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 September 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
-----------------------------------------------------
KNBT Bancorp, Inc.
- --------------------------------------------------------------------------------
(Exact 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, PA 18017
- --------------------------------------------------------------------------------
(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 November 12, 2004,
30,333,604 shares of the Registrant's common stock were outstanding.
PART 1 - FINANCIAL INFORMATION PAGE NO.
ITEM 1 - Financial Statements
Consolidated Balance Sheet 2
Consoliated Statement of Income 3
Consolidated Statement of Comprehensive Income 4
Consolidated Statement of Cash Flows 5
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
ITEM 3 - Quantitative and Qualitative Discussion About
Market Risk 28
ITEM 4 - Controls and Procedures 28
PART 11 - OTHER INFORMATION
ITEM 1 - Legal Proceedings 29
ITEM 2 - Unregistered Sales of Equity Securities and
Use of Proceeds
ITEM 3 - Defaults Upon Senior Securities 29
ITEM 4 - Submission of Matters to a Vote of Security Holders 29
ITEM 5 - Other Information 29
ITEM 6 - Exhibits and Reports on Form 8-K 29
SIGNATURES 30
CERTIFICATIONS 31
KNBT BANCORP, INC. AND SUBSDIARIES
CONSOLIDATED BALANCE SHEETS
- ---------------------------------------------------------------------------------------------------
Sept. 30, Dec. 31,
(dollars in thousands) 2004 2003
- ---------------------------------------------------------------------------------------------------
ASSETS (unaudited)
Cash and Due From Banks $ 26,186 $ 55,059
Interest-Bearing Deposits With Banks 12,643 83,918
----------- -----------
Cash and Cash Equivalents 38,829 138,977
Investment Securities Available-for-Sale 987,183 734,087
Investment Securities Held to Maturity 58,657 --
(Fair value of $59,344 at September 30, 2004)
Federal Home Loan Bank of Pittsburgh Stock 30,338 11,543
Mortgage Loans Held-for-Sale 1,980 4,677
Loans 1,006,719 890,076
Less: Allowance for Loan Losses (9,905) (7,910)
----------- -----------
Net Loans 996,814 882,166
Bank Owned Life Insurance 59,840 57,849
Premises and Equipment, Net 41,093 35,867
Accrued Interest Receivable 9,439 7,645
Goodwill and Other Intangible Assets 45,381 47,448
Other Assets 22,828 21,714
=========== ===========
TOTAL ASSETS $ 2,292,382 $ 1,941,973
=========== ===========
LIABILITIES
Non-Interest-Bearing Deposits $ 116,590 $ 117,270
Interest-Bearing Deposits 1,170,234 1,172,140
----------- -----------
Total Deposits 1,286,824 1,289,410
Securities Sold Under Agreements to Repurchase 20,501 24,550
Advances from the Federal Home Loan Bank 568,113 207,153
Guaranteed Preferred Beneficial Interest in the
Company's Subordinated Debentures -- 15,000
Subordinated Debt 15,464 --
Accrued Interest Payable 4,451 3,218
Other Liabilities 11,286 13,562
----------- -----------
TOTAL LIABILITIES 1,906,639 1,552,893
----------- -----------
SHAREHOLDERS' EQUITY
Preferred Stock, no par
Authorized: 20,000,000 shares, none issued and outstanding -- --
Common Stock, Par Value $0.01 a share 297 295
Authorized: 100,000,000 shares
Issued and Outstanding:
30,624,861 shares at Sept. 30, 2004
30,419,397 shares at Dec. 31, 2003
Additional Paid-In Capital 296,232 297,887
Retained Earnings 110,476 100,570
Unallocated Common Stock Held
by Employee Stock Ownership Plan (15,379) (15,987)
Unearned Common Stock Held
by Management Recognition and Retention Plan (9,640) --
Accumulated Other Comprehensive Income 3,757 6,315
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 385,743 389,080
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,292,382 $ 1,941,973
=========== ===========
- ---------------------------------------------------------------------------------------------------
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 Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------
INTEREST INCOME (unaudited)
Loans, including fees $ 14,724 $ 9,745 $ 43,295 $ 29,404
Investment Securities 10,012 3,272 26,709 11,089
Other Interest 36 160 314 368
-------- -------- -------- --------
Total Interest Income 24,772 13,177 70,318 40,861
-------- -------- -------- --------
INTEREST EXPENSE
Deposits 4,492 3,452 13,384 11,424
Securities sold under Agreements to Repurchase 49 28 126 88
Advances from the Federal Home Loan Bank 4,036 1,177 8,900 3,439
Subordinated Debt 200 -- 560 --
-------- -------- -------- --------
Total Interest Expense 8,777 4,657 22,970 14,951
-------- -------- -------- --------
NET INTEREST INCOME 15,995 8,520 47,348 25,910
Provision for Loan Losses 742 468 3,213 856
-------- -------- -------- --------
Net Interest Income After Provision
for Loan Losses 15,253 8,052 44,135 25,054
-------- -------- -------- --------
NON-INTEREST INCOME
Trust Income 363 -- 1,088 --
Brokerage Services Income 141 174 418 372
Deposit Service Charges 1,040 947 3,360 2,701
Bank Owned Life Insurance 669 344 1,991 1,041
Net Gain on Sale of Investment Securities 338 -- 350 2
Net Gain (Loss) on Sale of Residential Mortgage Loans 221 (127) 392 513
Net Gain on Sale of Credit Card Loans -- -- 298 --
Net Gain ( Loss) on Sale of Assets (18) -- 195 --
Net Gain ( Loss) on Sale of Other Real Estate Owned (1) 12 68 (23)
Non-Interest Operating Income 1,087 684 3,085 2,044
-------- -------- -------- --------
Total Non-Interest Income 3,840 2,034 11,245 6,650
-------- -------- -------- --------
NON-INTEREST EXPENSES
Compensation and Employee Benefits 7,473 4,333 22,027 11,791
Net Occupancy and Equipment Expense 2,318 1,046 6,105 3,058
Professional Fees 540 210 1,351 502
Advertising 281 59 731 413
Data Processing 405 514 1,414 1,434
