UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
------------------------------------
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
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 No. 000-50426
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KNBT Bancorp, Inc.
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(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 38-3681905
- ------------------------------- ---------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
90 Highland Avenue, Bethlehem, PA 18017
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(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, Including Area Code: 610-861-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO _____
Indicate by check mark whether the registrant is an accelerated filer as defined
in rule 12b-2 of the Exchange Act.
YES _ NO __X
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date: As of August 12, 2004,
30,579,727 shares of the Registrant's common stock were issued and outstanding.
KNBT BANCORP, INC. AND SUBSIDIARIES
INDEX
PART 1 - FINANCIAL INFORMATION PAGE NO.
ITEM 1 - Financial Statements
Consolidated Balance Sheets 2
Consolidated Statements of Income 3
Consolidated Statement of Changes in Shareholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 16
ITEM 3 - Quantitative and Qualitative Discussion About
Market Risk 28
ITEM 4 - Controls and Procedures 28
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 29
ITEM 2 - Changes in Securities, Use of Proceeds and
Issuer Purchases of Equity Securities 29
ITEM 3 - Defaults Upon Senior Securities 29
ITEM 4 - Submission of Matters to a Vote of Security Holders 30
ITEM 5 - Other Information 31
ITEM 6 - Exhibits and Reports on Form 8-K 31
SIGNATURES 32
CERTIFICATIONS 33
PART 1. FINANCIAL INFORMATION
ITEM 1. Financial Statements
KNBT BANCORP, INC. AND SUBSDIARIES
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------
June 30, December 31,
(dollars in thousands) 2004 2003
- -----------------------------------------------------------------------------------------
ASSETS (unaudited)
Cash and Due From Banks $ 43,582 $ 53,555
Interest-Bearing Deposits With Banks 18,631 85,422
----------- -----------
Cash and Cash Equivalents 62,213 138,977
Investment Securities Available-for-Sale 890,487 734,087
Investment Securities Held to Maturity
(Fair Value of $59,862 at June 30, 2004) 59,751 --
Federal Home Loan Bank of Pittsburgh Stock 23,746 11,543
Mortgage Loans Held-for-Sale 1,532 4,677
Loans 976,070 890,076
Less: Allowance for Loan Losses (9,519) (7,910)
----------- -----------
Net Loans 966,551 882,166
Bank Owned Life Insurance 59,171 57,849
Premises and Equipment, Net 41,310 35,867
Accrued Interest Receivable 9,041 7,645
Goodwill and Other Intangible Assets 45,991 47,448
Other Assets 24,895 21,714
----------- -----------
TOTAL ASSETS $ 2,184,688 $ 1,941,973
=========== ===========
LIABILITIES
Non-Interest-Bearing Deposits 124,456 117,270
Interest-Bearing Deposits 1,186,526 1,172,140
----------- -----------
Total Deposits $ 1,310,982 $ 1,289,410
Securities Sold Under Agreements to Repurchase 31,076 24,550
Advances from the Federal Home Loan Bank 433,428 207,153
Guaranteed Preferred Beneficial Interest in the
Company's Subordinated Debentures -- 15,000
Subordinated Debt 15,464 --
Accrued Interest Payable 3,826 3,218
Other Liabilities 13,690 13,562
----------- -----------
TOTAL LIABILITIES 1,808,466 1,552,893
----------- -----------
SHAREHOLDERS' EQUITY
Preferred Stock, no par
Authorized: 20,000,000 shares -- --
Common Stock, Par Value $0.01 a share 297 295
Authorized: 100,000,000 shares
Issued and Outstanding:
30,578,088 shares at June 30, 2004
30,419,397 shares at Dec. 31, 2003
Additional Paid-In Capital 296,094 297,887
Retained Earnings 107,512 100,570
Unallocated Common Stock Held
by Employee Stock Ownership Plan (15,582) (15,987)
Unearned Common Stock Held
by Management Recognition and Retention Plan (10,303) --
Accumulated Other Comprehensive (Loss) Income (1,796) 6,315
TOTAL SHAREHOLDERS' EQUITY 376,222 389,080
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,184,688 $ 1,941,973
=========== ===========
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See accompanying notes to consolidated financial statements.
2
KNBT BANCORP, INC.. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------ ---------------------
(Dollars in Thousands, except per share data) Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
- ------------------------------------------------------------------------------------ ---------------------
INTEREST INCOME (unaudited)
Loans, including fees $ 14,479 $ 9,526 $ 28,572 $ 19,659
Investment Securities 8,580 4,005 16,696 7,943
Other Interest 136 47 278 115
-------- -------- -------- --------
Total Interest Income 23,195 13,578 45,546 27,717
-------- -------- -------- --------
INTEREST EXPENSE
Deposits 4,357 3,809 8,892 7,972
Securities sold under Agreements to Repurchase 42 28 77 60
Advances from the Federal Home Loan Bank 2,740 1,154 4,864 2,262
Subordinated Debt 179 -- 360 --
-------- -------- -------- --------
Total Interest Expense 7,318 4,991 14,193 10,294
-------- -------- -------- --------
NET INTEREST INCOME 15,877 8,587 31,353 17,423
Provision for Loan Losses 971 326 2,471 388
-------- -------- -------- --------
Net Interest Income After Provision
for Loan Losses 14,906 8,261 28,882 17,035
-------- -------- -------- --------
NON-INTEREST INCOME
Trust Income 372 -- 725 --
Brokerage Services Income 117 111 277 198
Deposit Service Charges 1,009 933 2,320 1,785
Bank Owned Life Insurance 655 342 1,322 697
Net Gains on Sales of Investment Securities 20 2 12 2
Net Gains on Sales of Residential Mortgage Loans 12 376 171 640
Net Gains on Sales of Credit Card Loans -- -- 298 --
Net Gains on Sale of Assets 213 -- 213 --
Net Gains ( Losses) on Sale of Other Real Estate Owned 25 (14) 69 (35)
Non-Interest Operating Income 1,015 651 1,998 1,295
-------- -------- -------- --------
Total Non-Interest Income 3,438 2,401 7,405 4,582
-------- -------- -------- --------
NON-INTEREST EXPENSES
Compensation and Employee Benefits 7,309 3,723 14,554 7,458
Net Occupancy and Equipment Expense 1,962 842 3,787 1,693
Professional Fees 239 181 811 293
Advertising 340 209 493 516
Data Processing 478 489 1,009 920
Impairment of Mortgage Servicing Rights 154 -- 212 --
Amortization of Intangible Assets 546 -- 1,093 --
Other Operating Expenses 1,989 1,704 3,563 3,174
-------- -------- -------- --------
Total Non-Interest Expenses 13,017 7,148 25,522 14,054
-------- -------- -------- --------
Income Before Income Taxes 5,327 3,514 10,765 7,563
Income Taxes 1,019 888 2,342 1,988
-------- -------- -------- --------
NET INCOME $ 4,308 $ 2,626 $ 8,423 $ 5,575
======== ======== ======== ========
PER SHARE DATA
Net Income - Basic $ 0.15 N/A $ 0.29 N/A
======== ======== ======== ========
Net Income - Diluted $ 0.15 N/A $ 0.28 N/A
======== ======== ======== ========
Cash Dividends Per Common Share $ 0.05 N/A $ 0.05 N/A
======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Six Months Ended June 30, 2004 (Unaudited)
(dollars in thousands)
Accumulated
Other
Common Additional Unallocated Unearned Comprehensive
Common Stock Paid In Retained ESOP Compensation Income
Shares Value Capital Earnings Shares MRP (Loss) Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance January 1, 2004 29,479,275 $295 $297,887 $ 100,570 $ (15,987) $ 6,315 $ 389,080
Comprehensive Income
Net Income 8,423 8,423
Other Comprehensive Loss Net of Taxes
and Reclassification Adjustments (8,111) (8,111)
-----------
Total Comprehensive Income 312
Cash Dividends (1,481) (1,481)
Purchase of Stock for Management
Recognition and Retention Plan (MRRP) (13,281) (13,281)
Unallocated ESOP Shares Committed to
Employees 23,801 (3) 405 402
Shares Issued upon Exercise
of Stock Options 158,691 2 832 834
Establishment of a Management
Recognition and Retention Plan (MRRP) 10,659 (10,659) -
Amortization of compensation
related to MRRP 356 356
------------------------------------------------------------------------------------------
Balance at June 30, 2004 29,661,767 $297 $296,094 $ 107,512 $ (15,582) $ (10,303) $ (1,796) $ 376,222
===========================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
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Six Months Ended
------------------------------
June 30, June 30,
(Dollars in Thousands) 2004 2003
- ------------------------------------------------------------------------------------------------------
(unaudited)
OPERATING ACTIVITIES:
Net Income $ 8,423 $ 5,575
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Loan Losses 2,471 388
Depreciation and Amortization 2,758 795
Compensation expense stock option plan 4 --
Management Recognition and Retention Plan Expense 356 --
Amortization and Accretion of Security Premiums and Discounts, net 1,316 1,374
(Gain) Loss on Sale of Other Real Estate Owned (69) 35
Net Gain on Sales of Investment Securities (12) (2)
Gain on Sale of Credit Card Portfolio (298) --
