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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 20549
FORM 10-K
______________________________________
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 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 Number 000-50426
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[KNBT LOGO OMITTED]
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(Name of Registrant as specified in its charter)
Pennsylvania 38-3681905
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90 Highland Avenue, Bethlehem, Pennsylvania 18017
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 610-861-5000
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Securities registered pursuant to Section 12 (b) of the Exchange Act: None
Securities registered pursuant to Section 12 (g) of the Exchange Act:
Common Stock, $0.01 Par Value
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(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No ____
The aggregate market value of the 25,885,403 shares of the Registrant's
common stock held by non-affiliates (30,656,840 shares outstanding less
4,771,437 shares held by affiliates), based upon the closing price of $16.70 for
the Common Stock on June 30, 2004, the last business day in the Registrant's
second quarter, was approximately $432.3 million. Shares of Common Stock held by
each executive officer and director, the Registrant's Employee Stock Ownership
Plan and the Keystone Nazareth Charitable Foundation have been excluded since
such persons may be deemed affiliates. This determination of affiliate status is
not necessarily a conclusive determination for other purposes.
The number of shares of the Issuer's common stock, par value $0.01 per
share, outstanding as of March 11, 2005 was 30,662,305.
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DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of KNBT Bancorp's proxy statement to be filed in
connection with its 2005 Annual Meeting of Stockholders are incorporated by
reference in Part III of this Report. Other documents incorporated by reference
are listed in the Exhibit Index.
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KNBT BANCORP, INC.
Form 10-K
Table of Contents
Page
PART I
Item 1. Business.............................................................................................. 1
Item 2. Properties ...........................................................................................30
Item 3. Legal Proceedings.....................................................................................30
Item 4. Submission of Matters to a Vote of Security Holders...................................................30
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities ................................................................30
Item 6. Selected Financial Data ..............................................................................32
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................................................33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................................45
Item 8. Financial Statements and Supplementary Data ..........................................................46
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .................................................................................83
Item 9A. Controls and Procedures...............................................................................83
Item 9B. Other Information.....................................................................................83
PART III
Item 10. Directors and Executive Officers of the Registrant ...................................................86
Item 11. Executive Compensation................................................................................86
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters...........................................................................86
Item 13. Certain Relationships and Related Transactions........................................................87
Item 14. Principal Accounting Fees and Services................................................................87
PART IV
Item 15. Exhibits and Financial Statement Schedules............................................................87
Signatures ......................................................................................................90
ii
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION
The information contained in this Annual Report on Form 10-K may
contain forward-looking statements (as defined in the Securities Exchange Act of
1934 and the regulations thereunder) which are not historical facts or as to
KNBT Bancorp, Inc. ("KNBT" or "Holding Company") management's intentions, plans,
beliefs, expectations or opinions or with respect to the acquisition of the
Caruso Benefits Group, Inc. ("Caruso") and the pending acquisition of Northeast
Pennsylvania Financial Corp. ("NEPF"). These statements include, but are not
limited to, financial projections and estimates and their underlying
assumptions; statements regarding plans, objectives and expectations with
respect to future operations, products and services; and statements regarding
future performance. Such statements are subject to certain risks and
uncertainties, many of which are difficult to predict and generally beyond the
control of KNBT and its management, that could cause actual results to differ
materially from those expressed in, or implied or projected by, the
forward-looking information and statements. The following factors, among others,
could cause actual results to differ materially from the anticipated results or
other expectations expressed in the forward-looking statements: (1) economic and
competitive conditions which could affect the volume of loan originations,
deposit flows and real estate values; (2) the levels of non-interest income and
expense and the amount of loan losses; (3) estimated cost savings from the
acquisition of NEPF cannot be fully realized within the expected time frame; (4)
revenues following the acquisitions of Caruso and NEPF are lower than expected;
(5) competitive pressure among depository institutions increases significantly;
(6) costs or difficulties related to the integration of the businesses of KNBT,
NEPF and Caruso are greater than expected; (7) changes in the interest rate
environment may reduce interest margins; (8) general economic conditions, either
nationally or in the markets in which KNBT is or will be doing business, are
less favorable than expected; (9) legislation or changes in regulatory
requirements adversely affect the business in which KNBT would be engaged; (10)
regulatory approvals to acquire Caruso and/or NEPF are not obtained; or (11)
factors which result in a condition to the acquisition of Caruso and/or NEPF not
being met as well as other factors discussed in the documents filed by KNBT with
the Securities and Exchange Commission ("SEC") from time to time. Copies of
these documents may be obtained from KNBT upon request and without charge
(except for the exhibits thereto) or can be accessed at the website maintained
by the SEC at http://www.sec.gov. KNBT undertakes no obligation to update these
forward-looking statements to reflect events or circumstances that occur after
the date on which such statements were made.
PART I
Item 1. Business
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General
KNBT 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. The Holding Company and the Bank are
collectively referred to as "KNBT." Keystone Nazareth Bank & Trust Company
(which we also refer to as the "Bank") is the stock-form successor to Keystone
Savings Bank upon the mutual-to-stock conversion of Keystone Savings Bank, which
was completed on October 31, 2003. Concurrently with the mutual-to-stock
conversion, KNBT acquired, through a merger, First Colonial Group, Inc. ("First
Colonial"), the parent holding company for Nazareth National Bank and Trust
Company, which was merged with and into the Bank in connection with the
acquisition of First Colonial. The merger transaction was accounted for under
the purchase method of accounting. The result of operations for 2003 include the
operations acquired from First Colonial for the period October 31, 2003 through
December 31, 2003.
1
On November 11, 2004, KNBT acquired Oakwood Financial Corp.
("Oakwood"), a full-service brokerage firm based in Allentown, Pennsylvania.
KNBT paid $650,000 for Oakwood and acquired $121,000 in assets. Oakwood provides
a full menu of securities brokerage, insurance and investment advisory products
and services. Oakwood is a wholly owned subsidiary of the Bank and now operates
as KNBT Securities, Inc. This purchase augments the Bank's offering of
investment and insurance products offered to its customers in branch offices.
Combined with the expertise of KNBT's Trust and Wealth Management professionals,
KNBT Securities enhances our ability to provide customers with a full range of
products and services to meet their financial goals.
On October 27, 2004, the Board of Directors authorized the repurchase
of up to 3,062,486 shares or approximately 10% of KNBT's outstanding shares. For
the year ended December 31, 2004, KNBT repurchased 650,000 shares of its common
stock at an average cost of $17.20 per share. KNBT did not declare or pay any
dividends during the year ended December 31, 2003. Cash dividends were initiated
in the second quarter of 2004 with dividends declared and paid of $.05 cents per
share. For year ending December 31, 2004, total dividends of $.15 per share were
declared and paid.
Available Information
KNBT is a public company and files annual, quarterly and current
reports, proxy statements and other information with the Securities and Exchange
Commission. KNBT's filings are available to the public at the SEC's website at
HTTP://www.sec.gov. Members of the public may also read and copy any document
that KNBT files at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You can request copies of these documents by writing to
the SEC and paying a fee for the copying cost. Please call the SEC at
1-800-SEC-0330 for more information about the operation of the public reference
room. In addition to the foregoing, the Company maintains a website of
www.KNBT.com. KNBT makes available on its Internet website copies of its Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K and any amendments to such documents as soon as reasonably practicable after
KNBT electronically files such material with, or furnishes such documents to the
SEC.
Keystone Nazareth Bank & Trust Company
The Bank is the successor to Keystone Savings Bank, a
Pennsylvania-chartered mutual savings bank that was organized in 1925. The Bank
has 41 full service offices with 19 located in Northampton County, Pennsylvania,
16 in Lehigh County, Pennsylvania, five in Monroe County, Pennsylvania and one
in Carbon County, Pennsylvania. The Bank's office network includes 14 full
service in-store supermarket branch offices. The Bank has ATMs in all but one of
its banking offices and also maintains seven off-site ATMs.
The Bank is primarily engaged in attracting deposits from the general
public and using those funds to invest in loans and securities. The Bank's
principal sources of funds are deposits, repayments of loans and mortgage-backed
securities, maturation of investments, funds provided from operations and funds
borrowed from outside sources such as the Federal Home Loan Bank of Pittsburgh
("FHLB"). The Bank's deposit products include interest-bearing and
non-interest-bearing checking accounts, statement savings accounts, passbook
savings accounts, money market accounts, club accounts, individual retirement
accounts and certificates of deposit. These funds are primarily used for the
origination of various loan types including single-family residential mortgage
loans, non-residential or commercial real estate mortgage loans, direct or
indirect consumer loans, such as home equity loans, automobile and recreational
vehicle loans and commercial business lines of credit, letters of credit and
term loans. Most of the Bank's commercial customers are small to medium size
businesses operating in the Bank's primary market area.
2
The Bank also offers trust and wealth management services through its
trust department under the name KNBT Trust Services. These services include
acting as executor and trustee under wills and deeds, as guardian, custodian and
as trustee and agent for pension, profit sharing and other employee benefit
trusts as well as various investment, pension and estate planning services. The
market value of the funds held by the trust department was $314.4 million at
December 31, 2004 as compared with $312.4 million at December 31, 2003. KNBT
offers a selection of investment and insurance products, including equity
securities, mutual funds and annuities to its customers in its branch offices.
Subsidiaries
In addition to the Bank, KNBT Inv. I Inc. and KNBT Inv. II Inc. are
also subsidiaries of KNBT.
In December 2003, KNBT established a wholly owned subsidiary, KNBT Inv.
Inc., a Delaware corporation for the purpose of investing in various types of
securities. As of December 31, 2004, KNBT Inv. I, Inc. had total assets of $86.3
million, of which $41.6 million and $25.7 million consists of interest-bearing
accounts and investment securities, respectively.
KNBT Inv. II, Inc., formerly known as First C. G. Company, Inc., was
acquired on October 31, 2003 as part of KNBT's acquisition of First Colonial and
is a wholly owned subsidiary of KNBT. KNBT Inv. II, Inc. is a Delaware
corporation established for the purpose of investing in various types of
securities. As of December 31, 2004, KNBT Inv. II, Inc. had total assets of $6.4
million of which $6.0 million was invested in equity securities with most of the
remaining assets in interest-bearing money market accounts.
The Bank has four wholly owned subsidiaries, KLV, Inc., KLVI, Inc.,
Traditions Settlement Services LLC and KNBT Securities. KLV, Inc. is inactive.
KLVI, Inc. is a Delaware corporation, formed in 1997 to hold and manage certain
investment securities. As of December 31, 2004, KLVI had total assets of $880.3
million of which $14.9 million and $858.0 million consists of interest-bearing
accounts and investment securities, respectively. Traditions was organized in
May 2002 and provides real estate title and settlement services. KNBT
Securities, formerly Oakwood Financial Corp., offers a full range of securities
brokerage, insurance and investment products and services.
Pending Acquisitions
Northeast Pennsylvania Financial Corp. On December 9, 2004, KNBT
announced entering into an Agreement and Plan of Merger dated as of December 8,
2004 (the "Merger Agreement") with NEPF, a Delaware corporation, which sets
forth the terms and conditions under which NEPF will merge with and into KNBT
(the "Merger"). The total cost of the acquisition is expected to be
approximately $98.0 million.
Under the terms of the Merger Agreement, NEPF's shareholders may elect
to receive either $23.00 of KNBT common stock or $23.00 in cash in exchange for
their shares of NEPF common stock, subject to an overall requirement that 50% of
the total outstanding NEPF common stock be exchanged for KNBT common stock and
50% for cash. The stock component of the merger consideration will be valued at
$23.00 per share based on the average market price of KNBT common stock during
the 20-trading day period ending on the fifth business day prior to the
completion of the Merger.
In addition, each director of NEPF entered into a Shareholder Agreement
with KNBT, pursuant to which each such person agreed, among other things, to
vote his or her shares of NEPF common stock in favor of the Merger Agreement at
a meeting of shareholders of NEPF that has been called to consider and approve
the Merger Agreement.
The transaction is expected to close during the second quarter of 2005.
It is subject to a number of customary conditions, including, but not limited
to, (a) the approval of the Merger Agreement by shareholders of NEPF and (b) the
receipt of all required regulatory approvals by applicable federal and state
regulatory agencies.
3
Caruso Benefits Group Inc. On February 28, 2005, KNBT announced
entering into an agreement to purchase Caruso, a benefits management firm based
in Bethlehem, Pennsylvania.
Caruso specializes in benefits management with an emphasis on group
medical, life and disability. Under the terms of the definitive agreement, KNBT
will acquire all of the capital stock of Caruso for a purchase price of $28
million in cash of which $20 million will be paid at time of closing and $8
million payable over a three-year period, subject to Caruso maintaining certain
levels of profitability.
Upon completion of the transaction, Caruso will operate as Caruso
Benefits Group, Inc., a wholly owned subsidiary of the Bank. The acquisition is
subject to customary conditions including receipt of all required regulatory
approvals and currently is expected to close in the second quarter of 2005.
Market Area and Competition
KNBT is a community-oriented banking institution offering a variety of
financial products and services to meet the needs of its customers. KNBT's
lending and deposit gathering is concentrated in the communities surrounding its
41 banking offices.
The Bank's market area consists of Lehigh, Northampton, Carbon and
Monroe Counties, all of which are located in Pennsylvania. The greater Lehigh
Valley area, which is in eastern Pennsylvania approximately 60 miles north of
Philadelphia, is anchored by the cities of Bethlehem, Allentown and Easton. The
combined population of Lehigh and Northampton Counties is in excess of 600,000
and the market includes a mix of urban, suburban and rural areas. Between 1990
and 2002, the combined population of Lehigh and Northampton Counties grew by
approximately 8.3% compared to 3.4% for Pennsylvania as a whole. Over 14,000
companies operate in the Lehigh Valley along with 11 colleges and universities.
Major employers in the area include Federal, State and local governments and
local healthcare providers including Lehigh Valley Hospital and St. Luke's
Hospital, Air Products & Chemicals, PPL, Binney & Smith, Giant Food Stores,
Agere Systems and Mack Trucks.
The Bank faces significant competition in originating loans and
attracting deposits. This competition stems primarily from commercial banks,
other savings banks and savings associations and mortgage-banking companies.
Within the Bank's market area, more than 50 other banks, savings institutions
and credit unions are operating. Many of the financial service providers
operating in the Bank's market area are significantly larger, and have greater
financial resources, than the Bank. The Bank faces additional competition for
deposits from money market and other mutual funds, and from other non-depository
financial institutions such as brokerage firms and insurance companies.
Lending Activities
KNBT primarily extends loans to individuals and businesses in the
counties of Northampton, Lehigh, Monroe and Carbon, Pennsylvania. Historically,
KNBT's principal lending activity has been the origination of loans
collateralized by one-to-four-family residential real estate located in its
market area. In addition, KNBT traditionally has been actively involved in
construction and land development loans, with an emphasis on
construction/permanent single-family residential mortgage loans and loans to
local homebuilders. The securitization of some of its residential real estate
loans and the continuing sale of such loans has been a factor in reducing KNBT's
historical concentration in these types of loans. KNBT also originates various
types of consumer loans, primarily home equity loans and lines of credit. KNBT
has increased its commercial lending activities as a result of the merger and
through staff and product additions.
KNBT's one-to-four-family residential real estate loans amounted to
$325.0 million or 32.1% of the total loan portfolio at December 31, 2004. At
such date, commercial real estate loans amounted to $218.2 million or 21.5% of
the total portfolio, construction and land development loans were $106.4 million
or 10.5% of the total portfolio, commercial business loans were $50.7 million or
5.0% of the total portfolio and consumer loans were $297.9 million or 29.4% of
the total portfolio.
4
Loan Portfolio Composition. The following table shows the composition
of the loan portfolio by type of loan at the dates indicated.
At December 31,
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2004 2003 2002 2001 2000
--------------------- -------------------- ------------------- -------------------- -------------------
Amount % Amount % Amount % Amount % Amount %
--------------------------------- --------- ---------- -------- ---------- --------- ---------- --------
(dollars in thousands)
Real estate loans:
One-to four- family
residential (1) $ 324,990 32.06% $ 332,024 36.00% $ 361,842 59.34% $ 513,352 73.27% $ 509,188 73.20%
Multi-family
residential 14,493 1.43% 14,197 1.54% 5,377 0.88% 3,823 0.55% 4,020 0.58%
Commercial real
estate 218,201 21.52% 156,563 16.97% 29,385 4.82% 12,839 1.83% 6,715 0.97%
Construction and
land development (2) 106,361 10.49% 112,684 12.22% 59,363 9.74% 54,092 7.72% 59,687 8.58%
----------- --------- ---------- --------- ---------- -------- ---------- --------- ---------- --------
Total real estate
loans 664,045 65.50% 615,468 66.73% 455,967 74.78% 584,106 83.37% 579,610 83.33%
Commercial
business loans 50,691 5.00% 38,978 4.23% 10,050 1.65% 4,399 0.63% 4,166 0.60%
State and political
subdivision loans 1,170 0.12% 2,334 0.25% - - - - - -
Consumer loans:
Home equity loans
and lines of credit 170,762 16.84% 151,603 16.44% 102,275 16.77% 96,702 13.80% 94,317 13.56%
Automobile and other
vehicles 119,036 11.74% 102,256 11.09% 31,956 5.24% 5,887 0.84% 8,901 1.28%
Other 8,137 0.80% 11,682 1.26% 9,500 1.56% 9,572 1.37% 8,585 1.23%
----------- --------- ---------- --------- ---------- -------- ---------- --------- ---------- --------
Total consumer
loans 297,935 29.38% 265,541 28.79% 143,731 23.57% 112,161 16.00% 111,803 16.07%
----------- --------- ---------- --------- ---------- -------- ---------- --------- ---------- --------
Total loans 1,013,841 100.00% 922,321 100.00% 609,748 100.00% 700,666 100.00% 695,579 100.00%
----------- ========= ---------- ========= ---------- ======== ---------- ========= ---------- ========
Less:
Undisbursed portion
of construction
loans in process (2) - (27,099) (24,263) (23,552) (28,972)
Deferred loan fees 79 (469) (3,236) (5,682) (6,163)
Allowance for loan
losses (10,461) (7,910) (2,927) (3,386) (3,337)
----------- ---------- ---------- ---------- ----------
Net loans $ 1,003,459 $ 886,843 $ 579,322 $ 668,046 $ 657,107
=========== ========== ========== ========== ==========
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(1) Includes mortgage loans held-for-sale of $713,000 at December 31, 2004,
$4.7 million at December 31, 2003, and $23.8 million at December 31, 2002.
There were no mortgage loans held-for-sale at December 31, 2001 or 2000.
(2) For the years 2003 and prior, KNBT's core processing system included the
undisbursed portion of construction loans in process. Total loans had to be
reduced by this number in order to calculate net loans for the year 2004.
KNBT's new core processing system no longer includes the undisbursed amount
in loan totals. Loans in process at December 31, 2004 equaled $36.9
million.
Contractual Terms to Final Maturities. The following table shows the
scheduled contractual maturities of KNBT's loans as of December 31, 2004, before
giving effect to net items. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The amounts shown below do not take into account loan prepayments.
State and
One-to Multi- Construction Commercial Political
Four-Family Family Commercial and Land Business Subdivision Consumer
Residential Resdential Real Estate Development Loans Loans Loans Total
--------------------------- ----------- ------------- ------------ ----------- ----------- -------------
(dollars in thousands)
Amounts due after
December 31, 2004 in:
One year or less $ 117 $ 322 $ 17,862 $ 34,310 $ 17,574 $ - $ 10,536 $ 80,721
After one year through
three years 1,995 2,215 24,798 1,890 6,063 198 35,989 73,148
After three years
through five years 3,910 686 43,150 15,000 10,589 453 108,828 182,616
After five years
through fifteen years 83,853 7,073 82,930 6,371 10,785 519 124,397 315,928
After fifteen years 235,115 4,197 49,461 48,790 5,680 - 18,185 361,428
------------- ------------ ----------- ------------- ------------ ----------- ----------- -------------
Total $ 324,990 $ 14,493 $ 218,201 $ 106,361 $ 50,691 $ 1,170 $ 297,935 $ 1,013,841
============= ============ =========== ============= ============ =========== =========== =============
5
The following table shows the amount of KNBT's loans at December 31,
2004, which are due after December 31, 2005 and indicates whether they have
fixed rates of interest or have floating or adjustable rates.
Floating or
Fixed-Rate Adjustable Rate Total
------------------ ------------------- --------------------
(dollars in thousands)
One-to-four-family residential $ 300,056 $ 24,817 $ 324,873
Multi-family residential 7,098 7,073 14,171
Commercial real estate 95,585 104,754 200,339
Construction and land development 54,300 17,751 72,051
Commercial business 21,798 11,319 33,117
State and political subdivisions 776 394 1,170
Consumer 243,533 43,866 287,399
------------------ ------------------- --------------------
Total $ 723,146 $ 209,974 $ 933,120
================== =================== ====================
Loan Originations, Sales and Servicing. KNBT's lending activities are
subject to underwriting standards and loan origination procedures established by
its board of directors and management. KNBT relies on its staff of retail loan
representatives and commercial lenders to originate new loans. These employees
travel throughout KNBT's market area and meet with customers at their homes,
place of business or in the Bank's offices, to receive loan requests. KNBT has
designated certain employees at each of its branch offices to take consumer loan
applications. KNBT has centralized underwriting for consumer, residential real
estate and commercial lending. All new loan requests received are underwritten
by experienced staff at KNBT's main office or loan operations center.
KNBT's single-family residential mortgage loans generally are written
on standardized documents used by either the Federal National Mortgage
Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). To
manage interest rate risk, KNBT generally sells its newly originated
single-family residential mortgage loans that are agency eligible. KNBT sells
such newly originated loans on a loan-by-loan or "flow" basis as the loans
close. Excluding the effect of loan securitizations in 2003 and 2002 involving
$162.6 million of loans, KNBT sold an aggregate of $63.2 million and $50.3
million of its newly originated single-family residential mortgage loans in the
years ended December 31, 2004 and 2003, respectively. At the time of sale, KNBT
recognizes a gain or loss on the sale based on the difference between the net
proceeds received and the carrying value of the loans sold. KNBT's net gains on
sales of residential mortgage loans were $774,000, $246,000 and $900,000 in
2004, 2003 and 2002, respectively. These gains are included in non-interest
income. KNBT retains the right to continue to provide servicing for all loans
sold. The income from servicing is included in non-interest income as service
fees.
At December 31, 2004, KNBT was servicing $321.4 million of residential
real estate loans it had previously sold. Due to the continuing low interest
rate environment and a higher level of loan repayments than originally
estimated, KNBT recognized impairments of its mortgage servicing rights of
$415,000, $1.1 million and $676,000 during the years ended December 31, 2004,
2003 and 2002, respectively. Such impairments are recorded as non-interest
expense.
In addition to loan sales, KNBT "securitized" $47.3 million and $115.3
million of seasoned, single-family residential mortgage loans in the years ended
December 31, 2003 and 2002, respectively. In such transactions, loans which did
not meet FNMA's eligibility standards at the time of origination, due to the
lack of private mortgage insurance or other criteria, were able to be
securitized after being in KNBT's portfolio for certain stipulated periods of
time, generally 18 to 24 months. Securitization is the process of packaging and
transferring residential mortgage loans to issuers of mortgage-backed
securities, such as FNMA, in return for mortgage-backed securities backed by the
mortgage loans that are transferred. As there is an active market for
mortgage-backed securities, they generally can be sold more readily than the
underlying loans in response to changes in interest rates or other factors. KNBT
retained all of the securities from its 2003 securitization but sold $61.4
million of the $115.3 million of loans securitized in 2002.
6
The following table shows total loans originated, securitized, sold and
repaid at KNBT during the periods indicated.
Year Ended December 31,
----------------------------------------------------
2004 2003 2002
------------- ------------- --------------
(dollars in thousands)
Loan originations:
One-to-four-family residential $ 162,320 $ 135,325 $ 109,029
Consumer 156,209 131,989 114,188
Other 89,942 192,864 73,605
------------- ------------- --------------
Total loan originations 408,471 460,178 296,822
Sales, securitizations and loan principal repayments:
Loans sold:
One-to-four-family residential 63,193 50,286 37,178
------------- ------------- --------------
Total sold 63,193 50,286 37,178
Loans securitized:
Securitized and retained - 47,251 53,897
Securitized and sold - - 61,438
------------- ------------- --------------
Total securitized - 47,251 115,335
------------- ------------- --------------
Loans principal advances/repayments 228,741 298,760 205,534
------------- ------------- --------------
Total loans sold, securitized and
principal repayments 291,934 396,297 358,047
Decrease due to other items, net (79) 27,568 27,499
Loans received in merger with First Colonial - 271,208 -
------------- ------------- --------------
Net increase (decrease) in loans receivable $ 116,616 $ 307,521 $ (88,724)
============= ============= ==============
One-to-Four-Family Residential Mortgage Lending. A primary lending
activity of KNBT is the origination of loans secured by first mortgages on
one-to-four-family residences located in its market area. Traditionally, KNBT
has been a leading originator of single-family residential mortgage loans in
Lehigh and Northampton Counties, and the Bank expects to continue its
single-family loan origination efforts. At December 31, 2004, single-family
residential mortgage loans amounted to $325.0 million or 32.1% of KNBT's total
loan portfolio, which compares to $332.0 million or 36.0% of single-family
residential mortgage loans at December 31, 2003.
KNBT originates fixed-rate, fully amortizing mortgage loans with
maturities ranging between 10 and 30 years. Management establishes interest
rates charged on loans based on market conditions. KNBT also offers
adjustable-rate mortgage ("ARM") loans with terms of up to 30 years, with
interest rates based on the one year Constant Maturity Treasury Bill index plus
a spread, which adjusts annually from the outset of the loan or which adjusts
after a three, five, seven or ten year initial fixed period. Interest rate
adjustments on such loans are typically limited to no more than 2% during any
adjustment period or 6% over the life of the loan. Due to local market
conditions and the current interest rate environment, KNBT has originated few
ARM loans during the past three years. At December 31, 2004, 92.4% of KNBT's
single-family residential mortgage loans maturing after December 31, 2005 had
fixed interest rates and 7.6% had adjustable interest rates.
KNBT underwrites one-to-four-family residential mortgage loans with
loan-to-value ratios of up to 100%, provided that a borrower obtains private
mortgage insurance on loans that exceed 90% of the appraised value or sales
price, whichever is less, of the secured property. Exceptions to such
loan-to-value limits exist for loans originated under special CRA programs. KNBT
also requires that title insurance, hazard insurance and, if appropriate, flood
insurance be maintained on all properties securing real estate loans. A licensed
appraiser appraises all properties securing one-to four-family first mortgage
loans. Mortgage loans originated by KNBT generally include a due-on-sale clause.
This clause provides the contractual right to deem the loan immediately due and
payable in the event the borrower transfers ownership of the property without
KNBT's consent. Due-on-sale clauses are an important means of adjusting the
yields of fixed-rate mortgage loans in a portfolio and KNBT generally exercises
its rights under these clauses.
7
During 2004, KNBT's practice was to sell most of its newly originated,
agency eligible single-family residential mortgage loans with interest rates of
6.5% or less. Mortgage loans were sold to either FNMA or FHLMC. Such loans were
sold on a non-recourse basis with servicing retained. KNBT recorded mortgage
servicing rights of $813,000 and $416,000 during 2004 and 2003, respectively.
During the years ended December 31, 2004 and 2003, KNBT, excluding sales made as
a part of its securitization, sold an aggregate of $63.2 million and $50.3
million, respectively, of single-family residential mortgage loans.
Consumer Loans. At December 31, 2004, KNBT's consumer loans amounted to
$297.9 million or 29.4% of the total loan portfolio as compared with $265.5
million or 28.8% at December 31, 2003. KNBT's consumer loans are comprised
primarily of home equity loans and lines of credit and automobile and
recreational vehicle loans. KNBT also offers a variety of other consumer loans
including personal loans and lines of credit, and home improvement loans. At
December 31, 2004, KNBT's home equity loans and lines of credit amounted to
$170.8 million or 16.8% of the total loan portfolio as compared with $151.7
million or 16.4% at December 31, 2003. Of such amount, $126.1 million were loans
and $44.7 million were lines of credit. In addition, at such date the unadvanced
portion of home equity lines of credit was $51.5 million. Home equity loans and
lines of credit, like single-family residential mortgage loans, are secured by
the equity in the borrower's residence. However, the Bank generally obtains a
second mortgage position on a home equity loan or line of credit. KNBT's home
equity loans typically are structured as fixed-rate fully amortizing loans with
terms of up to 15 years and loan-to-value ratios, when combined with any senior
liens, of up to 100%. KNBT charges higher interest rates for loan-to-value
ratios exceeding 80%. KNBT's home equity lines of credit have adjustable rates
of interest that are indexed to the prime rate as reported in The Wall Street
Journal. Generally, the maximum loan-to-value ratio on home equity lines of
credit, including the outstanding amount of any first mortgage loan, is 80%,
however, larger loan-to-value loans are granted. A borrower may draw down a home
equity line of credit for a period of five years from the date of the loan
agreement. During this period, the borrower has the option of paying, on a
monthly basis, either principal and interest or only the interest.