Impairment of Mortgage Servicing Rights 105 293 317 1,220
Amortization of Intangible Assets 547 -- 1,640 --
Other Operating Expenses 1,827 1,397 5,433 3,488
-------- -------- -------- --------
Total Non-Interest Expenses 13,496 7,852 39,018 21,906
-------- -------- -------- --------
Income Before Income Taxes 5,597 2,234 16,362 9,798
Income Taxes 1,150 478 3,492 2,467
-------- -------- -------- --------
NET INCOME $ 4,447 $ 1,756 $ 12,870 $ 7,331
======== ======== ======== ========
PER SHARE DATA
Net Income - Basic $ 0.15 N/A $ 0.44 N/A
======== ======== ======== ========
Net Income - Diluted $ 0.15 N/A $ 0.43 N/A
======== ======== ======== ========
Cash Dividends Per Common Share $ 0.05 N/A $ 0.10 N/A
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Nine Months Ended September 30, 2004 (unaudited)
(dollars in thousands except share data)
Accumulated
Common Addl Unallocated Unearned Other
Common Stock Paid In Retained ESOP Compensation Comprehensive
Shares Value Capital Earnings Shares MRP Income Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance January 1, 2004 29,479,275 $295 $297,887 $100,570 ($15,987) $0 $6,315 $389,080
Comprehensive Income
Net Income 12,870 12,870
Other Comprehensive Loss Net of Taxes
and Reclassification Adjustments (2,558) (2,558)
-----------
Total Comprehensive Income $ 10,312
-----------
Cash Dividends (2,964) (2,964)
Purchase of Stock for Management
Recognition and Retention Plan (MRRP) (13,281) (13,281)
Unallocated ESOP Shares Committed to Employees 35,701 (14) 608 594
Shares Issued upon Exercise of Stock Options 205,464 2 1,113 1,115
Establishment of a Management Recognition
Program(MRRP) 10,527 (10,527) -
Amortization of Compensation related to MRRP 887 887
--------------------------------------------------------------------------------------
Balance at September 30, 2004 29,720,440 $297 $296,232 $110,476 ($15,379) ($9,640) $3,757 $385,743
======================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------
Nine months ended
(Dollars in Thousands) Sept. 30, 2004 Sept. 30, 2003
- -------------------------------------------------------------------------------------------------------------------
(unaudited)
OPERATING ACTIVITIES:
Net Income $ 12,870 $ 7,331
Adjustments to Reconcile Net Income to Net Cash
Provided by (Used in) Operating Activities:
Provision for Loan Losses 3,213 856
Depreciation and Amortization 4,544 1,230
Compensation expense stock option plan 10 --
Management Recognition and Retention Plan Expense 877 --
Amortization and Accretion of Security Premiums and Discounts, net 1,840 2,477
(Gain) Loss on Sale of Other Real Estate Owned (68) 23
Gain on Sales of Investment Securities (350) (2)
Gain on Sale of Credit Card Portfolio (298) --
Gain on Sale of Other Assets (195) --
Gain on Sale of Mortgage Loans (392) (513)
Mortgage Loans Originated for Sale (36,776) (45,514)
Mortgage Loan Sales 39,865 58,693
Changes in Assets and Liabilities: -- --
Increase in Bank Owned Life Insurance (1,991) (1,040)
Increase in Accrued Interest Receivable (1,794) (902)
Increase in Other Assets (8,895) (4,341)
Decrease in Other Liabilities and Accrued Interest Payable (1,043) (204)
--------- ---------
Net Cash Provided by Operating Activities 11,417 18,094
--------- ---------
INVESTING ACTIVITIES:
Proceeds from Calls and Maturities of Securities Available-for-Sale 109,851 212,473
Proceeds from Sales of Securities Available-for-Sale 12,237 3,051
Purchase of Securities Available-for-Sale (371,598) (214,987)
Purchase of Securities Held to Maturity (59,751) --
Purchase of Federal Home Loan Bank of Pittsburgh Stock (18,795) (1,111)
Redemption of Federal Home Loan Bank of Pittsburgh Stock -- 233
Proceeds from the Sale of Credit Cards 1,831 --
Net Increase in Loans (117,861) (65,428)
Purchase of Premises & Equipment (7,813) (6,752)
Proceeds from the Sale of Other Assets 775 --
Proceeds from the Sale of Other Real Estate Owned 364 740
--------- ---------
Net Cash Used in Investing Activities (450,760) (71,781)
--------- ---------
FINANCING ACTIVITIES:
Net (Decrease) Increase in Deposits (2,586) 46,232
Net (Decrease) Increase in Repurchase Agreements (4,049) 2,130
Net Increase in Short-Term Borrowings 8,500 --
Proceeds from Long-Term Debt 400,112 --
Repayment of Long-Term Debt (47,652) (7,500)
Increase in Stock Escrow Funds -- 304,477
Proceeds From the Exercise of Stock Options 1,115 --
Purchase of Stock for the Management Recognition and Retention Plan (13,281) --
Cash Dividends Paid (2,964) --
--------- ---------
Net Cash Provided by Financing Activities 339,195 345,339
--------- ---------
Inrcrease (decrease) in Cash and Cash Equivalents (100,148) 291,652
Cash & Cash Equivalents January 1, 138,977 86,293
--------- ---------
Cash & Cash Equivalents September 30, $ 38,829 $ 377,945
========= =========
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Year for
Income Taxes $ 1,522 $ 3,075
========= =========
Interest $ 21,737 $ 14,882
========= =========
Supplemental Disclosure of Non-cash Activities
Mortgage Loan Securitizations $ -- $ 47,251
========= =========
Reclassification of Loans Receivable to Other Real Estate Owned $ 326 $ 1,367
========= =========
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to interim 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
September 30, 2004, the Bank operates 41 banking 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 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 periods 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
First Colonial
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 nine months ended September 30, 2003 do not include First Colonial because
the acquisition was not completed until October 31, 2003.