Gain on Sale of Other Assets (213) --
Gains on Sale of Mortgage Loans (171) (640)
Mortgage Loans Originated for Sale (15,135) 22,069
Mortgage Loan Sales 16,462 (22,928)
Changes in Assets and Liabilities:
Increase in Bank Owned Life Insurance (1,322) --
Increase in Accrued Interest Receivable (1,396) (748)
Decrease (Increase) in Other Assets 1,348 (790)
Increase in Other Liabilities and Accrued Interest Payable 732 3,352
--------- ---------
Net Cash Provided by Operating Activities 15,254 8,480
--------- ---------
INVESTING ACTIVITIES:
Proceeds from Calls and Maturities of Securities Available-for-Sale 91,115 118,303
Proceeds from Sales of Securities Available-for-Sale 351 3,050
Purchase of Securities Available-for-Sale (261,466) (170,716)
Purchase of Securities Held-to-Maturity (59,751) --
Purchase of Stock of Federal Home Loan Bank of Pittsburgh (12,203) (741)
Redemption of Stock of Federal Home Loan Bank of Pittsburgh -- 233
Proceeds from the Sale of Credit Card Portfolio 1,831 --
Net Increase in Loans (85,994) (24,636)
Purchase of Premises and Equipment (7,100) (6,701)
Proceeds from Sale of Other Assets 418 --
Proceeds from Sale of Other Real Estate Owned 336 337
--------- ---------
Net Cash Used in Investing Activities (332,463) (80,871)
--------- ---------
FINANCING ACTIVITIES:
Net Increase in Deposits 21,572 42,853
Net Increase in Repurchase Agreements 6,526 362
Proceeds from Long-Term Debt 262,562 --
Repayment of Long-Term Debt (36,287) (5,500)
Proceeds from the Exercise of Stock Options 834 --
Purchase of Stock for the Management Recognition and Retention Plan (13,281) --
Cash Dividends Paid (1,481) --
--------- ---------
Net Cash Provided by Financing Activities 240,445 37,715
--------- ---------
Increase in Cash and Cash Equivalents (76,764) (34,676)
Cash and Cash Equivalents, January 1, 138,977 86,293
--------- ---------
Cash and Cash Equivalents, June 30, $ 62,213 $ 51,617
========= =========
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Period for
Income Taxes $ 22 $ 2,095
========= =========
Interest $ 13,585 $ 10,189
========= =========
Supplemental Disclosure of Non-cash Activities
Mortgage Loan Securitizations $ -- $ 47,251
========= =========
Reclassification of Loans Receivable to Other Real Estate Owned $ 152 $ 337
========= =========
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See accompanying notes to consolidated financial statements
5
KNBT BANCORP, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------
(unaudited)
NOTE A - BASIS OF PRESENTATION
KNBT Bancorp, Inc. ("KNBT" or the "Company") 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 (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. ("First Colonial"), the
parent bank holding company for Nazareth National Bank and Trust Company. At
June 30, 2004, the Bank operates 41 banking offices with nineteen located in
Northampton County, Pennsylvania, sixteen in Lehigh County, Pennsylvania, five
in Monroe County, Pennsylvania and one in Carbon County, Pennsylvania. The
Bank's office network includes fourteen full service in-store supermarket branch
offices. The Bank has ATMs in all but one of its facilities and also maintains
six off-site ATMs.
NOTE B - BASIS OF CONSOLIDATION
The accompanying consolidated financial statements were prepared in accordance
with instructions to Form 10-Q, and therefore, do not include information or
footnotes necessary for a complete presentation of financial position, results
of operations and cash flows in conformity with generally accepted accounting
principles ("GAAP"). However, all normal, recurring adjustments that, in the
opinion of management, are necessary for a fair presentation of these financial
statements have been included. These financial statements should be read in
conjunction with the audited financial statements and the notes thereto for the
Company for the year ended December 31, 2003, which are included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003. The
results for the interim period presented are not necessarily indicative of the
results that may be expected for the year ending December 31, 2004.
The financial information presented herein is unaudited; however, in the opinion
of management, all adjustments (which include normal recurring adjustments)
necessary to present fairly the unaudited financial information have been made.
The Company has prepared its accompanying consolidated financial statements in
accordance with GAAP as applicable to the banking industry. Certain amounts in
prior years are reclassified for comparability to the current year's
presentation. Such reclassifications, when applicable have no effect on net
income. The consolidated financial statements include the balances of the
Company and its wholly owned subsidiaries. All material intercompany balances
and transactions have been eliminated in consolidation. References to the
Company include the Bank unless otherwise noted.
In preparing the consolidated financial statements, the Company is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the statement of financial condition and revenue
and expense for the period. Actual results could differ significantly from those
estimates. A material estimate that is particularly susceptible to significant
changes in the near-term is the determination of the allowance for loan losses.
In addition to the Bank, KNBT's subsidiaries include KNBT Inv. I, founded in
December 2003, and two subsidiaries, acquired in October 2003 as a part of the
acquisition of First Colonial, KNBT Inv. II and First Colonial Statutory Trust
I. The Bank has two wholly owned subsidiaries KLV, Inc., which is inactive, and
KLVI, Inc. The Bank is the majority owner of Traditions Settlement Services,
LLC.
6
NOTE C - CONVERSION AND ACQUISITION
The mutual-to-stock conversion of Keystone Savings Bank coincided with the
completion of the initial public offering of KNBT Bancorp, Inc. KNBT sold
approximately 20.2 million shares of its common stock for aggregate proceeds of
$202.0 million to subscribers in its offering, contributed approximately 1.6
million shares of common stock to the Keystone Nazareth Charitable Foundation
and issued, as discussed below, approximately 8.5 million shares to former
shareholders of First Colonial in exchange for their First Colonial shares.
On October 31, 2003, KNBT and the Bank completed mergers with First Colonial 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. First Colonial stock options outstanding at the date of its
acquisition were converted into 808,157 options to purchase KNBT common stock
and were fully vested at the time of the merger. The transaction was accounted
for under the purchase method of accounting. The acquisition resulted in the
recording of approximately $45.9 million of goodwill and other intangible
assets. KNBT's financial position and results of operations at and for the three
and six months ended June 30, 2003 do not include First Colonial because the
acquisition was not completed until October 31, 2003.
7
NOTE D - EARNINGS PER SHARE
The Company calculates earnings per share as provided by the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share (SFAS
128)". Basic and diluted earnings per share for the three and six months ended
June 30, 2004 were calculated as follows:
For the Three Months Ended June 30, 2004
Net Average
Income Shares Per Share
(numerator) (denominator) Amount
------------------------------------------
(dollars in thousands)
Basic Earnings Per Share
Income Available to Common Shareholders $ 4,308 29,232,941 $ 0.15
Effect of Dilutive Securities
Stock Options 412,754
Management Recognition and Retention Plan 9,568
------------ --------
Total Effect of Dilutive Securities 422,322 $ --
Diluted Earnings Per Share
Income Available to Common Shareholders
plus Assumed Exercise of Options $ 4,308 29,655,263 $ 0.15
============ ============ ========
- ------------------------------------------------------------------------------------------------
For the Six Months Ended June 30, 2004
Net Average
Income Shares Per Share
(numerator) (denominator) Amount
------------------------------------------
(dollars in thousands)
Basic Earnings Per Share
Income Available to Common Shareholders $ 8,423 29,394,090 $ 0.29
Effect of Dilutive Securities
Stock Options 509,844
Management Recognition and Retention Plan 28,533
------------ --------
Total Effect of Dilutive Securities 538,377 $ (0.01)
Diluted Earnings Per Share
Income Available to Common Shareholders
plus Assumed Exercise of Options $ 8,423 29,932,467 $ 0.28
============ ============ ========
- ------------------------------------------------------------------------------------------------
KNBT had 1,132,000 options that were outstanding for the period May 6, 2004
(date of grant) through June 30, 2004. These options were not included in the
computation of diluted earnings per share for the three months ended June 30,
2004, because the option exercise price was greater than the average market
price.