KNBT's automobile and other vehicle loans amounted to $119.0 million at
December 31, 2004 an increase of $16.8 million or 16.4% compared with December
31, 2003. KNBT's indirect portfolio has increased significantly since the Bank
initiated indirect automobile lending in January 2002. The total automobile and
other vehicle loans included, at December 31, 2003, $26.4 million of
recreational vehicle loans that were acquired from First Colonial in the merger.
KNBT originates indirect auto and recreational vehicle loans through a network
of dealers located in its market area and was actively doing business with
approximately 56 dealers at December 31, 2004. KNBT employs an experienced
indirect lender to head its program and has grown its dealer network by
emphasizing quality service and the development of long-term relationships with
the owners and managers of dealerships.
KNBT makes indirect loans to purchase both new and used vehicles. The
loans have terms up to six years for loans secured by new and used autos and 15
years for loans secured by recreational vehicles. As of December 31, 2004,
approximately 27.1% of KNBT's indirect vehicle loans were secured by new
vehicles, 50.2% were secured by used vehicles and 22.7% were secured by
recreational vehicles. KNBT originated $61.5 million and $56.5 million of
indirect loans during 2004 and 2003, respectively.
To underwrite its indirect loans, KNBT reviews the credit history of
applicants and determines appropriate debt to income and loan to value ratios.
KNBT also believes that the quality of its indirect loan portfolio is positively
affected by its efforts to build and maintain relationships with dealers who
attract creditworthy customers. KNBT tries to identify such dealers based on
KNBT's knowledge of dealers in its market area.
Indirect auto and recreational vehicle lending entails greater risks
than owner-occupied residential mortgage lending since borrowers are more likely
to default on those loans than on a residential mortgage loan secured by their
primary residence. Moreover, automobiles and recreational vehicles depreciate
rapidly and, in the event of a default, principal loss as a percentage of the
loan balance depends upon the mileage and condition of the vehicle at the time
of repossession.
8
Consumer loans entail greater risk than residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles and recreational vehicles. In these
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment. In addition, consumer loan
collections are highly dependent upon the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy.
Construction and Land Development Loans. KNBT has been an active
originator of construction and land development loans in its market area for
many years. At December 31, 2004, KNBT's construction and land development loans
amounted to $106.4 million or 10.5% of the total loan portfolio as compared with
$112.7 million or 12.2% of the portfolio at December 31, 2003. KNBT's
construction lending includes both construction loans to individuals to
construct personal residences, which amounted to approximately $32.6 million at
December 31, 2004, and loans to building contractors and developers, which
amounted to approximately $20.3 million at December 31, 2004 as well as loans
for commercial real estate construction, which amounted to approximately $53.5
million at December 31, 2004. At December 31, 2004, the unadvanced portion of
construction loans in process amounted to $54.6 million.
KNBT's construction loans to individuals to build their residences
typically are structured as construction/permanent loans whereby there is one
closing for both the construction loan and the permanent financing. During the
construction phase, which typically lasts for six to nine months, employees of
KNBT make periodic inspections of the construction site and loan proceeds are
disbursed as construction progresses. Typically, disbursements are made in five
draws during the construction period. Construction loans require payment of
interest only during the construction phase and are structured to convert to
fixed-rate permanent loans at the end of the construction phase. Prior to making
a commitment to fund a construction loan, KNBT requires an appraisal of the
property by independent fee appraisers or the Bank's in-house appraisers. The
Bank's staff also reviews and inspects each project prior to every disbursement
of funds during the term of the construction loan. Loan proceeds are disbursed
based on a percentage of completion.
KNBT also originates construction and site development loans to
contractors and builders primarily to finance the construction of single-family
homes and subdivisions and, to a lesser extent, the construction of commercial
development projects, and site development projects. Loans to finance the
construction of single-family homes and subdivisions are generally offered to
experienced builders in the Lehigh Valley with whom KNBT has an established
relationship. Residential development loans are typically offered with terms of
up to 24 months. The maximum loan-to-value limit applicable to these loans is
80% of the appraised post-construction value. Construction loan proceeds are
disbursed periodically in increments as construction progresses and as
inspection by KNBT's approved appraisers warrants. At December 31, 2004, KNBT's
largest construction and site development loan totaled $3.1 million and was
secured by a first mortgage lien. This loan was performing according to its
original terms at December 31, 2004. During 2004, KNBT estimates that the
average balance of its construction loans to contractors and developers was
approximately $19.3 million.
KNBT also makes construction loans for commercial development projects.
The projects include multi-family, apartment, industrial, retail and office
buildings. These loans generally have an interest-only phase during
construction, and generally convert to permanent financing when construction is
completed. Disbursement of funds is at the sole discretion of KNBT and is based
on the progress of construction. The maximum loan-to-value limit applicable to
these loans is generally 80% of the appraised post-construction value. KNBT's
largest commercial construction loan commitment to a single borrower was $16.8
million at December 31, 2004 for a commercial construction development project
located within KNBT's primary market area. While this loan was performing in
accordance with all its terms at December 31, 2004, management has downgraded
this loan on its internal classification system due to construction overruns.
Additional funding has been provided by a third party and leasing of the
remaining space in the property is continuing.
9
KNBT also originates land loans to local contractors and developers for
the purpose of improving the property, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 65% of the lower of the acquisition price or the appraised value
of the land, and have a term of up to two years with a floating interest rate
based on KNBT's internal base rate. KNBT's land loans are generally secured by
property in its primary market area.
Construction financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of
the initial estimate of the property's value at completion of construction
compared to the estimated cost, including interest, of construction and other
assumptions. Additionally, if the estimate of value proves to be inaccurate,
KNBT may be confronted with a project, when completed, having a value less than
the loan amount. KNBT attempts to minimize these risks through effective
inspection and monitoring procedures.
Commercial Real Estate Loans and Multi-Family Residential Real Estate
Loans. At December 31, 2004, KNBT's commercial real estate loans amounted to
$218.2 million or 21.5% of the total loan portfolio. The amount of KNBT's
commercial real estate loans increased $61.6 million in 2004 from a total of
$156.6 million at year-end 2003. KNBT's commercial real estate loans are secured
by mortgages on various commercial income producing properties and
owner-occupied commercial buildings including office buildings, retail and
industrial properties. Substantially all of KNBT's commercial real estate loans
are secured by properties located within the Bank's primary market area.
KNBT offers both adjustable-rate and fixed-rate commercial real estate
loans. Such loans typically have terms of 15 or 20 years with call options every
5 to 7 years. Loan-to-value ratios are generally 80% or less, and debt service
coverage of 1.20 times or better generally is required. Personal guarantees
often are required.
KNBT performs extensive diligence in underwriting commercial real
estate loans. KNBT attempts to understand and control the risk in several ways
including inspection of all such properties and the review of the overall
financial condition of the borrower, which may include, for example, the review
of the rent rolls and the verification of income. KNBT reviews a minimum of two
years of tax returns and financial statements of the borrower in its
underwriting of commercial real estate loans and these documents must be updated
and provided to the Bank on an annual basis. KNBT's commercial lending staff
undertakes an extensive credit review at least annually of each commercial real
estate loan in excess of $500,000. KNBT's largest commercial real estate loan at
December 31, 2004 was a $7.6 million loan secured by commercial real estate in
KNBT's primary market area. Such loan was performing in accordance with its
terms at December 31, 2004.
Commercial real estate loans have interest rates which are generally
more sensitive to changes in market interest rates than residential real estate
loans. Commercial real estate loans, however, entail significant additional
credit risk as compared with one-to-four-family residential mortgage lending, as
they typically involve larger loan balances concentrated with single borrowers
or groups of related borrowers. In addition, the payment experience on
commercial real estate loans secured by income producing properties is typically
dependent on the successful operation of the related real estate project and
thus may be more significantly impacted by adverse conditions in the real estate
market or in the economy generally.
At December 31, 2004, KNBT's multi-family residential mortgage loans
amounted to $14.5 million or 1.4% of the loan portfolio. Such loans are secured
by apartment buildings with five or more units. KNBT has not emphasized the
origination of multi-family residential mortgage loans but, when originated,
they are underwritten pursuant to the same policies and procedures as commercial
real estate loans.
Commercial Business Loans. KNBT's commercial business loans amounted to
$50.7 million or 5.0% of the total loan portfolio at December 31, 2004.
Commercial business loans increased by $11.7 million between December 31, 2003
and December 31, 2004. KNBT expects that its commercial business loan portfolio
will continue to grow.
10
KNBT's commercial business loans are typically extended to small to
mid-sized businesses with annual revenues generally not exceeding $100 million
in its market area and may be for working capital, equipment financing,
inventory financing or accounts receivable financing. Small business loans may
have adjustable or fixed rates and generally have terms of five years or less
but may go up to 10 years. KNBT's commercial business loans generally are
secured by equipment, machinery, real property or other corporate assets. In
addition, KNBT generally obtains personal guarantees from the principals of the
borrower with respect to all commercial business loans. KNBT's commercial loans
structured, as advances are made upon perfected security interests in accounts
receivable and/or inventory. Generally KNBT will advance amounts up to 75% of
accounts receivable and 50% of the value of inventory.
At December 31, 2004, KNBT's largest commercial business loan was $5.3
million extended to a business located in KNBT's primary market area. Such loan
was performing in accordance with its terms at December 31, 2004.
Commercial business loans generally are deemed to involve a greater
degree of risk than single-family residential mortgage loans. KNBT is attempting
to aggressively increase its originations of commercial business loans. KNBT
acquired additional experienced commercial loan officers as a result of the
First Colonial merger and continues to hire experienced commercial loan
officers. KNBT has implemented policies and procedures for commercial business
lending which management believes are conservative and prudent.
Loan Approval Procedures and Authority. KNBT's Board of Directors
establishes its lending policies and procedures. KNBT's Loan Policy Manual is
reviewed on at least an annual basis by its Directors' Loan Committee and
management in order to propose modifications as a result of market conditions,
regulatory changes and other factors. Key modifications must be approved by the
Board of Directors of KNBT.
The Bank is restricted in the amount of commitments to any one borrower
by its legal lending limit. This amount is equal to 15% of KNBT's unimpaired
capital and surplus or approximately $39.6 million at December 31, 2004. The
Bank is further restricted by its tiered in-house lending limit to any one
borrower, which is patterned upon the Bank's ten point internal rating system
for loans (see "Allowance for Loan Losses").
Various officers or combinations of officers of KNBT have the authority
within specifically identified limits to approve new loans. Larger loan amounts
are approved by an Officer's Loan Committee, Director's Loan Review Committee or
Board of Directors depending upon the customer's total credit exposure.
Non-Performing Assets
On loans where the collection of principal or interest payments is
doubtful, the accrual of interest income ceases ("non-accrual" loans). On loans
90 days or more past due as to principal and interest payments, KNBT's policy,
with certain limited exceptions, is to discontinue accruing additional interest
and reverse any interest currently accrued. On occasion, this action may be
taken earlier if the financial condition of the borrower raises significant
concern with regard to the borrower's ability to service the debt in accordance
with the terms of the loan agreement. Interest income is not accrued on these
loans until the borrower's financial condition and payment record demonstrate an
ability to service the debt.
Real estate that is acquired as a result of foreclosure is classified
as other real estate owned. Other real estate owned is recorded at the lower of
cost or fair value less estimated selling costs. Costs associated with acquiring
and improving a foreclosed property are usually capitalized to the extent that
the carrying values does not exceed fair value less estimated selling costs.
Holding costs are charged to expense. Gains and losses on the sale of other real
estate owned are credited or charged to operations, as incurred.
11
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 the dates indicated. KNBT did not have troubled debt
restructurings at any of the dates indicated.
At December 31,
--------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- -------------- ------------- -------------
(dollars in thousands)
Non-accruing loans $ 4,544 $ 1,720 $ 2,197 $ 1,752 $ 763
Accruing loans 90 days
or more past due 511 405 298 938 35
------------- ------------- -------------- ------------- -------------
Total non-performing loans 5,055 2,125 2,495 2,690 798
Other real estate owned 71 173 115 200 151
------------- ------------- -------------- ------------- -------------
Total non-performing assets $ 5,126 $ 2,298 $ 2,610 $ 2,890 $ 949
============= ============= ============== ============= =============
Total non-performing loans
as a percentage of loans, net 0.50% 0.24% 0.43% 0.40% 0.12%
Total non-performing loans
as a percentage of total assets 0.21% 0.11% 0.25% 0.29% 0.10%
Total non-performing assets
as a percentage of total assets 0.21% 0.12% 0.26% 0.31% 0.12%
The $2.8 million increase in non-performing loans between December 31,
2004 and December 2003 was primarily due to a $1.9 million increase in
non-performing single family residential loans and a $1.0 million increase in
non-performing consumer loans, primarily indirect vehicle financing. Since
residential loans are typically well secured, KNBT anticipates minimal
charge-offs from this portfolio. The indirect vehicle portfolio represents 11.7%
of the total loan portfolio, and includes loans generally with one to six year
maturities and are secured by vehicles, limiting charge off potential. During
the fourth quarter of 2004, KNBT instituted policies limiting vehicle collateral
advance levels based on key credit criteria which management believes will yield
improved portfolio non-accrual and charge-off results.
The following table shows the effect non-accrual loans have had on
interest income for each of the periods indicated.
Year ended December 31,
------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ------------ ------------ ----------- -----------
(dollars in thousands)
Interest which would have been
recorded at the original rate $ 125 $ 50 $ 66 $ 81 $ 43
Interest that was reflected
in income - 60 45 40 26
----------- ------------ ------------ ----------- -----------
Net impact on interest income $ (125) $ 10 $ (21) $ (41) $ (17)
=========== ============ ============ =========== ===========
KNBT accounts for impaired loans under SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by
Creditors for Impairment of a Loan--Income Recognition and Disclosures." This
standard requires, that a creditor measure impairment based on the present value
of expected future cash flows discounted at the loan's effective interest rate,
except that as a practical expedient, a creditor may measure impairment based on
a loan's observable market price, or the fair value of the collateral if the
loan is collateral dependent. Regardless of the measurement method, a creditor
must measure impairment based on the fair value of the collateral when the
creditor determines that foreclosure is probable.
KNBT identifies a loan as impaired when it is probable that interest
and principal will not be collected according to the contractual terms of the
loan agreement. The accrual of interest is discontinued on such loans and no
income is recognized until all recorded amounts of interest and principal are
recovered in full.
12
Loan impairment is measured by estimating the expected future cash
flows and discounting them at the respective effective interest rate or by
valuing the underlying collateral. The total principal amount of KNBT's impaired
loans was $424,000 at December 31, 2004 and $217,000 at December 31, 2003. The
recorded investment in these loans and the valuation for credit losses related
to loan impairment at December 31, 2004 and 2003 were as follows:
At December 31,
---------------------------------
2004 2003
------------- -------------
(dollars in thousands)
Principal amount of impaired loans $ 424 $ 217
Accrued interest - 2
------------- -------------
424 219
Less valuation allowance at December 31, 61 33
------------- -------------
$ 363 $ 186
============= =============
The activity in KNBT's allowance account for credit losses related to
impaired loans for the years ended December 31, 2004 and 2003 were as follows:
Year ended December 31,
----------------------------------
2004 2003
------------- -------------
(dollars in thousands)
Valuation allowance at January 1, $ 33 $ -
Received in merger - 33
Provision for loan impairment 28 -
------------- -------------
Valuation allowance at December 31, $ 61 $ 33
============= =============
Total cash collected on impaired loans by KNBT during 2004 was $77,000,
all of which was credited to the principal balance outstanding on such loans.
KNBT's valuation allowance for impaired loans of $61,000 at December 31, 2004 is
included in its allowance for loan losses which amounted to $10.5 million at
December 31, 2004. KNBT's valuation allowance for impaired loans at December 31,
2003 was $33,000. KNBT did not have impaired loans at December 31, 2002.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses. KNBT maintains the allowance at a level
believed, to the best of management's knowledge, to cover all known and inherent
losses in the portfolio that are both probable and reasonable to estimate at
each reporting date. Management reviews all loans 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,
KNBT's management considers a ten point internal rating system for all loans
originated by the Commercial Lending department. At the time of origination,
each commercial loan is assigned a rating based on the assumed risk elements of
the loan. Such risk ratings are periodically reviewed by management and revised
as deemed appropriate. As a result of this risk assessment, management has
identified $66.3 million of loans at December 31, 2004 which were performing in
accordance with their terms but were deemed to have certain weaknesses or
increased levels of risk. Included in this amount is one commercial construction
loan in the amount of $16.8 million that was performing in accordance with its
terms but management downgraded based on its internal classification system due
to construction cost overruns.
13
Additional funding has been provided by a third party and leasing of the
remaining space in the property is continuing. The establishment of the
allowance for loan losses is significantly affected by management's judgment and
uncertainties and there is likelihood that different amounts would be reported
under different conditions or assumptions. Various regulatory agencies, as an
integral part of their examination process, periodically review KNBT's allowance
for loan losses. Such agencies may require it to make additional provisions for
estimated loan losses based upon judgments different from those of management.
As of December 31, 2004, KNBT's allowance for loan losses was 1.03% of total
loans receivable compared with 0.89% at December 31, 2003.
KNBT will continue to monitor and modify its allowance for loan losses
as conditions dictate. No assurances can be given that its level of allowance
for loan losses will cover all of the inherent losses on its loans or that
future adjustments to the allowance for loan losses will not be necessary if
economic and other conditions differ substantially from the economic and other
conditions used by management to determine the current level of the allowance
for loan losses.
The following table shows changes in KNBT's allowance for loan losses
during the periods presented.
At or For the Year ended December 31,
-------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Allowance for loan losses, beginning of period $ 7,910 $ 2,927 $ 3,386 $ 3,337 $ 3,101
Acquired from merger with First Colonial - 3,548 - - -
Provision for loan losses 4,308 2,951 111 391 442
Charge-offs
One-to-four family residential 92 242 229 154 100
Multi-family - - - - -
Commercial real estate - - - - -
Construction and land development 5 - - - -
Commercial business - 154 - - -
Consumer 1,915 1,207 394 224 146
---------- ---------- ---------- ---------- ----------
Total charge offs 2,012 1,603 623 378 246
---------- ---------- ---------- ---------- ----------
Recoveries on loans previously charged-off
One-to-four family residential 99 32 37 19 33
Consumer 152 49 - - -
Commercial business 4 6 16 17 7
---------- ---------- ---------- ---------- ----------
Total charge offs 255 87 53 36 40
---------- ---------- ---------- ---------- ----------
Net loans charged off 1,757 1,516 570 342 206
---------- ---------- ---------- ---------- ----------
Allowance for loan losses, at period end $10,461 $ 7,910 $ 2,927 $ 3,386 $ 3,337
========== ========== ========== ========== ==========
Allowance for loan losses at period end to:
Average loans (net) 1.09% 1.27% 0.47% 0.50% 0.52%
Total loans at period end 1.03% 0.89% 0.52% 0.50% 0.51%
Non-performing loans 206.94% 388.28% 117.31% 125.87% 418.17%
Charge-offs to average loans during period 0.21% 0.26% 0.10% 0.06% 0.04%
14
The following table shows how KNBT's allowance for loan losses has been
allocated by type of loan at each of the dates indicated.
At December 31,
-------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
-------------------- -------------------- -------------------- -------------------- --------------------
Loan Loan Loan Loan Loan
Category Category Category Category Category
Amount as a % Amount as a % Amount as a % Amount as a % Amount as a %
of of Total of of Total of of Total of of Total of of Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
-------------------- -------------------- -------------------- -------------------- --------------------
(dollars in thousands)
One-to-four- family
residential $ 553 32.06% $ 349 36.00% $ 1,086 59.34% $2,053 73.27% $2,291 73.20%
Multi-family
residential 350 1.43 4 1.54 33 0.88 35 0.55 48 0.58
Commercial real
estate 2,140 21.52 1,602 16.97 145 4.82 39 1.83 43 0.97
Construction and
land development 3,350 10.49 1,826 12.22 451 9.74 291 7.72 106 8.58
Commercial
business 454 5.00 712 4.23 500 1.65 464 0.63 115 0.60
State and political
subdivision 3 0.12 - 0.25 - - - - - -
Consumer 2,804 29.38 2,673 28.79 590 23.57 303 16.00 123 16.07
Unallocated 807 - 744 - 122 - 201 - 611 -
--------- --------- -------- ---------- --------- --------- --------- --------- --------- ---------
Total loans $ 10,461 100.00% $ 7,910 100.00% $ 2,927 100.00% $3,386 100.00% $3,337 100.00%
========= ========= ======== ========== ========= ========= ========= ========= ========= =========
Investment Activities
KNBT invests in securities pursuant to its Investment Policy. KNBT's
Investment Policy is designed primarily to maintain liquidity, to generate a
favorable return without incurring undue interest rate or credit risk, to
complement its lending activities, to manage the interest rate sensitivity of
its assets and liabilities and minimize KNBT's tax liability. KNBT also uses a
leverage investment strategy for the purpose of enhancing returns. Pursuant to
this strategy, KNBT has increased the size of its investment portfolio by
utilizing borrowings to support such investments.
KNBT classifies its debt and marketable securities into three
categories: held-to-maturity, available-for-sale and trading at the time of
acquisition. Securities, classified as held-to-maturity are securities that KNBT
has the intent and ability to hold until their contractual maturity date and are
reported at cost. Held-to-maturity securities can be sold prior to maturity only
under rare circumstances. Securities classified as available for sale are
reported at their fair value with unrealized gains and losses on these
securities, net of income tax provisions, reflected in retained earnings as
accumulated other comprehensive income. Available-for-sale securities can be
sold at any time based upon needs or market conditions. Trading securities are
measured at fair value, with unrealized gains and losses included in income. At
the present time, KNBT does not have a trading portfolio.
At December 31, 2004, KNBT's investment securities portfolio amounted
to $1.1 billion or 46.1% of total assets as compared with $734.1 million or
37.8% of total assets at December 31, 2003. The largest component of KNBT's
investment securities in recent periods has been mortgage-backed securities that
amounted to $743.7 million or 66.8% of the investment securities portfolio at
December 31, 2004 compared with $464.4 million or 63.2% at December 31, 2003. In
addition, KNBT invests in municipal securities, corporate debt obligations, U.S.
government and agency obligations and other securities. In recent periods, KNBT
has increased the amount of its investment in municipal securities due to the
tax advantage provided by such securities. Under KNBT's Investment Policy,
municipal bonds must be rated in the top three investment rating categories at
the time of purchase. At December 31, 2004, such securities amounted to $112.1
million.
Held-to-maturity. At December 31, 2004, KNBT's held-to-maturity
investment securities totaled $56.6 million. KNBT has the intent and ability to
hold these securities until maturity. The fair value of these securities were
$57.0 million at December 31, 2004.
15
Available-for-sale. KNBT had $1.1 billion of securities
available-for-sale at December 31, 2004, as compared with $734.1 at December 31,
2003. At December 31, 2004, the net unrealized gain recorded in other
comprehensive income on these securities was $2.4 million, net of the tax effect
of $1.2 million. There was a net unrealized gain of $6.3 million, net of tax
effect of $3.3 million, at December 31, 2003.
Currently, KNBT is not participating in hedging programs, interest rate
swaps, collars or other activities involving the use of off-balance sheet
financial derivatives. Also, KNBT does not purchase mortgage-backed derivative
instruments that would be characterized "high-risk" under Federal banking
regulations at the time of purchase, nor does it purchase corporate obligations
that are not rated investment grade.
KNBT's mortgage-backed securities include mortgage pass-through
certificates issued by the GNMA, FNMA and FHLMC as well as collateralized
mortgage obligations ("CMOs") issued by such agencies or private issuers.
Investments in mortgage-backed securities involve a risk that actual prepayments
will be greater than estimated prepayments over the life of the security, which
may require adjustments to the amortization of any premium or accretion of any
discount relating to such instruments thereby changing the net yield on such
securities. There is also reinvestment risk associated with the cash flows of
such securities or in the event the issuer redeems such securities. In addition,
the market value of such securities may be adversely affected by changes in
interest rates.
CMOs are typically issued by a special-purpose entity, in KNBT's case,
private issuers or government agencies, which may be organized in a variety of
legal forms, such as a trust, a corporation, or a partnership. Substantially all
of the CMOs held in KNBT's portfolio consist of senior sequential tranches,
primarily investments in the first tranche of the CMOs. By purchasing senior
sequential tranches, management attempts to ensure the cash flow associated with
such an investment. While non-agency private issues are somewhat less liquid
than CMOs issued by GNMA, FNMA or FHLMC, they generally have a higher yield than
agency insured or guaranteed CMOs. This higher yield reflects, in part, a lack
of such guarantee or protection and, thus, the potentially higher risk of loss
or default associated with such assets. KNBT's investment portfolio policy
requires that all privately issued CMOs have a Standard & Poor's rating of AAA
at the time of purchase.
The following table sets forth the carrying value of KNBT's securities
at the dates indicated.
Year ended December 31,
----------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- ------------------------- -------------------------
Available- Held-to- Available- Held-to- Available- Held-to-
for-Sale Maturity for-Sale Maturity for-Sale Maturity
------------- ----------- ----------- ----------- ----------- ----------
(dollars in thousands)
U.S. Government and
agency obligations $ 175,649 $ - $120,380 $ - $ 31,075 $ -
Corporate securities 9,197 - 15,637 - 35,172 -
Municipal obligations 106,574 5,510 115,655 - 41,039 -
Mortgage-backed securities:
GNMA 1,460 - 2,138 - 3,327 -
FHLMC 104,654 - 83,985 - 18,348 -
FNMA 310,641 25,893 227,538 - 76,101 -
CMOs 275,882 25,183 150,697 - 84,174 -
------------- ----------- ----------- ----------- ----------- ----------
Total mortgage-backed
securities 692,637 51,076 464,358 - 181,950 -
Equity securities 73,052 - 18,057 - 4,914 -
------------- ----------- ----------- ----------- ----------- ----------
Total investment securities $1,057,109 $ 56,586 $734,087 $ - $ 294,150 $ -
============= =========== =========== =========== =========== ==========
16
The following table sets forth the amount of investment securities, at
amortized cost, which mature during each of the periods indicated and the
weighted average yields for each range of maturities at the dates indicated. No
tax-exempt yields have been adjusted to a tax-equivalent basis.
At December 31, 2004
------------------------------------------------------------------------------------
Over One Over Five
One Year Year Through Years Through Over Ten
or Less Five Years Ten Years Years Total
--------------- ----------------- ---------------- ---------- --------------
(dollars in thousands)
Available-for-Sale
U.S. Government and
agency obligations
Fair value $ - $77,320 $ 62,598 $ 35,731 $ 175,649
Amortized cost $ - $77,664 $ 62,454 $ 34,746 $ 174,864
Yield - % 3.06% 3.85% 5.00% 3.81%
Corporate securities
Fair value $ 4,009 $ 5,188 $ - $ - $ 9,197
Amortized cost $ 3,996 $ 5,033 $ - $ - $ 9,029
Yield 4.86% 5.72% - % - % 5.34%
Municipal obligations
Fair value $ - $ 1,735 $ 39,776 $ 65,063 $ 106,574
Amortized cost $ - $ 1,711 $ 39,339 $ 63,426 $ 104,476
Yield - % 3.56% 3.77% 4.58% 4.26%
Mortgage-backed securities
Fair value $ - $15,333 $117,943 $559,361 $ 692,637
Amortized cost $ - $15,382 $117,553 $559,365 $ 692,300
Yield - % 3.81% 4.15% 4.48% 4.41%
Equity securities
Fair value $ - $ - $ - $ 73,052 $ 73,052
Amortized cost $ - $ - $ - $ 72,853 $ 72,853
Yield - % - % - % 4.01% 4.01%
Held-to-Maturity
Municipal obligations
Fair value $ - $ - $ - $ 5,545 $ 5,545
Amortized cost $ - $ - $ - $ 5,510 $ 5,510
Yield - % - % - % 4.86% 4.86%
Mortgage-backed securities
Fair value $ - $ - $ 2,815 $ 48,674 $ 51,489
Amortized cost $ - $ - $ 2,799 $ 48,277 $ 51,076
Yield - % - % 4.59% 4.68% 4.68%
Total Securities
Fair value $ 4,009 $ 99,576 $223,132 $787,426 $1,114,143
Amortized cost $ 3,996 $ 99,790 $222,145 $784,177 $1,110,108
Yield 4.86% 3.32% 4.01% 4.48% 4.30%
17
The following table sets forth the purchases, sales and principal
repayments of mortgage-backed securities, at amortized cost, for KNBT for the
periods indicated.