Oakwood Financial Corp.
On September 28, 2004, KNBT announced its agreement to purchase Oakwood
Financial Corp. ("Oakwood"), a full-service securities and insurance brokerage
firm based in Allentown, PA.
Oakwood provides a full menu of securities brokerage, insurance and investment
advisory products and services. Upon completion of the transaction, Oakwood will
operate as KNBT Securities, a wholly owned subsidiary of the Bank. Management
intends to account for the transaction using the purchase method of accounting.
The acquisition is subject to customary conditions, including the receipt of all
required regulatory approvals. This transaction is expected to close in the
fourth quarter of 2004.
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 nine months ended
September 30, 2004 were calculated as follows:
For the Three Months Ended Sept. 30, 2004
Net Average
Income Shares Per Share
(numerator) (denominator) Amount
-------------------------------------------------------
(dollars in thousands except per share amounts)
Basic Earnings Per Share
Income Available to Common Shareholders $ 4,447 28,875,080 $ 0.15
Effect of Dilutive Securities
Stock Options 370,998
Management Recognition and Retention Plan 39,172
------------------- ----------------
Total Effect of Dilutive Securities 410,170 $ -
Diluted Earnings Per Share
Income Available to Common Shareholders
plus Assumed Exercise of Options $ 4,447 29,285,250 $ 0.15
================ =================== ================
For the Nine Months ended Sept. 30, 2004
Net Average
Income Shares Per Share
(numerator) (denominator) Amount
-------------------------------------------------------
(dollars in thousands)
Basic Earnings Per Share
Income Available to Common Shareholders $ 12,870 29,219,824 $ 0.44
Effect of Dilutive Securities
Stock Options 427,494
Management Recognition and Retention Plan 55,216
------------------- ----------------
Total Effect of Dilutive Securities 482,710 $ (0.01)
Diluted Earnings Per Share
Income Available to Common Shareholders
plus Assumed Exercise of Options $ 12,870 29,702,534 $ 0.43
================ =================== ================
KNBT had 1,132,000 options that were outstanding for the period from May 6, 2004
(date of grant) through September 30, 2004. These options were not included in
the computation of diluted earnings per share for the three months ended
September 30, 2004, because the option exercise price was greater than the
average market price.
Common stock outstanding at September 30, 2004 for the purpose of calculating
basic earnings per share does not include 904,421 unallocated shares held by the
Employee Stock Ownership Plan ("ESOP").
8
Unearned Management Recognition and Retention Plan ("MRRP") and uncommitted MRRP
shares to be released are not considered to be outstanding for basic earnings
per share calculations. At September 30, 2004, unearned MRRP shares totaled
638,000 and uncommitted MRRP shares totaled 170,047.
Earnings per share are presented only for the three and nine-month periods ended
September 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 September 30,
2004 (unaudited) and available-for-sale at December 31, 2003 are as follows:
Investment Securities
Sept. 30, 2004 (unaudited)
-----------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses Value
-----------------------------------------------------
(in thousands)
Held to Maturity:
Obligations of states and political
subdivisions $ 5,514 $ 29 $ (5) $ 5,538
Mortgaged-backed securities
FNMA 27,030 302 -- 27,332
Other CMOs 26,113 361 -- 26,474
-----------------------------------------------------
Total mortgage backed 53,143 663 -- 53,806
Total Held to Maturity $ 58,657 $ 692 $ (5) $ 59,344
=====================================================
Available for Sale:
U.S. Government and agencies $163,239 $ 2,039 $ (309) $164,969
Obligations of states and political
subdivisions 105,924 2,385 (143) 108,166
Asset-managed funds 4,904 -- (88) 4,816
Federated Liquid Cash Trust 36 -- -- 36
Mortgaged-backed securities
GNMA 1,568 61 -- 1,629
FHLMC 99,998 725 (295) 100,428
FNMA 315,141 3,489 (1,061) 317,569
Other CMOs 245,440 592 (1,833) 244,199
-----------------------------------------------------
Total mortgage backed 662,147 4,867 (3,189) 663,825
Corporate and other debt securities 9,037 246 -- 9,283
Equity Securities 36,211 544 (667) 36,088
-----------------------------------------------------
Total Available for Sale $981,498 $ 10,081 $ (4,396) $987,183
=====================================================
9
Investment Securities
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 (in thousands, except per share amounts).
For the Three Months Ended
Sept. 30, 2004
-----------------------------
(dollars in thousands
except per share data)
Net Income As reported $ 4,447
Add: Stock-based employee compensation expense
included in reported net income, net 6
of related tax effects
Less: Stock-based compensation cost determined
under fair value method for all awards, net 138
of related tax effects
Pro forma $ 4,315
=====================
Earnings per share (Diluted)
As reported $ 0.15
Pro forma $ 0.15
Earnings per share (Basic)
As reported $ 0.15
Pro forma $ 0.15
For the Nine Months Ended
Sept. 30, 2004
-----------------------------
(dollars in thousands
except per share data)
Net Income As reported $ 12,870
Add: Stock-based employee compensation expense
included in reported net income, net 10
of related tax effects
Less: Stock-based compensation cost determined
under fair value method for all awards, net 231
of related tax effects
Pro forma $ 12,649
=====================
Earnings per share (Diluted)
As reported $ 0.43
Pro forma $ 0.43
Earnings per share (Basic)
As reported $ 0.44
Pro forma $ 0.43
11
The weighted average fair value of each option grant under the Company's 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 and $10,000 was
recognized during the three and nine months ended September 30, 2004,
respectively, 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 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. FASB has postponed the effective date for periods after June 15,
2005.