Common Stock outstanding at June 30, 2004 for basic earnings per share
calculations does not include 916,321 unallocated shares held by the Employee
Stock Ownership Plan ("ESOP").
Unearned Management Recognition and Retention Plan ("MRRP") and MRRP shares not
committed to be released are not considered to be outstanding for basic earnings
per share calculations. At June 30, 2004, unearned shares totaled 638,000 and
uncommitted shares totaled 170,047.
8
Earnings per shares are presented only for the three and six-month periods ended
June 30, 2004. KNBT had no shares outstanding in the first quarter of 2003, as
KNBT did not complete its initial public offering until October 31, 2003.
NOTE E - INVESTMENT SECURITIES
The amortized cost, unrealized gains and losses and fair value of KNBT's
investment securities held-to-maturity and available-for-sale at June 30, 2004
(unaudited) and available-for-sale at December 31, 2003 are as follows:
Investment Securities
June 30, 2004 (unaudited)
- --------------------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses Value
-------- -------- -------- --------
Held-to-Maturity: (in thousands)
Obligations of states and political
subdivisions $ 5,517 $ 7 $ (36) $ 5,488
Mortgaged-backed securities
FNMA 27,394 62 (7) 27,449
Other CMO's 26,840 85 -- 26,925
-------- -------- -------- --------
Total mortgage-backed 54,234 147 (7) 54,374
Total Held-to-Maturity $ 59,751 $ 154 $ (43) $ 59,862
======== ======== ======== ========
- ------------------------------------------------------------------------------------
Available-for-sale:
U.S. Government and agencies $143,652 $ 629 $ (978) $143,303
Obligations of states and political
subdivisions 106,582 1,944 (1,486) 107,040
Asset-managed funds 4,904 -- (88) 4,816
Federated Liquid Cash Trust 35 -- -- 35
Mortgaged-backed securities
GNMA 1,796 7 (21) 1,782
FHLMC 95,512 1,155 (1,053) 95,614
FNMA 325,541 1,619 (2,468) 324,692
Other CMO's 190,475 183 (2,480) 188,178
-------- -------- -------- --------
Total mortgage-backed 613,324 2,964 (6,022) 610,266
Corporate and other debt securities 11,045 307 -- 11,352
Equity Securities 13,673 380 (378) 13,675
-------- -------- -------- --------
Total Available-for-Sale $893,215 $ 6,224 $ (8,952) $890,487
======== ======== ======== ========
- --------------------------------------------------------------------------------------
9
At December 31, 2003
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------
Available-for-Sale: (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
Mortgage-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
======== ======== ======== ========
- ------------------------------------------------------------------------------------------
NOTE F - STOCK BASED COMPENSATION
Stock Option Plans
- ------------------
KNBT maintains the 2004 Stock Option Plan adopted by its stockholders at the
2004 annual meeting, as well as the stock option plans previously maintained by
First Colonial acquired as a part of the acquisition of First Colonial in
October 2003. KNBT's stock option plans are accounted for under Statement of
Financial Accounting Standards No. 123 (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. The Company has
elected to account for options, except as discussed below, in accordance with
APB Opinion No. 25.
The Company accounts for stock-based compensation on awards granted pursuant to
the former First Colonial option plans and to directors, officers and employees
under KNBT's 2004 Stock Option Plan using the intrinsic value method, except as
discussed below. Since each option granted had an exercise price per share equal
to the fair market value of one share of the Company's stock on the date of the
grant, no compensation cost at date of grant has been recognized.
10
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS No. 123
to stock-based employee compensation. The results are not necessarily indicative
of results that may be expected for the year ended December 31, 2004.
Six Months Ended
June 30, 2004
- ---------------------------------------------------------------------------
(dollars in thousands,
except per share data)
Net income
As reported $ 8,423
Add: Stock-based employee compensation expense
included in reported net income, net
of related tax effets 4
Less: Stock-based compensation cost determined
under fair value method for all awards, net
of related tax effects (92)
--------------
Proforma $ 8,335
==============
Earnings per share (Diluted)
As reported 0.28
Proforma 0.28
Earnings per share (Basic)
As reported 0.29
Proforma 0.28
- ---------------------------------------------------------------------------
The weighted average fair value of each option grant, of the 2004 Stock Option
Plan, is $4.69. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes options pricing model with the following
assumptions used for the Company's 2004 Stock Option Plan: dividend yield of
2.0%; expected volatility of 25.0%; weighted average risk-free interest rate of
3.91%; and weighted average expected life of 6.67 years.
In May 2004, the Company granted 22,500 options to purchase shares of the
Company's common stock at $16.50 to KNBT's advisory directors. The Company will
recognize compensation expense in accordance with the fair value-based method of
accounting described in SFAS No. 123. The fair value of each option is expensed
over its vesting period. Compensation expense of $4,000 was recognized during
the three and six months ended June 30, 2004 for options granted to advisory
directors.
On March 31, 2004, the Financial Accounting Standards Board ("FASB") issued a
proposed Statement, "Share-Based Payment an Amendment of FASB Statements No. 123
and No 95," that addresses the accounting for share-based payment transactions
in which an enterprise receives employee services in exchange for (a) equity
instruments of the enterprise or (b) liabilities that are based on the fair
value of the enterprise's equity instruments or that may be settled by the
issuance of such equity instruments. Under the FASB's proposal, all forms of
share-based payments to employees, including employee stock options, would be
treated the same as other forms of compensation by recognizing the related cost
in the income statement. The expense of the award would generally be measured at
fair value at the grant date. Current accounting guidance requires that the
expense relating to so-called fixed plan employee stock options only
11
be disclosed in the footnotes to the financial statements. The proposed
Statement would eliminate the ability to account for share-based compensation
transactions using APB Opinion No. 25, "Accounting for Stock Issued to
Employees". KNBT is currently evaluating this proposed statement and its effects
on its results of operations.
Management Recognition and Retention Plan
- -----------------------------------------
The MRRP, which is a stock-based incentive plan, provides for 808,047 shares of
the Company's common stock, subject to adjustment, which may be granted as
restricted shares to the Company's directors, advisory directors, officers and
employees. Shares awarded by the MRRP are earned by the participants at the rate
of 20% per year. On May 6, 2004, 638,000 restricted shares had been awarded and
170,047 are available for future grants. Compensation expense for this plan is
being recorded over the vested period or a 60-month period and is based on the
market value of the Company's stock as of the date the awards were made. The
Company, for the benefit of the MRRP Trust, purchased 808,047 shares of KNBT
common stock at an average price of $16.44 per share, which is shown as
reduction of additional paid-in-capital. The remaining unamortized cost of the
MRRP shares acquired to date is reflected as a reduction in shareholders'
equity. Expense under this plan for the three and six months ended June 30, 2004
was $355,300.
NOTE G - LOANS
A summary of KNBT's loans receivable at June 30, 2004 and December 31, 2003 is
as follows:
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
--------- ---------
(unaudited)
(in thousands)
Real Estate
Residential $ 340,350 $ 346,221
Construction 99,182 112,684
Commercial 220,647 156,563
--------- ---------
Total real estate 660,179 615,468
Consumer loans 281,427 265,541
Commercial (non real estate) 43,586 38,978
States and political subdivisions 1,302 2,334
--------- ---------
Total gross loans 986,494 922,321
Less:
Mortgage loans held-for-sale (1,532) (4,677)
Loans in process (8,561) (27,099)
Deferred fees (costs) (331) (469)
--------- ---------
Total loans 976,070 890,076
Less: Allowance for loan losses (9,519) (7,910)
--------- ---------
Total net loans $ 966,551 $ 882,166
========= =========
- --------------------------------------------------------------------------------
12
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 other real
estate owned at June 30, 2004 (unaudited) and December 31, 2003.