At or For the
Years Ended December 31,
------------------------------------------------
2004 2003 2002
Held to maturity:
Purchases $ 54,234 $ - $ -
Repayments (3,242) - -
Amortizations of premiums and discounts, net 84 - -
-------------- --------------- ---------------
Mortgage-backed securities at end of period $ 51,076 $ - $ -
============== =============== ===============
Weighted average yield at end of period 4.68% - -
Available for sale:
Mortgage-backed securities at beginning of period $ 461,308 $ 178,389 $ 75,320
Mortgage-backed securities acquired through merger
with First Colonial - 151,584 -
Purchase price adjustment of mortgage-backed securities
acquired through merger with First Colonial - (2,309) -
Purchases 380,220 333,675 140,911
Securitized and retained - 47,251 53,897
Securitized and sold - - 61,438
Repayments (135,540) (218,339) (88,850)
Sales (10,900) (25,495) (63,844)
Amortizations of premiums and discounts, net (2,788) (3,448) (483)
-------------- --------------- ---------------
Mortgage-backed securities at end of period $ 692,300 $ 461,308 $ 178,389
============== =============== ===============
Weighted average yield at end of period 4.41% 4.05% 5.85%
Sources of Funds
Deposits. Deposits are the primary source of KNBT's funds. KNBT offers
a variety of deposit accounts with a range of interest rates and terms. KNBT's
deposits consist of interest-bearing and non-interest bearing checking accounts,
money market, savings and certificate of deposit accounts. KNBT also offers IRA
accounts. For business customers, KNBT offers several checking and savings
plans, in addition to cash management services. Our customer relationship
strategy focuses on relationship banking for retail and business customers to
enhance their overall experience with KNBT. Deposit activity is influenced by
state and local economic activity, changes in interest rates, internal pricing
decisions and competition. Deposits are primarily obtained from the areas
surrounding our branch locations. In order to attract and retain deposits, KNBT
offers competitive rates, quality customer service, on-line banking and other
products to meet the needs of customers
Total deposits increased to $1.32 billion at December 31, 2004 from
$1.29 billion at December 31, 2003, an increase of $33.6 million or 2.6%. Such
increase reflected, in part, KNBT's continuing effort to increase the level of
our checking accounts and other core deposits. Contributing to the increase in
deposits were increases in money market and checking products due to the market
penetration of branches that opened in 2003 and KNBT's marketing programs. Total
core deposits which consists of all deposits other than certificates of deposit,
increased by $20.5 million in 2004.
18
The following table shows for KNBT the average balance of each type of
deposit and the average rate paid on each type of deposit for the periods
indicated.
Year Ended December 31,
--------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------- ---------------------------- -----------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Expense Rate Paid Balance Expense Rate Paid Balance Expense Rate Paid
------------------------------- ---------------------------- -----------------------------
(dollars in thousands)
Savings $ 221,027 $ 1,063 0.48% $182,548 $ 1,315 0.72% $111,689 $ 1,680 1.50%
Interest-bearing
checking 174,698 273 0.16 102,506 298 0.29 81,609 466 0.57
Money market 249,065 2,477 0.99 203,978 2,212 1.08 134,456 2,784 2.07
Certificates of deposit 539,505 14,372 2.66 409,003 12,168 2.98 417,073 18,169 4.36
------------ --------- ---------- -------- ---------- ---------
Total interest-bearing
deposits 1,184,295 18,185 1.54 898,035 15,993 1.78 744,827 23,099 3.10
Non-interest-bearing
deposits 119,133 - - 53,559 - - 28,881 - -
------------ --------- ---------- -------- ---------- ---------
Total deposits $ 1,303,428 $ 18,185 1.40% $951,594 $15,993 1.68% $773,708 $23,099 2.99%
============ ========= ========== ======== ========== =========
The following table shows for KNBT the deposit flows during the periods
indicated.
Year Ended December 31,
-----------------------------------------------------------
2004 2003 2002
--------------------- -------------------- ----------------
(dollars in thousands)
Deposits assumed in merger $ - $ 512,086 $ -
Total deposits 17,564,185 10,938,793 4,352,478
Total withdrawals (17,555,628) (10,947,524) (4,373,961)
Interest credited 25,086 14,230 21,089
--------------------- -------------------- ----------------
Total increase (decrease) in deposits $ 33,643 $ 517,585 $ (394)
===================== ==================== ================
The following table shows for KNBT the amount of certificates of
deposit, by various interest rate categories and maturities, at the dates
indicated.
Balance at December 31, 2004
Maturing in the 12 Months Ending December 31,
Certificates of Deposit: 2005 2006 2007 2008 2009 Thereafter Total
- -----------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Less than 1% $ 3,913 $ 1 $ 137 $ - $ 7 $ - $ 4,058
1.00% - 1.99% 145,542 33,974 14 27 - - 179,557
2.00% - 2.99% 60,448 46,767 5,675 3,722 - 105 116,717
3.00% - 3.99% 34,002 45,761 56,201 14,090 3,801 113 153,968
4.00% - 4.99% 25,939 15,478 27,752 139 19,377 550 89,235
5.00% - 5.99% 1,808 2,310 13,702 138 20 5 17,983
6.00% - 6.99% 138 - 4 - - - 142
7.00% or more - - - - - - -
------------ ------------- ------------- ------------ ------------- ------------ --------------
Total certificates of deposit $ 271,790 $ 144,291 $ 103,485 $ 18,116 $ 23,205 $ 773 $ 561,660
============ ============= ============= ============ ============= ============ ==============
19
The following table shows the maturities of KNBT's certificates of
deposit of $100,000 or more at December 31, 2004 indicated by time remaining to
maturity.
Weighted
Maturing in Quarter Ending: Amount Average Rate
- ------------------------------------------ -------------- ------------------
(dollars in thousands)
Three months or less $14,941 2.56%
Over three months to six months 8,197 2.15%
Over six through twelve months 12,360 2.61%
Over twelve months 52,229 3.20%
--------------
Total certificates of deposit with
balances of $100,000 or more $87,727 2.91%
============== ===========
Borrowings. KNBT, as part of its operating strategy, utilizes advances
from the FHLB of Pittsburgh as an alternative to retail deposits to fund its
operations. These FHLB advances are collateralized primarily by certain of
KNBT's mortgage loans and mortgage-backed securities and secondarily by its
investment in capital stock of the FHLB of Pittsburgh. FHLB advances are made
pursuant to several different credit programs, each of which has it own interest
rate and range of maturities. The maximum amount that the FHLB of Pittsburgh
will advance to member institutions, including KNBT, fluctuates from time to
time in accordance with the policies of the FHLB. At December 31, 2004, KNBT had
$660.7 million in outstanding FHLB advances while at December 31, 2003 FHLB
advances totaled $207.2 million, which included $20.0 million in short-term
(overnight) borrowings. KNBT had no other short-term (overnight) borrowings from
the FHLB in 2004, 2003 and 2002.
The weighted average interest rate on KNBT's advances was 3.30% and
4.21% for the years ended December 31, 2004 and 2003, respectively.
The principal payments due on KNBT's long-term FHLB advances at
December 31, 2004 are as follows:
FHLB Advances
Due In At December 31, 2004
- --------------------------- --------------------------
(dollars in thousands)
2005 $ 137,005
2006 123,364
2007 157,682
2008 56,949
2009 115,168
2010 and thereafter 70,506
--------------------------
Total $ 660,674
==========================
In addition to FHLB advances, KNBT's borrowings include securities sold
under agreements to repurchase ("repurchase agreements"). Repurchase agreements
are contracts for the sale of securities owned or borrowed by KNBT, with an
agreement to repurchase those securities at an agreed upon price and date. The
collateral for such repurchase agreements are U.S. Treasury and agency
securities and municipal securities. At December 31, 2004, KNBT's repurchase
agreements amounted to $22.6 million and all of such borrowings were short-term,
having maturities of one year or less. KNBT's securities sold under repurchase
agreements totaled $24.6 million at December 31, 2003.
20
The following table shows certain information regarding KNBT's
repurchase agreements:
At or For the Year Ended December 31,
-------------------------------------------------------------------
2004 2003 2002
---------------- ---------------- ----------------
(dollars in thousands)
Repurchase Agreements:
Average balance outstanding $ 22,579 $ 11,931 $ 7,330
Maximum amount outstanding at
any month-end during the period $ 31,076 $ 24,550 $ 10,051
Balance outstanding at end of period $ 22,643 $ 24,550 $ 8,904
Average interest rate during the period 0.75% 1.10% 2.09%
Weighted average interest rate at
end of period 0.99% 0.64% 1.85%
In conjunction with the merger with First Colonial, KNBT assumed $15.0
million of subordinated debentures which were issued by First Colonial Trust I
("Trust I") in June 2002, a wholly owned Connecticut statutory business trust
subsidiary of First Colonial. Trust I issued $15.0 million in pooled trust
preferred securities using the proceeds to purchase subordinated debentures
issued by First Colonial. The subordinated debentures are the sole asset of the
Trust I. The trust preferred securities are classified as long-term debt for the
financial statements, but are included as Tier I capital for regulatory
purposes. The interest rate on these securities (5.99% at December 31, 2004) is
variable, adjusting quarterly at three-month LIBOR plus 3.45%. The interest is
payable quarterly. The trust preferred securities mature in June 2032 but may be
redeemed in whole or in part beginning in June 2007 and may be redeemed at any
time in the event that the deduction of related interest for federal income tax
purposes is prohibited, treatment as Tier I capital is no longer permitted, or
certain other contingencies arise.
Regulation of KNBT Bancorp
Set forth below is a brief description of certain laws relating to the
regulation of KNBT Bancorp and the Bank. This description does not purport to be
complete and is qualified in its entirety by reference to applicable laws and
regulations.
General. The Bank as a Pennsylvania-chartered savings bank with
deposits insured by the Savings Association Insurance Fund administered by the
Federal Deposit Insurance Corporation ("FDIC") is subject to extensive
regulation and examination by the Pennsylvania Department of Banking and by the
FDIC. The federal and state laws and regulations applicable to banks regulate,
among other things, the scope of their business, their investments, the reserves
required to be kept against deposits, the timing of the availability of
deposited funds and the nature and amount of collateral for certain loans. This
regulatory structure also gives the federal and state banking agencies extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. The laws and regulations governing the Bank generally have been
promulgated to protect depositors and not for the purpose of protecting
stockholders.
Federal law provides the federal banking regulators, including the FDIC
and the Federal Reserve Board, with substantial enforcement powers. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease-and-desist or removal orders, and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities. Any change in
such regulation, whether by the Pennsylvania Department of Banking, the FDIC,
the Federal Reserve Board or the United States Congress, could have a material
impact on KNBT and its operations.
21
KNBT is a bank holding company under the Bank Holding Company Act
subject to regulation and supervision by the Federal Reserve Board and by the
Pennsylvania Department of Banking. KNBT is required to file annually a report
of its operations with, and is subject to examination by, the Federal Reserve
Board and the Pennsylvania Department of Banking. This regulation and oversight
is generally intended to ensure that KNBT limits its activities to those allowed
by law and that it operates in a safe and sound manner without endangering the
financial health of its subsidiary bank.
KNBT has registered its common stock with the SEC under Section 12(g)
of the Securities Exchange Act of 1934. KNBT is subject to the proxy and tender
offer rules, insider trading reporting requirements and restrictions, and
certain other requirements under the Securities Exchange Act of 1934. KNBT's
common stock is listed on the Nasdaq Stock Market National Market under the
symbol "KNBT." The Nasdaq Stock Market listing requirements impose additional
requirements on KNBT, including, among other things, rules relating to corporate
governance and the composition and independence of its Board of Directors and
various committees of the board, such as the audit committee.
Bank Holding Company Act Activities and Other Limitations. Under the
Bank Holding Company Act, KNBT must obtain the prior approval of the Federal
Reserve Board before it may acquire control of another bank or bank holding
company, merge or consolidate with another bank holding company, acquire all or
substantially all of the assets of another bank or bank holding company, or
acquire direct or indirect ownership or control of any voting shares of any bank
or bank holding company if, after such acquisition, KNBT would directly or
indirectly own or control more than 5% of such shares.
Federal statutes impose restrictions on the ability of a bank holding
company and its non-bank subsidiaries to obtain extensions of credit from its
subsidiary bank, on the subsidiary bank's investments in the stock or securities
of the holding company, and on the subsidiary bank's taking of the holding
company's stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale of
property, or furnishing of services by the subsidiary bank.
A bank holding company is required to serve as a source of financial
and managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, it is the policy of the
Federal Reserve Board that a bank holding company should stand ready to use
available resources to provide adequate capital to its subsidiary banks during
periods of financial stress or adversity and should maintain the financial
flexibility and capital-raising capacity to obtain additional resources for
assisting its subsidiary banks. A bank holding company's failure to meet its
obligations to serve as a source of strength to its subsidiary banks will
generally be considered by the Federal Reserve Board to be an unsafe and unsound
banking practice or a violation of the Federal Reserve Board regulations, or
both.
Non-Banking Activities. The business activities of KNBT, as a bank
holding company, are restricted by the Bank Holding Company Act. Under the Bank
Holding Company Act and the Federal Reserve Board's bank holding company
regulations, KNBT may only engage in, or acquire or control voting securities or
assets of a company engaged in:
o banking or managing or controlling banks and other
subsidiaries authorized under the Bank Holding Company Act;
and
o any Bank Holding Company Act activity the Federal Reserve
Board has determined to be so closely related that it is
incidental to banking or managing or controlling banks.
22
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking including operating a mortgage
company, finance company, credit card company, factoring company, trust company
or savings association; performing certain data processing operations; providing
limited securities brokerage services; acting as an investment or financial
advisor; acting as an insurance agent for certain types of credit-related
insurance; leasing personal property on a full-payout, non-operating basis;
providing tax planning and preparation services; operating a collection agency;
and providing certain courier services. However, as discussed below, certain
other activities are permissible for a bank holding company that becomes a
financial holding company.
Financial Modernization. The Gramm-Leach-Bliley Act permits greater
affiliation among banks, securities firms, insurance companies, and other
companies under a new type of financial services company known as a "financial
holding company." A financial holding company essentially is a bank holding
company with significantly expanded powers. Financial holding companies are
authorized by statute to engage in a number of financial activities previously
not permissible for bank holding companies, including securities underwriting,
dealing and market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; and merchant banking activities. The act also
permits the Federal Reserve Board and the Treasury Department to authorize
additional activities for financial holding companies if they are "financial in
nature" or "incidental" to financial activities. A bank holding company may
become a financial holding company if each of its subsidiary banks is well
capitalized, well managed, and has at least a "satisfactory" Community
Reinvestment Act rating. A financial holding company must provide notice to the
Federal Reserve Board within 30 days after commencing activities previously
determined by statute or by the Federal Reserve Board and Department of the
Treasury to be permissible. KNBT has not submitted notice to the Federal Reserve
Board of its intent to be deemed a financial holding company. However, it is not
precluded from submitting a notice in the future should it wish to engage in
activities only permitted to financial holding companies.
Regulatory Capital Requirements. The Federal Reserve Board has adopted
capital adequacy guidelines pursuant to which it assesses the adequacy of
capital in examining and supervising a bank holding company and in analyzing
applications to it under the Bank Holding Company Act. The Federal Reserve
Board's capital adequacy guidelines for KNBT, on a consolidated basis, are
similar to those imposed on the Bank by the FDIC. Prompt corrective action
provisions, however, are not applicable to bank holding companies.
Restrictions on Dividends. KNBT's ability to declare and pay dividends
may depend in part on dividends received from the Bank. The Pennsylvania Banking
Code regulates the distribution of dividends by savings banks and states, in
part, that dividends may be declared and paid only out of accumulated net
earnings and may not be declared or paid unless surplus, retained earnings, is
at least equal to contributed capital. In addition, dividends may not be
declared or paid if the Bank is in default in payment of any assessment due the
FDIC.
The Federal Reserve Board issued a policy statement in 1985 on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the holding company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earnings retention
that is consistent with the holding company's capital needs, asset quality and
overall financial condition. The Federal Reserve Board also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends. Furthermore, under the federal prompt corrective
action regulations, the Federal Reserve Board may prohibit a bank holding
company from paying any dividends if the holding company's bank subsidiary is
classified as "undercapitalized." See - "Regulation of the Bank" below.
Federal Securities Laws. KNBT is subject to the proxy and tender offer
rules, insider trading reporting requirements and restrictions, and certain
other requirements under the Securities Exchange Act of 1934.
23
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into
law the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") implementing
legislative reforms intended to address corporate and accounting fraud. In
addition to the establishment of a new accounting oversight board which will
enforce auditing, quality control and independence standards and will be funded
by fees from all publicly traded companies, the Sarbanes-Oxley Act restricts
provision of both auditing and consulting services by accounting firms. To
ensure auditor independence, any non-audit services being provided to an audit
client requires pre-approval by the company's audit committee members. In
addition, the audit partners must be rotated. The Sarbanes-Oxley Act requires
chief executive officers and chief financial officers, or their equivalent, to
certify to the accuracy of periodic reports filed with the SEC, subject to civil
and criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under the Sarbanes-Oxley Act, counsel are required to
report evidence of a material violation of the securities laws or a breach of
fiduciary duty by a company to its chief executive officer or its chief legal
officer, and, if such officer does not appropriately respond, to report such
evidence to the audit committee or other similar committee of the board of
directors or the board itself.
Longer prison terms now apply to corporate executives who violate
federal securities laws, the period during which certain types of suits can be
brought against a company or its officers has been extended, and bonuses issued
to top executives prior to restatement of a company's financial statements are
now subject to disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
"blackout" periods, and loans to company executives are restricted. In addition,
a provision directs that civil penalties levied by the SEC as a result of any
judicial or administrative action under the Sarbanes-Oxley Act be deposited to a
fund for the benefit of harmed investors. The Federal Accounts for Investor
Restitution ("FAIR") provision also requires the SEC to develop methods of
improving collection rates. The legislation accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers must also provide information for most changes in ownership in a
company's securities within two business days of the change.
The Sarbanes-Oxley Act also increases the oversight of, and codifies
certain requirements relating to audit committees of public companies and how
they interact with the company's "registered public accounting firm" ("RPAF").
Audit Committee members must be independent and are barred from accepting
consulting, advisory or other compensatory fees from the issuer. In addition,
companies must disclose whether at least one member of the committee is a
"financial expert," as such term is defined by the SEC, and if not, why not.
Under the Sarbanes-Oxley Act, a RPAF is prohibited from performing statutorily
mandated audit services for a company if such company's chief executive officer,
chief financial officer, comptroller, chief accounting officer or any person
serving in equivalent positions has been employed by such firm and participated
in the audit of such company during the one-year period preceding the audit
initiation date. The Sarbanes-Oxley Act also prohibits any officer or director
of a company or any other person acting under their direction from taking any
action to fraudulently influence, coerce, manipulate or mislead any independent
public or certified accountant engaged in the audit of the company's financial
statements for the purpose of rendering the financial statement's materially
misleading. The Sarbanes-Oxley Act also required the SEC to prescribe rules
requiring inclusion of an internal control report and assessment by management
in the annual report to stockholders. The Sarbanes-Oxley Act requires the RPAF
that issues the audit report to attest to and report on management's assessment
of the company's internal controls. In addition, the Sarbanes-Oxley Act requires
that each financial report required to be prepared in accordance with, or
reconciled to, generally accepted accounting principles and filed with the SEC
reflect all material correcting adjustments that are identified by a RPAF in
accordance with generally accepted accounting principles and the rules and
regulations of the SEC.
Regulation of the Bank
Pennsylvania Savings Bank Law. The Pennsylvania Banking Code contains
detailed provisions governing the organization, location of offices, rights and
responsibilities of directors, officers, and employees, as well as corporate
powers, savings and investment operations and other aspects of the Bank and its
affairs. The code delegates extensive rule-making power and administrative
discretion to the Pennsylvania Department of Banking so that the supervision and
regulation of state-chartered savings banks may be flexible and readily
responsive to changes in economic conditions and in savings and lending
practices.
24
The Pennsylvania Banking Code also provides that state-chartered
savings banks may engage in any activity permissible for a federal savings
association, subject to regulation by the Pennsylvania Department of Banking.
The Federal Deposit Insurance Act, however, will prohibit the Bank from making
new investments, loans, or becoming involved in activities as principal and
equity investments which are not permitted for national banks unless:
o the FDIC determines the activity or investment does not pose a
significant risk of loss to the Savings Association Insurance
Fund; and
o the Bank meets all applicable capital requirements.
Accordingly, the additional operating authority provided to the Bank by
the Pennsylvania Banking Code is significantly restricted by the Federal Deposit
Insurance Act.
Insurance of Accounts. The deposits of the Bank are insured to the
maximum extent permitted by the Savings Association Insurance Fund, which is
administered by the FDIC, as well as the Bank Insurance Fund as a result of the
assumption of deposit liabilities of Nazareth National Bank and are backed by
the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, insured
institutions. It also may prohibit any insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious threat to
the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions.
Under current FDIC regulations, Savings Association Insurance Fund and
Bank Insurance Fund insured institutions are assigned to one of three capital
groups which are based solely on the level of an institution's capital "well
capitalized," "adequately capitalized" and "undercapitalized" which are defined
in the same manner as the regulations establishing the prompt corrective action
system discussed below. These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those that are
considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates during the last six months of 2004 ranging from zero
for well capitalized, healthy institutions, such as the Bank, to 27 basis points
for undercapitalized institutions with substantial supervisory concerns.
In addition, all institutions with deposits insured by the FDIC are
required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation, a mixed-ownership government corporation established to
recapitalize the predecessor to the Savings Association Insurance Fund. The
assessment rate for the last quarter of 2004 was 0.146% of insured deposits and
is adjusted quarterly. These assessments will continue until the Financing
Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
25
Regulatory Capital Requirements. The FDIC has promulgated capital
adequacy requirements for state-chartered banks that, like the Bank, are not
members of the Federal Reserve Board System. The capital regulations establish a
minimum 3% Tier 1 leverage capital requirement for the most highly rated
state-chartered, non-member banks, with an additional cushion of at least 100 to
200 basis points for all other state-chartered, non-member banks, which
effectively increases the minimum Tier 1 leverage ratio for such other banks to
4% to 5% or more. Under the FDIC's regulations, the highest rated banks are
those that the FDIC determines are not anticipating or experiencing significant
growth and have well diversified risk, including no undue interest rate risk
exposure, excellent asset quality, high liquidity, good earnings and, in
general, which are considered a strong banking organization, rated composite 1
under the Uniform Financial Institutions Rating System. Tier 1, or leverage
capital, is defined as the sum of common shareholders' equity, including
retained earnings, non-cumulative perpetual preferred stock and related surplus,
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain purchased mortgage servicing rights and purchased credit card
relationships.
The FDIC's regulations also require that state-chartered, non-member
banks meet a risk-based capital standard. The risk-based capital standard
requires the maintenance of total capital, defined as Tier 1 capital and
supplementary (Tier 2) capital, to risk weighted assets of 8%. In determining
the amount of risk-weighted assets, all assets, plus certain off balance sheet
assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the
FDIC believes are inherent in the type of asset or item. The components of Tier
1 capital for the risk-based standards are the same as those for the leverage
capital requirement. The components of supplementary (Tier 2) capital include
cumulative perpetual preferred stock, mandatory subordinated debt, perpetual
subordinated debt, intermediate-term preferred stock, up to 45% of unrealized
gains on equity securities and a portion of a bank's allowance for loan losses.
Allowance for loan losses includable in supplementary capital is limited to a
maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary
capital that may be included in total capital is limited to 100% of Tier 1
capital.
A bank that has less than the minimum leverage capital requirement is
subject to various capital plan and activities restriction requirements. The
FDIC's regulations also provide that any insured depository institution with a
ratio of Tier 1 capital to total assets that is less than 2.0% is deemed to be
operating in an unsafe or unsound condition pursuant to Section 8(a) of the
Federal Deposit Insurance Act and could be subject to potential termination of
deposit insurance.
The Bank is also subject to minimum capital requirements imposed by the
Pennsylvania Department of Banking on Pennsylvania chartered depository
institutions. Under the Pennsylvania Department of Banking's capital
regulations, a Pennsylvania bank or savings association must maintain a minimum
leverage ratio of Tier 1 capital, as defined under the FDIC's capital
regulations, to total assets of 4%. In addition, the Pennsylvania Department of
Banking has the supervisory discretion to require a higher leverage ratio for
any institution or association based on inadequate or substandard performance in
any of a number of areas. The Pennsylvania Department of Banking incorporates
the same FDIC risk-based capital requirements in its regulations.
Prompt Correction Action. The following table shows the amount of
capital associated with the different capital categories set forth in the prompt
correction action regulations.
Total Tier 1 Tier 1
Risk-Based Risk-Based Leverage
Capital Category Capital Capital Capital
- -------------------------------------- ------------- ------------ --------------
Well capitalized 10% or more 6% or more 5% or more
Adequately capitalized 8% or more 4% or more 4% or more
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly undercapitalized Less than 6% Less than 3% Less than 3%
26
In addition, an institution is "critically undercapitalized" if it has
a ratio of tangible equity to total assets that is equal to or less than 2.0%.
Under specified circumstances, a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category, except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized.
An institution generally must file a written capital restoration plan
which meets specified requirements within 45 days of the date that the
institution receives notice or is deemed to have notice that it is
undercapitalized, significantly undercapitalized or critically undercapitalized.
A federal banking agency must provide the institution with written notice of
approval or disapproval within 60 days after receiving a capital restoration
plan, subject to extensions by the agency. An institution that is required to
submit a capital restoration plan must concurrently submit a performance
guaranty by each company that controls the institution. In addition,
undercapitalized institutions are subject to various regulatory restrictions,
and the appropriate federal banking agency also may take any number of
discretionary supervisory actions.
At December 31, 2004, the Bank was deemed a well-capitalized
institution for purposes of the above regulations and as such is not subject to
the above-mentioned restrictions.
The following table provides a comparison of KNBT's and the Bank's
capital amounts, risk-based capital ratios and leverage ratios for the periods
indicated.
At December 31, 2004
----------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------- ------------------------- --------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Company (consolidated) $355,857 25.64% $ 111,042 8.00% N/A N/A
Bank $264,159 19.17% $ 110,233 8.00% $137,792 10.00%
Tier I Capital
(To risk-weighted assets)
Company (consolidated) $345,396 24.88% $ 55,521 4.00% N/A N/A
Bank $253,698 18.41% $ 55,117 4.00% $ 82,675 6.00%
Tier I Capital
(To average assets, leverage)
Company (consolidated) $345,396 14.66% $ 55,521 4.00% N/A N/A
Bank $253,698 12.17% $ 55,117 4.00% $ 68,896 5.00%
At December 31, 2003
----------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------- ------------------------- --------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Company (consolidated) $359,522 33.24% $ 86,535 8.00% N/A N/A
Bank $258,441 24.01% $ 86,123 8.00% $107,654 10.00%
Tier I Capital
(To risk-weighted assets)
Company (consolidated) $351,612 32.51% $ 43,268 4.00% N/A N/A
Bank $250,499 23.27% $ 43,062 4.00% $ 64,593 6.00%
Tier I Capital
(To average assets, leverage)
Company (consolidated) $351,612 19.39% $ 72,525 4.00% N/A N/A
Bank $250,499 13.42% $ 74,646 4.00% $ 93,307 5.00%
27
Affiliate Transaction Restrictions. Federal laws strictly limit the
ability of banks to engage in transactions with their affiliates, including
their bank holding companies. Such transactions between a subsidiary bank and
its parent company or the non-bank subsidiaries of the bank holding company are
limited to 10% of a bank subsidiary's capital and surplus and, with respect to
such parent company and all such non-bank subsidiaries, to an aggregate of 20%
of the bank subsidiary's capital and surplus. Further, loans and extensions of
credit generally are required to be secured by eligible collateral in specified
amounts. Federal law also requires that all transactions between a bank and its
affiliates be on terms as favorable to the bank as transactions with
non-affiliates.