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 nine months ended September
30, 2004 was $526,000 and $877,000 respectively.
12
NOTE G - LOANS
A summary of KNBT's loans receivable at September 30, 2004 and December 31, 2003
is as follows:
Sept. 30, Dec. 31,
2004 2003
----------- -----------
(unaudited)
(in thousands)
Real Estate
Residential $ 328,577 $ 346,221
Construction 108,198 112,684
Commercial 232,046 156,563
----------- -----------
Total real estate 668,821 615,468
Consumer loans 296,062 265,541
Commercial (non real estate) 46,215 38,978
States and political subdivisions 1,237 2,334
----------- -----------
Total gross loans 1,012,335 922,321
Less:
Mortgage loans held-for-sale (1,980) (4,677)
Loans in process (3,593) (27,099)
Deferred fees (costs) (43) (469)
----------- -----------
Total loans 1,006,719 890,076
Less: Allowance for loan losses (9,905) (7,910)
----------- -----------
Total net loans $ 996,814 $ 882,166
=========== ===========
13
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 September 30, 2004 (unaudited) and December 31, 2003.
At Sept. 30, At Dec. 31,
2004 2003
------- -------
(unaudited)
(in thousands)
Non-accrual loans $ 3,801 $ 1,720
Accruing loans 90 days or more past due 653 405
------- -------
Total non-performing loans 4,454 2,125
------- -------
Other real estate owned 32 173
------- -------
Total non-performing assets $ 4,486 $ 2,298
======= =======
Total non-performing loans as a percentage of loans, net 0.45% 0.24%
Total non-performing loans as a percentage of total assets 0.19% 0.11%
Total non-performing assets as a percentage of total assets 0.20% 0.12%
Interest on non-accrual loans which would have been
recorded at the original rate $ 70 $ 50
Interest on non-accrual loans that was reflected in income -- 60
------- -------
Net (decrease) increase on interest income $ (70) $ 10
======= =======
KNBT's recorded investment in impaired loans was $370,000 at September 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
$39,000 at September 30, 2004 and $33,000 at December 31, 2003. The average
impaired loan balance for the nine months ended September 30, 2004 was $456,000.
During the quarter ended September 30, 2004, we received principal payments of
$3,000 on impaired loans, which payments are recognized on a cash basis. We
recognized no income on impaired loans in the nine-month period ended September
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 Sept. 30, Nine Months Ended Sept. 30,
2004 2003 2004 2003
--------------- --------------- --------------- ----------------
(unaudited) (unaudited)
(in thousands) (in thousands)
Balance, beginning of period $ 9,519 $ 2,814 $ 7,910 $ 2,927
Provision charged to operations 742 468 3,213 856
Loans charged-off (395) (362) (1,453) (886)
Recoveries of loans previously charged-off 39 21 235 44
--------------- --------------- --------------- ----------------
Balance, end of period $ 9,905 $ 2,941 $ 9,905 $ 2,941
=============== =============== =============== ================
14
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 nine months ended September 30,
2004 was $131,000. During the nine months ended September 30, 2003 the
contribution to this plan amounted to $593,000. 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 15-year period beginning at
age 65. The net periodic defined benefit expense for the nine months ended
September 30, 2004 was as follows.
(dollars in thousands)
Service cost $
Interest cost 19
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 $19
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 September 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
15
proposed rule 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 March 31, 2004 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
In March 2004, the Securities and Exchange Commission 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. At its meeting on
September 8, 2004, the FASB discussed whether additional guidance related to
paragraph 16 of EITF 03-1 should be issued in a FASB Staff Position ("FSP"). The
FASB agreed that additional guidance is necessary and that such guidance should
be issued in an FSP. Given the current effective date of paragraph 16 of Issue
03-1 for application of the other-than-temporary impairment evaluations in
reporting periods beginning after June 15, 2004, the FASB also agreed that an
additional FSP should be issued to delay the effective date of paragraph 16 of
Issue 03-1. 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 September 30, 2004 presentation.
16
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, potential loss in the event of default, expected commitment
usage, the amounts and timing of expected future cash flows on impaired loans
and the general amounts of 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.
17
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 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 September 30, 2004 and December 31, 2003
Assets. KNBT's total assets were $2.3 billion at September 30, 2004 as compared
to $1.9 billion at December 31, 2003, an increase of $350.4 million or 18.1%.
The increase in assets was principally due to increases in investment
securities, loans receivable, Federal Home Loan Bank ("FHLB") 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 nine months of 2004, KNBT's investment securities increased $311.8 million
or 42.5% to $1.0 billion at September 30, 2004 compared to $734.1 million at
December 31, 2003. The primary sources of funds used for the increase in
investment securities were advances from the FHLB and to a lesser extent cash
and cash equivalents. KNBT's total loans receivable were $1.0 billion at
September 30, 2004, an increase of $116.6 million or 13.1% over the December 31,
2003 total of $890.1 million. The growth in loans receivable was principally due
to a $75.5 million or 48.2% increase in commercial real estate loans, a $7.2
million or 18.6% in other commercial loans and a $30.5 million or 11.5% increase
in consumer loans. These loan increases were offset in part by a $17.6 million
or 5.1% decrease in single-family residential mortgage loans. The decrease in
single-family residential mortgage loans was a result of a $39.9 million sale of
loans during the nine-month period ended September 30, 2004, customer repayments
and a reduced level of new mortgage loan originations because of rising interest
rates. Construction loans decreased $4.5 million or 4.0% during the nine months
ended September 30, 2004. We believe that rising interest rates reduced the
level of activity in this category. During the first quarter of 2004, KNBT sold
its $1.8 million credit card portfolio for a gain of $298,000. These credit card
loans were sold because of relatively low volume and high administrative costs.