- ---------------------------------------------------------------------------------------
At June 30, At December 31,
2004 2003
----------- --------------
(unaudited)
(in thousands)
Non-accrual loans $ 4,020 $ 1,720
Accruing loans 90 days or more past due 654 405
------- -------
Total non-performing loans 4,674 2,125
------- -------
Other real estate owned 201 173
------- -------
Total non-performing assets $ 4,875 $ 2,298
======= =======
- ---------------------------------------------------------------------------------------
Total non-performing loans as a percentage of loans, net 0.48% 0.24%
Total non-performing loans as a percentage of total assets 0.21% 0.11%
Total non-performing assets as a percentage of total assets 0.22% 0.12%
- ---------------------------------------------------------------------------------------
Interest on non-accrual loans which would have been
recorded at the original rate $ 59 $ 50
Interest on non-accrual loans that was reflected in income -- 60
------- -------
Net (decrease) increase on interest income $ (59) $ 10
======= =======
- ---------------------------------------------------------------------------------------
KNBT's recorded investment in impaired loans was $844,000 at June 30, 2004 and
$217,000 at December 31, 2003. The valuation allowance for loan losses related
to impaired loans is a part of the allowance for loan losses and was $111,000 at
June 30, 2004 and $33,000 at December 31, 2003. The average impaired loan
balance for the six months ended June 30, 2004 was $420,000. During the quarter
ended June 30, 2004, we received principal payments of $11,000 on impaired
loans, which payments are recognized on a cash basis. We recognized no income on
impaired loans in the six-month period ended June 30, 2004. There were no
principal payments and no income recognized on impaired loans in the second
quarter of 2003.
The following table shows the activity in KNBT's allowance for loan losses
during the periods indicated:
- -------------------------------------------------------------------------------------------------------------------------
At or for the At or for the
Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(unaudited) (unaudited)
(in thousands) (in thousands)
Balance, beginning of period $ 9,000 $ 2,689 $ 7,910 $ 2,927
Provision charged to operations 971 326 2,471 388
Loans charged-off (566) (212) (1,058) (524)
Recoveries of loans previously charged-off 114 11 196 23
------------- ------------- ------------- -------------
Balance, end of period $ 9,519 $ 2,814 $ 9,519 $ 2,814
============= ============= ============= =============
- -------------------------------------------------------------------------------------------------------------------------
13
NOTE H - RETIREMENT PLANS
1. Defined Benefit Plan. KNBT participates in a multiple employer defined
benefit pension plan, which covers substantially all employees with 1,000
hours of service during plan years prior to October 2003. In October 2003,
KNBT froze the future accrual of benefits under this plan. KNBT continues
to contribute to this plan for benefits accrued prior to October 2003.
KNBT's contribution to this plan in the six months ended June 30, 2004 was
$131,000. During the six months ended June 30, 2003 the contribution to
this plan amounted to $429,000. KNBT currently expects to contribute
approximately $88,000 to this plan during the remainder of 2004.
2. Directors' Deferred Plan. KNBT, as a part of the merger with First
Colonial, assumed, as of October 31, 2003, the First Colonial directors'
deferred plan involving certain former directors of First Colonial. The
plan requires defined annual payments over a fifteen-year period beginning
at age 65. The net periodic defined benefit expense for the six months
ended June 30, 2004 was as follows.
- ---------------------------------------------------------------------------
(dollars in thousands)
Service cost $ -
Interest cost 13
Expected return on plan assets -
Amortization of unrecognized net
transition asset or obligation -
Amortization of Unrecognized Prior Service Cost -
Amortization of Unrecognized Net Gain or Loss -
------------
Total Net Periodic Pension Cost for the Quarter $ 13
============
- ---------------------------------------------------------------------------
KNBT currently expects to contribute a total of approximately $22,000 to
this plan in the year ended December 31, 2004. We are currently evaluating
the impact on the Company of the Pension Funding Equity Act enacted in
April 2004 on our projected funding.
NOTE I - VARIABLE INTEREST ENTITY
Management has determined that The First Colonial Statutory Trust I ("Trust I"),
which was created by First Colonial and acquired by KNBT in the merger with
First Colonial, qualifies as a variable interest entity under FASB
Interpretation 46 ("FIN 46"), "Consolidation of Variable Interest Entities," as
revised. Trust I issued mandatorily redeemable preferred stock in July 2002 to
investors and loaned the proceeds to the Company. Trust I is included in KNBT's
consolidated balance sheet and statements of operations as of and for the year
ended December 31, 2003. Subsequent to the issuance of FIN 46 in January 2003,
the FASB issued a revised interpretation, FIN 46(R), the provisions of which
must be applied to certain variable interest entities by March 31, 2004.
KNBT adopted the provisions under the revised interpretation in the first
quarter of 2004. Accordingly, KNBT no longer consolidates 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 Trust
I's expected residual returns. The deconsolidation resulted in the investment in
the common stock of Trust I to be included in other assets as of March 31, 2004
and June 30, 2004 and the corresponding increase in outstanding debt of
$464,000. In addition, the income received on KNBT's common stock investment is
included in other income. The adoption of FIN 46(R) had no material impact on
the financial position or results of operation. The banking regulatory agencies
have issued no guidance that would change the regulatory capital treatment for
the trust-preferred securities issued by Trust I based on the adoption of FIN
46(R). The Federal Reserve has issued proposed guidance on the regulatory
capital treatment for the trust-preferred securities issued by KNBT as a result
of the adoption of FIN 46(R). The proposed rule
14
would retain the current maximum percentage of total capital permitted for trust
preferred securities at 25%, but would enact other changes to the rules
governing trust preferred securities that affect their use as part of the
collection of entities known as "restricted core capital elements". The rule
would take effect March 31, 2007; however, a three-year transition period
starting now and leading up to that date would allow bank holding companies to
continue to count trust preferred securities as Tier I Capital after applying
FIN-46(R). Management has evaluated the effects of the proposed rule and does
not anticipate a material impact on its capital ratios when the proposed rule is
finalized.
NOTE J - NEW ACCOUNTING PRONOUNCEMENTS
The Securities and Exchange Commission recently released Staff Accounting
Bulletin ("SAB") 105, Application of Accounting Principles to Loan Commitments.
SAB 105 provides guidance regarding the measurement of loan commitments
recognized at fair value under FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SAB 105 also requires companies
to disclose their accounting policy for those loan commitments including methods
and assumptions used to estimate fair value and associated hedging strategies.
SAB 105 is effective for all loan commitments accounted for as derivatives that
are entered into after March 31, 2004. The adoption of SAB 105 had no material
effect on KNBT's consolidated financial statements.
In November 2003, the Emerging Issues Task Force (EITF) of the FASB issued EITF
Abstract 03-1, The meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments (EITF 03-1). The quantitative and qualitative
disclosure provisions of EITF 03-1 were effective for years ending after
December 15, 2003 and were included in the Company's 2003 Form 10-K. In March
2004, the EITF issued a Consensus on Issue 03-1 requiring that the provisions of
EITF 03-1 be applied for reporting periods beginning after June 15, 2004 to
investments accounted for under SFAS No. 115 and 124, EITF 03-1 establishes a
three-step approach for determining whether an investment is considered
impaired, whether that impairment is other-than-temporary, and the measurement
of an impairment loss. The Company is in the process of determining the impact
that this EITF will have on its financial statements.
NOTE K - RECLASSIFICATIONS
Certain reclassifications of prior years' amounts have been made to conform to
the June 30, 2004 presentation.
15
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION
In addition to historical information, this Quarterly Report on Form 10-Q
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, 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.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of KNBT conform to accounting principles
generally accepted in the United States of America and general practices within
the financial services industry. The preparation of financial statements
requires management to make estimates and 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
all known and inherent losses in the loan portfolio, which are both probable and
reasonably estimable. 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.
16
Goodwill, under SFAS No. 142, is subject to impairment testing at least annually
to determine whether write-downs of the recorded balances are necessary. KNBT
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 KNBT's books to write down the related goodwill to the proper
carrying value. KNBT recorded goodwill and other identifiable intangible assets
as a result of the acquisition of First Colonial in October 2003.