FHLB System. The Bank is a member of the FHLB of Pittsburgh, which is
one from a region of 12. Each FHLB serves as a reserve or central bank for its
members within its assigned region. It is funded primarily from funds deposited
by member institutions and proceeds from the sale of consolidated obligations of
the FHLB system. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the board of directors of the FHLB. At
December 31, 2004, the Bank had $660.7 million in FHLB advances.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to the greater of 1% of its aggregate
unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year or 5% of its outstanding advances from
the FHLB of Pittsburgh. At December 31, 2004, the Bank had $36.5 million in
stock of the FHLB of Pittsburgh, which was in compliance with this requirement.
Federal Reserve Board System. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts, which are primarily checking and NOW
accounts, and non-personal time deposits. The balances maintained to meet the
reserve requirements imposed by the Federal Reserve Board might be used to
satisfy the liquidity requirements that are imposed by the Pennsylvania
Department of Banking. At December 31, 2004, the Bank was in compliance with
these reserve requirements.
Federal Taxation
General. KNBT and the Bank are subject to federal income taxation in
the same general manner as other corporations with some exceptions listed below.
The following discussion of federal, state and local income taxation is only
intended to summarize certain pertinent income tax matters and is not a
comprehensive description of the tax rules applicable to KNBT and the Bank.
Method of Accounting. For federal income tax purposes, KNBT reports
income and expenses on the accrual method of accounting and files its federal
income tax return on a calendar year basis.
Bad Debt Reserves. The Small Business Job Protection Act of 1996
eliminated the use of the reserve method of accounting for bad debt reserves by
savings associations, effective for taxable years beginning after 1995. Prior to
that time, KNBT was permitted to establish a reserve for bad debts and to make
additions to the reserve. These additions could, within specified formula
limits, be deducted in arriving at taxable income. As a result of the Small
Business Job Protection Act of 1996, savings associations must use the specific
charge-off method in computing their bad debt deduction beginning with their
1996 federal tax return. In addition, federal legislation required the recapture
over a six-year period of the excess of tax bad debt reserves at December 31,
1995 over those established as of December 31, 1987.
Taxable Distributions and Recapture. Prior to the Small Business Job
Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were
subject to recapture into taxable income if KNBT failed to meet certain thrift
asset and definitional tests. Federal legislation eliminated these savings
association related recapture rules. However, under current law, pre-1988
reserves remain subject to recapture should the Bank make certain non-dividend
distributions or cease to maintain a bank charter.
28
At December 31, 2004, KNBT's total federal pre-1988 reserve was
approximately $9.8 million. The reserve reflects the cumulative effects of
federal tax deductions by KNBT for which no federal income tax provisions have
been made.
Alternative Minimum Tax. The Internal Revenue Code imposes an
alternative minimum tax at a rate of 20% on a base of regular taxable income
plus certain tax preferences. The alternative minimum tax is payable to the
extent such alternative minimum tax income is in excess of an exemption amount.
Net operating losses, of which KNBT has none, can offset no more than 90% of
alternative minimum taxable income. Certain payments of alternative minimum tax
may be used as credits against regular tax liabilities in future years. KNBT had
a minimum tax credit carryover of $202,000 at December 31, 2004.
Net Operating Loss Carryovers. For net operating losses in tax years
beginning before August 6, 1997, KNBT may carry back net operating losses to the
three years preceding the loss year and then forward to fifteen years following
the loss years. For net operating losses in years beginning after August 5,
1997, net operating losses can be carried back to the two years preceding the
loss year and forward to the 20 years following the loss year. At December 31,
2004, KNBT had a $729,000 net operating loss carry-forwards for federal income
tax purposes.
Corporate Dividends-Received Deduction. KNBT may exclude from its
income 100% of dividends received from KNBT as a member of the same affiliated
group of corporations. The corporate dividends received deduction is 80% in the
case of dividends received from corporations in which a corporate recipient owns
less than 80%, but at least 20% of the distribution corporation. Corporations
which own less than 20% of the stock of a corporation distributing a dividend,
may deduct only 70% of dividends received.
State and Local Taxation
Pennsylvania Taxation. KNBT is subject to the Pennsylvania Corporate
Net Income Tax, Capital Stock and Franchise Tax. The Corporation Net Income Tax
rate for 2004 was 9.99% and is imposed on unconsolidated taxable income for
federal purposes with certain adjustments. In general, the Capital Stock and
Franchise Tax is a property tax imposed on a corporation's capital stock value
at a statutorily defined rate, such value being determined in accordance with a
fixed formula based upon average net income and net worth.
The Bank is subject to tax under the Pennsylvania Mutual Thrift
Institutions Tax Act, as amended to include thrift institutions having capital
stock. Pursuant to the Mutual Thrift Institutions Tax, the tax rate is 11.5%.
The Mutual Thrift Institutions Tax exempts the Bank from other taxes imposed by
the Commonwealth of Pennsylvania for state income tax purposes and from all
local taxation imposed by political subdivisions, except taxes on real estate
and real estate transfers. The Mutual Thrift Institutions Tax is a tax upon net
earnings, determined in accordance with generally accepted accounting principles
with certain adjustments. The Mutual Thrift Institutions Tax, in computing
income according to generally accepted accounting principles, allows for the
deduction of interest earned on state and federal obligations, while disallowing
a percentage of a thrift's interest expense deduction in the proportion of
interest income on those securities to the overall interest income of the Bank.
Net operating losses, if any, thereafter can be carried forward three years for
Mutual Thrift Institutions Tax purposes.
Employees
As of December 31, 2004, KNBT had approximately 633 employees of whom
120 were part-time. At December 31, 2003, KNBT had approximately 649 employees
of whom 141 were part-time. A collective bargaining unit does not represent the
employees. KNBT considers its relationship with its employees to be good.
29
Item 2. Properties
- ----------------------------
KNBT does not own or lease any property. The Bank owns 20 properties
and leases 27 other properties. The principal office of KNBT is located at 90
Highland Avenue, Bethlehem, Pennsylvania 18017. The book value of this office
was $3.5 million at December 31, 2004.
The Bank also owns an operations and lending office at 236 Brodhead
Road, Bethlehem, Pennsylvania 18017. This building was purchased in 2003 and had
a book value of $7.3 million at December 31, 2004. The Bank acquired an office
building at 3864 Adler Place, Bethlehem, Pennsylvania 18017 as a part of the
acquisition of First Colonial. The Bank will continue to use this facility for
general office space. This building had a book value of $3.3 million at December
31, 2004.
In addition, the Bank owns 16 branch banking facilities and leases 25
other branch banking facilities. All of which are located within the Bank's
market area.
The Bank also owns a garage and parking lot in Nazareth, Pennsylvania,
a vacant lot which is available for a possible future branch in Easton,
Pennsylvania and a property for future use as a drive-thru facility for KNBT's
banking branch office in Palmerton, Pennsylvania.
Item 3. Legal Proceedings
- -----------------------------------
From time-to-time, KNBT and the Bank are parties to routine litigation
incidental to their business.
Neither KNBT, the Bank nor any of their subsidiaries is subject to any
material legal proceedings, nor are any such proceedings known to be
contemplated by any governmental authorities.
Item 4. Submission of Matters to a Vote of Security Holders
- ---------------------------------------------------------------------
No matter was submitted to a vote of stockholders during the fourth
quarter of the fiscal year covered by this report.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
- --------------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
KNBT's common stock trades on the Nasdaq National Market under the
trading symbol "KNBT." At the close of business on December 31, 2004, there were
approximately 3,641 stockholders of record not including the number of persons
or entities holding stock in nominee or street name through various brokers and
banks.
The following table reflects the ranges of high and low bid prices of
KNBT's common stock and the dividends declared per share of KNBT common stock
during the periods presented. Such bid information reflects inter-dealer prices
without retail mark-up, markdown or commission and may not represent actual
transactions.
30
The closing market price of the common stock at December 31, 2004 was $16.90.
Year Ended December 31, 2004
----------------------------
High Low Dividends
---- --- ---------
First Quarter ...................... $17.96 $16.26 None Declared
Second Quarter ..................... $17.64 $14.55 $0.05
Third Quarter ...................... $17.52 $15.44 $0.05
Fourth Quarter ..................... $17.45 $16.45 $0.05
Year Ended December 31, 2003
----------------------------
High Low Dividends
---- --- ---------
First Quarter ...................... - - -
Second Quarter ..................... - - -
Third Quarter ...................... - - -
Fourth Quarter ..................... $17.70 $15.85 None Declared
The declaration and payment of dividends is at the sole discretion of
the Board of Directors, and the timing and amount of any such dividend will
depend upon the Board of Directors' consideration of the earnings, financial
condition, and capital needs of KNBT and certain other factors including
restrictions arising from Federal banking laws and regulations. KNBT common
shares were first sold in KNBT's initial public offering as a part of Keystone
Savings Bank's mutual-to-stock conversion on October 31, 2003 at the offering
price of $10.00 per share. KNBT's common stock began trading on Nasdaq National
Market on November 3, 2003.
KNBT did not sell any of its equity securities during 2003 or 2004 that
were not registered under the Securities Act of 1933.
For information regarding KNBT's equity compensation plans, see Item 12
hereto.
The following table sets forth information regarding KNBT's repurchases
of its common stock during the quarter ended December 31, 2004.
Total Number of Maximum Number
Shares Purchased of Shares that may
Total Number Average as Part of Publicly yet be Purchased
of shares Price Paid Announced Plans Under the Plan or
Period Purchased Per Share or Programs Program(s) (1)
- -------------------------------------------- -------------- ----------- -------------------- -------------------
October 1 - 31, 2004 - - - 3,062,486 (2)
November 1 - 30, 2004 650,000 $17.20 650,000 2,412,486 (2)
December 1 - 31, 2004 - - - 2,412,486 (2)
-------------- ----------- --------------------
Total 650,000 $17.20 650,000 N/A
============== =========== ====================
- --------------------------------------------
(1) On October 27, 2004, the Board of Directors authorized the repurchase of
up to 3,062,486 shares or approximately 10% of KNBT's outstanding shares.
Repurchases will be made from time to time, during the next 12 months or
longer if necessary as, in the opinion of management, market conditions
warrant. This plan will continue until it is completed or terminated by
the Board of Directors.
(2) The 2004 Management Recognition and Retention Plan and Trust Agreement
("MRRP") was adopted by the Board of Directors and approved by KNBT
stockholders at their Annual Meeting on May 6, 2004. The MRRP is a
stock-based plan that provides for 808,047 shares of the Company's common
stock which may be granted as restricted shares to the Company's
directors, advisory directors, officers and employees. The 808,047 shares
were purchased in May, 2004 at an average cost of $16.44 and are not
included in the amount set forth above.
31
Item 6. Selected Financial Data
- -----------------------------------------
As of and For the Year Ended December 31,
2004 2003(1) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
----------------------------------------------------------------------
Consolidated Summary of Income
Interest Income $ 97,291 $ 59,063 $ 59,479 $ 60,493 $ 57,603
Interest Expense 33,446 21,061 26,416 34,064 31,141
------------- ------------ ------------- ------------ -------------
Net Interest Income 63,845 38,002 33,063 26,429 26,462
Provision for Loan Losses 4,308 2,951 111 391 442
Total Non-Interest Income 15,434 9,048 8,814 5,013 3,214
Total Non-Interest Expense (2) 52,699 55,119 24,568 19,613 17,999
------------- ------------ ------------- ------------ -------------
Income (Loss) Before Income Taxes (Benefit) 22,272 (11,020) 17,198 11,438 11,235
Income Taxes (Benefit) 4,666 (5,264) 5,188 3,326 3,718
------------- ------------ ------------- ------------ -------------
Net Income (Loss) (2) $ 17,606 $ (5,756) $ 12,010 $ 8,112 $ 7,517
============= ============ ============= ============ =============
Net Income Per Share - Diluted (3) $ 0.60 N/M N/M N/M N/M
Net Income Per Share - Basic $ 0.61 N/M N/M N/M N/M
Cash Dividends Declared Per Share $ 0.15 - - - -
- --------------------------------------------------------------------------------------------------------------------------
Consolidated Balance Sheet Data
Total Assets $ 2,415,103 $ 1,941,973 $ 1,015,906 $ 922,045 $ 824,736
Investment Securities Available-for-Sale 1,057,109 734,087 294,150 156,785 114,077
Investment Securities Held to Maturity 56,586 - - - -
Loans Receivable, Net 1,002,741 882,166 555,526 668,046 657,107
Mortgage Loans Held-for-Sale 718 4,677 23,796 - -
Deposits 1,323,053 1,289,410 771,825 772,226 713,520
Securities Sold Under Agreements to Repurchase 22,643 24,550 8,904 5,752 -
FHLB Advances 660,674 207,153 113,500 40,500 13,000
Subordinated Debentures (4) 15,464 15,000 - - -
Shareholders' Equity/Retained Earnings 377,354 389,080 111,049 95,788 86,204
Book Value Per Share 13.33 13.20 n/a n/a n/a
Full Service Offices 41 41 19 16 16
Selected Consolidated Ratios
Net Income (Loss) To:
Average Total Assets 0.81% (0.46%) 1.25% 0.92% 0.94%
Average Equity 4.57% (3.58%) 11.46% 8.79% 9.27%
Net Interest Margin 3.27% 3.35% 3.57% 3.14% 3.38%
Efficiency Ratio (5) 63.39% 117.15% 58.67% 62.38% 60.65%
Equity to Assets (6) 15.62% 20.05% 10.93% 10.39% 10.45%
Tier 1 Capital to Average Assets (Leverage) (6) 14.66% 19.39% 10.78% 10.50% 10.45%
Tier 1 Risk-based Capital Ratio (6) 24.88% 32.51% 18.19% 17.09% 16.99%
Total Risk-based Capital Ratio (6) 25.64% 33.24% 18.19% 17.71% 17.65%
- --------------------------------------------------------------------------------------------------------------------------
(1) On October 31, 2003, KNBT completed the mutual-to-stock conversion of the Bank and the related
subscription stock offering and the acquisition of First Colonial. See "Business - General" in Item 1.
(2) Included in the non-interest expenses for the year ended December 31, 2003 are a $16.1 million contribution to the
Keystone Nazareth Charitable Foundation and $5.7 million of merger and systems integration costs as a result of the
acquisition of First Colonial.
(3) Per share data is not included for 2003 because no shares were issued prior to November 2003.
(4) Previously reported as "Guaranteed Preferred Beneficial Interest in the Company's subordinated debentures" prior to the
adoption of FIN 46(R).
(5) The calculation of the efficiency ratio for 2003 includes the effect of the $16.1 million contribution to the Keystone
Nazareth Charitable Foundation and $5.7 million of merger and systems integration costs as a result of the acquisition of First
Colonial Group.
(6) Ratios for 2004-2003 are for KNBT Bancorp. Ratios for 2000, 2001 and 2002 are for Keystone Nazareth Bank & Trust
Company (formerly Keystone Savings Bank).
32
Item 7. Management's Discussion and Analysis of Financial Condition
- --------------------------------------------------------------------------------
and Results of Operations
-------------------------
General
The following presents a review of KNBT Bancorp's results of operations
and financial condition. This information should be read in conjunction with
KNBT's consolidated financial statements and the accompanying notes to financial
statements. KNBT's consolidated earnings are derived primarily from the
operations of its wholly owned savings bank subsidiary, Keystone Nazareth Bank &
Trust Company, and its other subsidiaries.
KNBT's results of operations depend, to a large extent, on net interest
income, which is the difference between the income earned on its loan and
investment portfolios and interest expense on deposits and borrowings.
Non-interest income, non-interest expense and the provision for loan losses also
impact KNBT's results of operations. Non-interest income consists primarily of
fees and service charges related to deposits and lending activities, fees from
other banking and non-banking operations, loan servicing and other non-interest
income. Non-interest expense primarily consists of compensation and employee
benefits, office occupancy and equipment expense, data processing, advertising
and business promotion and other expenses. KNBT's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities. Future changes in applicable law, regulations or
government policies may materially impact KNBT's financial condition and results
of operations.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of KNBT conform with accounting
principles generally accepted in the United States of America and general
practices within the financial services industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and the accompanying notes.
Actual results could differ from those estimates.
KNBT considers that the determination of the allowance for loan losses
involves a higher degree of judgment and complexity than its other significant
accounting policies. The allowance for loan losses is calculated with the
objective of maintaining a reserve level believed by management to be sufficient
to absorb estimated probable credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, expected commitment usage, the amounts and
timing of expected future cash flows on impaired loans, mortgages, and general
amounts for historical loss experience. The process also considers economic
conditions, uncertainties in estimating losses and inherent risks in the loan
portfolio. All of these factors may be susceptible to significant change. To the
extent actual outcomes differ from management estimates, additional provisions
for loan losses may be required that would adversely impact earnings in future
periods.
KNBT recognizes deferred tax assets and liabilities for future tax
effects of temporary differences, net operating loss carry forwards and tax
credits. Deferred tax assets are subject to management's judgment based upon
available evidence that future realization is more likely than not. If
management determines that KNBT may be unable to realize all or part of net
deferred tax assets in the future, a direct charge to income tax expense may be
required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
33
Goodwill, under SFAS No. 142, is subject to impairment testing at least
annually to determine whether write-downs of the recorded balance is 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.
Operating Strategy
KNBT was organized in 2003 by Keystone Savings Bank in connection with
its mutual-to-stock conversion and as the holding company for the Bank.
Historically, Keystone Savings Bank operated as a traditional savings bank
primarily providing single-family residential mortgage loans and a variety of
retail products and services to its customers.
Concurrent with the conversion on October 31, 2003, First Colonial was
merged with and into KNBT and Nazareth National Bank and Trust Company was
merged into the Bank. Historically, Nazareth National Bank and Trust Company was
a full-service community commercial bank with full trust services. The resulting
Bank, Keystone Nazareth Bank & Trust Company is a Pennsylvania-chartered stock
savings bank. Some of the Bank's key operating strategies and characteristics
are described below.
o Maintain current branch network system with 41 branch offices
located throughout Lehigh, Northampton, Monroe and Carbon
Counties, Pennsylvania with consideration for additional
branches in the future.
o Continue to develop as a "relationship bank" offering a broad
array of deposit and loan products as well as securities and
insurance products and trust services.
o Accelerate core deposit growth, utilizing strong deposit
market share particularly in Northampton and Lehigh Counties
in which the Bank has the largest and second largest,
respectively, deposit market share. Overall, the Bank
estimates that it has the second largest deposit share in the
Lehigh Valley.
o Focus on asset generation that continues the Bank's success in
growing commercial and consumer loan portfolios without
sacrificing credit quality. Intensify efforts targeting small
to mid-sized businesses in the Lehigh Valley.
o Ensure customer satisfaction by delivering unmatched personal
service and provide high-quality products and services to meet
the changing needs of individuals, families and businesses.
o Grow and diversify our operations as a community bank.
o Execute capital management strategy.
Comparison of Financial Condition at December 31, 2004 and December 31, 2003
KNBT had a net income for 2004 of $17.6 million compared with a net
loss of $5.8 million in 2003. The results for 2003 included one-time charges
aggregating $21.8 million (pre-tax) resulting from the $16.1 million
contribution to the Keystone Nazareth Charitable Foundation and $5.7 million of
merger related and systems integration related charges incurred in connection
with the merger with First Colonial. KNBT's net income was $12.0 million in
2002.
34
KNBT's return on average assets was 0.81% in 2004 as compared to
(0.46)% in 2003 and 1.25% in 2002. The return on average equity was 4.57%,
(3.58)%, and 11.46% in 2004, 2003 and 2002, respectively.
KNBT's total assets increased by $473.1 million, or 24.4%, to $2.4
billion at December 31, 2004 compared to $1.9 billion at December 31, 2003. This
increase in total assets was due primarily to an increase in investment
securities and net loans receivable which was partially offset by decreases in
cash and cash equivalents. For the year ended December 31, 2004, KNBT's
investment securities increased by $379.6 million, or 51.7% to $1.1 billion at
December 31, 2004 compared to $734.1 million at December 31, 2003 as KNBT
implemented its asset/liability management strategy. KNBT's net loans
receivable, including mortgage loans held-for-sale, increased by $116.6 million,
or 13.1% to $1.0 billion at December 31, 2004 compared to $886.8 million at
December 31, 2003. Cash and cash equivalents decreased from $52.8 million, or
38.0%, from $139.0 million at December 31, 2003 to $86.2 million at December 31,
2004. Such decrease primarily reflects KNBT's purchases of investment securities
during the 2004 fiscal year.
KNBT's total liabilities increased $484.9 million, or 31.2% from $1.6
million at December 31, 2003 to $2.0 million at December 31, 2004. The increase
was primarily due to a $453.5 million, or 218.9% increase in FHLB advances which
were used to fund the increase in the investment securities. Total deposits
increased $33.6 million, or 2.6%, to $1.3 billion at December 31, 2004 compared
to December 31, 2003.
Shareholders' equity totaled $377.4 million at December 31, 2004
compared to $389.1 million at December 31, 2003, a decrease of $11.7 million or
3.0%. The decrease in shareholders' equity was principally the result of the
purchase of 808,047 shares of KNBT's stock to fund the stockholder approved 2004
Management Recognition and Retention Plan ("MRRP") at an average cost of $16.44
per share combined with the repurchase of 650,000 shares of its common stock, in
connection with the Board of Directors authorized stock repurchase program, at
an average cost of $17.20 per share.
Analysis of Net Interest Income
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them. Net interest income is the primary source of earnings for KNBT. Therefore,
changes in net interest income are an important factor in KNBT's overall net
income.
Net Interest Income. KNBT's net interest income was $63.8 million for
2004, a $25.8 million or 68.0% increase when compared to $38.0 million for 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 the net proceeds from KNBT's initial public offering
completed 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 at December 31, 2004 as compared to
$1.1 billion at December 31, 2003. Total interest income was $97.3 million for
2004, a $38.2 million or 64.7% increase when compared to the $59.1 million in
total interest income for 2003. Average interest-bearing liabilities were $1.6
billion at December 31, 2004 compared to $1.0 billion at December 31, 2003.
Total interest expense was $33.4 million for 2004, a $12.4 million or 58.8%
increase when compared to the $21.1 million in total interest expense for 2003.
Net interest income, in 2003, increased $4.9 million or 14.9% from the
2002 level of $33.1 million. This increase was primarily the result of an
increase in the average balances of investment securities and interest-bearing
balances with banks including a decrease in the average rate paid on
interest-bearing deposits, partially offset by an increase in FHLB borrowings.
35
Average Balances, Net Interest Income, and Yields Earned and Rates
Paid. The following table shows for the periods indicated the total dollar
amount of interest from average interest-earnings assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. The table
includes information adjusted to a tax equivalent yield basis for KNBT'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.
For the Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------- ------------------------------ ----------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
----------------------------- ------------------------------ ----------------------------
Assets (dollars in thousands)
Interest-Earning Assets
Interest-Bearing Balances with Banks $ 31,209 $ 498 1.60% $ 106,395 $ 1,028 0.97% $ 30,577 $ 408 1.33%
Investment Securities
Taxable (1) 851,624 33,757 3.96% 345,048 13,334 3.86% 241,475 13,272 5.50%
Non-Taxable (2) 109,515 7,188 6.56% 62,508 4,358 6.97% 31,229 2,441 7.82%
Loans Receivable (2) (3) 967,799 58,338 6.03% 622,525 41,833 6.72% 627,001 44,188 7.05%
Allowance for Loan Losses (9,240) (3,447) (3,021)
----------- --------- ----------- --------- ---------- ---------
Net Loans 958,559 58,338 6.09% 619,078 41,833 6.76% 623,980 44,188 7.08%
----------- --------- ----------- --------- ---------- ---------
Total Interest-Earning Assets 1,950,907 99,781 5.11% 1,133,029 60,553 5.34% 927,261 60,309 6.50%
------ -------- -------
Non-Interest-Earning Assets 213,763 - 121,964 - 33,531 -
----------- --------- ----------- --------- ---------- ---------
Total Assets,
Interest Income $2,164,670 99,781 $1,254,993 60,553 $960,792 60,309
=========== --------- =========== --------- ========== ---------
Liabilities
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand Deposits $ 174,698 273 0.16% $ 102,506 298 0.29% $ 81,609 466 0.57%
Money Market Deposits 249,065 2,477 0.99% 203,978 2,212 1.08% 134,456 2,784 2.07%
Savings Deposits 221,027 1,063 0.48% 182,548 1,315 0.72% 111,689 1,680 1.50%
Certificates of Deposit 539,505 14,372 2.66% 409,003 12,168 2.98% 417,073 18,169 4.36%
----------- --------- ----------- --------- ---------- ---------
Total Interest-Bearing Deposits 1,184,295 18,185 1.54% 898,035 15,993 1.78% 744,827 23,099 3.10%
------ -------- -------
Securities Sold Under Agreements
to Repurchase 22,579 170 0.75% 11,931 131 1.10% 7,330 155 2.11%
FHLB Advances 425,167 14,316 3.37% 114,520 4,822 4.21% 67,358 3,162 4.69%
Other Debt 15,464 775 5.01% 2,507 115 4.59%
----------- --------- ----------- --------- ---------- ---------
Total Interest-Bearing
Liabilities 1,647,505 33,446 2.03% 1,026,993 21,061 2.05% 819,515 26,416 3.22%
------ -------- -------
Non-Interest-Bearing Liabilities
Non-Interest-Bearing Deposits 119,133 - - 53,559 - - 28,881 -
Other Liabilities 12,376 - - 13,832 - - 7,603 -
----------- --------- ----------- --------- ---------- ---------
Total Liabilities 1,779,014 33,446 1,094,384 21,061 855,999 26,416
Shareholders' Equity /
Retained Earnings 385,656 - - 160,609 - -104,793 -
----------- --------- ----------- --------- ---------- ---------
Total Liabilities and Shareholders'
Equity, Interest Expense $2,164,670 33,446 $1,254,993 21,061 $960,792 26,416
=========== --------- =========== --------- ========== ---------
Net Interest Income on Tax Equivalent
Basis (2) 66,335 39,492 33,893
--------- --------- ---------
Net Interest Spread on
Tax Equivalent Basis (4) 3.08% 3.29% 3.28%
Effect of Interest-Free Sources
Used to Fund Earning Assets 0.13% 0.14% 0.09%
Net Interest Margin
Tax Equivalent Basis (5) 3.40% 3.49% 3.66%
Tax-Exempt Adjustment (2,490) (1,490) (830)
--------- --------- ---------
Net Interest Income and Margin (4) $63,845 3.27% $38,002 3.35% $33,063 3.57%
========= ====== ========= ======== ========= =======
Average Interest-Earning Assets
to Average Interest-Bearing
Liabilities 118.42% 110.32% 113.15%
======= ======== ========
- ------------------------------------------------------------------------------------------------------------------------------------
(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 $2.5 million, $1.5 million, and $830,000 for the years 2004, 2003, and 2002, respectively.
The effective tax rate used for the taxable equivalent adjustment was 34%.
(3) Loan fees of $678,000, $1.5 million, and $1.2 million for the years 2004, 2003, and 2002, respectively, are included in
interest income. Average loan balances include non-accruing loans of $4.9 million, $1.7 million, and $1.2 million and
average loans held-for-sale of $1.4 million, $3.1 million, and $4.4 million for the years of 2004, 2003, and 2002,
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.
36
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. Amounts shown are on a tax-equivalent basis.
2004 Compared to 2003 2003 Compared to 2002
----------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Total Due to Total
-------------------------- Increase ------------------------ Increase
Rate Volume (Decrease) Rate Volume (Decrease)
------------- ----------- ------------ ----------- ----------- -----------
(Dollars in Thousands)
Interest Income:
Cash and cash equivalents $ 196 $ (726) $ (530) $ (392) $ 1,012 $ 620
Investment securities (779) 24,032 23,253 (5,790) 7,769 1,979
Loans receivable, net (6,697) 23,202 16,505 (2,009) (346) (2,355)
------------- ----------- ------------ ----------- ----------- -----------
Total interest-earning assets (7,280) 46,508 39,228 (8,191) 8,435 244
Interest Expense:
Savings deposits (529) 277 (252) (288) 120 (168)
Checking deposits (235) 210 (25) (2,011) 1,439 (572)
Money market deposits (224) 489 265 (1,431) 1,066 (365)
Certificates of deposit (1,678) 3,882 2,204 (5,649) (352) (6,001)
------------- ----------- ------------ ----------- ----------- -----------
Total interest-bearing deposits (2,666) 4,858 2,192 (9,379) 2,273 (7,106)
Securities sold under agreements
to repurchase (78) 117 39 (121) 97 (24)
FHLB advances and other borrowings (3,587) 13,081 9,494 (554) 2,214 1,660
Other debt 66 594 660 - 115 115
------------- ----------- ------------ ----------- ----------- -----------
Total interest-bearing liabilities (6,265) 18,650 12,385 (10,054) 4,699 (5,355)
Increase (decrease) in net
interest income $ (1,015) $ 27,858 $ 26,843 $ 1,863 $ 3,736 $ 5,599
============= =========== ============ =========== =========== ===========
Net interest income, on a fully taxable equivalent basis, amounted to
$66.3 million for 2004, an increase of $26.8 million or 68.0% over $39.5 million
in 2003. As shown in the "Rate/Volume Analysis" table, the increase in net
interest income in 2004 was attributable to higher net interest income of $27.9
million due to changes in volume that more than offset a $1.0 million decline in
net interest income due to a decline in the weighted average interest rate
spread resulting from declines in market rates. The volume-related change
resulted primarily from increases in investment securities and net loans (see
the discussion in "Business-Lending Activities"), an increase in deposits,
particularly in certificates of deposit, and an increase in FHLB advances. The
decrease in the interest rate spread was primarily the result of the decrease in
the yield on investment securities and loans being greater than the decrease in
the rate paid on deposits and debt.