KNBT continues to offer credit cards to its customers through a third party
provider and receives fee income through this arrangement. KNBT's investment in
the stock of the FHLB was $30.3 million at September 30, 2004 as compared to
$11.5 million at December 31, 2003. This was an increase of $18.8 million or
162.8% for the period. Net premises and equipment increased by $5.2 million or
14.6% to $41.1 million at September 30, 2004 compared to $35.9 million at
December 31, 2003. The primary reason for the increase was the result of the
purchase of new computer equipment and the cost of renovations to the Company's
headquarters and operations buildings. At September 30, 2004, such renovations
were substantially complete. KNBT's cash and cash equivalents were $38.8 million
at September 30, 2004 as compared to $139.0 million at December 31, 2003. This
decrease of $100.1 million or 72.1% was principally the result of the investment
of these funds in additional investment securities and new loans.
18
Allowance for Loan Losses. KNBT's allowance for loan losses increased $2.0
million or 25.2% during the first nine months of 2004. The allowance for loan
losses was $9.9 million and $7.9 million at September 30, 2004 and December 31,
2003, respectively. The increase in the allowance for loan losses was based upon
management's analysis of the inherent losses 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 loans, 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 September 30, 2004 and December
31, 2003, respectively. See "Comparison of Operating Results for the three and
nine months ended September 30, 2004 and 2003 - Provision for Loan Losses."
Liabilities. KNBT's total liabilities amounted to $1.9 billion at September 30,
2004, an increase of $353.7 million or 22.8% compared to total liabilities at
December 31, 2003 of $1.6 billion. The increase in liabilities was principally
due to a $361.0 million or 174.3% increase in advances from the FHLB during the
first nine months of 2004. These advances totaled $568.1 million and $207.2
million at September 30, 2004 and December 31, 2003, respectively. KNBT's
deposit growth remained flat during the nine-month period ended September 30,
2004. Deposits totaled $1.3 billion at both September 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 subordinated debt in the September 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 September
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 September 30,
2004 continue to qualify as Tier I capital under current guidance issued by the
Federal Reserve Board.
Shareholders' Equity. Shareholders' equity totaled $385.7 million at September
30, 2004 compared to $389.1 million at December 31, 2003, a decrease of $3.3
million or .9%. 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 a cash dividend of $.05
per share during the quarters ended September 30, 2004 and June 30, 2004. This
resulted in a decrease in retained earnings of $3.0 million. Another factor
contributing to the decrease in shareholders' equity was a decrease in
accumulated other comprehensive income of $2.6 million relating to a decrease in
unrealized gains on investment securities available-for-sale. Net income for the
nine months ended September 30, 2004 was $12.9 million and partially offset the
impact of the funding of the MRRP.
19
KNBT committed to release 35,701 shares of the Company's common stock during the
nine months ended September 30, 2004 pursuant to the ESOP for a value of
$594,000 and issued 205,464 common shares upon the exercise of stock options for
proceeds of $1.1 million. Regulatory capital ratios for KNBT and the Bank at
September 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 September 30, 2004 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Total Capital
(To Risk-Weighted Assets)
Company $ 361,985 28.13% $ 102,955 8.00% N/A N/A
Bank $ 258,628 20.18% $ 102,529 8.00% $ 128,161 10.00%
Tier 1 Capital
(To Risk-Weighted Assets)
Company $ 352,080 27.36% $ 51,477 4.00% N/A N/A
Bank $ 248,723 23.27% $ 51,264 4.00% $ 76,897 6.00%
Tier 1 Capital
(To Average Assets, Leverage)
Company $ 352,080 16.29% $ 86,466 4.00% N/A N/A
Bank $ 248,723 12.41% $ 80,188 4.00% $ 100,235 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%
- -----------------------------------------------------------------------------------------------------------------------------------
20
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 $334.6
million and $105.2 million for the nine months ended September 30, 2004 and
September 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 September 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 September 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.
21
INTEREST RATE SENSITIVITY "GAP"
At September 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 $ 12,643 $ -- $ -- $ -- $ -- $ -- $ 12,643
Loans receivable (2) 174,954 87,155 170,764 319,954 156,515 102,993 1,012,335
Investment securities, debt 85,739 48,548 74,060 339,832 205,512 286,156 1,039,847
Investment securities, equity -- -- -- -- -- 36,331 36,331
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning
assets $ 273,336 $ 135,703 $ 244,824 $ 659,786 $ 362,027 $ 425,480 $2,101,156
========== ========== ========== ========== ========== ========== ==========
Cumulative total interest-
earning assets $ 273,336 $ 409,039 $ 653,863 $1,313,649 $1,675,676 $2,101,156 $2,101,156
========== ========== ========== ========== ========== ========== ==========
Interest-bearing
liabilities:
Savings deposits $ -- $ 8,573 $ 8,573 $ 11,430 $ 14,288 $ 171,452 $ 214,315
Interest-bearing
checking deposits -- -- -- 6,734 3,367 158,247 168,348
Money market deposits 31,176 35,972 23,982 31,975 15,988 100,722 239,815
Certificates of deposit 89,058 90,714 108,157 218,885 40,823 118 547,756
FHLB advances and other
borrowings 70,541 13,126 45,153 230,977 168,419 75,861 604,078
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing
liabilities $ 190,776 $ 148,385 $ 185,864 $ 500,001 $ 242,885 $ 506,401 $1,774,313
========== ========== ========== ========== ========== ========== ==========
Cumulative total interest-
bearing liabilities $ 190,776 $ 339,161 $ 525,025 $1,025,026 $1,267,911 $1,774,313 $1,774,313
========== ========== ========== ========== ========== ========== ==========
Interest-earning assets
less interest-bearing
liabilities $ 82,560 $ (12,682) $ 58,960 $ 159,785 $ 119,142 $ (80,922) $ 326,843
========== ========== ========== ========== ========== ========== ==========
Cumulative interest-rate
sensitivity GAP (3) $ 82,560 $ 69,878 $ 128,838 $ 288,623 $ 407,765 $ 326,843
========== ========== ========== ========== ========== ==========
Cumulative interest-rate
GAP as a percentage
of total assets at
September 30, 2004 3.60% 3.05% 5.62% 12.59% 17.79% 14.26%
Cumulative interest-rate
earning assets as a
percentage of
cumulative interest-
bearing liabilities at
September 30, 2004 143.28% 120.60% 124.54% 128.16% 132.16% 118.42%
- ------------------------------------------------------------------------------------------------------------------------------------
(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.
