Net loss .......................................................................... $ (5,756)
Adjustments to reconcile net loss to net cash provided by operating activities:
Distribution in excess of undistributed net loss of subsidiaries ............... (4,704)
Contribution to charitable foundation .......................................... 16,161
Changes in assets and liabilities:
Increase in other assets .................................................... (7,380)
Increase in other liabilities ............................................... 5,842
-------------------
Net Cash Provided by Operating Activities ............................................ 4,163
-------------------
Investing Activities
Investment in subsidiaries ........................................................ (106,225)
-------------------
Net Cash Used In Investing Activities ................................................ (106,225)
Financing Activities
Net proceeds from issuance of common stock ........................................ 196,261
Proceeds from the exercise of stock options ....................................... 311
-------------------
Net Cash Provided by Financing Activities ............................................ 196,572
-------------------
Increase (decrease) in cash and cash equivalents ..................................... 94,480
Cash and cash equivalents, January 1, ................................................ -
-------------------
Cash and cash equivalents, December 31, .............................................. $ 94,480
===================
- ---------------------------------------------------------------------------------------------------------------
-81-
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- ------- --------------------------------------------------------------------
None
Item 9A. Controls and Procedures
- ------- -----------------------
Quarterly evaluation of KNBT's Disclosure Controls and Procedures. As
of December 31, 2003, KNBT evaluated the effectiveness of the design and
operation of its "disclosure controls and procedures" ("Disclosure Controls").
This evaluation ("Controls Evaluation") was done under the supervision and with
the participation of the Chief Executive Officer ("CEO") Scott V. Fainor and
Chief Financial Officer ("CFO") Eugene T. Sobol.
Conclusions. Based upon the Controls Evaluation, the CEO and CFO have
concluded that the Disclosure Controls are effective to timely alert management
of material information relating to KNBT during the period when its periodic
reports are being prepared.
-82-
PART III
Item 10. Directors and Executive Officers of the Registrant
- -------- --------------------------------------------------
The information required by Item 10 of Form 10-K with respect to
directors and executive officers is incorporated by reference from the section
captioned "Information with Respect to Nominees for Director, Continuing
Directors and Executive Officers" in KNBT's definitive proxy statement for the
annual meeting of stockholders to be held on May 6, 2004, (the "Proxy
Statement") to be filed with the Securities and Exchange Commission prior to
April 29, 2004.
KNBT has adopted a Code of Conduct and Ethics that applies to its
principal executive officer and principal financial officer, as well as other
officers and employees of KNBT and the Bank. A copy of the Code of Conduct and
Ethics may be found on KNBT's website at www.KNBT.com.
Item 11. Executive Compensation
- -------- ----------------------
The information required by Item 11 of Form 10-K is incorporated by
reference from the sections captioned "Management Compensation," "Report of the
Human Resources Committee of Keystone" and "Performance Graph" in the Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- -------- --------------------------------------------------------------
and Management and Related Stockholder Matters
----------------------------------------------
The information required by Item 12 of Form 10-K is incorporated by
reference from the section captioned "Beneficial Ownership of Common Stock by
Certain Beneficial Owners and Management" and "Management Compensation - Equity
Compensation Plan Information" in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
- -------- ----------------------------------------------
The information required by Item 13 of Form 10-K is incorporated by
reference from the section captioned "Management Compensation - Indebtedness of
Management and Related Party Transactions" in the Proxy Statement.
Item 14. Principal Accountant Fees and Services
- ------- --------------------------------------
The information required by Item 14 of Form 10-K is incorporated by
reference from the section captioned "Ratification of Appointment of Auditors -
Audit Fees" in the Proxy Statement.
-83-
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------- ---------------------------------------------------------------
(a) Documents Filed as Part of this Report:
---------------------------------------
Financial Statements: The Consolidated Financial Statements
of KNBT Bancorp, Inc. and the Report of Independent
Certified Public Accountants thereon, as listed below, have
been filed under "Item 8, Financial Statements and
Supplementary Data".
Report of Independent Certified Public Accountants
Consolidated Balance Sheets for the Years Ended
12/31/03 and 12/31/02
Consolidated Statements of Operations
for the Years Ended 12/31/03, 12/31/02 and 12/31/01
Consolidated Statement of Changes in Shareholders' Equity
for the Years Ended 12/31/03, 12/31/02 and 12/31/01
Consolidated Statements of Cash Flows for the Years Ended
12/31/03, 12/31/02 and 12/31/01
Notes to Consolidated Financial Statements
(b) Reports on Form 8-K
-------------------
(1) On October 27, 2003, KNBT filed a Form 8-K that included under
Items 7 and 9 a press release announcing the receipt of
regulatory approvals required to complete the conversion of
Keystone Savings Bank and the merger with First Colonial Group,
Inc.