The net interest income, on a fully taxable equivalent basis, in 2003
increased $5.6 million or 16.5% over the 2002 figure of $33.9 million. This
increase was the result of growth in investments and interest-bearing balances
with banks reduced in part by a small increase in net loans, and an increase in
deposits and FHLB advances.
37
Net interest margin, a measure of net interest income performance, is
determined by dividing net interest income by the average balance of total
interest-earning assets. The net interest margin was 3.27% for 2004, 3.35% for
2003 and 3.57% for 2002. The net interest margin on a tax equivalent basis was
3.40% for 2004, 3.49% for 2003 and 3.66% for 2002. The decrease in 2004 from
2003 in net interest margin was due to a 23 basis point drop in average yields
on interest-earning assets versus a 2 basis point decrease in the average rate
paid on interest bearing liabilities. In addition the average balance of
non-interest-earning assets increased to $213.8 million in 2004 as compared to
$122.0 million in 2003. The decrease in the net interest margin in 2003 compared
to prior year was primarily due to the increase in non-interest earning assets
which were $124.6 million at December 31, 2003 versus $33.5 million at December
31, 2002. The interest rate spread which is the difference between interest
earned on assets and the interest paid on liabilities, was 3.08%, 3.29% and
3.28% for 2004, 2003 and 2002, respectively.
KNBT presents its net interest margin on a tax equivalent basis because
management believes that presentation of its net interest margin on a tax
equivalent basis provides information that is useful for a proper understanding
of the operating results of KNBT's business. These disclosures should not be
viewed as a substitute for operating results determined in accordance with GAAP
nor are they necessarily comparable to non-GAAP performance measures, which may
be presented by other companies. Without the adjustment for tax-free income, the
net interest margin would be 3.27%, 3.35%, and 3.57% for the years ending
December 31, 2004, 2003 and 2002, respectively.
Provision for Loan Losses
The provision for loan losses is determined by management's review and
analysis of the loan portfolio. This evaluation process includes, among other
things, an analysis of delinquent and non-performing loans, the level of
charge-offs and recoveries, the value of collateral securing the loan, the
borrower's ability to repay, repayment performance and local economic
conditions. The valuation also takes into consideration performing loans that
may have certain weaknesses as identified by management in its review of loans.
For the year ended December 31, 2004, KNBT made a provision for loan
losses of $4.3 million, as compared to $3.0 million for the year ended December
31, 2003. A primary factor in the increased provision over the comparable 2003
period 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,
management believes, to the best of its knowledge, covers all known and inherent
losses in the portfolio that are both probable and reasonable to estimate at
this time.
The provision in 2002 was $111,000, which was prior to the First
Colonial merger and against a loan portfolio of predominately consisting of
residential mortgage loans. Net charge-offs were $1.8 million, $1.5 million, and
$570,000 in 2004, 2003, and 2002, respectively. For more information see
"Business - Lending Activities - Non-Performing Assets" in Item 1.
Non-Interest Income
Non-interest income increased in 2004 by $6.4 million or 70.6% to a
total of $15.4 million from $9.0 million in 2003. The increase for 2004 over
2003 was the result of an increase of trust revenues from the Company's Trust
Services Department, acquired from First Colonial, of $1.3 million or 453.8%, a
$1.1 million or 75.0% increase in the cash surrender value of Bank Owned Life
Insurance ("BOLI") resulting from a November 2003 purchase of an additional $30
million of such insurance, an increase of $435,000 or 10.8% in deposit service
charges due to the addition of accounts from the acquisition of First Colonial
and a $1.6 million or 57.8% increase in non-interest operating income,
consisting primarily of higher loan fees, fees received for servicing mortgages,
Visa interchange fees and other fee-based services. Non-interest income also
increased
38
as a result of an increase in net gain on sales from investment securities of
$645,000, an increase of $528,000 from sale of residential mortgage loans, and
gains on sale of KNBT's credit card portfolio and operations center that
contributed $298,000 and $213,000, respectively, to non-interest income in 2004.
Non-interest income increased $234,000 or 2.7% from $8.8 million in
2002 to $9.0 million in 2003. The increase in non-interest income in 2003
compared with 2002 was the result of an increase of $414,000 or 11.4% in fees
for deposit service charges and increased fees from non-interest operating
income of $1.5 million or 123.8%. These increases were offset by a decrease of
$1.5 million on net gains on sales of investment securities. The Bank
securitized a portion of its mortgage portfolio which resulted in the securities
gain in 2002.
Non-Interest Expense
Non-interest expense decreased to $52.7 million in 2004 from $55.1
million in 2003, a $2.4 million or 4.4% decrease. Non-interest expense for 2003
reflected a $16.1 million contribution to the KNBT Charitable Foundation in
connection with the Bank's conversion from mutual to stock form as well as $5.7
million of merger expenses relating to the fourth quarter acquisition of First
Colonial. Compensation and benefit expenses increased $10.8 million or 58.2% for
the year ended December 31, 2004 as compared to the prior year. Contributing to
the increase in compensation and employee benefit expense was the addition of
245 employees as a result of the merger with First Colonial. Salaries for such
employees were included for two months in 2003 compared to the full year in
2004. Benefit expense for the ESOP, implemented in November 2003, was $867,000
for the year ended December 31, 2004 compared to $165,000 for the prior year
reflecting a full year of operation for the ESOP in 2004. Net occupancy and
equipment costs increased $3.7 million or 81.2%. The principal factors in the
higher occupancy expense were the acquisition of First Colonial which added 20
offices, extensive building renovations at the newly acquired 47,000 sq. ft.
operations center, at KNBT's headquarters and also at the former operations
center of First Colonial. Professional fees increased $1.2 million or 110.4%.
Compliance with the Sarbanes-Oxley Act of 2002, an extensive review of our loan
portfolio, outsourcing certain audit functions and increased services due to the
growth of the Company, contributed to such increase. Advertising expenses
increased $663,000 or 189.4%. A concerted campaign to introduce the KNBT brand
in the market was the primary reason for the increase. Other operating expense
increased $3.9 million or 72.5% primarily due to amortization of identifiable
intangible assets resulting from the First Colonial acquisition, which accounted
for $2.2 million of the increase in 2004.
Non-interest expense in 2003 increased $30.5 million or 124.4% over
2002. Total non-interest expenses were $55.1 million in 2003 and $24.6 million
in 2002. The pre-tax contribution of $16.1 million to the Charitable Foundation
and merger expenses of $5.7 million were the principal factors in the increase.
The increase in compensation and employee benefit expense from 2002 to 2003 was
$5.4 million or 41.0%. Occupancy expenses in 2003 were $4.6 million or 49.0%
higher than in 2002. Contributing to the increase in compensation and employee
benefit expense were normal salary increases, additional staff required for the
new branches added in 2003, and staff increases in the lending and trust
divisions and a benefit expense of $165,000 for the ESOP.
Income Tax Expense (Benefit)
KNBT recorded a $4.7 million income tax provision for the year ended
December 31, 2004 compared to an income tax benefit of $5.3 million for the year
ended December 31, 2003. The income tax expense in 2002 amounted to $5.2
million. The tax benefit in 2003 was the result of a net operating loss for the
year. KNBT's effective Federal tax rate was 21.0% for the year ended December
31, 2004 compared to a benefit of (47.8)% for the year ended December 31, 2003
and a tax rate of 30.2% for the year ended December 31, 2002.
39
Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. KNBT's market risk arises primarily from interest rate risk, which is
inherent in its lending and deposit taking activities. To that end, management
actively monitors and manages interest rate risk exposure. In addition to market
risk, KNBT's primary risk is credit risk on its loan portfolio. KNBT attempts to
manage credit risk through its loan underwriting and oversight policies. See
"Business-Lending Activities".
The Bank operates as a community banking institution primarily in the
Pennsylvania counties of Northampton, Lehigh, Monroe and Carbon. As a result of
the Bank's location and nature of operations, KNBT is not subject to foreign
currency exchange or commodity price risk. The Bank makes real estate and other
loans primarily in the counties adjacent to its operations and thus is subject
to risks associated with those local economies. At December 31, 2004, the Bank
held a concentration of one-to four family residential real estate loans (32.1%
of total loans) and consumer/installment loans (29.4% of total loans) in its
loan portfolio. Loans for automobiles and other vehicles represented 40.0% of
the consumer/installment loans and 11.7% of total loans at year-end 2004. The
Bank's loans are subject to interest and economic risks. The Bank also
originates residential real estate loans for sale in the secondary market. Such
loans are identified as "Mortgage Loans Held-for-Sale" on the KNBT's balance
sheet and are subject to interest rate risk (see discussion on "Business-Loan
Originations, Sales and Servicing"). KNBT does not own any trading assets and
does not have any hedging transactions in place such as interest rate swaps (see
discussion on "Business-Investment Activities").
Interest Rate Sensitivity
Interest rate sensitivity is a measure of the extent to which net
interest income would change due to changes in the level of interest rates.
The principal objective of KNBT's interest rate risk management
function is to evaluate the interest rate risk embedded in certain balance sheet
accounts, determine the level of risk appropriate, given its business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. Through
such management, KNBT seeks to minimize its exposure to interest rate risk. An
Asset/Liability Committee ("ALCO"), consisting of key financial and service
management personnel, meet on a monthly basis. The ALCO is responsible for
reviewing the interest rate sensitivity of the balance sheet, formulating and
overseeing the implementation of strategies regarding interest rate risk and
examining the effects on net interest income and liquidity.
KNBT primarily has utilized the following strategies in its efforts to
manage interest rate risk:
o It has emphasized originations for a portfolio of shorter term
loans, particularly construction loans, commercial loans and
consumer loans;
o It has been an active seller in the secondary market of its
newly originated, agency eligible long-term fixed-rate
residential mortgage loans; KNBT securitized an aggregate of
$47.3 million of single-family residential mortgage loans in
2003 and $115.3 million in 2002; and
o It has invested in securities with relatively short
anticipated lives, generally three to five years.
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset
and liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2004, KNBT's cumulative one-year interest rate
gap, which is the difference between the amount of interest-earning assets
maturing or repricing within one year and interest-bearing liabilities maturing
or repricing within one year, as a percentage
40
of total assets, was a positive 3.80%. A gap is considered positive when the
amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities. A gap is considered negative when the amount of interest
rate sensitive liabilities exceeds the amount of interest rate sensitive assets.
During a period of rising interest rates, a negative gap would tend to affect
adversely net interest income while a positive gap would tend to result in an
increase in net interest income. Conversely, during a period of falling interest
rates, a negative gap would tend to result in an increase in net interest income
while a positive gap would tend to affect adversely net interest income.
The following table sets forth the amounts of KNBT's interest-earning
assets and interest-bearing liabilities outstanding at December 31, 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 December
31, 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, multi-family
mortgage loans and mortgage-backed securities are assumed to range from 12% to
32%. Annual rates of withdrawal or "decay rates" for money market deposit
accounts, savings accounts and interest bearing checking accounts are assumed to
be 38%, 8% and 8%, respectively.
At December 31, 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 $ 56,002 $ - $ - $ - $ - $ - $ 56,002
Loans receivable (2) 140,743 97,755 125,996 314,471 191,251 142,986 1,013,202
Investment securities, debt 109,897 49,977 101,486 383,751 190,650 272,679 1,108,440
Investment securities, equity 41,711 41,711
------------ --------- ------------ ------------- ------------- ------------- -------------
Total interest-earning
assets $ 306,642 $147,732 $227,482 $ 698,222 $ 381,901 $ 457,376 $ 2,219,355
============ ========= ============ ============= ============= ============= =============
Cumulative total interest-
earning assets $ 306,642 $454,374 $681,856 $1,380,078 $ 1,761,979 $2,219,355 $ 2,219,355
============ ========= ============ ============= ============= ============= =============
Interest-bearing liabilities:
Savings deposits $ - $ 8,410 $ 8,410 $ 11,214 $ 14,017 $ 168,206 $ 210,257
Interest-bearing checking deposits - 10,849 7,232 7,233 3,616 151,881 180,811
Money market deposits 31,437 36,274 24,183 32,244 16,122 101,567 241,827
Certificates of deposit 93,547 73,297 105,712 247,670 41,321 114 561,661
FHLB advances and other
borrowings 110,927 29,126 50,753 276,981 161,513 69,481 698,781
------------ --------- ------------ ------------- ------------- ------------- -------------
Total interest-bearing
liabilities $ 235,911 $157,956 $196,290 $ 575,342 $ 236,589 $ 491,249 $ 1,893,337
============ ========= ============ ============= ============= ============= =============
Cumulative total interest-
bearing liabilities $ 235,911 $393,867 $590,157 $1,165,499 $ 1,402,088 $1,893,337 $ 1,893,337
============ ========= ============ ============= ============= ============= =============
Interest-earning assets
less interest-bearing
liabilities $ 70,731 $(10,224) $ 31,192 $ 122,880 $ 145,312 $ (33,873) $ 326,018
============ ========= ============ ============= ============= ============= =============
Cumulative interest-rate
sensitivity gap (3) $ 70,731 $ 60,507 $ 91,699 $ 214,579 $ 359,891 $ 326,018
============ ========= ============ ============= ============= =============
Cumulative interest-rate gap as a
percentage of total assets at
December 31, 2004 2.93% 2.51% 3.80% 8.88% 14.90% 13.50%
Cumulative interest-earning assets
as a percentage of
cumulative interest-bearing
liabilities at December 31, 2004 129.98% 115.36% 115.54% 118.41% 125.67% 117.22%
- ------------------------------------------------------------------------------------------------------------------------------------
(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.
41
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate loans, have
features that restrict changes in interest rates both on a short-term basis and
over the life of the asset. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Finally, the ability of many borrowers
to service their adjustable-rate loans may decrease in the event of an interest
rate increase.
KNBT's interest rate sensitivity is monitored by management through the
use of models that generate estimates of the change in its net portfolio value
("NPV") and net interest income ("NII") over a range of interest rate scenarios.
NPV is the present value of expected cash flows from assets, liabilities, and
off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is
defined as the NPV in that scenario divided by the market value of assets in the
same scenario. KNBT also analyzes potential changes to NII for a twelve-month
period under rising and falling interest rate scenarios. The following table
sets forth KNBT's NPV and NII analysis as of December 31, 2004 and reflects the
changes to NPV and NII as a result of immediate and sustained changes in
interest rates as indicated.
Net Portfolio Value Projected
at December 31, 2004 Net Interest Income for 2005
------------------------------ --------------------------------
% Change % Change
from from
Rate Scenario Amount Base Case Amount Base Case
- --------------------------------------- -------------- ------------- ------------- ----------------
(dollars in thousands)
+ 300 basis point rate shock $ 509,843 -8.1% $ 69,742 5.0%
+ 200 basis point rate shock 529,905 -4.4% 69,189 4.2%
+ 100 basis point rate shock 547,637 -1.2% 67,859 2.2%
Static - base case 554,498 - 66,411 -
- - 100 basis point rate shock 523,554 -5.6% 61,782 -7.0%
- - 200 basis point rate shock 482,684 -13.0% 54,497 -17.9%
- - 300 basis point rate shock 444,211 -19.9% 47,960 -27.8%
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 of Pittsburgh, as an
additional funding source.
KNBT uses its liquidity to fund existing and future loan commitments,
to fund maturing certificates of deposit and demand deposit withdrawals, to
invest in other interest-earning assets, and to meet operating expenses. In
addition to cash flow from loan and securities payments and prepayments as well
as from sales of 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 especially in 2004, as a cost efficient
alternative to deposits as a source of funds. The average balance of FHLB
borrowings was $425.2 million, $114.5 million, and $67.4 million for the years
ended December 31, 2004, 2003, and 2002, respectively. To date, KNBT borrowings
have consisted primarily of advances from the FHLB of Pittsburgh.
42
Conversion from Mutual-to-Stock Form. The Bank completed its conversion
in October 2003. In connection with the conversion, KNBT sold 20,201,188 shares
of common stock at a price of $10.00 per share for total proceeds of $202.0
million. The capitalized expenses for the conversion were $5.8 million resulting
in net proceeds of $196.2 million. Concurrent with the conversion, KNBT
established the Keystone Nazareth Charitable Foundation with a contribution of
1,616,095 shares of KNBT common stock to the Foundation.
Also concurrent with the conversion, KNBT acquired First Colonial and
in connection therewith issued 8,545,855 shares of common stock to the
stockholders of First Colonial in exchange for their First Colonial shares.
In connection with the conversion, KNBT also established the ESOP. The
ESOP purchased 949,845 shares in open market transactions at an average price of
$17.01 per share for a total cost of $16.1 million. At December 31, 2004, 57,324
KNBT common shares were allocated to plan participants.
A significant amount of capital was raised during the mutual-to-stock
conversion and capital levels exceeded 25% at year-end 2004. KNBT's management
has developed capital management strategies to effectively utilize the excess
capital and improve return on equity and grow earnings per share. KNBT's capital
management strategy includes the following components: 1) payment of cash
dividends, 2) stock repurchases, 3) acquisitions and 4) use of leverage.
KNBT declared and paid its first cash dividend in the second quarter of
2004 and also declared and paid dividends for the third and fourth quarters of
2004. During the fourth quarter of 2004, KNBT's Board of Directors authorized
the repurchase of up to 3,062,486 shares or approximately 10% of KNBT's
outstanding shares. During 2004, KNBT acquired Oakwood Financial Corp., a
full-service brokerage firm based in Allentown, PA. Oakwood is a wholly owned
subsidiary of the Bank and supplements the Bank's offering of investment and
insurance products.
Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance-
Sheet Obligations
KNBT has not used, and has no intention to use, any significant
off-balance sheet financing arrangements for liquidity purposes. Its primary
financial instruments with off-balance sheet risk are limited to loan servicing
for others, obligations to fund loans to customers pursuant to existing
commitments and commitments to sell mortgage loans. In addition, KNBT has not
had, and has no intention to have, any significant transactions, arrangements or
other relationships with any unconsolidated, limited purpose entities that could
materially affect its liquidity or capital resources. KNBT has not, and does not
intend to, trade in commodity contracts.
KNBT anticipates that it will continue to have sufficient funds and
alternative funding sources to meet its current commitments.
KNBT's contractual cash obligations as of December 31, 2004 are as
follows:
Payments Due by Period:
------------------------------------------------------------
Less Than More Than
Total 1 Year 1-3 Years 3-5 Years 5 Years
------------ ------------- ------------ ------------- -------------
(dollars in thousands)
Federal Home Loan Bank debt $660,674 $ 137,005 $ 281,046 $ 172,117 $ 70,506
Subordinated debt 15,464 - - - 15,464
Operating leases 9,228 1,177 1,723 680 5,648
Severance agreements 650 650 - - -
Deferred directors' fees and
officer compensation 3,403 44 89 92 3,178
------------ ------------- ------------ ------------- -------------
Total obligations $689,419 $ 138,876 $ 282,858 $ 172,889 $ 94,796
============ ============= ============ ============= =============
43
KNBT is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the balance sheet. KNBT's
exposure to credit loss in the event of non-performance by the other party to
the financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual notional amount of those instruments.
KNBT uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
KNBT's contingent liabilities and commitments as of December 31, 2004
are as follows:
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
------------- ------------ ------------ ------------- -------------
(dollars in thousands)
Lines of credit $155,820 $ 87,344 $ 18,808 $ 27,832 $ 21,836
Standby letters of credit 23,973 17,175 6,715 83 -
Other commitments to make loans 116,954 68,611 1,576 9,677 37,090
------------- ------------ ------------ ------------- -------------
Total $296,747 $173,130 $ 27,099 $ 37,592 $ 58,926
============= ============ ============ ============= =============
Impact of Inflation and Changing Prices. The financial statements,
accompanying notes, and related financial data of KNBT presented herein have
been prepared in accordance with generally accepted accounting principals, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in purchasing power of money
over time due to inflation. The impact of inflation is reflected in the
increased cost of operations. Most of KNBT's assets and liabilities are monetary
in nature; therefore, the impact of interest rates has a greater impact on its
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services.
Leverage Transactions. Several leverage transactions were completed
during the year. KNBT used capital and FHLB borrowings to purchase investments.
Leverage strategies generally increase the company's interest rate risk exposure
and leverage transactions are carefully monitored and measured as part of active
balance sheet management.
Regulatory Capital Requirements. KNBT and the Bank are subject to
various regulatory capital requirements administered by the Federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possible additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on KNBT's financial statements.
New Accounting Pronouncements
On December 16, 2004, FASB issued Statement No. 123 (revised 2004),
Share-Based Payment "Statement 123(R)" replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123(R) establishes standards
for which an entity exchanges its equity instruments for good or services. It
also addresses transactions in which an entity incurs liabilities in exchange
for goods and services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
Under Statement 123(R), all forms of share-based payments to employees,
including 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 requires the entity to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award. That cost will be recognized over the period
during which an employee is required to provide service in exchange for the
award ("vesting period"). Fair value of that award will be re-measured
subsequently at each reporting date through the
44
settlement date. The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments.
All public entities that use the fair-value based method for either
recognition or disclosure under Statement 123(R) will apply this Statement using
a modified version of prospective application. Under the transition method,
compensation cost is recognized on or after the required effective date for the
portion of outstanding awards for which the requisite service has not yet been
rendered, based on the grant-date fair value of those awards calculated under
Statement 123(R) for either recognition or pro forma disclosure. For periods
before the required effective date, those entities may elect to apply a modified
version of retrospective application under which the financial statements for
prior periods are adjusted on a basis consistent with the pro forma disclosures
required for those periods by Statement 123(R).
Statement 123(R) is effective for public companies at the beginning of
the first interim or annual period beginning after June 15, 2005. This Statement
applies to all awards granted after the required effective date including
existing awards not vested, modified, repurchased, or canceled after that date.
KNBT is currently evaluating the impact of Statement 123(R) will have on its
financial statements.
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.
In October 2003, the AICPA issued SOP 03-3, "Accounting for Loans or
Certain Debt Securities Acquired in a Transfer". SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the Bank
will be unable to collect all contractually required payments receivable. SOP
03-3 is effective for loans acquired in fiscal years beginning after December
31, 2004. Management is currently evaluating the provisions of SOP 03-3 and does
not anticipate its adoption to have a material affect on the Bank's financial
position or results of operations.
Item 7A. Quantitative and Qualitative Disclosure About Market Risks
- ----------------------------------------------------------------------------
Information with respect to quantitative and qualitative disclosure is
contained in Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
45
Item 8. Financial Statements and Supplementary Data
- -------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
KNBT Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of KNBT Bancorp,
Inc. (and previously Keystone Savings Bank) and subsidiaries as of December 31,
2004 and 2003, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of KNBT Bancorp, Inc.