22
Comparison of Operating Results for the Three and Nine Months Ended September
30, 2004 and 2003
General. KNBT's net income increased by $2.7 million, or 153.3% to $4.4 million
for the three months ended September 30, 2004 compared to $1.8 million for the
three months ended September 30, 2003. For the nine months ended September 30,
2004, net income increased $5.5 million, or 75.6% to $12.9 million compared to
$7.3 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 losses. 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 FHLB 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
September 30, 2004 was $16.0 million, a $7.5 million or 87.7% increase when
compared to $8.5 million for the three months ended September 30, 2003. For the
nine months ended September 30, 2004, net interest income was $47.3 million, a
$21.4 million or 82.7% increase when compared to $25.9 million for the nine
months ended September 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 $2.0 billion for the three months ended September 30,
2004 as compared to $1.0 billion for the three months ended September 30, 2003.
Average interest earning assets for the nine-month period ended September 30,
2004 were $1.9 billion as compared to $974.9 million for the nine-month period
ended September 30, 2003. Total interest income was $24.8 million for the third
quarter of 2004, an $11.6 million or 88.0% increase when compared to the $13.2
million in total interest income during the third quarter of 2003. For the nine
months ended September 30, 2004, total interest income was $70.3 million, a
$29.5 million or 72.1% increase when compared to the same period in 2003.
Average interest-bearing liabilities were $1.7 billion for the three months
ended September 2004 compared to $883.6 million for the three months ended
September 30, 2004. For the nine months ended September 30, 2004 and 2003,
average interest-bearing liabilities were $1.6 billion and $871.8 million,
respectively. Total interest expense was $8.8 million for the third quarter of
2004, a $4.1 million or 88.5% increase when compared to the $4.7 million in
total interest expense during the third quarter of 2003. For the nine months
ended September 30, 2004, total interest expense was $23.0 million, an $8.0
million or 53.6% increase when compared to the same period in 2003. Our net
interest margin on a tax equivalent basis was 3.34% and 3.51% for the three and
nine months, respectively, ended September 30, 2004 compared to 3.41% and 3.67%
for the prior year comparable periods. Net interest spread on a tax equivalent
basis was 3.01% and 3.18% for the three and nine months, respectively, ended
September 30, 2004 versus 3.10% and 3.43% 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.
23
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Comparative Statement Analysis
(Dollars in Thousands) For the Three Months Ended September 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 $ 9,272 $ 36 1.55% $ 88,434 $ 160 0.72%
Investment Securities
Taxable (1) 885,687 8,879 4.01% 314,099 2,629 3.35%
Non-Taxable (2) 111,088 1,717 6.18% 56,659 974 6.88%
Loans Receivable (2) (3) 992,696 14,733 5.94% 581,224 9,745 6.71%
Allowance for Loan Losses (9,641) - (2,810) -
------------ ------------ ------------
Net Loans 983,055 14,733 5.99% 578,414 9,745 6.74%
------------ ------------ ------------ ------------
Total Interest-Earning Assets 1,989,102 25,365 5.10% 1,037,606 13,508 5.21%
Non-Interest-Earning Assets 217,201 - 65,291 -
------------ ------------ ------------ ------------
Total Assets,
Interest Income $ 2,206,304 25,365 $ 1,102,897 13,508
------------ ------------ ------------ ------------
Liabilities
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand Deposits $ 174,871 $ 72 0.16% $ 93,482 $ 56 0.24%
Money Market Deposits 250,345 661 1.06% 168,822 480 1.14%
Savings Deposits 220,901 269 0.49% 130,135 201 0.62%
Certificates of Deposit 533,892 3,490 2.61% 374,247 2,715 2.90%
------------ ------------ ------------ ------------
Total interest-Bearing Deposits 1,180,009 4,492 1.52% 766,686 3,452 1.80%
Securities Sold Under Agreements
to Repurchase 24,739 49 0.79% 10,583 29 1.10%
FHLB Advances 457,031 4,036 3.53% 106,345 1,176 4.42%
Other Debt 15,464 200 5.17% - -
------------ ------------ ------------ ------------
Total Interest-Bearing Liabilities 1,677,243 8,777 2.09% 883,614 4,657 2.11%
Non-Interest-Bearing Liabilities
Non-Interest-Bearing Deposits 119,155 - 45,920 -
Other Liabilities 29,469 - 57,560 -
------------ ------------ ------------ ------------
Total Liabilities 1,825,867 8,777 987,094 4,657
Shareholders' Equity /
Retained Earnings 380,437 - 115,803 -
------------ ------------ ------------ ------------
Total Liabilities and Shareholders'
Equity, Interest Expense $ 2,206,304 8,777 $ 1,102,897 4,657
------------ ------------ ------------ ------------
Net Interest Income Tax Equivalent Basis $ 16,588 $ 8,852
------------ ------------
Net Interest Spread
Tax Equivalent Basis (4) 3.01% 3.10%
Effect of Interest-Free Sources
Used to Fund Earning Assets 0.12% 0.13%
------------- ------------
Net Interest Margin
Tax Equivalent Basis (5) 3.34% 3.41%
------------- ------------
Tax-Exempt Adjustment 593 332
------------ ------------
Net Interest Income and Margin $ 15,995 3.22% $ 8,520 3.28%
============ ============= ============ ============
Average Interest-Earning Assets
to Average Interest-Bearing Liabilities 118.59% 117.43%
------------- ------------
- ------------------------------------------------------------------------------------------------------------------------------------
(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
$593,000 and $332,000 for the three months ended September 30, 2004 and
September 30, 2003, respectively. The effective tax rate used for the
taxable equivalent adjustment was 34%.