Comparison of Financial Condition as of June 30, 2004 and December 31, 2003
Assets. KNBT's total assets were $2.2 billion at June 30, 2004 as compared to
$1.9 billion at December 31, 2003, an increase of $242.7 million or 12.5%. The
increase in assets was principally due to increases in investment securities,
loans receivable, Federal Home Loan Bank stock and premises and equipment. These
increases were offset in part by a reduction in cash and cash equivalents and an
increase in the allowance for loan losses. During the first six months of 2004,
KNBT's investment securities increased $216.2 million or 29.4% to $950.2 million
at June 30, 2004 compared to $734.1 million at December 31, 2003. The primary
source of funds used for the increase in investment securities were additional
advances from the Federal Home Loan Bank of Pittsburgh ("FHLB"). KNBT's total
loans receivable were $976.1 million at June 30, 2004, an increase of $86.0
million or 9.7% over the December 31, 2003 total of $890.1 million. The growth
in loans receivable was principally due to a $64.1 million or 40.9% increase in
commercial real estate loans, a $4.6 million or 11.8% in other commercial loans
and a $15.9 million or 6.0% increase in consumer loans. These loan increases
were offset in part by a $5.9 million or 1.7% decrease in single-family
residential mortgage loans. The decrease in single-family residential mortgage
loans was a result of a $16.5 million sale of these loans during the six- month
period ended June 30, 2004, customer repayments and a reduced level of new
mortgage loans because of rising interest rates. Construction loans decreased
$13.5 million or 12.0% during the six months ended June 30, 2004. We believe
that rising interest rates reduced the level of activity in this category.
During the first quarter of 2004, KNBT sold $1.8 million of its credit card
portfolio for a gain of $298,000. These credit card loans were sold because of
the relatively low volume and high administrative costs. KNBT will continue to
offer credit cards to its customers through a third party provider and will
receive fee income through this arrangement. KNBT's investment in the stock of
the FHLB was $23.7 million at June 30, 2004 as compared to $11.5 million at
December 31, 2003. This was an increase of $12.2 million or 105.7% for the
period. Net premises and equipment increased by $5.4 million or 15.2% to $41.3
million at June 30, 2004 compared to $35.9 million at December 31, 2003
principally as a result of the purchase of new computer equipment and the cost
of renovations to the Company's headquarters and operations buildings. At June
30, 2004, such renovations were substantially complete. KNBT's cash and cash
equivalents were $62.2 million at June 30, 2004 as compared to $139.0 million at
December 31, 2003. This decrease of $76.8 million or 55.2% was principally the
result of the investment of these funds in investment securities and loans
receivable.
17
Allowance for Loan Losses. KNBT's allowance for loan losses increased $1.6
million or 20.3% during the first six months of 2004. The allowance for loan
losses was $9.5 million and $7.9 million at June 30, 2004 and December 31, 2003,
respectively. The increase in the allowance for loan losses was based upon
management's analysis of the inherent loss in the loan portfolio. 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 that 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 economic conditions and industry experience. In
addition, in establishing the allowance for loan losses, 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. 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
the Company to make additional provisions for estimated loan losses based upon
judgments different from those of management. KNBT's allowance for loan losses
was 0.98% and 0.89% of total loans receivable at June 30, 2004 and December 31,
2003, respectively. See "Comparison of Operating Results for the six months
ended June 30, 2004 and 2003 - Provision for Loan Losses."
Liabilities. KNBT's total liabilities amounted to $1.8 billion at June 30, 2004,
an increase of $255.6 million or 16.5% compared to total liabilities at December
31, 2003 of $1.6 billion. The increase in liabilities was principally due to a
$226.3 million or 109.2% increase in advances from the FHLB during the first
half of 2004. These advances totaled $433.4 million and $207.2 million at June
30, 2004 and December 31, 2003, respectively. KNBT's deposits increased $21.6
million or 1.7% during the six-month period ended June 30, 2004. Deposits
totaled $1.3 billion at both June 30, 2004 and December 31, 2003. At March 31,
2004, KNBT adopted FIN 46(R) and, as a result, KNBT deconsolidated Trust I. The
$15.5 million of debentures issued by KNBT to Trust I were reflected as other
debt in the June 30, 2004 consolidated balance sheet. KNBT's investment in the
Trust in the amount of $464,000 was included in other assets in the consolidated
balance sheet of KNBT at June 30, 2004. At December 31, 2003 Trust I was a
consolidated subsidiary and was included in liabilities in the consolidated
balance sheet as "Guaranteed preferred beneficial interest in the Company's
subordinated debentures" and the common stock and the debentures of Trust I
along with the related income effects were eliminated in the consolidated
financial statements. The debentures issued to Trust I, less the common stock of
Trust I, or $15.0 million at June 30, 2004 continue to qualify as Tier I capital
under current guidance issued by the Federal Reserve Board.
Shareholders' Equity. Shareholders' equity totaled $376.2 million at June 30,
2004 compared to $389.1 million at December 31, 2003, a decrease of $12.9
million or 3.3%. The decrease in shareholders' equity was principally the result
of the purchase of 808,047 shares of the Company's stock to fund the shareholder
approved 2004 Management Recognition and Retention Plan (MRRP) at an average
cost of $16.44 per share. KNBT also declared and paid its first cash dividend of
$.05 per share during the quarter ended June 30, 2004. This resulted in a
decrease in retained earnings of $1.5 million. Another factor contributing to
the decrease in shareholders' equity was a decrease in accumulated other
comprehensive income of $8.1 million relating to a decrease in unrealized gains
on investment securities available-for-sale. We had $8.4 million in net income
for the six months ended June 30, 2004 that partially offset the impact of the
funding of the MRRP.
18
KNBT committed to release 23,801 shares of the Company's common stock during the
six months ended June 30, 2004 pursuant to the ESOP for a value of $402,000 and
issued 158,691 common shares upon the exercise of stock options for proceeds of
$834,000. Regulatory capital ratios for KNBT and the Bank at June 30, 2004 and
December 31, 2003 are shown in the following tables.
CAPITAL RATIOS
- -------------------------------------------------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------- --------------------------- -----------------------------
(Dollars in Thousands)
At June 30, 2004 Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------------
Total Capital
(To Risk-Weighted Assets)
Company $ 357,950 29.96% $ 95,587 8.00% N/A N/A
Bank $ 253,473 21.41% $ 94,702 8.00% $ 118,377 10.00%
Tier 1 Capital
(To Risk-Weighted Assets)
Company $ 348,431 29.16% $ 47,794 4.00% N/A N/A
Bank $ 243,954 20.61% $ 47,351 4.00% $ 71,026 6.00%
Tier 1 Capital
(To Average Assets, Leverage)
Company $ 348,431 17.21% $ 81,005 4.00% N/A N/A
Bank $ 243,954 12.54% $ 77,829 4.00% $ 97,287 5.00%
- -------------------------------------------------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------- --------------------------- -----------------------------
(Dollars in Thousands)
At December 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------------------
Total Capital
(To Risk-Weighted Assets)
Company $ 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 1 Capital
(To Risk-Weighted Assets)
Company $ 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 1 Capital
(To Average Assets, Leverage)
Company $ 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%
- -------------------------------------------------------------------------------------------------------------------------------
19
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 FHLB, 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 $288.5
million and $104.6 million for the six months ended June 30, 2004 and June 30,
2003, respectively.
"GAP" Analysis. The following interest rate sensitivity "GAP" table sets forth
the amounts of KNBT's interest-earning assets and interest-bearing liabilities
outstanding at June 30, 2004, which are expected, based upon certain
assumptions, to reprice or mature in each of the future time periods shown.
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 June 30, 2004, 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 38%, 8% and 3%, respectively.
20
INTEREST RATE SENSITIVITY "GAP"
- ------------------------------------------------------------------------------------------------------------------------------------
At June 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
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 $ 18,631 $ -- $ -- $ -- $ -- $ -- $ 18,631
Loans receivable (2) 162,921 42,349 77,276 209,147 244,777 250,024 986,494
Investment securities, debt 27,979 36,856 56,042 288,609 215,766 311,311 936,563
Investment securities, equity -- -- -- -- -- 37,421 37,421
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning
assets $ 209,531 $ 79,205 $ 133,318 $ 497,756 $ 460,543 $ 598,756 $1,979,109
========== ========== ========== ========== ========== ========== ==========
Cumulative total interest-
earning assets $ 209,531 $ 288,736 $ 422,054 $ 919,810 $1,380,353 $1,979,109 $1,979,109
========== ========== ========== ========== ========== ========== ==========
Interest-bearing
liabilities:
Savings deposits $ -- $ 8,910 $ 8,910 $ 11,880 $ 14,850 $ 178,204 $ 222,754
Interest-bearing
checking deposits -- -- -- 6,860 3,430 161,216 171,506
Money market deposits 33,843 39,049 26,033 34,711 17,355 109,338 260,329
Certificates of deposit 94,515 70,662 141,323 179,640 25,486 20,311 531,937
FHLB advances and other
borrowings 42,708 15,632 38,314 153,858 137,059 92,397 479,968
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing
liabilities $ 171,066 $ 134,253 $ 214,580 $ 386,949 $ 198,180 $ 561,466 $1,666,494
========== ========== ========== ========== ========== ========== ==========
Cumulative total interest-
bearing liabilities $ 171,066 $ 305,319 $ 519,899 $ 906,848 $1,105,028 $1,666,494 $1,666,494
========== ========== ========== ========== ========== ========== ==========
Interest-earning assets
less interest-bearing
liabilities $ 38,465 $ (55,048) $ (81,262) $ 110,807 $ 262,363 $ 37,290 $ 312,615
========== ========== ========== ========== ========== ========== ==========
Cumulative interest-rate
sensitivity gap (3) $ 38,465 $ (16,583) $ (97,845) $ 12,962 $ 275,325 $ 312,615
========== ========== ========== ========== ========== ==========
Cumulative interest-rate
gap as a percentage
of total assets at
June 30, 2004 1.76% -0.76% -4.48% 0.59% 12.60% 14.31%
Cumulative interest
earning assets as a
percentage of
cumulative interest-
bearing liabilities at
June 30, 2004 122.49% 94.57% 81.18% 101.43% 124.92% 118.76%
- ------------------------------------------------------------------------------------------------------------------------------------
(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 maturity.