as of December 31, 2004 and 2003, and the consolidated results of its operations
and its cash flows for the each of the three years in the period ended December
31, 2004, in conformity with accounting principles generally accepted in the
United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of KNBT Bancorp,
Inc.'s internal control over financial reporting as of December 31, 2004, based
on criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 16, 2005 expressed an unqualified opinion on management's
assessment of the effectiveness of internal controls over financial reporting
and an unqualified opinion on the effectiveness of internal control over
financial reporting.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
March 16, 2005
46
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
At December 31,
---------------------------------------------
2004 2003
- -----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
ASSETS
Cash and Due From Banks $ 30,218 $ 55,059
Interest-Bearing Deposits With Banks 56,002 83,918
------------------ ------------------
Cash and Cash Equivalents 86,220 138,977
Investment Securities Available-for-Sale 1,057,109 734,087
Investment Securities Held to Maturity 56,586 -
(Fair value of $57,034 at December 31, 2004)
Federal Home Loan Bank of Pittsburgh Stock 36,456 11,543
Mortgage Loans Held-for-Sale 718 4,677
Loans 1,013,202 890,076
Less: Allowance for Loan Losses (10,461) (7,910)
------------------ ------------------
Net Loans 1,002,741 882,166
Bank Owned Life Insurance 60,501 57,849
Premises and Equipment, Net 40,790 35,867
Accrued Interest Receivable 9,509 7,645
Goodwill and Other Intangible Assets 53,255 47,448
Other Assets 11,218 21,714
------------------ ------------------
TOTAL ASSETS $ 2,415,103 $ 1,941,973
================== ==================
LIABILITIES
Non-Interest-Bearing Deposits $ 128,498 $ 117,270
Interest-Bearing Deposits 1,194,555 1,172,140
------------------ ------------------
Total Deposits 1,323,053 1,289,410
Securities Sold Under Agreements to Repurchase 22,643 24,550
Advances from the Federal Home Loan Bank 660,674 207,153
Guaranteed Preferred Beneficial Interest in the
Company's Subordinated Debentures - 15,000
Subordinated Debt 15,464 -
Accrued Interest Payable 5,811 3,218
Other Liabilities 10,104 13,562
------------------ ------------------
TOTAL LIABILITIES 2,037,749 1,552,893
------------------ ------------------
SHAREHOLDERS' EQUITY
Preferred Stock, Par Value $.01 per share
Authorized: 20,000,000 shares - -
Common Stock, Par Value $0.01 a share 297 295
Authorized: 100,000,000 shares
Issued and Outstanding:
30,656,840 shares at December 31, 2004
30,419,397 shares at December 31, 2003
Treasury Stock, at cost; 650,000 and 0 shares at
December 31, 2004 and December 31, 2003, respectively (11,179) -
Additional Paid-In Capital 296,403 297,887
Retained Earnings 113,748 100,570
Unallocated Common Stock Held
by Employee Stock Ownership Plan (15,176) (15,987)
Unearned Common Stock Held
by Management Recognition and Retention Plan (9,107) -
Accumulated Other Comprehensive Income 2,368 6,315
------------------ ------------------
TOTAL SHAREHOLDERS' EQUITY 377,354 389,080
------------------ ------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,415,103 $ 1,941,973
================== ==================
- -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
47
KNBT BANCORP, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
2004 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
INTEREST INCOME
Loans, including fees $ 58,292 $ 41,823 $ 44,188
Investment Securities 38,501 16,212 14,883
Other Interest 498 1,028 408
----------------- ----------------- -----------------
Total Interest Income 97,291 59,063 59,479
----------------- ----------------- -----------------
INTEREST EXPENSE
Deposits 18,185 15,993 23,099
Securities sold under Agreements to Repurchase 170 131 155
Advances from the Federal Home Loan Bank 14,316 4,822 3,162
Subordinated Debt 775 115
----------------- ----------------- -----------------
Total Interest Expense 33,446 21,061 26,416
----------------- ----------------- -----------------
NET INTEREST INCOME 63,845 38,002 33,063
Provision for Loan Losses 4,308 2,951 111
----------------- ----------------- -----------------
Net Interest Income After Provision
for Loan Losses 59,537 35,051 32,952
----------------- ----------------- -----------------
NON-INTEREST INCOME
Trust Revenue 1,545 279 -
Brokerage Services Revenue 673 465 420
Deposit Service Charges 4,477 4,042 3,628
Bank Owned Life Insurance 2,652 1,515 1,435
Net Gains (Losses) on Sales of Investment Securities 396 (249) 1,202
Net Gains on Sales of Residential Mortgage Loans 774 246 900
Net Gains on Sales of Credit Card Loans 298 - -
Net Gains on Sale of Assets 191 - -
Net Gains on Sale of Other Real Estate Owned 90 - -
Non-Interest Operating Income 4,338 2,750 1,229
----------------- ----------------- -----------------
Total Non-Interest Income 15,434 9,048 8,814
----------------- ----------------- -----------------
NON-INTEREST EXPENSES
Compensation and Employee Benefits 29,478 18,633 13,217
Net Occupancy and Equipment Expense 8,335 4,599 3,086
Professional Fees 2,279 1,083 868
Advertising 1,013 350 840
Data Processing 1,782 2,124 1,712
Impairment of Mortgage Servicing Rights 415 1,068 676
Contribution to Charitable Foundation - 16,161
Merger-Related Expenses - 5,652
Other Operating Expenses 9,397 5,449 4,169
----------------- ----------------- -----------------
Total Non-Interest Expenses 52,699 55,119 24,568
----------------- ----------------- -----------------
Income (Loss) Before Income Taxes (Benefit) 22,272 (11,020) 17,198
Income Taxes (Benefit) 4,666 (5,264) 5,188
----------------- ----------------- -----------------
NET INCOME (LOSS) $ 17,606 $ (5,756) $ 12,010
================= ================= =================
PER SHARE DATA
Net Income - Basic $ 0.61 N/M N/A
================= ================= =================
Net Income - Diluted $ 0.60 N/M N/A
================= ================= =================
Cash Dividends Per Common Share $ 0.15 N/M N/A
================= ================= =================
- --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
48
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Accumulated
Common Addl Unallocated Unearned Other
Common Stock Paid In Retained ESOP Compensation Comprehensive Treasury
Shares Value Capital Earnings Shares MRP Income Stock Total
- ---------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands except share data)
Balance December 31, 2001 - $ - $ - $ 94,316 $ - $ - $ 1,472 $ - $ 95,788
Comprehensive Income
Net Income 12,010 12,010
Other Comprehensive Income
Net of Taxes 3,251 3,251
--------
Total Comprehensive Income 15,261
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 - - - 106,326 - - 4,723 - 111,049
Comprehensive Income
Net Loss (5,756) (5,756)
Other Comprehensive Income
Net of Taxes and
Reclassification Adjustments 1,592 1,592
--------
Total Comprehensive Loss (4,164)
Proceeds from Sale
of Common Stock, Net 20,201,188 202 196,059 196,261
Shares in Merger with
First Colonial 8,545,855 85 85,374 85,459
Issuance of Common Stock
to Charitable Foundation 1,616,095 16 16,145 16,161
Purchase of Shares for ESOP (949,845) (9) (16,152) (16,161)
Unallocated ESOP Shares
Committed to Employees 9,723 (1) 165 164
Shares Issued upon
Exercise of Stock Options 56,259 1 310 311
---------------------------------------------------------------------------------------------------
Balance at December
31, 2003 29,479,275 295 297,887 100,570 (15,987) - 6,315 - 389,080
Comprehensive Income
Net Income 17,606 17,606
Other Comprehensive Income
Net of Taxes and
Reclassification Adjustments (3,947) (3,947)
--------
Total Comprehensive Income 13,659
Cash Dividends (4,428) (4,428)
Purchase of Stock for Management
Recognition and
Retention Plan (MRRP) (13,281) (13,281)
Unallocated ESOP Shares
Committed to Employees 47,601 (16) 811 795
Shares Issued upon
Exercise of Stock Options 237,443 2 1,286 1,288
Repurchase of
common stock (650,000 shares) (11,179) (11,179)
Establishment of a Management
Recognition Program(MRRP) 10,527 (10,527) -
Amortization of Compensation
related to MRRP 1,420 1,420
----------------------------------------------------------------------------------------------------
Balance at December
31, 2004 29,764,319 $297 $296,403 $ 113,748 $(15,176) $ (9,107) $ 2,368 $ (11,179) $377,354
====================================================================================================
49
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31,
--------------------------------------
2004 2003 2002
- ----------------------------------------------------------------------------------------------------- -----------
(Dollars in Thousands)
OPERATING ACTIVITIES
Net Income $17,606 $ (5,756) $ 12,010
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Provision for Loan Losses 4,308 2,951 111
Depreciation and Amortization 6,359 3,180 1,317
Compensation Expense Stock Option Plan 16 - -
Management Recognition and Retention Plan Expense 1,404 - -
Amortization and Accretion of Security Premiums and Discounts, net 2,521 3,630 (521)
(Gain) Loss on Sale of Other Real Estate Owned (90) 31 28
Gain on Sales of Investment Securities (396) 249 (1,202)
Gain on Sale of Credit Card Portfolio (298) - -
Gain on Sale of Other Assets (191) - 99
Gain on Sale of Mortgage Loans (774) (246) (900)
Mortgage Loans Originated for Sale (63,193) (29,043) (60,974)
Mortgage Loan Sales 67,926 50,286 37,178
Contribution to Charitable Foundation - 16,161 -
Changes in Assets and Liabilities: - - -
Increase in Bank Owned Life Insurance (2,652) (1,515) (1,435)
Increase (Decrease) in Accrued Interest Receivable (1,864) 283 (1,805)
Increase (Decrease) in Other Assets 2,830 (5,849) (2,678)
Increase (Decrease) in Other Liabilities and Accrued Interest Payable (865) 5,760 2,842
----------- ----------- -----------
Net Cash Provided by Operating Activities 32,647 40,122 (15,930)
----------- ----------- -----------
INVESTING ACTIVITIES
Proceeds from Calls and Maturities of Securities Available-for-Sale 172,937 264,030 104,037
Proceeds from Calls and Maturities of Securities Held to Maturity 3,242 - -
Proceeds from Sales of Securities Available-for-Sale 11,478 28,540 63,844
Purchase of Securities Available-for-Sale (516,223) (462,963) (184,848)
Purchase of Securities Held to Maturity (59,751) - -
Purchase of Federal Home Loan Bank of Pittsburgh Stock (26,883) (3,531) (1,912)
Redemption of Federal Home Loan Bank of Pittsburgh Stock 1,970 - -
Purchase of Bank Owned Life Insurance - (30,000) (4,000)
Proceeds from the Sale of Credit Cards 1,831 - -
Net Increase in Loans (124,883) (62,542) (1,915)
Purchase of Premises and Equipment (8,680) (13,138) (1,376)
Proceeds from the Sale of Other Assets 1,537 - -
Proceeds from the Sale of Other Real Estate Owned 364 556 791
Cash and Cash Equivalents Acquired through Merger - 45,616 -
----------- ----------- -----------
Net Cash Used in Investing Activities (543,061) (233,432) (25,379)
----------- ----------- -----------
FINANCING ACTIVITIES
Net Increase (Decrease) in Deposits 33,643 5,499 (394)
Net Increase (Decrease) in Repurchase Agreements (1,907) (2,113) 3,152
Proceeds from Long-Term Debt 526,827 92,300 73,000
Repayment of Long-Term Debt (73,306) (30,103) -
Purchase of ESOP Shares - (16,161) -
Purchase of Treasury Stock (11,179) - -
Purchase of Stock for the Management Recognition and Retention Plan (13,281) - -
Proceeds from Issuance of Common Stock - 196,261 -
Proceeds From the Exercise of Stock Options 1,288 311 -
Cash Dividends Paid (4,428) - -
----------- ----------- -----------
Net Cash Provided by Financing Activities 457,657 245,994 75,758
----------- ----------- -----------
Increase (Decrease) in Cash and Cash Equivalents (52,757) 52,684 34,449
----------- ----------- -----------
Cash and Cash Equivalents January 1, 138,977 86,293 51,844
----------- ----------- -----------
Cash and Cash Equivalents December 31, $86,220 $ 138,977 $ 86,293
=========== =========== ===========
Supplemental Disclosure of Cash Flow Information
Cash Paid During the Year for
Income Taxes $ 3,300 $ 3,075 $ 4,075
=========== =========== ===========
Interest $30,853 $ 14,882 $ 26,344
=========== =========== ===========
Supplemental Disclosure of Non-cash Activities
Mortgage Loan Securitizations $ - $ 47,251 $ 115,335
=========== =========== ===========
Reclassification of Loans Receivable to Other Real Estate Owned $ 191 $ 473 $ 998
=========== =========== ===========
- ----------------------------------------------------------------------------------------------------- -----------
See accompanying notes to interim consolidated financial statements.
50
KNBT BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION
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 ("Nazareth National Bank"). In connection with
the acquisition of First Colonial, Nazareth National Bank and Trust Company was
merged into the Bank. At December 31, 2004, the Bank operated 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 seven off-site ATMs.
The Bank competes with other banking and financial institutions in its
primary market communities, including financial institutions with resources
substantially greater than its own. Commercial banks, savings banks, savings and
loan associations, credit unions and money market funds actively compete for
savings and time deposits and for various types of loans. Such institutions, as
well as consumer finance and insurance companies, may be considered competitors
of the Bank with respect to one or more of the services it renders.
KNBT and the Bank are subject to regulations of certain state and
Federal agencies and, accordingly, they are periodically examined by those
regulatory agencies. As a consequence of the extensive regulation of commercial
banking activities, the Bank's business is particularly susceptible to being
affected by state and Federal legislation and regulation, which may have the
effect of increasing the cost of doing business.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
The accounting and reporting policies of KNBT conform to accounting
principles generally accepted in the United States of America and predominant
practices within the banking industry. The accompanying consolidated financial
statements include the accounts of KNBT and its wholly owned subsidiaries, the
Bank, Inv. I, Inv. II, the Bank's wholly owned subsidiaries KLVI, Traditions
Settlement Services, and KNBT Securities.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the balance sheets and revenues and
expenditures for the periods. Therefore, actual results could differ
significantly from those estimates.
The principal estimates that are particularly susceptible to
significant change in the near term relate to the allowance for loan losses and
the evaluation of impairment of goodwill. The evaluation of the adequacy of the
allowance for loan losses includes an analysis of the individual loans and
overall risk characteristics and size of the different loan portfolios, and
takes into consideration current economic and market conditions, the capability
of specific borrowers to pay specific loan obligations, as well as current loan
collateral values. However, actual losses on specific loans, which also are
encompassed in the analysis, may vary from estimated losses.
51
2. Cash and Cash Equivalents
For reporting cash flows, cash and cash equivalents include cash and
due from banks and interest-bearing deposits with banks. The Company maintains
cash deposits in other depository institutions that occasionally exceed the
amount of deposit insurance available. Management periodically assesses the
financial condition of these institutions and believes that the risk of any
possible credit loss is minimal. Interest-bearing deposits in other financial
institutions consist of short-term investments generally having maturities of
less than 30 days.
3. Investment Securities
KNBT accounts for its investment securities in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities". This
standard requires, among other things, that debt and equity securities,
classified as held-to-maturity, are accounted for at cost, adjusted for
amortization of premiums and accretion of discount, using the constant yield
method, based on KNBT's intent and ability to hold the securities until
maturity. All other securities are included in the available-for-sale category
and are reported at fair value, with unrealized gains and losses excluded from
earnings and reported, net of tax, as a component of shareholders' equity. At
the time of purchase, KNBT makes a determination as to whether or not it will
hold the securities to maturity, based on an evaluation of the probability of
future events. Securities that KNBT believes may be involved in interest rate
risk, liquidity or other asset/liability management decisions, which might
reasonably result in such securities not being held to maturity, are classified
as available for sale. If securities are sold, a gain or loss is determined by
specific identification and reflected in the operating results in the period the
trade occurs.
KNBT follows SFAS No. 133 as amended by SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133, as
amended requires that entities recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. KNBT did not have any derivative instruments as of
December 31, 2004 and 2003.
KNBT adopted EITF 03-1, "The Meaning of Other than Temporary Impairment
and Its Application to Certain Investments" as of December 31, 2003. EITF 03-1
includes certain disclosures regarding quantitative and qualitative disclosures
for investment securities accounted for under SFAS No. 115 that are impaired at
the balance sheet date, but an other-than-temporary impairment has not been
recognized. The disclosures under EITF 03-1 are included.
4. Mortgage Loans Held-for-Sale
Mortgage loans originated and intended for sale in the secondary market
are carried at the lower of aggregate cost or estimated fair value. Gains and
losses on the sales of loans are also accounted for in accordance with SFAS No.
134, "Accounting for Mortgage Securities Retained after the Securitizations of
Mortgage Loans Held-for-Sale by a Mortgage Banking Enterprise". This statement
requires that an entity engaged in mortgage banking activities classify the
retained mortgage-backed security or other interest, which resulted from the
securitization of a mortgage loan held-for-sale, based upon its ability and
intent to sell or hold these investments.
KNBT follows SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," which revised the
standards for accounting for the securitizations and other transfers of
financial assets and collateral. Transfers of financial assets for which KNBT
has surrendered control of the financial assets are accounted for as sales to
the extent that consideration other than beneficial interests in the transferred
assets is received in exchange. Retained interest in a sale or securitization of
financial assets are measured at the date of transfer by allocating the previous
carrying amount between the assets transferred and based on the relative
estimated fair values. The fair values of retained debt securities are generally
determined through reference to independent pricing information. The fair values
of retained
52
servicing rights and any other retained interests are determined based on the
present value of expected future cash flows associated with those interests and
by reference to market prices for similar assets.
KNBT adopted SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities", on July 1, 2003. Implementation issue C13,
"When a Loan Commitment Is Included in the Scope of Statement 133" is included
in SFAS No. 149. SFAS No. 149 amends SFAS No. 133 to add a scope exception for
borrowers (all commitments) and lenders (all commitments except those relating
to mortgage loans that will be held-for-sale). Statement 149 also amends
paragraph SFAS No. 133 to require a lender to account for loan commitments
related to mortgage loans that will be held-for-sale as derivatives. KNBT
periodically enters into commitments with its customers, which it intends to
sell in the future. KNBT's commitments to extend credit for loans intended for
resale were not material at December 31, 2004.
5. Loans and Allowance for Loan Losses
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and reduced by an allowance for loan losses. Interest on loans
accrues and is credited to operations based upon the principal amounts
outstanding. The allowance for loan losses is established through a provision
for loan losses charged to operations. Loans are charged against the allowance
for loan losses when management believes that the collectibility of the
principal is unlikely.
Interest is discontinued when, in the opinion of management, the
collectibility of such interest becomes doubtful. A loan is generally classified
as nonaccrual when the loan is 90 days or more delinquent. Loan origination fees
and certain direct origination costs are deferred and amortized over the life of
the related loans as an adjustment to the yield on loans receivable in a manner
which approximates the interest method.
The allowance for loan losses is maintained at an amount management
deems adequate to cover estimated losses. In determining the level to be
maintained, management evaluates many factors, including current economic
trends, industry experience, historical loss experience, industry loan
concentrations, the borrowers' ability to repay and repayment performance, and
estimated collateral values. In the opinion of management, the allowance at
December 31, 2004, was adequate to absorb future loan losses which are
foreseeable and reasonably estimable. While management uses the best information
available to make such evaluations, future adjustments to the allowance may be
necessary based on changes in economic conditions or any of the other factors
used in management's determination. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review KNBT's
allowance for losses on loans. Such agencies may require KNBT to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination. Charge-offs to the allowance are made
when the loan is transferred to real estate owned or some other determination of
impairment is made.
KNBT accounts for its impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118,
"Accounting by Creditors of a Loan - Income Recognition and Disclosures." This
standard requires that a creditor measure impairment based on the present value
of expected future cash flows discounted at the loan's observable market price,
or the fair value of the collateral if the loan is collateral dependent.
Regardless of the measurement method, a creditor must measure impairment based
on the fair value of the collateral when the creditor determines that
foreclosure is probable.
FASB Interpretation FIN No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others", requires certain disclosures effective for the year ended December 31,
2002 regarding the nature of the guarantee, the maximum potential amount of
future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. Significant guarantees that have been entered
into by KNBT include standby and performance letters of credit. The adoption of
FIN No. 45 did not have a material impact on the consolidated financial
statements.
53
In October 2003, the AICPA issued SOP 03-3, "Accounting for Loans or
Certain Debt Securities Acquired in a Transfer". SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the Bank
will be unable to collect all contractually required payments receivable. SOP
03-3 is effective for loans acquired in fiscal years beginning after December
31, 2004. SOP 03-3 did not have a material affect on KNBT's consolidated
financial position or results of operations.
6. Premises and Equipment
Premises and equipment are carried at cost less accumulated
depreciation, and include expenditures for new facilities, major betterments and
renewals. Expenditures of maintenance and repairs are charged to expense as
incurred. Depreciation is computed using the straight-line method based upon the
estimated useful lives of the related assets.
On January 1, 2002, KNBT adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. The adoption of this statement did
not have an impact on the financial condition or results of operations of the
Company.
7. Other Real Estate Owned
Real estate acquired through foreclosure is classified as other real
estate owned ("OREO"). OREO is carried at the lower of cost (lesser of carrying
value of the loan or fair value at date of acquisition) or fair value less
estimated costs to sell. Any reductions in value, at or prior to the dates the
real estate is considered foreclosed, is charged to the allowance for loan
losses. Any subsequent reductions in value are charged through earnings. Costs
relating to the development or improvement of the property are capitalized;
holding costs are charged to expense.
8. Goodwill and Intangible Assets
KNBT adopted SFAS No. 142, "Goodwill and Intangible Assets", on January
1, 2002. This statement modifies the accounting for all purchased goodwill and
intangible assets. SFAS No. 142 includes requirements to test goodwill and
indefinite lived intangible assets for impairment rather than amortize them.
Goodwill is subject to impairment testing at least annually to determine whether
write-downs of the recorded balances are necessary. In this testing, KNBT
employs industry practices in accordance with GAAP. KNBT tests for impairment as
of September 30 each year. KNBT has tested the goodwill included on its
consolidated balance sheet as of September 30, 2004 and has determined that it
was not impaired as of such date.
Intangible assets are comprised of core deposit intangibles and
goodwill acquired in business combinations. KNBT's goodwill of $34.9 million
primarily is the result of its acquisition of First Colonial in October 2003.
Additional goodwill of $531,000 was recorded as a result of the acquisition of
Oakwood on September 28, 2004. The balance of goodwill at December 31, 2004 and
2003 was $35.3 million and $29.2 million, respectively. Core deposit intangibles
of $14.9 million (net of accumulated amortization of $2.6 million) at December
31, 2004 and $17.1 million at December 31, 2003 are being amortized over the
estimated useful lives of the existing deposit base of 8 years using a method,
which approximates the interest method. Amortization expense was $2.2 million
are $364,000 for the years ended December 31, 2004 and 2003, respectively.
9. Income Taxes
Under the liability method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities as measured by the enacted tax rates which will be in
effect when these temporary differences are estimated to reverse. Deferred tax
expense is the result of changes in deferred tax assets and liabilities.
54
10. Advertising
The Company expenses advertising costs as incurred.
11. 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 currently 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. Except as discussed in Note L, KNBT has elected to account for
options, in accordance with APB Opinion No. 25.
The following table illustrates the effect on net income and earnings
per share if KNBT had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation.
For the Year Ended
December 31, 2004
---------------------------------------------
(dollars in thousands except per share data)
Net Income as reported $ 17,606
Add: Stock-based employee compensation expense
included in reported net income, net 16
of related tax effects
Less: Stock-based compensation cost determined
under fair value method for all awards, net 369
-------------------
of related tax effects
Pro forma $ 17,253
===================
Earnings per share (diluted)
As reported $ 0.60
Pro forma $ 0.59
Earnings per share (basic)
As reported $ 0.61
Pro forma $ 0.59
Management Recognition and Retention Plan
-----------------------------------------
The MRRP, which is a stock-based incentive plan, provides the ability
to award up to 808,047 shares of the Company's common stock, subject to
adjustment, to the Company's directors, advisory directors, officers and
employees. The terms of the grants made to date provide that the shares covered
by the MRRP are earned by the participants at the rate of 20% per year.
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.
55
12. Employee Benefit Plans
KNBT has certain employee benefit plans covering substantially all
employees. KNBT expenses such costs as incurred. KNBT follows SFAS No. 132, as
revised in December 2003, "Employers' Disclosures about Pensions and Other
Post-retirement Benefits". SFAS No. 132 revised employers' disclosures about
pension and other post-retirement benefit plans. It requires additional
information about changes in the benefit obligation and the fair values of plan
assets. It also standardized the requirements for pensions and other
postretirement benefit plans to the extent possible, and illustrates combined
formats for the presentation of pension plan and other post-retirement benefit
plan disclosures.
In November 2003, KNBT established an Employee Stock Ownership Plan
("ESOP") covering all eligible employees as defined by the ESOP. The ESOP is a
tax-qualified plan designed to invest primarily in KNBT's common stock that
provides employees with the opportunity to receive a KNBT-funded retirement
benefit based primarily on the value of KNBT's common stock. KNBT accounts for
its ESOP in accordance with Statement of Position ("SOP") 93-6, "Employer's
Accounting for Employee Stock Ownership Plans", issued by the Accounting
Standards Division of the American Institute of Certified Public Accountants
("AICPA").
To purchase KNBT's common stock, the ESOP borrowed $16.1 million from
KNBT to purchase 949,845 shares of KNBT common stock in the market. The ESOP
loan is being repaid principally from the Bank's contributions to the ESOP over
a period of up to 30 years. Dividends declared on common stock held by the ESOP
and not allocated to the account of a participant can be used to repay the loan.
Compensation expense is recognized in accordance with SOP 93-6. The number of
shares released annually is based upon the ratio that the current principal and
interest payment bears to the current and all remaining scheduled future
principal and interest payments.
All shares that have not been released for allocation to participants
are held in a suspense account by the ESOP for future allocation as the loan is
repaid. Unallocated common stock purchased by the ESOP is recorded as a
reduction of shareholders' equity at cost.
13. Bank Owned Life Insurance ("BOLI")
KNBT has purchased BOLI. BOLI involves the purchasing of life insurance
by the corporation on a chosen group of employees. The proceeds are used to help
defray employee benefit costs. KNBT is the owner and beneficiary of the
policies. The Company originally invested $20.0 million in BOLI in 2001 and made
additional BOLI investments of $4.0 million in 2002 and $30.0 million in 2003.
BOLI is recorded on the consolidated balance sheets at its cash surrender value
and changes in the cash surrender value are recorded in non-interest income.
BOLI income is tax-exempt.
14. Trust Assets and Revenue
Assets held by the Trust Department of the Bank in fiduciary or agency
capacities for its customers are not included in the accompanying consolidated
balance sheets since such assets are not assets of KNBT. Operating revenue and
expenses of the Trust Department are included under their respective captions in
the accompanying consolidated statements of income and are recorded on the
accrual basis.
15. Per Share Information
KNBT follows the provisions of SFAS No. 128, "Earnings Per Share".
Basic earnings per share exclude dilution and is computed by dividing income
available to common stockholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. Earnings per share
were not meaningful in 2003 since KNBT did not complete its initial public
offering until October 31, 2003.
56
Basic and diluted earnings per share for the year ended December 31,
2004 were calculated as follows:
Net Average
Income Shares Per Share
(numerator) (denominator) Amount
---------------------------------------------------
(dollars in thousands)
Basic Earnings Per Share
Income Available to Common Shareholders $ 17,606 29,060,702 $ 0.61
Effect of Dilutive Securities
Stock Options 416,888
Management Recognition and Retention Plan 89,793
------------------ --------------
Total Effect of Dilutive Securities 506,681 $ (0.01)
Diluted Earnings Per Share
Income Available to Common Shareholders
plus Assumed Exercise of Options $ 17,606 29,567,383 $ 0.60
=============== ================== ==============
Common stock outstanding at December 31, 2004 for the purpose of
calculating basic earnings per share does not include 892,521 unallocated shares
held by the ESOP.
Unearned MRRP shares and MRRP shares not subject to grant are not
considered to be outstanding for basic earnings per share calculations. At
December 31, 2004, unearned MRRP shares totaled 629,500 and uncommitted MRRP
shares totaled 178,547.
16. Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires KNBT to disclose the estimated fair value of their assets and
liabilities considered to be financial instruments. Financial instruments
requiring disclosure consist primarily of cash and cash equivalents, investment
securities, loans, deposits and borrowings.
17. Segment Information
"SFAS" No. 131, "Disclosures About Segments of an Enterprise and
Related Information," defines how operating segments are determined and requires
disclosures of certain financial and descriptive information about KNBT's
operating segments. Management has determined that KNBT has one operating
segment and, accordingly, one reportable segment, "Community Banking." All of
KNBT's activities are interrelated, and each activity is dependent and assessed
based on how each of the activities of KNBT supports the others. For example,
consumer and residential mortgage lending is dependent upon the ability of KNBT
to fund itself with retail deposits and other borrowings and to manage interest
rate and credit risk. All significant operating decisions are based upon
analysis of KNBT as one operating segment.
57
18. Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," includes net income as
well as certain other items, which result in a change to equity during the
period.
The income tax effects allocated to comprehensive income for the years
ended December 31, 2004, 2003 and 2002 were as follows:
Tax
Before tax benefit Net of tax
amount (expense) amount
-----------------------------------------------
(dollars in thousands)
Year ended December 31, 2004
Unrealized Gains on Securities:
Unrealized holding gains (losses) rising $ (5,584) $ 1,898 $ (3,686)
during period
Less reclassification adjustment for
net realized gains (396) (135) (261)
-----------------------------------------------
Other comprehensive income (loss), net $ (5,980) $ 2,033 $ (3,947)
============= ============ =============
Year ended December 31, 2003
Unrealized Gains on Securities:
Unrealized holding gains (losses) rising $ 2,162 $ (734) $ 1,428
during period
Less reclassification adjustment for
net realized gains 249 85 164
-----------------------------------------------
Other comprehensive income (loss), net $ 2,411 $ (819) $ 1,592
============= ============ =============
Year ended December 31, 2002
Unrealized Gains on Securities:
Unrealized holding gains (losses) rising $ 6,266 $ (2,222) $ 4,044
during period
Less reclassification adjustment for
net realized gains (1,202) (409) (793)
-----------------------------------------------
Other comprehensive income (loss), net $ 5,064 $ (1,813) $ 3,251
============= ============ =============
19. Statement of Cash Flows
KNBT considers cash, due from banks and Federal funds sold as cash
equivalents for the purposes of the Consolidated Statement of Cash Flows.
20. Variable Interest Entities
In January 2003, FASB Interpretation FIN No. 46, "Consolidation of
Variable Interest Entities", was issued. FIN 46 clarifies the application of
Accounting Research Bulletin 51, "Consolidated Financial Statements", to certain
entities in which voting rights are not effective in identifying the investor
with the controlling financial interest. An entity is subject to consolidation
under FIN 46 if the investors either do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support, are unable to direct the entity's activities, or are not exposed to the
entity's losses or entitled to its residual returns ("variable interest
entities"). Variable interest entities within the scope of FIN 46 were required
to be consolidated by their primary beneficiary. The primary beneficiary of a
variable interest entity is determined to be the party that absorbs a majority
of the entity's expected losses, receives a majority of its expected returns, or
both.
58
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 FIN
46. Trust I issued mandatorily redeemable preferred stock in July 2002 to
investors and purchased subordinated debt issued by First Colonial. Trust I is
included in KNBT's consolidated balance sheet and statements of operations as of
and for the year ended December 31, 2003 and 2004. Subsequent to the issuance of
FIN 46 in January 2003, the FASB issued a revised interpretation, FIN 46(R), the
provisions of which had to 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 ceased consolidating 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 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 Board 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 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.
21. Reclassifications
Certain reclassifications of prior years' amounts have been made to
conform to the 2004 presentation.
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. 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 stockholders of
First Colonial in exchange for their shares of First Colonial common stock.
On October 31, 2003, KNBT and the Bank completed mergers with First
Colonial and its subsidiary Nazareth National Bank, respectively. Under the
terms of the merger agreement, which was the result of arms-length negotiation,
each of the shares of First Colonial common stock was exchanged for 3.7 shares
of KNBT common stock for a total issuance of 8,545,855 shares of common stock.
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 completion of the merger. The transaction was
accounted for under the purchase method of accounting. The acquisition resulted
in the recording of an aggregate of approximately $45.9 million of goodwill and
other intangible assets. The transaction was accounted for under the purchase
method of accounting and KNBT's results of operations include that of First
Colonial from October 31, 2003 (date of acquisition) through December 31, 2003.
59
The following condensed consolidated balance sheet of First Colonial
discloses the amounts assigned to each major asset and liability caption on the
acquisition date of October 31, 2003.
(dollars in thousands)
Assets
Cash and due from banks $ 45,616
Investment securities 271,784
Net loans 272,270
Fair value allocated to premises and equipment 4,408
Goodwill and core deposit intangible asset 46,442
Other assets 26,368
------------------------
Total assets $ 666,888
========================
Liabilities
Total deposits (512,086)
Borrowings (64,215)
Other liabilities (5,128)
------------------------
Total liabilities assumed (581,429)
------------------------
Net assets acquired $ 85,459
========================
The following represents the unaudited pro forma financial information
of KNBT as if the acquisition occurred on the first date of the periods
indicated. The pro forma information should be read in conjunction with the
related historical information and is not necessarily indicative of the results
that would have been attained had the transaction actually taken place.