(3) Loan fees of $154,000 and $520,000 for the three months ended September 30,
2004 and September 30, 2003, respectively, are included in interest income.
Average loan balances include non-accruing loans of $3,966,000 and $817,000
and average loans held-for-sale of $929,000 and $6,950,000 for the three
months ended September 30, 2004 and September 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
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Comparative Statement Analysis
(Dollars in Thousands) For the Nine Months Ended September 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 $ 29,361 $ 314 1.43% $ 62,945 $ 368 0.78%
Investment Securities
Taxable (1) 787,912 23,144 3.92% 294,980 9,262 4.19%
Non-Taxable (2) 109,226 5,401 6.59% 52,146 2,767 7.08%
Loans Receivable (2) (3) 952,080 43,323 6.07% 567,659 29,404 6.91%
Allowance for Loan Losses (8,950) - (2,792) -
------------ ------------ ------------- -------------
Net Loans 943,130 43,323 6.12% 564,867 29,404 6.94%
------------ ------------ ------------- -------------
Total Interest-Earning Assets 1,869,629 72,182 5.15% 974,938 41,801 5.72%
Non-Interest-Earning Assets 215,853 - 76,449 -
------------ ------------ ------------- -------------
Total Assets,
Interest Income $ 2,085,482 72,182 $ 1,051,387 41,801
------------ ------------ ------------- -------------
Liabilities
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand Deposits $ 174,687 $ 203 0.15% $ 90,311 $ 236 0.35%
Money Market Deposits 247,658 1,772 0.95% 160,757 1,634 1.36%
Savings Deposits 223,737 805 0.48% 124,902 798 0.85%
Certificates of Deposit 534,703 10,604 2.64% 381,536 8,756 3.06%
------------ ------------ ------------- -------------
Total interest-Bearing Deposits 1,180,785 13,384 1.51% 757,506 11,424 2.01%
Securities Sold Under Agreements
to Repurchase 24,077 126 0.70% 9,092 88 1.29%
FHLB Advances 334,616 8,900 3.55% 105,199 3,439 4.36%
Other Debt 15,464 560 4.83% -
------------ ------------ ------------- -------------
Total Interest-Bearing Liabilities 1,554,942 22,970 1.97% 871,797 14,951 2.29%
Non-Interest-Bearing Liabilities
Non-Interest-Bearing Deposits 117,560 - 40,291 -
Other Liabilities 26,327 - 24,087 -
------------ ------------ ------------- -------------
Total Liabilities 1,698,829 22,970 936,175 14,951
Shareholders' Equity /
Retained Earnings 386,653 - 115,212 -
------------ ------------ ------------- -------------
Total Liabilities and Shareholders'
Equity, Interest Expense $ 2,085,482 22,970 $ 1,051,387 14,951
------------ ------------ ------------- -------------
Net Interest Income Tax Equivalent Basis $ 49,212 $ 26,850
------------ -------------
Net Interest Spread
Tax Equivalent Basis (4) 3.18% 3.43%
Effect of Interest-Free Sources
Used to Fund Earning Assets 0.13% 0.13%
------------ -------------
Net Interest Margin
Tax Equivalent Basis (5) 3.51% 3.67%
------------ -------------
Tax-Exempt Adjustment 1,864 940
------------ -------------
Net Interest Income and Margin $ 47,348 3.38% $ 25,910 3.54%
============ ============ ============= =============
Average Interest-Earning Assets
to Average Interest-Bearing Liabilities 120.24% 111.83%
------------ -------------
- ------------------------------------------------------------------------------------------------------------------------------------
(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
$1,864,000 and $940,000 for the nine months ended September 30, 2004 and
September 30, 2003, respectively. The effective tax rate used for the
taxable equivalent adjustment was 34%.
(3) Loan fees of $619,000 and $1,410,000 for the nine months ended September
30, 2004 and September 30, 2003, respectively, are included in interest
income. Average loan balances include non-accruing loans of $3,195,000 and
$1,331,000 and average loans held-for-sale of $2,672,000 and $4,613,000 for
the nine months ended September 30, 2004 and September 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.
25
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
(in thousands)
(unaudited)
Three Months Ended Sept 30, 2004 vs. Nine Months Ended Sept 30, 2004 vs.