(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.
21
Comparison of Operating Results for the Three and Six Months Ended June 30, 2004
and 2003
General. KNBT's net income increased by $1.7 million, or 64.1% to $4.3 million
for the three months ended June 30, 2004 compared to $2.6 million for the three
months ended June 30, 2003. For the six months ended June 30, 2004, net income
increased $2.8 million, or 51.1% to $8.4 million compared to $5.6 million for
the same period in 2003. Net income increased during 2004 due to higher levels
of net interest income and non-interest income. This increase was partially
offset by increases in non-interest expenses and the provision for loan loss.
The increase in net interest income primarily reflects increased interest income
in the 2004 periods due to a significant increase in the average balance of
interest-earning assets as a result of the use of $196.2 million in net proceeds
received in the Company's initial public offering in October 2003, the
acquisition of First Colonial, also in October 2003 and the investment of funds
received from Federal Home Loan Bank advances as part of the our leverage
strategy. At the time of acquisition, First Colonial had total assets of $666.9
million. Including $272.3 million in net loans and $271.8 million in investment
securities, and total deposits of $512.1 million.
Net Interest Income. KNBT`s net interest income for the three months ended June
30, 2004 was $15.9 million, a $7.3 million, or 84.9% increase when compared to
$8.6 million for the three months ended June 30, 2003. For the six months ended
June 30, 2004, net interest income was $31.4 million, a $13.9 million or 80.0%
increase when compared to $17.4 million for the six months ended June 30, 2003.
The major factors in the increases in both interest income and interest expense
were the increased average balances of interest-earning assets and
interest-bearing liabilities due to the acquisition of First Colonial on October
31, 2003, the use of proceeds from KNBT's initial public offering, on October
31, 2003 and an increase in FHLB advances which were used to fund the increase
in the investment portfolio. KNBT's average interest earning assets totaled $1.9
billion for the three months ended June 30, 2004 as compared to $973.9 million
for the three months ended June 30, 2003. Average interest earning assets for
the six-month period ended June 30, 2004 were $1.8 billion as compared to $966.2
million for the six-month period ended June 30, 2003. Total interest income was
$23.2 million for the second quarter of 2004, a $9.6 million or 70.8% increase
when compared to the $13.6 million in total interest income during the second
quarter of 2003. For the six months ended June 30, 2004, total interest income
was $45.5 million, a $17.8 million or 64.3% increase when compared to the same
period in 2003. Average interest- bearing liabilities were $1.6 billion for the
three months ended June 2004 compared to $876.0 million for the three months
ended June 30, 2004. For the six months ended June 30, 2004 and 2003, average
interest-bearing liabilities were $1.5 billion and $865.9 million, respectively.
Total interest expense was $7.3 million for the second quarter of 2004, a $2.3
million or 46.6% increase when compared to the $5.0 million in total interest
expense during the second quarter of 2003. For the six months ended June 30,
2004, total interest expense was $14.2 million, a $3.9 million or 37.9% increase
when compared to the same period in 2003. Our net interest margin on a tax
equivalent basis was 3.56% and 3.62% for the three and six months, respectively,
ended June 30, 2004 compared to 3.66% and 3.73% for the prior year comparable
periods. Net interest spread on a tax equivalent basis was 3.26% and 3.31% for
the three and six months, respectively, ended June 30, 2004 versus 3.43% and
3.49% for the prior year comparable period. The lower interest margin and
interest spread in the 2004 periods was the result of the decline of interest
rates during the past year with the average yield earned on our interest-earning
assets declining to a greater degree than the average interest we paid our
interest-bearing liabilities.
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-earning 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 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
common 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.
22
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Comparative Statement Analysis
(Dollars in Thousands) For the Three Months Ended June 30,
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003
-------------------------------------------- ------------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
-------------------------------------------- ------------------------------------------
Assets
Interest-Earning Assets
Interest-Bearing Balances with Banks $ 31,649 $ 136 1.72% $ 45,347 $ 110 0.97%
Investment Securities
Taxable (1) 768,551 7,393 3.85% 335,393 3,334 3.98%
Non-Taxable (2) 110,002 1,798 6.54% 52,389 921 7.03%
Loans Receivable (2) (3) 951,846 14,488 6.09% 543,492 9,526 7.01%
Allowance for Loan Losses (9,124) - - (2,672) - -
------------ ------------ ------------- -------------
Net Loans 942,722 14,730 6.25% 540,820 9,526 7.05%
------------ ------------ ------------- -------------
Total Interest-Earning Assets 1,852,924 23,815 5.14% 973,949 13,891 5.71%
Non-Interest-Earning Assets 217,296 - - 68,686 - -
------------ ------------ ------------- -------------
Total Assets,
Interest Income $ 2,070,220 23,815 $ 1,042,635 13,891
------------ ------------ ------------- -------------
Liabilities
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand Deposits $ 171,152 $ 68 0.16% $ 91,649 $ 67 0.29%
Money Market Deposits 254,073 570 0.90% 160,210 528 1.32%
Savings Deposits 226,276 273 0.48% 125,966 289 0.92%
Certificates of Deposit 533,766 3,446 2.58% 383,109 2,925 3.05%
------------ ------------ ------------- -------------
Total interest-Bearing Deposits 1,185,267 4,357 1.47% 760,934 3,809 2.00%
Securities Sold Under Agreements
to Repurchase 24,127 42 0.70% 8,813 27 1.23%
FHLB Advances 328,562 2,740 3.34% 106,290 1,155 4.35%
Other Debt 15,464 179 4.63% - -
------------ ------------ ------------- -------------
Total Interest-Bearing Liabilities 1,553,420 7,318 1.88% 876,037 4,991 2.28%
Non-Interest-Bearing Liabilities
Non-Interest-Bearing Deposits 117,570 - - 40,538 - -
Other Liabilities 12,964 - - 9,045 - -
------------ ------------ ------------- -------------
Total Liabilities 1,683,954 7,318 925,620 4,991
Shareholders' Equity /
Retained Earnings 386,266 - - 117,015 - -
------------ ------------ ------------- -------------
Total Liabilities and Shareholders'
Equity, Interest Expense $ 2,070,220 7,318 $ 1,042,635 4,991
------------ ------------ ------------- -------------
Net Interest Income Tax Equivalent Basis $ 16,497 $ 8,900
------------ -------------
Net Interest Spread (4)
Tax Equivalent Basis 3.26% 3.43%
Effect of Interest-Free Sources
Used to Fund Earning Assets 0.30% 0.23%
---------------- --------------
Net Interest Marginn (5)
Tax Equivalent Basis 3.56% 3.66%
---------------- --------------
Tax-Exempt Adjustment 620 313
------------ -------------
Net Interest Income and Margin $ 15,877 3.43% $ 8,587 3.53%
============ ================ ============= ==============
Average Interest-Earning Assets
to Average Interest-Bearing Liabilities 119.28% 111.18%
---------------- --------------
- ------------------------------------------------------------------------------------------------------------------------------------
(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 $620,000 and $313,000 for the three months ended June 30,
2004 and June 30, 2003, respectively. The effective tax rate used for
the taxable equivalent adjustment was 34%.