(2) On November 3, 2003, KNBT filed a Form 8-K that included under
Items 7 and 9 a press release announcing the completion of the
conversion of Keystone Savings Bank and the merger with First
Colonial Group, Inc.
(3) On December 23, 2003, KNBT filed a Form 8-K reporting under Items
2 and 7 the acquisition of First Colonial Group, Inc.
-84-
(c) Exhibits
--------
3.1 Articles of Incorporation of KNBT Bancorp, Inc. (1)
3.2 Bylaws of KNBT Bancorp, Inc. (1)
4.0 Form of Stock Certificate of KNBT Bancorp, Inc. (1)
10.1 Employment Agreement between Keystone Savings Bank, KNBT
Bancorp and Scott V. Fainor (1)
10.2 Employment Agreement between Keystone Savings Bank, KNBT
Bancorp and Eugene T. Sobol (1)
10.3 Supplemental Executive Retirement Plan (1)
10.4 Trustee and Executive Deferred Compensation Program
10.5 Senior Management Variable Compensation Program (1)
10.6 First Colonial Group, Inc. 1994 Stock Option Plan for
Non-Employee Directors (2)
10.7 First Colonial Group, Inc. 1996 Employee Stock Option Plan (3)
10.8 First Colonial Group, Inc. 2001 Stock Option Plan (4)
10.9 Nazareth National Bank and Trust Co. Deferred Compensation
Plan for Directors
21.0 Subsidiaries of the Registrant - Reference is made to "Item 1.
Business" for the required information
23.0 Consent of Grant Thornton LLP
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer
32.0 Section 1350 Certifications
- --------------------------------------------------------------------------------
(1) Incorporated by reference from KNBT's Registration Statement
on Form S-1 filed on June 6, 2003, as amended, and declared
effective on August 12, 2003 (Registration No. 333-105899).
(2) Incorporated by reference from First Colonial's Annual Report
on Form 10-KSB, for the fiscal year ended December 31, 1994
(File No. 000-11526).
(3) Incorporated by reference from First Colonial's Annual Report
on Form 10-KSB, for the fiscal year ended December 31, 1995
(File No. 000-11526).
(4) Incorporated by reference from First Colonial's quarterly
report on Form 10-Q, for the quarter ended June 30, 2001 (File
No. 000-11526).
-85-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
KNBT BANCORP, INC.
Dated: March 26, 2004 By: /s/ Scott V. Fainor
------------------------------
SCOTT V. FAINOR, 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 as of
March 26, 2004.
By: /s/ Jeffrey P. Feather
-----------------------------------------------------------
JEFFREY P. FEATHER
Chairman of the Board
and Director
March 26, 2004
By: /s/ Scott V. Fainor
-----------------------------------------------------------
SCOTT V. FAINOR
President, Chief Executive Officer
and Director (Principal Executive Officer)
March 26, 2004
By: /s/ Eugene T. Sobol
-----------------------------------------------------------
EUGENE T. SOBOL
Senior Executive Vice President and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
March 26, 2004
By: /s/ Michael J. Gausling
-----------------------------------------------------------
MICHAEL J. GAUSLING
Director
March 26, 2004
By: /s/ Donna D. Holton
-----------------------------------------------------------
DONNA D. HOLTON
Director
March 26, 2004
By: /s/ Christian F. Martin, IV
-----------------------------------------------------------
CHRISTIAN F. MARTIN, IV
Director
March 26, 2004
By: /s/ John A. Mountain
-----------------------------------------------------------
JOHN A. MOUNTAIN
Director
March 26, 2004
-86-
By: /s/ Daniel B. Mulholland
-----------------------------------------------------------
DANIEL B. MULHOLLAND
Director
March 26, 2004
By: /s/ R. Chadwick Paul, Jr.
-----------------------------------------------------------
R. CHADWICK PAUL, JR.
Director
March 26, 2004
By: /s/ Charles J. Peischl, Esquire
-----------------------------------------------------------
CHARLES J. PEISCHL, ESQUIRE
Director
March 26, 2004
By: /s/ Robert R. Scholl
-----------------------------------------------------------
ROBERT R. SCHOLL
Director
March 26, 2004
By: /s/ Kenneth R. Smith
-----------------------------------------------------------
KENNETH R. SMITH
Director
March 26, 2004
By: /s/ R. Charles Stehly
-----------------------------------------------------------
R. CHARLES STEHLY Director March 26, 2004
By: /s/ Richard Stevens, III
-----------------------------------------------------------
RICHARD STEVENS, III
Director
March 26, 2004
By: /s/ Richard L. Strain
-----------------------------------------------------------
RICHARD L. STRAIN
Director
March 26, 2004
By: /s/ Maria Z. Thulin
-----------------------------------------------------------
MARIA Z. THULIN
Director
March 26, 2004
-87-