Year ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------- ------------
(dollars in thousands)
Interest Income $ 83,713 $ 89,009 $ 90,528
Interest Expense 33,896 38,826 48,033
------------ ------------- ------------
Net Interest Income 49,817 50,183 42,495
Provision for Loan Losses 4,001 1,652 971
Non-interest Income 14,761 15,721 10,620
Non-Interest Expense 77,911 43,834 37,671
Net (Loss) Income $ (9,901) $ 20,333 $ 10,339
Oakwood Financial Corp.
On November 11, 2004, KNBT acquired Oakwood Financial Corp.
("Oakwood"), a full-service brokerage firm based in Allentown, PA, for $650,000.
KNBT acquired $121,000 in assets and recorded $531,000 of goodwill. The merger
transaction was accounted for under the purchase method of accounting. KNBT's
results of operations include the operations acquired from Oakwood for the
period November 11, 2004 through December 31, 2004.
Oakwood provides a full menu of securities brokerage, insurance and
investment advisory products and services. Oakwood is a wholly owned subsidiary
of the Bank and now operates as KNBT Securities Inc. This purchase augments the
Bank's offering of investment and insurance products offered to its customers in
branch offices.
60
Northeast Pennsylvania Financial Corp.
On December 8, 2004, KNBT entered into an Agreement and Plan of Merger
dated December 8, 2004 (the "Merger Agreement") with Northeast Pennsylvania
Financial Corp., a Delaware corporation ("NEPF"), which sets forth the terms and
conditions under which NEPF will merge with and into KNBT (the "Merger").
Under the terms of the Merger Agreement, NEPF's shareholders may elect
to receive either $23.00 of KNBT common stock or $23.00 in cash in exchange for
their shares of NEPF common stock, subject to an overall requirement that 50% of
the total outstanding NEPF common stock be exchanged for KNBT common stock and
50% for cash. The stock component of the merger consideration will be valued at
$23.00 per share based on the average market price of KNBT common stock during
the 20-trading day period ending on the fifth business day prior to the Merger.
The total cost of the transaction is expected to be approximately $98.0 million.
In addition, each director of NEPF entered into a Shareholder Agreement
with KNBT, pursuant to which each such person agreed, among other things, to
vote his or her shares of NEPF common stock in favor of the Merger Agreement at
a meeting of shareholders of NEPF which has been called to consider and approve
the Merger Agreement.
The transaction is expected to close during the second quarter of 2005.
It is subject to a number of customary conditions, including, but not limited
to, (a) the approval of the Merger Agreement by shareholders of NEPF and (b) the
receipt of all required regulatory approvals by applicable Federal and State
regulatory agencies.
Caruso Benefits Group Inc.
On February 28, 2005, KNBT announced the purchase of Caruso Benefits
Group, Inc. ("Caruso"), a benefits management firm based in Bethlehem,
Pennsylvania.
Caruso specializes in benefits management with an emphasis on group
medical, life and disability. Under the terms of the definitive agreement, KNBT
will acquire all of the capital stock of Caruso for a purchase price of $28
million in cash of which $20 million will be paid a time of closing and $8
million will be payable over a three-year period, subject to Caruso maintaining
certain levels of profitability.
Upon completion of the transaction, Caruso will operate as a wholly
owned subsidiary of the Bank. The acquisition is subject to customary conditions
including receipt of all required regulatory approvals and is expected to close
in the second quarter of 2005.
61
NOTE D - INVESTMENT SECURITIES
The amortized cost, unrealized gains and losses, and fair value of
KNBT's investment securities held-to-maturity and available-for-sale are as
follows:
At December 31, 2004
-----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- --------------- -------------- --------------
(dollars in thousands)
Held to maturity:
Obligations of states and political
subdivisions $ 5,510 $ 39 $ (4) $ 5,545
Mortgaged-backed securities
FNMA 25,893 100 - 25,993
CMOs 25,183 313 25,496
------------------------------------------------ --------------
Total mortgage-backed securities 51,076 413 - 51,489
-------------- --------------- -------------- --------------
Total held to maturity 56,586 452 (4) 57,034
-------------- --------------- -------------- --------------
Available for sale:
U.S. Government and agencies 174,864 1,562 (777) 175,649
Obligations of states and political
subdivisions 104,476 2,249 (151) 106,574
Asset-managed funds 4,904 - (93) 4,811
Federated Liquid Cash Trust 35 - - 35
Mortgaged-backed securities
GNMA 1,416 44 - 1,460
FHLMC 104,476 524 (346) 104,654
FNMA 308,923 2,975 (1,257) 310,641
CMOs 277,485 522 (2,125) 275,882
-------------- --------------- -------------- --------------
Total mortgage backed securities 692,300 4,065 (3,728) 692,637
Corporate and other debt securities 9,029 168 - 9,197
Equity securities 67,914 1,093 (801) 68,206
-------------- --------------- -------------- --------------
Total available for sale 1,053,522 9,137 (5,550) 1,057,109
-------------- --------------- -------------- --------------
Total investment securities $ 1,110,108 $ 9,589 $ (5,554) $ 1,114,143
============== =============== ============== ==============
The amortized cost and fair value of KNBT's investment and
mortgage-backed securities available-for-sale at December 31, 2003, by
contractual maturity, are shown below. No securities were held to maturity as
such date.
At December 31, 2003
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ -------------
(dollars in thousands)
U. S. Government and agencies $118,037 $ 2,442 $ (99) $120,380
Obligations of states and political subdivisions 112,228 3,584 (157) 115,655
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
CMOs 150,645 628 (576) 150,697
------------ ------------ ------------ -------------
Total mortgaged-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
============ ============ ============ =============
62
The amortized cost and fair value of KNBT's investment and
mortgage-backed securities held-to-maturity and available-for-sale at December
31, 2004, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
At December 31, 2004
---------------------------------------
Amortized Fair
Cost Value
----------------- ----------------
(dollars in thousands)
Held to maturity
Investment securities
Due in one year or less $ - $ -
Due after one year through five years - -
Due after five years through ten years - -
Due after ten years 5,510 5,545
----------------- ----------------
Total investment securities held to maturity 5,510 5,545
----------------- ----------------
Mortgage-backed securities 51,076 51,489
Asset managed funds - -
Equity securities - -
----------------- ----------------
Total held to maturity 56,586 57,034
----------------- ----------------
Available for sale
Investment securities
Due in one year or less 3,996 4,009
Due after one year through five years 84,408 84,243
Due after five years through ten years 101,793 102,374
Due after ten years 98,172 100,794
----------------- ----------------
Total investment securities available for sale 288,369 291,420
----------------- ----------------
Mortgage-backed securities 692,300 692,637
Asset managed funds 4,939 4,846
Equity securities 67,914 68,206
----------------- ----------------
Total available for sale 1,053,522 1,057,109
----------------- ----------------
Total investment securities $ 1,110,108 $ 1,114,143
================= ================
Gross gains of $409,000 and losses of $14,000 were realized on sales of
investment securities classified as available-for-sale during the year ended
December 31, 2004. Gross gains of $146,000 and losses of $395,000 were realized
on sales of investment securities classified as available-for-sale for the year
ended December 31, 2003. Gross gains of $1.2 million were realized on sales of
investment securities classified as available-for-sale for the year ended
December 2002. There were no gross losses realized on the sale of investment
securities in 2002.
As of December 31, 2004 and 2003, FHLB securities having a book value
of $337.9 million and $63.8 million were pledged to secure public deposits,
outstanding advances and for other purposes as required by law.
63
The table below indicates the length of time individual securities have
been in a continuous unrealized loss position at December 31, 2004.
Less than 12 Months 12 Months or Longer Total
------------------------------ -------------------------- ------------------------
Description of Securities Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses
- ---------------------------------------------- ----------------- ----------- ----------------- ----------- ------------
(dollars in thousands)
U.S. Government and agencies $ 82,624 $ (777) $ - $ - $ 82,624 $ (777)
Obligations of states and
political subdivisions 16,240 (37) 7,511 (118) 23,751 (155)
Mortgage-backed securities 343,852 (3,411) 25,870 (318) 369,722 (3,729)
Corporate debt securities 19,956 (69) - - 19,956 (69)
------------- ---------------- ----------- -------------- ----------- -------------
Subtotal, debt securities 462,672 (4,293) 33,381 (436) 496,053 (4,729)
ARM funds - - 4,811 (93) 4,811 (93)
Equity securities 2,950 (327) 5,352 (405) 8,302 (732)
------------- ---------------- ----------- -------------- ----------- -------------
Total temporarily impaired
securities $ 465,622 $ (4,620) $ 43,544 $ (935) $ 509,166 $ (5,554)
============= ================ =========== ============== =========== =============
Management has reviewed the securities listed in the above table and
believes all unrealized losses to be temporary. The unrealized losses are due
primarily to changes in market interest rates and other temporary changes in
market conditions. As of December 31, 2004, KNBT held 648 different securities
of which 181 were in an unrealized loss position.
NOTE E - LOANS
A summary of KNBT's loans receivable is as follows:
At December 31,
--------------------------------------
2004 2003
--------------- ---------------
(dollars in thousands)
Real Estate
Residential $ 326,552 $ 346,221
Construction 106,361 112,684
Commercial 231,132 156,563
--------------- ---------------
Total real estate 664,045 615,468
Consumer loans 297,935 265,541
Commercial (non real estate) 50,691 38,978
States and political subdivisions 1,170 2,334
--------------- ---------------
Total gross loans 1,013,841 922,321
Less:
Mortgage loans held-for-sale (718) (4,677)
Undisbursed portion of construction
loans in process (1) - (27,099)
Deferred fees (costs) 79 (469)
--------------- ---------------
Total loans 1,013,202 890,076
Less: Allowance for loan losses (10,461) (7,910)
--------------- ---------------
Total net loans $ 1,002,741 $ 882,166
=============== ===============
(1) For the years 2003 and prior, KNBT's core processing system included the undisbursed
portion of construction loans in process. Total loans had to be reduced by this number
in order to calculate net loans. For the year 2004, KNBT's new core processing system
no longer includes the undisbursed amount in loan totals. Loans in process at
December 31, 2004 equaled $36.9 million.
64
The Bank makes loans to its directors and executive officers. These
loans were made in the ordinary course of business and on substantially the same
terms and conditions as those with other borrowers.
An analysis of the 2004 activity of these loans follows:
(dollars in thousands)
Balance, January 1, 2004 $ 3,486
New loans 152
Repayments (1,533)
------------------------
Balance, December 31, 2004 $ 2,105
========================
KNBT's non-performing loans are as follows:
At December 31,
-----------------------------------------------
2004 2003 2002
------------- ------------- -------------
( dollars in thousands )
Non-accrual loans $ 4,544 $ 1,720 $ 2,197
Accruing loans 90 days or more past due 511 405 298
------------- ------------- -------------
Total non-performing loans $ 5,055 $ 2,125 $ 2,495
============= ============= =============
Interest income not recognized on
non-accrual loans $ 125 $ 50 $ 66
============= ============= =============
KNBT's recorded investment in impaired loans was $424,000 at December
31, 2004 and $217,000 at December 31, 2003. KNBT did not have any impaired loans
at December 31, 2002. The valuation allowance for loan losses related to
impaired loans is a part of the allowance for loan losses and was $61,000 at
December 31, 2004 and $33,000 at December 31, 2003. The average impaired loan
balance for the year ended December 31, 2004 was $446,000 compared with $217,000
for the year ended December 31, 2003. KNBT received principal payments of
$64,000 on impaired loans in 2004. Income on impaired loans is recognized by
KNBT on a cash basis. KNBT did not recognized any income on impaired loans in
2004 and recognized income of approximately $34,000 on impaired loans in 2003.
There were no principal payments and no income recognized on impaired loans in
2002.
Activity in the allowance for loan losses is as follows:
At December 31,
------------------------------------------
2004 2003 2002
----------- ------------ ------------
(dollars in thousands)
Allowance for loan losses,
beginning of period $ 7,910 $ 2,927 $ 3,386
Allowance acquired from merger with First Colonial - 3,548 -
Provision for loan losses 4,308 2,951 111
Loans charged-off (2,012) (1,603) (623)
Recoveries of loans previously charged-off 255 87 53
----------- ------------ ------------
Balance, end of year $ 10,461 $ 7,910 $ 2,927
=========== ============ ============
65
NOTE F - PREMISES AND EQUIPMENT
KNBT's premises and equipment are summarized as follows:
At December 31,
Estimated --------------------------------
useful lives 2004 2003
-------------- -------------- ---------------
(dollars in thousands)
Land Indefinite $ 3,608 $ 3,624
Buildings and leasehold
improvements 30-50 years 28,469 25,923
Furniture and fixtures 3-10 years 22,102 16,279
Purchase accounting adjusment 20 years 4,184 4,379
-------------- ---------------
58,363 50,205
Less accumulated depreciation
and amortization (17,573) (14,338)
-------------- ---------------
$ 40,790 $ 35,867
============== ===============
Construction in process of approximately $600,000 for December 31, 2004
is included in the balances in the above table and will not be depreciated until
the property is put in service.
Depreciation expense was $3.6 million, $1.8 million and $1.3 million
for the years ended December 31, 2004, 2003 and 2002. As a result of the merger
with First Colonial, the premises and equipment of First Colonial were marked to
fair value, which resulted in an intangible amount of $4.4 million. Amortization
of $195,000 and $29,000 of this intangible asset was recorded for the year ended
December 31, 2004 and 2003, respectively. The intangible related to the
buildings and leasehold improvements is being amortized over a 20-year period.
NOTE G - ASSET SECURITIZATIONS AND CAPITALIZED SERVICING ASSETS
1. Asset Securitization
During 2004, KNBT did not securitize any loans. In 2003, KNBT
securitized approximately $47.3 million of one-to four-family residential
mortgage loans in a guaranteed mortgage securitization with the Federal National
Mortgage Association ("FNMA"). KNBT recognized no gain or loss on the
transaction as it retained all of the resulting securities. All of the resulting
securities were classified as investment securities available-for-sale. In 2002,
KNBT securitized approximately $115.3 million of one-to four-family residential
mortgage loans in a guaranteed mortgage securitization with the FNMA. KNBT sold
$61.4 million to various investors and recognized a gain of $1.2 million on the
transaction. The remaining $53.9 million of loans securitized were retained by
KNBT and classified as investment securities available-for-sale. No gain or loss
was recognized on the securities retained. KNBT retained the servicing rights on
all of the loans securitized and allocated $736,000 of the carrying value of the
loans to be treated as capitalized servicing assets.
At December 31, 2004, and December 31, 2003, KNBT's retained securities
had an aggregate amortized cost of $32.0 million and $49.0 million,
respectively, and an aggregate estimated fair value of $33.2 million and $50.8
million, respectively. The estimated fair values were obtained from independent
pricing sources and management does not anticipate that a hypothetical adverse
change from expected pricing assumptions would have a significant impact on the
fair value of the subordinated debt. During the years ended December 31, 2004
and 2003, KNBT received $19.5 million and $46.1 million, respectively, in
principal and interest payments on the retained securities and $103,000 and
$106,000 in servicing fees from FNMA. At December 31, 2004, KNBT held $332.0
million of residential mortgage loans, $9.8 million of which were past due 30
days or more. KNBT had $41,000 in credit losses on residential real estate loans
during the period ended December 31, 2004. At December 31, 2003, KNBT held
$346.2 million of residential mortgage loans, $4.2 million of which were past
due 30 days or more. KNBT had $92,000 in credit losses during the period ended
December 31, 2003.
66
2. Capitalized Servicing Assets
Changes in capitalized servicing assets were as follows:
Year ended December 31,
--------------------------------------------------------
2004 2003 2002
-------------- --------------- ----------------
(dollars in thousands)
Balance, beginning $ 1,040 $ 911 $ 567
Acquired from First Colonial - 662 -
Amortizations (415) (1,068) (287)
Sales 813 416 1,020
Valuation allowance - 119 (389)
-------------- --------------- ----------------
Ending balance, net $ 1,438 $ 1,040 $ 911
============== =============== ================
NOTE H - DEPOSITS
KNBT's deposits are as follows:
At December 31,
-----------------------------------------
2004 2003
------------------- ----------------
(dollars in thousands)
Non-interest bearing deposits $ 128,498 $ 117,270
Interest-bearing checking deposits 180,811 163,749
Savings and club deposits 210,257 221,176
Money market deposits 241,827 239,521
Time deposits 473,933 490,838
Time deposits of $100,000 or more 87,727 56,856
------------------- ----------------
$ 1,323,053 $ 1,289,410
=================== ================
Maturities of time deposits at December 31, 2004 are as follows:
(dollars in thousands)
2005 $ 271,790
2006 144,291
2007 103,485
2008 18,116
2009 23,205
Thereafter 773
----------------------
$ 561,660
======================
NOTE I - BORROWINGS
1. FHLB Advances
FHLB ("FHLB") advances at December 31, 2004 and December 31, 2003
totaled $660.7 million and $207.2 million, respectively. The advances are
collateralized by FHLB stock and otherwise unencumbered qualified assets. The
fair value of such collateral for these advances totaled approximately $1.1
billion at December 31, 2004 and $821.7 million at December 31, 2003. These
advances had a weighted average interest rate of 3.30%, 4.21% and 4.69% for the
years ended December 31, 2004, 2003 and 2002, respectively. Advances are made
pursuant to several different credit programs offered from time to time by the
FHLB.
67
The following table shows certain information regarding KNBT's FHLB
advances:
FHLB Advances
Due In At December 31, 2004
- --------------------------- ------------------------
(dollars in thousands)
2005 $ 137,005
2006 123,364
2007 157,682
2008 56,949
2009 115,168
2010 and thereafter 70,506
------------------------
Total $ 660,674
========================
At or For the Year Ended December 31,
-----------------------------------------------------
2004 2003 2002
--------------- ---------------- ---------------
(dollars in thousands)
Average balance outstanding $ 425,167 $ 114,520 $ 67,358
Maximum amount outstanding at
any month-end during the period $ 664,228 $ 207,153 $ 113,500
Balance outstanding at end of period $ 660,674 $ 207,153 $ 113,500
Average interest rate during the period 3.37% 4.21% 4.69%
Weighted average interest rate at end of period 3.30% 4.11% 4.40%
2. Securities Sold Under Agreements to Repurchase
KNBT, pursuant to a designated cash management agreement, utilizes
securities sold under agreements to repurchase as vehicles for customers' sweep
and term investment products. Securitizations under these cash management
agreements are in U.S. Treasury and agency securities and obligations of states
and political subdivisions securities.
These securities are held in a third party custodian's account,
designated by KNBT under a written custodial agreement that explicitly
recognizes KNBT's interest in the securities.
The details of securities sold under agreements to repurchase are as
follows:
At or For the Year Ended December 31,
-----------------------------------------------
2004 2003 2002
----------- --------------- -------------
(dollars in thousands)
Average balance outstanding $ 22,579 $ 11,931 $ 7,330
Maximum amount outstanding at any
month-end during the period $ 31,076 $ 29,010 $ 10,051
Balance outstanding at end of period $ 22,643 $ 24,550 $ 8,904
Average interest rate during the period 0.75% 1.10% 2.09%
Weighted average interest rate at end of period 0.99% 0.64% 1.85%
68
3. Guaranteed Preferred Beneficial Interest in KNBT's Subordinated Debenture.
As a result of the merger with First Colonial, the Company also
acquired Trust I and assumed its debt. Trust I is a wholly-owned Connecticut
statutory business trust subsidiary of KNBT organized for the sole purpose of
issuing trust preferred securities that are fully and unconditionally guaranteed
by KNBT. On June 26, 2002, First Colonial issued $15.0 million of subordinated
debentures to Trust I and Trust I issued $15.0 million in pooled trust preferred
securities. The subordinated debentures are the sole asset of the Trust I. The
trust preferred securities are classified as long-term debt for the financial
statements, but are included as Tier I capital for regulatory purposes. The
interest rate on this security (5.99% at December 31, 2004) is variable,
adjusting quarterly at the three-month LIBOR rate plus 3.45%. The interest is
payable quarterly. The trust preferred securities mature in June 2032, but may
be redeemed in whole or in part beginning in June 2007 and may be redeemed at
any time in the event that the deduction of related interest for federal income
tax purposes is prohibited, treatment as Tier I capital is no longer permitted
or certain other contingencies arise. The net proceeds of the trust preferred
securities have been used to support the Company's growth and expansion and for
other general corporate purposes.
NOTE J - INCOME TAXES
The components of KNBT's income taxes were as follows for the years
ended:
Year ended December 31,
-----------------------------------------------
2004 2003 2002
------------ ------------ -------------
(dollars in thousands)
Current:
Federal $ 4,745 $ 1,249 $ 5,232
State - - 128
------------ ------------ -------------
4,745 1,249 5,360
Deferred:
Federal (79) (6,513) 172
------------ ------------ -------------
$ 4,666 $ (5,264) $ 3,326
============ ============ =============
The reconciliation of KNBT's tax computed at the statutory rate is as follows:
Year ended December 31,
-----------------------------------------------
2004 2003 2002
------------ ------------ -------------
(dollars in thousands)
Tax expense (benefit) at statutory rate of 35% $ 7,795 $ (3,857) $ 6,019
Increase (decrease) resulting from:
Tax-exempt income (3,156) (1,565) (1,036)
State tax expense, net federal benefit - - 84
Other, net 27 158 121
------------ ------------ -------------
Income tax expense (benefit) $ 4,666 $ (5,264) $ 5,188
============ ============ =============
69
Deferred tax assets and liabilities consist of the following:
At December 31,
----------------------------
2004 2003
------------- ------------
(dollars in thousands)
Deferred tax assets:
Deferred compensation $ 1,584 $ 1,268
Allowance for loan losses 3,661 2,344
Investment acquisition adjustment 2,081
Charitable contribution 5,209 5,540
Other 1,165 584
------------- ------------
11,619 11,817
------------- ------------
Deferred tax liabilities:
Fixed assets 2555 2,057
Core deposit intangible 5230 5,995
Mortgage servicing rights 503 111
Unrealized gains on securities
available-for-sale 1220 3,253
------------- ------------
9508 11,416
------------- ------------
Net deferred tax (asset) $ 2,111 $ 401
============= ============
As a result of the acquisition of First Colonial, KNBT computed a
deferred tax liability of $5.1 million and deferred tax liability of $1.5
million for the core deposit intangible and the step up of the fixed assets
acquired, respectively. KNBT will not be required to recapture approximately
$9.8 million of its tax bad debt reserve attributable to bad debt deductions
taken prior to 1988 as long as the Bank continues to operate as a bank under
federal tax law and does not use the reserve for any other purpose. In
accordance with SFAS No. 109, KNBT has not recorded any deferred tax liability
on this portion of its tax bad debt reserve. The tax that would be paid if KNBT
ultimately was required to recapture that portion of the reserve would amount to
approximately $3.4 million.
NOTE K - RETIREMENT PLANS
1. Defined Benefit Plans
KNBT participates in a multiple employer defined benefit pension plan,
which covers substantially all employees with 1,000 hours of service during the
plan year. Benefits are generally based on years of service and the highest
average compensation of five consecutive years of employment. It is KNBT's
policy to fund the amount that satisfies the statutory requirements under the
Employee Retirement Income Security Act. KNBT's contributions to the multiple
employee pension plan for the years ended December 31, 2004, 2003, and 2002 were
approximately $139,000, $816,000 and $529,000, respectively. In October 2003,
KNBT froze the future accrual of benefits under the defined benefit pension plan
and ceased admission of any new participants. KNBT will continue to contribute
to this plan for benefits accrued prior to October 2003.
2. Defined Contribution Plan
KNBT also has a 401(k) plan which covers substantially all employees.
Employees may elect to defer 1% to 20% of their compensation per year. KNBT will
match 50% of the contributions up to 6% of compensation per year. KNBT's
contributions to the 401(k) plan totaled approximately $498,000, $306,000 and
$222,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
3. Employee Stock Ownership Plan
KNBT established an ESOP in November 2003 for all eligible employees as
defined by the ESOP. KNBT accounts for its ESOP in accordance with SOP 93-6,
"Employers' Accounting for Employee Stock Ownership Plans." The ESOP borrowed
$16.1 million from KNBT which was used to purchase 949,845 shares of KNBT common
stock in the market at an average price of $17.01 per share.
70
Under SOP 93-6, unearned ESOP shares are not considered outstanding and
are shown as a reduction of shareholders' equity as unearned compensation.
Dividends on unallocated ESOP shares are considered to be compensation expense.
KNBT will recognize compensation cost equal to the fair value of the ESOP shares
during the periods in which they become committed to be released. To the extent
that the fair value of KNBT's ESOP shares differs from the cost of such shares,
this differential is credited to equity. KNBT will receive a tax deduction equal
to the cost of the shares released. As the loan is internally leveraged, the
loan extended to the ESOP by KNBT is not reported as an asset nor is the debt of
the ESOP shown as a liability. Dividends on allocated shares are expected to be
used to pay the ESOP debt. The ESOP compensation expense for 2004 was $798,000
which is the fair value of the shares released in 2004 as provided by SOP 93-6.
Dividends of $5,000 were paid in 2004 on ESOP shares held. ESOP compensation
expense was $165,000 for 2003. At December 31, 2004, the ESOP had a total of
949,845 shares of KNBT common stock, of which 892,521 were unallocated and
57,324 were allocated. At December 31, 2003, ESOP has a total of 949,845 shares
of KNBT stock of which 940,122 were unallocated and 9,723 were allocated. At
December 31, 2004, the fair value of the unreleased ESOP shares, using the
closing quoted market price of $16.90 per share at year-end, was approximately
$15.1 million.
4. Post-Retirement Benefit
KNBT, as a part of the merger, assumed First Colonial's post-retirement
benefit plan that covers certain First Colonial retired employees. This plan
generally provides medical insurance benefits to a group of previously qualified
retirees and spouses who were 60 years of age or older on January 1, 1992 and
who have retired after attaining age 65. This plan is unfunded. As permitted by
SFAS No. 106, KNBT elected to delay the recognition of this transition
obligation by accruing $308,000, which arose from adopting SFAS No. 106, and
amortizing this amount on a straight-line basis over 20 years.
The components of the net periodic post-retirement benefit cost are as
follows:
Year Ended December 31,
--------------------------------
2004 2003
-------------- ------------
(dollars in thousands)
Interest cost $ 14 $ 8
Amortization of transition
obligation 15 15
Amortization of unrecognized gain - (8)
-------------- ------------
Net periodic benefit cost $ 29 $ 15
============== ============
The assumptions used to develop the net periodic post-retirement
benefit cost are as follows:
Year Ended December 31,
------------------------------------
2004 2003
---------------- ----------------
Discount rate 6.00% 6.50%
Medical care cost trend rate 9.00% 7.00%
The medical care cost trend used in the actuarial computation
ultimately was increased to 9.0% in 2004 and 6.0% in 2007 and subsequent years.
This was accomplished by using 1.0% decrements through the year 2007 and later.
71
The table of actuarially computed plan assets and benefit obligations
for KNBT is presented below.
Post-Retirement Plan Year Ended December 31,
----------------------------------
2004 2003
--------------- --------------
(dollars in thousands)
Change in benefit obligation:
Benefit obligation assumed from merger
with First Colonial $ 124 $ 163
Service cost - -
Interest cost 14 8
Actual gain - -
Change due to change in experience 105 (31)
Change due to change in assumption 16 -
Benefits paid (25) (16)
--------------- --------------
Benefits obligation at end of year $ 234 $ 124
=============== ==============
Change in plan assets:
Fair value of plan assets at beginning of year - -
Actual return on plan assets - -
Employer contribution - -
Benefits paid - -
--------------- --------------
Fair value of plan assets at end of year - -
Funded status $(234) $(124)
Unrecognized net transition obligation 124 139
Unrecognized net gain (loss) 38 (83)
--------------- --------------
Accrued benefit cost $ (72) $ (68)
=============== ==============
The effect of a one percentage point increase in each future year's
assumed medical care cost trend rate, holding all other assumptions constant,
would increase the accumulated post-retirement benefit obligation by $14,801
and the net post-retirement benefit cost by $827. Decreasing the assumed
health care cost trend rates by one percentage point in each year would
decrease the accumulated post-retirement benefit obligation by $13,508 and the
net post-retirement benefit cost by $758.
Health care benefits are provided to certain retired employees. The
cost of providing these benefits was approximately $18,000 in 2004.
Post-Retirement Plan Estimated Future Benefit Payments
(dollars in thousands)
1/1/2005 to 12/31/2005 $ 28,942
1/1/2006 to 12/31/2006 $ 27,548
1/1/2007 to 12/31/2007 $ 26,362
1/1/2008 to 12/31/2008 $ 24,953
1/1/2009 to 12/31/2009 $ 23,576
1/1/2010 to 12/31/2014 $ 97,149
5. Directors' Deferred Plan
KNBT, as part of the merger, assumed the First Colonial directors'
deferred plan involving certain former directors of First Colonial. The plan
requires defined annual payments for five to fifteen years beginning at age 65
or death. The annual benefit is based upon the amount deferred plus interest.