(3) Loan fees of $741,000 and $507,000 for the three months ended June 30,
2004 and June 30, 2003, respectively, are included in interest income.
Average loan balances include non-accruing loans of $3,351,000 and
$1,117,000 and average loans held-for-sale of $3,735,000 and
$4,076,000 for the three months ended June 30, 2004 and June 30, 2003,
respectively.
(4) Net interest spread is the arithmatic difference between yield on
interest-earning assets and the rate paid on interest-bearing
liabilities.
(5) Net interest margin is computed by dividing net interest income by
average interest-earning assets.
23
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Comparative Statement Analysis
(Dollars in Thousands) For the Six Months Ended June 30,
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003
---------------------------------------- --------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
---------------------------------------- --------------------------------------
Assets
Interest-Earning Assets
Interest-Bearing Balances with Banks $ 34,020 $ 278 1.63% $ 50,062 $ 243 0.97%
Investment Securities
Taxable (1) 735,237 14,264 3.88% 308,092 6,632 4.31%
Non-Taxable (2) 111,793 3,685 6.59% 49,890 1,792 7.19%
Loans Receivable (2) (3) 931,605 28,591 6.14% 560,913 19,659 7.01%
Allowance for Loan Losses (8,601) - - (2,784) - -
------------ ------------ ------------- -------------
Net Loans 923,004 28,833 6.20% 558,129 19,659 7.04%
------------ ------------ ------------- -------------
Total Interest-Earning Assets 1,804,054 46,818 5.19% 966,173 28,326 5.86%
Non-Interest-Earning Assets 220,661 - - 59,460 - -
------------ ------------ ------------- -------------
Total Assets,
Interest Income $ 2,024,715 46,818 $ 1,025,633 28,326
------------ ------------ ------------- -------------
Liabilities
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand Deposits $ 174,626 $ 132 0.15% $ 88,725 $ 179 0.40%
Money Market Deposits 246,224 1,112 0.90% 156,724 1,154 1.47%
Savings Deposits 225,155 536 0.48% 122,285 595 0.97%
Certificates of Deposit 535,151 7,112 2.66% 385,181 6,044 3.14%
------------ ------------ ------------- -------------
Total interest-Bearing Deposits 1,181,156 8,892 1.51% 752,915 7,972 2.12%
Securities Sold Under Agreements
to Repurchase 23,712 77 0.65% 8,346 59 1.41%
FHLB Advances 288,516 4,864 3.37% 104,626 2,263 4.33%
Other Debt 15,464 360 4.66% - -
------------ ------------ ------------- -------------
Total Interest-Bearing Liabilities 1,508,848 14,193 1.88% 865,887 10,294 2.38%
Non-Interest-Bearing Liabilities
Non-Interest-Bearing Deposits 116,748 - - 37,477 - -
Other Liabilities 9,287 - - 7,352 - -
------------ ------------ ------------- -------------
Total Liabilities 1,634,883 14,193 910,716 10,294
Shareholders' Equity /
Retained Earnings 389,832 - - 114,917 - -
------------ ------------ ------------- -------------
Total Liabilities and Shareholders'
Equity, Interest Expense $ 2,024,715 14,193 $ 1,025,633 10,294
------------ ------------ ------------- -------------
Net Interest Income Tax Equivalent Basis $ 32,625 $ 18,032
------------ -------------
Net Interest Spread (4)
Tax Equivalent Basis 3.31% 3.49%
Effect of Interest-Free Sources
Used to Fund Earning Assets 3.10% 2.50%
------------ ----------
Net Interest Margin (5)
Tax Equivalent Basis 3.62% 3.73%
------------ ----------
Tax-Exempt Adjustment 1,272 609
------------ -------------
Net Interest Income and Margin $ 31,353 3.48% $ 17,423 3.61%
============ ============ ============= ==========
Average Interest-Earning Assets
to Average Interest-Bearing Liabilities 119.56% 111.58%
------------ ----------
- ------------------------------------------------------------------------------------------------------------------------------------
(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 $1,272,000 and $609,000 for the six months ended June 30,
2004 and June 30, 2003, respectively. The effective tax rate used for
the taxable equivalent adjustment was 34%.
(3) Loan fees of $465,000 and $890,000 for the six months ended June 30,
2004 and June 30, 2003, respectively, are included in interest income.
Average loan balances include non-accruing loans of $4,020,000 and
$1,588,000 and average loans held-for-sale of $3,544,000 and
$3,451,000 for the six months ended June 30, 2004 and June 30, 2003,
respectively.
(4) Net interest spread is the arithmatic difference between yield on
interest-earning assets and the rate paid on interest-bearing
liabilities.
(5) Net interest margin is computed by dividing net interest income by
average interest-earning assets.
24
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.
RATE / VOLUME ANALYSIS
(Dollars in Thousands)
(Unaudited)
Three Months Ended June 30, 2004 vs. Six Months Ended June 30, 2004 vs.
Three Months Ended June 30, 2003 Six Months Ended June 30, 2003
----------------------------------------- ---------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------- -------------------------------
Total Total
Increase Increase
(Fully Taxable Equivalent) Rate Volume (Decrease) Rate Volume (Decrease)
----------------------------- -------------- ----------------------------- --------------
Interest Income:
Cash and cash equivalents $ 59 $ (33) $ 26 $ 113 $ (78) $ 35
Investment Securities (449) 5,385 4,936 (1,983) 11,508 9,525
Loans receivable, net (2,117) 7,079 4,962 (3,920) 12,852 8,932
------------- ------------- -------------- ------------- ------------- --------------
Total interest-earning assets (2,507) 12,431 9,924 (5,790) 24,282 18,492
Interest expense:
Demand deposits (57) 58 1 (220) 173 (47)
Money market deposits (267) 309 42 (701) 659 (42)
Savings & club deposits (246) 230 (16) (560) 501 (59)
Certificates of deposit (629) 1,150 521 (1,285) 2,353 1,068
------------- ------------- -------------- ------------- ------------- --------------
Total interest-bearing deposits (1,199) 1,747 548 (2,766) 3,686 920
Securities sold under agreements
to repurchase (32) 47 15 (91) 109 18
FHLB advances and other borrowings (830) 2,415 1,585 (1,376) 3,977 2,601
Other debt - 179 179 - 360 360
------------- ------------- -------------- ------------- ------------- --------------
Total interest-bearing liabilities (2,061) 4,388 2,327 (4,233) 8,132 3,899
Increase in Net Interest Income $ (446) $ 8,043 $ 7,597 $ (1,557) $16,150 $ 14,593
------------- ------------- -------------- ------------- ------------- --------------
25
Provision for Loan Losses. KNBT made a provision for loan losses of $971,000 for
the three months ended June 30, 2004 as compared to $326,000 for the three
months ended June 30, 2003. For the six months ended June 30, 2004, our
provision for loan losses was $2.5 million as compared to $388,000 for the same
period in 2003. A primary factor in the increased provision over the comparable
2003 periods was the acquisition of $271.2 million of net loans from the First
Colonial acquisition of which commercial loans totaled $61.5 million. Commercial
loans and commercial real estate loans are deemed to have higher levels of known
and inherent losses than one-four family residential loans due to, among other
things, the nature of the collateral and the dependency on economic conditions
for successful completion or operation of the project. KNBT has made provisions
in order to maintain the allowance for loan losses at a level, we believe, to
the best of our knowledge, covers all known and inherent losses in the portfolio
that are both probable and reasonable to estimate at this time. For the six
months ended June 30, 2004, KNBT charged-off, net of recoveries, $862,000 as
compared to $501,000 for the same period in 2003. Most charge-offs were
primarily related to consumer loans. Non-performing loans totaled $4.7 million,
$2.1 million and $1.6 million at June 30, 2004, December 31, 2003 and June 30,
2003, respectively. The increase in non-performing loans was due to a $1.6
million increase in non-performing single-family residential loans over the
six-month period ending June 30, 2004. Due to the nature of single-family
residential loans, KNBT is well secured and does not anticipate the increase in
this category's non-performing levels to generate above normal charge-offs. At
June 30, 2004, KNBT's allowance for loan losses amounted to 204.6% of
non-performing loans as compared to 372.2% at December 31, 2003. Allowance for
loan losses as a percentage of net loans was .98% and .89% at June 30, 2004 and
December 31, 2003, respectively.