Three Months Ended Sept 30, 2003 Nine Months Ended Sept 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 $ 19 $ (143) $ (124) $ 142 $ (196) $ (54)
Investment Securities 913 6,079 6,993 (2,545) 19,060 16,516
Loans receivable, net (1,827) 6,815 4,988 (5,771) 19,690 13,919
-------- -------- -------- -------- -------- --------
Total interest-earning assets (895) 12,751 11,857 (8,173) 38,554 30,381
Interest expense:
Demand deposits (33) 49 16 (253) 220 (33)
Money market deposits (51) 232 181 (745) 883 138
Savings & club deposits (72) 140 68 (624) 631 7
Certificates of deposit (383) 1,158 775 (1,667) 3,515 1,848
-------- -------- -------- -------- -------- --------
Total interest-bearing deposits (539) 1,579 1,040 (3,290) 5,250 1,960
Securities sold under agreements
to repurchase (19) 39 20 (107) 145 38
FHLB advances and other borrowings (1,011) 3,871 2,860 (2,039) 7,500 5,461
Other debt -- 200 200 -- 560 560
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities (1,569) 5,689 4,120 (5,436) 13,455 8,019
Increase (decrease) in net
interest income $ 674 $ 7,062 $ 7,737 $ (2,737) $ 25,099 $ 22,362
======== ======== ======== ======== ======== ========
26
Provision for Loan Losses. KNBT made a provision for loan losses of $742,000 for
the three months ended September 30, 2004 as compared to $468,000 for the three
months ended September 30, 2003. For the nine months ended September 30, 2004,
the provision for loan losses was $3.2 million as compared to $856,000 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 to 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 nine months ended September 30, 2004, KNBT charged-off, net
of recoveries, $1.2 million as compared to $842,000 for the same period in 2003.
Most charge-offs were primarily related to consumer loans. Non-performing loans
totaled $4.5 million, $2.1 million and $1.7 million at September 30, 2004,
December 31, 2003 and September 30, 2003, respectively. The increase in
non-performing loans was primarily due to a $1.6 million increase in
non-performing single-family residential loans over the nine-month period ending
September 30, 2004. At September 30, 2004, KNBT's allowance for loan losses
amounted to 222.4% of non-performing loans as compared to 372.2% at December 31,
2003. Allowance for loan losses as a percentage of net loans was .99% and .89%
at September 30, 2004 and December 31, 2003, respectively.
Non-Interest Income. Non-Interest income increased $1.8 million or 88.8% to $3.8
million for the three months ended September 30, 2004 as compared to $2.0
million for the three months ended September 30, 2003. For the nine months ended
September 30, 2004, non-interest income totaled $11.2 million, a $4.6 million or
69.1% increase over the same period in 2003. The increase in the three month
period ended September 30, 2004 over the comparable period in 2003 primarily was
the result of trust revenues from the Company's Trust Department, acquired from
First Colonial of $363,000, a $325,000 increase in revenue from Bank Owned Life
Insurance ("BOLI") resulting from a November 2003 purchase of an additional $30
million of insurance, an increase in net gains on sale of residential mortgage
loans of $348,000 and net gains on sales of investment securities totaling
$338,000. The increase for the nine-month period ended September 30, 2004 over
the comparable period in 2003 was the result of Trust Department revenue of $1.1
million, an increase of $950,000 in revenue from BOLI, an increase in deposit
service charges of $659,000 due to the addition of accounts from the First
Colonial acquisition, an increase on net gains on sale of investment securities
of $348,000 and the gains on the sales of our credit card portfolio and
operations center that contributed $298,000 and $213,000 respectively. The
nine-month increase in non-interest income was offset in part by a decrease in
gains on sale of residential mortgages of $121,000.
Non-Interest Expense. Non-interest expense increased by $5.6 million, or 71.9%,
to $13.5 million for the three months ended September 30, 2004 as compared to
$7.9 million for the three months ended September 30, 2003. For the nine months
ended September 30, 2004, non-interest expense totaled $39.0 million, a $17.1
million, or 78.1% increase compared to $21.9 million during the comparable
period in 2003. The reasons for the increase in non-interest expense in 2004
were similar for both the three and nine-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 $3.1 million or 72.5% and $10.2
million or 86.8% for the three and nine-month periods of 2004 and 2003,
respectively. At September 30, 2004, we had 569 employees compared to 357 at
September 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 $1.3 million or 121.6% and $3.0 million or 99.6% for
the three and nine-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 September 30, 2003, we have opened four 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 Colonial. The amortization of
intangible assets related to the First Colonial acquisition amounted to $547,000
and $1.6 million for the three and nine-month periods ended September 30, 2004,
respectively. All other non-interest expenses including professional fees,
advertising, data processing, supplies, postage, telephone and other
miscellaneous aggregated $9.2
27
million and $7.1 million for the first nine months of 2004 and 2003,
respectively. The increase of $2.2 million or 31.0% was primarily due to merger
and systems integration following the First Colonial acquisition.
Income Tax Expense. KNBT's income tax expense increased by $672,000 to $1.2
million and by $1.0 to $3.5 million for the three and nine months ended
September 30, 2004 and September 30, 2003 respectively. The effective income tax
rate for the three and nine months ended September 30, 2004 was 20.6% and 21.3%,
respectively, as compared to 21.4% and 25.0% for the three and nine-month
periods ended September 30, 2003. The principal factors in the lower effective
tax rate were the increased investment in tax-free securities and in BOLI.
ITEM 3. Quantitative and Qualitative Disclosures 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
Exchange Act of 1934) at September 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 September 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. Unregistered Sales of Equity Securities and Use of Proceeds
There are no matters required to be reported under this item.
ITEM 3. Defaults Upon Senior Securities
There are no matters required to be reported under this item.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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.
29
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: November 15, 2004 BY: /s/ Scott V. Fainor
- -------------------------- ------------------------
Scott V. Fainor
President and Chief Executive Officer
DATE: November 15, 2004 BY: /s/ Eugene T. Sobol
- -------------------------- ------------------------
Eugene T. Sobol
Senior Executive Vice President,
Chief Operating Officer and
Chief Financial Officer
30