Non-Interest Income. KNBT's non-interest income increased $1.0 million or 43.2%
to $3.4 million for the three months ended June 30, 2004 as compared to $2.4
million for the three months ended June 30, 2003. For the six months ended June
30, 2004, non-interest income totaled $7.4 million, a $2.8 million or 61.6%
increase over the same period in 2003. The increase during the three month
period ended June 30, 2004 over the comparable period in 2003 was primarily the
result of trust revenues from the Company's Trust Department, acquired from
First Colonial, of $372,000; a $313,000 increase in revenue from Bank Owned Life
Insurance (BOLI) income, due to the purchase of an additional $30 million of
insurance in November 2003, and a $213,000 gain on the sale of our former
operations center. The increase for the six month period ended June 30, of 2004
over the comparable period in 2003 was the result of an increase in deposit
service charges of $535,000 due primarily to a larger number of deposit accounts
added as a result of the First Colonial acquisition, a gain of $298,000 on the
sale of our credit card portfolio, Trust Department revenue of $725,000 and a
$625,000 increase in revenue from BOLI. These increases in non-interest income
were offset in part by a $364,000 and $469,000 decrease in gains on the sale of
residential mortgages for the three and six-month periods ended June 30, 2004,
respectively.
Non-Interest Expense. Non-interest expense increased by $5.9 million, or 82.1%,
to $13.0 million for the three months ended June 30, 2004 as compared to $7.1
million for the three months ended June 30, 2003. For the six months ended June
30, 2004, non-interest expense totaled $25.5 million, an $11.5 million, or 81.6%
increase compared to $14.1 million during the same period in 2003. The reasons
for the increase in non-interest expense in 2004 were similar for both the three
and six month periods. The primary reason was higher salary and benefit costs,
higher occupancy and equipment expenses, amortization of intangible assets and
increases in other expenses due principally to the acquisition of First Colonial
in the fourth quarter of 2003. Compensation and benefit expenses increased $3.6
million or 96.3% and $7.1 million or 95.2% for the three and six month periods
of 2004 and 2003, respectively. At June 30, 2004, we had 570 employees compared
to 343 at June 30, 2003. The increase in employees was due to the addition of
245 employees as a result of the First Colonial acquisition. Net occupancy and
equipment costs increased $1.1 million or 133.0% and $2.1 million or 123.7% for
the three and six month periods of 2004 and 2003. The principal factor in the
higher occupancy expenses was the acquisition of First Colonial, which added 20
offices. Since June 30, 2003, we have opened two branch offices and acquired a
47,000 square foot operations center. Extensive building renovation occurred at
the newly acquired operations center, KNBT's headquarters and also at the former
operations center of First
26
Colonial. The amortization of intangible assets related to the First Colonial
acquisition amounted to $546,000 and $1.1 million for the three and six-month
periods ended June 30, 2004, respectively. All other non-interest expenses
including professional fees, advertising, data processing, supplies, postage,
telephone and other miscellaneous aggregated $6.0 million and $4.9 million for
the first six months of 2004 and 2003, respectively. The increase of $1.2
million or 24.2% was due to merger and systems integration following the First
Colonial acquisition.
Income Tax Expense. KNBT's income tax expense increased by $131,000 to $1.0
million and by $354,000 to $2.3 million for the three and six months ended June
30, 2004 and June 30, 2003 respectively. The effective income tax rate for the
three and six months ended June 30, 2004 was 19% and 22%, respectively, as
compared to 25% and 26% for the three and six month periods ended June 30, 2003.
The principal factors in the lower effective tax rate was the increased
investment in tax-free securities and in BOLI.
27
ITEM 3. Quantitative and Qualitative Discussion About Market Risk
For a discussion of KNBT's asset and liability management policies as well as
the methods used to manage its exposure to the risk of loss from adverse changes
in market prices and interest rates see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" - "Market Risk" and "Interest
Rate Sensitivity" in KNBT's annual report on Form 10-K for the year ended
December 31, 2003. There have been no material changes in KNBT's assessment of
its sensitivity to market risk since December 31, 2003.
ITEM 4. Controls and Procedures
Management evaluated, with the participation of the Chief Executive Officer and
Chief Financial Officer, the effectiveness of the disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities
Exchanges Act of 1934) at June 30, 2004. Based on such evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that the disclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports that the Company files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
same time period specified in the SEC's rules and regulations and are operating
in an effective manner.
During the quarter ended March 31, 2004, the Company converted certain of its
operating and accounting functions to a new data processing system. This has
resulted in certain changes in the information gathering, collection and
reporting functions during the quarter ended June 30, 2004. The Company has
adjusted the internal controls appropriately and none of these changes, or any
other changes during the quarter, have materially affected, or are reasonably
likely to materially affect, the internal control over financial reporting (as
defined in Rules 13a - 15(f) or 15(d) - 15(f) under the Securities Exchange Act
of 1934).
28
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
There are no matters required to be reported under this item.
ITEM 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
(e) The following table sets forth information with respect to
purchases made by or on behalf of the Company of shares of
common stock of the Company during the indicated periods.
Total Number of
Shares Purchased as Maximum Number of Shares
Total Number Average Part of Publicly that May Yet Be Purchased
of Shares Price Paid Announced Plans or Under the Plans or
Period Purchased per Share Programs Programs(1)
- ----------------- ------------ ---------- ------------------ ---------------------------
April 1-30, 2004 -- $ -- -- --
May 1-31, 2004 808,047 16.44 808,047
(1)
June 1-30, 2004 -- -- -- --
------- ---- ------- --------
Total 808,047 $16.44 808,047 --
======= ===== ======= ========
- ------------
(1) The Company commenced purchasing a total of 808,047 shares in May 2004 on
behalf of the Company's 2004 Recognition and Retention Plan Trust that
was publicly announced on May 6, 2004. A total of 808,047 shares were
purchased in open-market transactions in May 2004, all of which are held
in the recognition plan trust until earned by participants.
ITEM 3. Defaults Upon Senior Securities
There are no matters required to be reported under this item.
29
ITEM 4. Submission of Matters to a Vote of Security Holders
On May 6, 2004, the Company held its first Annual Meeting of Stockholders to
obtain approval for four proxy proposals submitted on behalf of the Company's
Board of Directors. Stockholders of record as of March 19, 2004, received proxy
materials and were considered eligible to vote on these proposals. The following
is a brief summary of each proposal and the result of the vote.
1. The following directors were elected by the requisite plurality of the
votes cast to serve on the Company's Board of Directors:
For Withheld
---------- --------
Scott V. Fainor 26,106,699 814,057
Christian F. Martin, IV 26,546,248 374,508
R. Chadwick Paul, Jr. 26,107,238 813,518
Kenneth R. Smith 26,474,979 445,777
R. Charles Stehly 26,110,267 810,489
For Against Abstain Broker Non-Votes
---------- ---------- ---------- -----------------
2. To adopt the 2004 Stock Option Plan 16,051,001 3,529,692 265,414 7,074,649
3. To adopt the 2004 Recognition and Retention
Plan and Trust Agreement 15,695,527 3,897,582 252,998 7,074,649
4. To ratify the appointment of Grant
Thornton LLP as independent auditors for
the year ended December 31, 2004 26,640,294 179,352 101,110 N/A
30
ITEM 5. Other Information
There are no matters required to be reported under this item.
ITEM 6. Exhibits and Reports on Form 8-K
(a) List of exhibits:
31.1 Section 302 Certification of the Chief Executive Officer
31.2 Section 302 Certification of the Chief Financial Officer
32.1 Certification Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
On April 30, 2004, the Registrant filed a Current Report
on Form 8-K, dated April 30, 2004, providing under Item
12, information with respect to the results of operations
and financial condition at and the for the quarter ended
March 31, 2003.
On May 6, 2004, the Registrant filed a Current Report on
Form 8-K, dated May 6, 2004, providing under Item 9, a
slide presentation shown at the Company's Annual Meeting
on May 6, 2004.
On May 6, 2004, the Registrant filed a Current Report on
Form 8-K, dated May 6, 2004, providing under Item 9, the
results of the voting at the Annual Meeting of
Stockholders.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KNBT BANCORP, INC.
DATE: August 16, 2004 BY: /S/ Scott V. Fainor
----------------------- --------------------------------------
Scott V. Fainor
President and Chief Executive
Officer
DATE: August 16, 2004 BY: /S/ Eugene T. Sobol
----------------------- --------------------------------------
Eugene T. Sobol
Senior Executive Vice President,
Chief Operating Officer and
Chief Financial Officer
32