KNBT has recorded the deferred compensation liabilities using the present value
method.
72
The following table sets forth the changes in benefit obligations and
plan assets of the directors' deferred plan.
Directors' Deferred Plan Year ended December 31,
----------------------------------
2004 2003
--------------- ---------------
(dollars in thousands)
Change in benefit obligation:
Benefit obligation assumed from merger with First Colonial $ 360 $ 389
Service cost - -
Interest cost 21 25
Change due to change in assumptions 10 10
Change due to plan amendment - -
Actual loss (1) (11)
Benefits paid (52) (53)
--------------- ---------------
Benefits obligation at end of year $ 338 $ 360
=============== ===============
Change in plan assets:
Fair value of plan assets received from merger with First Colonial - -
Actual return on plan assets - -
Employer contribution 52 53
Benefits paid (52) (53)
--------------- ---------------
Fair value of plan assets at end of year - -
Funded status $ (338) $ (360)
Unrecognized net transition asset - -
Unrecognized net actuarial (gain) loss 40 31
Unrecognized prior service cost - -
Adjustment to recognize
additional minimum liability (40) (31)
--------------- ---------------
Accrued benefit cost $ (338) $ (360)
=============== ===============
Actuarial present value of benefit obligations is as follows:
Directors' Deferred Plan Year ended December 31,
-------------------------------
2004 2003
------------- -------------
(dollars in thousands)
Service cost $ - $ -
Interest cost 21 25
Net amortization and
deferral of prior service costs - -
------------- -------------
Net Periodic Benefit Cost $ 21 $ 25
============= =============
The weighted-average assumed discount rates used in determining the
actuarial present value of the projected benefit obligation were 6.25% in 2004
and 6.50% in 2003. The weighted-average expected long-term rate of return on
assets was 9.0% for 2004 and 2003.
Directors' Deferred Plan Estimated Future Benefit Payments
(dollars in thousands)
1/1/2005 to 12/31/2005 $ 45,570
1/1/2006 to 12/31/2006 $ 37,774
1/1/2007 to 12/31/2007 $ 26,143
1/1/2008 to 12/31/2008 $ 37,896
1/1/2009 to 12/31/2009 $ 37,881
1/1/2010 to 12/31/2014 $158,074
73
6. Deferred Compensation Plans
KNBT maintains two deferred compensation plans. One of these plans was
acquired through KNBT's acquisition of First Colonial. These deferred
compensation arrangements permit the directors and certain executive officers to
defer director's fees or salary, as the case may be, and other compensation at
the election of the participants. At December 31, 2004, there were $320,000 in
accumulated balances for KNBT's directors (compared to $223,000 at December 31,
2003) and $189,000 in accumulated balances for former First Colonial directors
(compared to $224,000 at December 31, 2003) under the acquired First Colonial
plan for an aggregate of $509,000. The weighted-average earnings for directors
in these plans in 2004 was 7.0% under the KNBT plan and 1.4% under the former
First Colonial plan. The weighted-average earnings for director's deferred
accounts in 2003 was 4.3% for the KNBT plan and 1.3% for the former First
Colonial plan. Deferred fees will be paid out when the participant retires or as
otherwise provided by the plan agreements. Selected executive officers also are
permitted to defer compensation. The KNBT plan includes all funds that were
previously identified as the executive supplemental retirement plan. At December
31, 2004 and 2003, the balance accumulated for executive officers was
approximately $2.4 million and $1.7 million respectively. The weighted-average
earnings on these deferred funds for executive officers was 9.06% in 2004 and
2.0% in 2003. These deferred amounts will be paid out when the executive retires
or as otherwise provided by the plan agreement.
NOTE L - STOCK OPTIONS
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 during 2004 were 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 using the intrinsic value method. 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 but are not
required to expense the awards. The Company has elected to account for options,
except as discussed below, in accordance with APB Opinion No. 25 until June 30,
2005.
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. 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.
74
A summary of the stock option plans as of December 31, 2004 and 2003
and changes during the year are as follows:
Year ended December 31, 2004 Year ended December 31, 2003
--------------------------------------- -----------------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
--------------- ------------------- ------------- -------------------
Outstanding as of beginning of year 789,423 $ 5.63 - $ -
Issued 1,132,000 16.50 808,157 5.62
Exercised (242,002) 5.66 - -
Forfeited (61,025) 9.81 (56,259) 5.51
Expired - - - -
--------------- ------------------- ------------- -------------------
Outstanding as of year end 1,618,396 $13.07 751,898 $ 5.63
=============== =================== ============= ===================
Shares exercisable as of year end 509,896 $ 5.61 751,898 $ 5.63
=============== =================== ============= ===================
The following table summarizes information concerning KNBT's stock
options outstanding at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------- ----------------------------------
Weighted Average
Range of Stock Options Remaining Weighted Average Stock Options Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- -------------------------- --------------- ------------------------------------- -------------- ----------------
$2.35 - $4.35 66,272 5.41 $ 4.07 66,272 $ 4.07
$4.36 - $6.36 358,258 6.82 $ 5.64 358,258 $ 5.64
$6.37 - $8.36 85,366 7.21 $ 6.67 85,366 $ 6.67
$14.40 - $16.50 1,108,500 9.35 $ 16.50 - -
--------------- --------------
1,618,396 509,896
=============== ==============
The weighted average fair value of each option grant under KNBT'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 KNBT'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, KNBT 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 $16,000 was recognized for the
year ended December 31, 2004 for options granted to advisory directors.
On December 16, 2004, FASB issued Statement No.123 (revised 2004),
"Share-Based Payment." Statement 123(R) replaces FASB Statement No.123,
"Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. Statement 123(R) establishes standards
for which an entity exchanges its equity instruments for good or services. It
also addresses transactions in which an entity incurs liabilities in exchange
for good and services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
Under Statement 123(R), all forms of share-based payments to employees,
including stock options, will be treated the same as other forms of compensation
by recognizing the related cost in the income statement. The expense of the
award requires the entity to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award (vesting
period). Fair value of that award will be re-measured subsequently at each
reporting date through the settlement date. The grant-date fair value of
employee share options and similar instruments will be estimated using
option-pricing models adjusted for the unique characteristics of those
instruments.
75
All public entities that use the fair-value based method for either
recognition or disclosure under Statement 123(R) will apply this Statement using
a modified version of prospective application. Under the transition method,
compensation cost is recognized on or after the required effective date for the
portion of outstanding awards for which the requisite service has not yet been
rendered, based on the grant-date fair value of those awards calculated under
Statement 123(R) for either recognition or pro forma disclosure. For periods
before the required effective date, those entities may elect to apply a modified
version of retrospective application under which the financial statements for
prior periods are adjusted on a basis consistent with the pro forma disclosures
required for those periods by Statement 123(R).
Statement 123(R) is effective for public companies at the beginning of
the first interim or annual period beginning after June 15, 2005. This Statement
applies to all awards granted after the required effective date and to awards
modified, repurchased, or canceled after that date. KNBT is currently evaluating
the impact Statement 123(R) will have on its financial statements as well as
awards made prior hereto in which the requisite service has not yet been fully
rendered.
Management Recognition and Retention Plan
-----------------------------------------
The MRRP, which is a stock-based incentive plan, provides for 808,047
shares of KNBT'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 to date by the MRRP are earned by the participants at
the rate of 20% per year. On May 6, 2004, 638,000 restricted shares were awarded
leaving 170,047 shares available for future grants. Compensation expense for
this plan is being recorded over the vesting period or a 60-month period and is
based on the market value of KNBT's stock as of the date the awards were made.
KNBT, 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 year ended December 31, 2004 was $1.4 million.
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of assets
and liabilities considered to be financial instruments. For KNBT, as for most
financial institutions, the majority of its assets and liabilities are
considered financial instruments as defined in SFAS No. 107. However, many such
instruments lack an available trading market as characterized by a willing buyer
and willing seller engaging in an exchange transaction. Therefore, KNBT had to
use significant estimations and present value calculations to prepare this
disclosure, as required by SFAS No. 107. Accordingly, the information presented
below does not purport to represent the aggregate net fair value of KNBT.
Changes in the assumptions or methodologies used to estimate fair
values may materially affect the estimated amounts. Also, management is
concerned that there may not be reasonable comparability between institutions
due to the wide range of permitted assumptions and methodologies in the absence
of active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
Estimated fair values have been determined by KNBT using what
management believes to be the best available data and an estimation methodology
suitable for each category of financial instruments. The estimated methodologies
used, the estimated fair values, and recorded book balances at December 31, 2004
and 2003 are set forth below.
For cash and due from banks and interest-bearing deposits with banks,
the recorded book values of approximately $86.2 million and $139.0 million are
deemed to approximate fair values at December 31, 2004 and 2003, respectively.
76
The estimated fair values of investment and mortgage-backed securities
are based on quoted market prices, if available. If quoted market prices are not
available, then the estimated fair values are based on quoted market prices of
comparable instruments. The fair values of loans are estimated on a discounted
cash flow analysis using interest rates currently offered for loans with similar
terms to borrowers of similar credit quality. The carrying value of accrued
interest is deemed to approximate fair value.
At December 31,
----------------------------------------------------------------
2004 2003
----------------------------- ----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------------------------------------------------------
(dollars in thousands)
Investments and mortgage-backed securities $ 1,113,695 $ 1,114,143 $ 734,087 $ 734,087
Federal Home Loan Bank of Pittsburgh stock 36,456 36,456 11,543 11,543
Loans receivable 1,002,741 1,013,337 882,166 884,585
Mortgage loans held-for-sale 718 718 4,677 4,677
The estimated fair values of demand deposits (i.e., interest-bearing
and non-interest bearing checking accounts, passbook savings and certain types
of money market accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). The carrying
amounts of variable-rate, fixed-term money market accounts and certificates of
deposit approximate their fair values at the reporting date. The fair values of
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered to a schedule of
aggregated expected monthly time deposit maturities. The carrying amount of
accrued interest payable approximates its fair value.
At December 31,
----------------------------------------------------------------
2004 2003
----------------------------- ----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------------------------------------------------------
(dollars in thousands)
Time deposits $ 561,660 $ 562,367 $ 547,697 $ 562,174
Securities sold under agreements to repurchase 22,643 22,643 24,550 24,550
Advances from the Federal Home Loan Bank 660,674 658,308 207,153 212,082
KNBT's subordinated debt had a carrying value of $15.5 million at
December 31, 2004 and 2003. The interest on this debt is tied to LIBOR and
changes quarterly. The estimated fair value at December 31, 2004 was $15.5
million.
The fair value of commitments to extend credit is estimated based on
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based on the amount of unearned fees plus the estimated
cost to terminate the letters of credit. Fair values of unrecognized financial
instruments including commitments to extend credit and the fair value of letters
of credit are considered immaterial.
NOTE N - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
KNBT is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheet. KNBT's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit and standby letters of credit is represented by the contractual
amount of those instruments. KNBT uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
77
KNBT had the following approximate off-balance-sheet financial
instruments whose contract amounts represent credit risk.
At December 31,
----------------------------------
2004 2003
-------------- ---------------
(dollars in thousands)
Commitments to extend credit Lines of credit:
Commercial loans $ 98,804 $ 86,664
Home equity secured by mortgage 51,476 45,341
Unsecured consumer including credit card 5,540 7,100
-------------- ---------------
Total lines of credit 155,820 139,105
Letters of credit 23,973 15,297
Other loan commitments:
Commercial loans unsecured 33,190 14,580
Commercial loans secured 32,406 -
Residential mortgages 49,160 55,583
Other mortgages - 51,758
Consumer (auto, personal) 2,198 8,881
-------------- ---------------
Total other loan commitments 116,954 130,802
-------------- ---------------
Total commitments to extend credit $ 296,747 $ 285,204
============== ===============
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. KNBT evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by KNBT upon extension of credit, is based on management's
credit evaluation of the customer. Collateral held varies but may include
guarantees, personal or commercial real estate, accounts receivable, inventory
and equipment.
Standby letters of credit are conditional commitments issued by KNBT to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support contracts entered into by customers. Most guarantees
extend for one year. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
KNBT holds collateral to support these commitments. The Bank had standby letters
of credit of $24.0 million and $15.3 million at December 31, 2004 and 2003,
respectively. These letters of credit expire as follows: $17.2 million in 2005,
$6.7 million in 2006 through 2007, and $83,000 in 2008.
A substantial amount of KNBT's loans are secured by real estate in the
Northampton, Lehigh, Monroe, and Carbon counties of northeastern Pennsylvania.
Loans purchased from other financial institutions or participation interests in
loans originated by other financial institutions constitute less than 1% of
KNBT's loans outstanding. Accordingly, KNBT's primary concentration of credit
risk is related to the real estate market in the four county area and the
ultimate collectibility of this portion of KNBT's loan portfolio is susceptible
to changes in economic conditions in that area.
78
NOTE O - LEASE COMMITMENTS
KNBT has entered into several noncancellable operating lease agreements
for its branch banking facilities. KNBT is responsible for pro-rata operating
expense escalations. The approximate minimum annual rental payments at December
31, 2004 under these leases are as follows:
(dollars in thousands)
2005 $ 1,177
2006 989
2007 734
2008 627
2009 53
2010 and Thereafter 5,648
---------------
$ 9,228
===============
Lease expense for the years ended December 31, 2004, 2003 and 2002 was
$1.3 million, $769,000, and $474,000, respectively.
NOTE P - REGULATORY MATTERS
KNBT is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory - and possibly additional discretionary - actions
by regulators that, if undertaken, could have a direct material effect on KNBT's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, KNBT and the Bank must meet specific
capital guidelines that involve quantitative measures of KNBT's and the Bank's
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. KNBT's and the Bank's capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
KNBT's ability to declare and pay dividends may depend in part on
dividends received from the Bank. The Pennsylvania Banking Code regulates the
distribution of dividends by savings banks and states, in part, that dividends
may be declared and paid only out of accumulated net earnings and may not be
declared or paid unless surplus, retained earnings, is at least equal to
contributed capital. In addition, dividends may not be declared or paid if the
Bank is in default in payment of any assessment due the FDIC.
The Federal Reserve Board issued a policy statement on the payment of
cash dividends by the bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the holding company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earnings retention
that is consistent with the holding company's capital needs, asset quality and
overall financial condition.
Quantitative measures established by regulations to ensure capital
adequacy require KNBT and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). As of December 31, 2004, KNBT and the
Bank met all regulatory capital adequacy requirements to which they are subject.
As of December 31, 2004, the most recent notification from the FDIC
categorized the Bank as "well-capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "adequately capitalized" the Bank
must maintain minimum total risk-based, Tier I risk-based and Tier I leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed in the institution's
category.
79
The following table provides a comparison of KNBT's and the Bank's
capital amounts, risk-based capital ratios and leverage ratios for the periods
indicated.
At December 31, 2004
----------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------- ------------------------- --------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Company (consolidated) $355,857 25.64% $ 111,042 8.00% N/A N/A
Bank $264,159 19.17% $ 110,233 8.00% $137,792 10.00%
Tier I Capital
(To risk-weighted assets)
Company (consolidated) $345,396 24.88% $ 55,521 4.00% N/A N/A
Bank $253,698 18.41% $ 55,117 4.00% $ 82,675 6.00%
Tier I Capital
(To average assets, leverage)
Company (consolidated) $345,396 14.66% $ 55,521 4.00% N/A N/A
Bank $253,698 12.17% $ 55,117 4.00% $ 68,896 5.00%
At December 31, 2003
----------------------------------------------------------------------------------------
Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------- ------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------- ------------------------- --------------------------
Total Capital (dollars in thousands)
(To risk-weighted assets)
Company (consolidated) $359,522 33.24% $ 86,535 8.00% N/A N/A
Bank $258,441 24.01% $ 86,123 8.00% $107,654 10.00%
Tier I Capital
(To risk-weighted assets)
Company (consolidated) $351,612 32.51% $ 43,268 4.00% N/A N/A
Bank $250,499 23.27% $ 43,062 4.00% $ 64,593 6.00%
Tier I Capital
(To average assets, leverage)
Company (consolidated) $351,612 19.39% $ 72,525 4.00% N/A N/A
Bank $250,499 13.42% $ 74,646 4.00% $ 93,307 5.00%
80
NOTE Q - QUARTERLY FINANCIAL DATA (Unaudited)
The following represents summarized quarterly financial data of KNBT,
which, in the opinion of management, reflects all adjustments (comprising only
normal recurring accruals) necessary for a fair presentation.
Three Months Ended
- ----------------------------------------- ----------------------------------------------------------
2004 Dec. 31 Sept. 30 June 30 March 31
----------------------------------------------------------
(dollars in thousands except per share data)
Interest income $ 26,973 $ 24,772 $ 23,195 $ 22,351
Interest expense 10,476 8,777 7,318 6,875
Net interest income 16,497 15,995 15,877 15,476
Provision for loan losses 1,095 742 971 1,500
Non-interest income 4,189 3,840 3,438 3,967
Non-interest expense 13,681 13,496 13,017 12,505
Income before income taxes 5,910 5,597 5,327 5,438
Net income 4,736 4,447 4,308 4,115
Per Common Share Data (1)
- -----------------------------------------
Weighted Average Common Shares- Diluted 29,077,739 29,285,250 29,655,263 30,011,264
Weighted Average Common Shares- Basic 28,586,796 28,875,080 29,232,941 29,555,238
Net Income Per Share- Diluted $ 0.16 $ 0.15 $ 0.15 $ 0.14
Net Income Per Share- Basic $ 0.17 $ 0.15 $ 0.15 $ 0.14
Book Value $ 13.33 $ 13.35 $ 13.04 $ 13.44
2003
- -----------------------------------------
Interest income $ 18,153 $ 13,193 $ 13,578 $ 14,139
Interest expense 6,110 4,657 4,991 5,303
Net interest income 12,043 8,536 8,587 8,836
Provision for loan losses 2,095 468 326 62
Non-interest income 2,447 2,018 2,401 2,182
Non-interest expense 33,213 7,852 7,148 6,906
Income (loss) before income taxes (20,819) 2,234 3,514 4,050
Net income (loss) (13,087) 1,756 2,626 2,949
- ------------------------------------------------------------------------------------------------------
(1) Per share data is not included for 2003 because no shares were issued prior
to November 2003.
81
NOTE R - KNBT BANCORP, INC.
(PARENT COMPANY ONLY)
- --------------------------------------------------------------------------------
CONDENSED BALANCE SHEET At December 31,
2004 2003
- --------------------------------------------------------------------------------
(dollars in thousands)
Assets
Cash and due from banks $ -- $ 3
Interest-bearing deposits with banks 714 94,477
-------- --------
Total cash and cash equivalents 714 94,480
Loans receivable 15,483 15,920
Investment in banking subsidiary 300,780 302,897
Investment in other subsidiaries 91,703 5,706
Other assets 7,400 7,380
-------- --------
Total Assets $416,080 $426,383
======== ========
Liabilities
Long-term ESOP debt $ -- $ 15,920
Subordinated Debentures 15,464 15,464
Other liabilities 23,262 5,919
-------- --------
Total Liabilities 38,726 37,303
Shareholders' Equity 377,354 389,080
-------- --------
Total Liability and Shareholders' Equity $416,080 $426,383
======== ========
- --------------------------------------------------------------------------------
For the Year Ended December 31,
CONDENSED STATEMENT OF OPERATIONS 2004 2003
- --------------------------------------------------------------------------------
(dollars in thousands)
Income
Interest on deposits with banks $ 101 $ 264
Interest on ESOP loan 507 96
Statutory trust income 23 5
Other income 5 --
-------- --------
Total Income 636 365
-------- --------
Expenses
Interest on long-term ESOP debt 172 96
Interest on Subordinated Debt 775 120
Contribution to charitable foundation -- 16,161
Other expenses 2,340 80
-------- --------
Total Expenses 3,287 16,457
-------- --------
Loss before tax benefit and
equity in undistributed net
earnings of subsidiaries (2,651) (16,092)
Income tax benefit (1,445) (5,632)
-------- --------
Loss before equity in undistributed
net earnings of subsidiaries (1,206) (10,460)
Equity in undistributed net
earnings of subsidiaries 18,812 4,704
-------- --------
Net Income (Loss) $ 17,606 $ (5,756)
======== ========
82
- ----------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENT OF CASH FLOWS For the Years Ended December 31,
2004 2003
- ----------------------------------------------------------------------------------------------------------------------------
Operating Activities (dollars in thousands)
Net income (loss) $ 17,606 $ (5,756)
Adjustments to reconcile net loss to net cash provided by operating activities
Distribution in excess of undistributed net loss of subsidiaries (18,812) (4,704)
Contribution to charitable foundation 16,161
Changes in assets and liabilities
Increase in other assets 1,489 (7,380)
Increase in other liabilities 17,360 5,842
Management Recognition and Retention Plan expense 1,404 -
--------------- ---------------
Net Cash Provided by Operating Activities 19,047 4,163
--------------- ---------------
Investing Activities
Proceeds from repayment of ESOP loan 437 -
Investment in subsidiaries (85,650) 106,225
--------------- ---------------
Net Cash Used In Investing Activities (85,213) 106,225
Financing Activities
Net proceeds from issuance of common stock - 196,261
Proceeds from the exercise of stock options 1,288 311
Dividend payments on common stock (4,428) -
Purchase of treasury stock (11,179) -
Purchase of MRRP stock (13,281) -
--------------- ---------------
Net Cash Provided by (used in) Financing Activities (27,600) 196,572
--------------- ---------------
Increase (decrease) in cash and cash equivalents (93,766) 94,480
Cash and cash equivalents, January 1 94,480 -
--------------- ---------------
Cash and cash equivalents, December 31 $ 714 $ 94,480
=============== ===============
Item 9. Changes in and Disagreements with Accountants on Accounting and
- --------------------------------------------------------------------------------
Financial Disclosure
--------------------
None
Item 9A. Controls and Procedures
- -----------------------------------------
Evaluation of Disclosure Controls and Procedures. KNBT's management
evaluated, with the participation of its Chief Executive Officer and Chief
Financial Officer, the effectiveness of its disclosure controls and procedures
(as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of
1934) as of the end of the period covered by this report. Based on such
evaluation, KNBT's Chief Executive Officer and Chief Financial Officer have
concluded that its disclosure controls and procedures are designed to ensure
that information required to be disclosed in the reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and are operating in an effective manner.
Changes in Internal Control Over Financial Reporting. No change in
KNBT's internal control over financial reporting (as defined in Rules 13a-15(f)
or 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred
during the quarter ended December 31, 2004 that has materially affected or is
reasonably likely to materially affect, KNBT's internal control over financial
reporting.
83
Management's Report on Internal Control Over Financial Reporting
The management of KNBT is responsible for establishing and maintaining
adequate internal control over financial reporting.
KNBT's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles and includes those policies and
procedures that:
o Pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of KNBT.
o Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that receipts and expenditures of KNBT are being made only in
accordance with authorizations of management and the board of
directors of KNBT; and
o Provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of
KNBT's assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to risk that controls
may become inadequate because of changes in conditions or because of declines in
the degree of compliance with the policies or procedures.
KNBT's management assessed the effectiveness of its internal control
over financial reporting as of December 31, 2004. In making this assessment,
KNBT's management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated
Framework.
As of December 31, 2004, based on management's assessment, KNBT's
internal control over financial reporting was effective.
84
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
KNBT Bancorp, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that KNBT
Bancorp, Inc. maintained effective internal control over financial reporting as
of December 31, 2004, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). KNBT Bancorp, Inc.'s management
is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that KNBT Bancorp, Inc. maintained
effective internal control over financial reporting as of December 31, 2004, is
fairly stated, in all material respects, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, KNBT
Bancorp, Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2004 based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
KNBT Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 2004 and our report
dated March 16, 2005 expressed an unqualified opinion on those financial
statements.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
March 16, 2005
85
Item 9B. Other Information
- -----------------------------------
None
PART III
Item 10. Directors and Executive Officers of the Registrant
- --------------------------------------------------------------------
The information required by Item 10 of Form 10-K with respect to
directors and executive officers is incorporated by reference from the section
captioned "Information with Respect to Nominees for Director, Continuing
Directors and Executive Officers" in KNBT's definitive proxy statement for the
annual meeting of stockholders to be held on May 5, 2005, (the "Proxy
Statement") to be filed with the Securities and Exchange Commission prior to
April 30, 2005.
KNBT has adopted a Code of Conduct and Ethics that applies to its
principal executive officer and principal financial officer, as well as other
officers and employees of KNBT and the Bank. A copy of the Code of Conduct and
Ethics may be found on KNBT's website at www.KNBT.com.
Item 11. Executive Compensation
- ----------------------------------------
The information required by Item 11 of Form 10-K is incorporated by
reference from the sections captioned "Management Compensation," "Report of the
Human Resources Committee of KNBT" and "Performance Graph" in the Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- --------------------------------------------------------------------------------
and Related Stockholder Matters
-------------------------------
The information required by Item 12 of Form 10-K is incorporated by
reference from the section captioned "Beneficial Ownership of Common Stock by
Certain Beneficial Owners and Management."
Equity Compensation Plan Information
The following table provides information as of December 31, 2004 with
respect to shares of common stock that may be issued under our existing equity
compensation plans, which consist of the 2004 Stock Option Plan and 2004
Recognition and Retention Plan, both of which were approved by our stockholders.
The table does not include information with respect to shares of common
stock subject to outstanding options granted under equity compensation plans
assumed by us in connection with the acquisition of First Colonial, which
originally granted these options. Note 2 to the table sets forth the total
number of shares of common stock issuable upon the exercise of assumed options
as of December 31, 2004 and the weighted average exercise price of those
options. No additional options may be granted under those assumed plans.
86
Number of securities
Number of securities to be remaining available for
issued upon exercise of Weighted-average future issuance under equity
outstanding options, exercise price of compensation plans (excluding
warrants outstanding options, securities reflected in
and rights warrants and rights column (a))
Plan Category (a) (b) (c)
- -------------------------------- --------------------------- ------------------------ ------------------------------
Equity compensation plans
approved by security holders 1,738,000 (1) $16.50 (1) 1,090,165 (3)
Equity compensation plans not
approved by security holders -- -- --
--------------------------- ------------------------ ------------------------------
Total 1,738,000 (2) $16.50 1,090,165
========= ====== =========
___________________
(1) Includes 629,500 shares subject to restricted stock grants which were not
vested as of December 31, 2004. The weighted-average exercise price
excludes such restricted stock grants.
(2) The table does not include information for equity compensation plans
assumed by us in connection with the acquisition of First Colonial which
originally established those plans. As of December 31, 2004, a total of
509,896 shares of Common Stock were issuable upon exercise of outstanding
options under those assumed plans and the weighted average exercise price
of those outstanding options was $5.61 per share. No additional options may
be granted under any assumed plans.
(3) Includes 178,547 shares available for grant pursuant to the MRRP.
Item 13. Certain Relationships and Related Transactions
- ----------------------------------------------------------------
The information required by Item 13 of Form 10-K is incorporated by
reference from the section captioned "Management Compensation - Indebtedness of
Management and Related Party Transactions" in the Proxy Statement.
Item 14. Principal Accounting Fees and Services
- --------------------------------------------------------
The information required by Item 14 of Form 10-K is incorporated by
reference from the section captioned "Ratification of Appointment of Auditors -
Audit Fees" in the Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules
- -------------------------------------------------------------
(a) Documents Filed as Part of this Report:
Financial Statements: The Consolidated Financial Statements of
KNBT Bancorp, Inc. and the Report of Independent Certified
Public Accountants thereon, as listed below, have been filed
under "Item 8, Financial Statements and Supplementary Data".
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets for the Years Ended 12/31/04 and
12/31/03
Consolidated Statements of Income for the Years Ended
12/31/04, 12/31/03 and 12/31/02
Consolidated Statement of Changes in Shareholders' Equity for
the Years Ended 12/31/04, 12/31/03 and 12/31/02
Consolidated Statements of Cash Flows for the Years Ended
12/31/04, 12/31/03 and 12/31/02
Notes to Consolidated Financial Statements
87
(b) Exhibits
Exhibit No. Description Location
- ----------- ----------- --------
2.1 Agreement and Plan of Merger between KNBT Bancorp, Inc. and Northeast Pennsylvania
Financial Corp., dated December 8, 2004. (1)
3.1 Articles of Incorporation of KNBT Bancorp, Inc. (2)
3.2 Amended and Restated Bylaws of KNBT Bancorp, Inc.
Filed herewith
4.0 Form of Stock Certificate of KNBT Bancorp, Inc. (2)
10.1 Employment Agreement between Keystone Savings Bank, KNBT Bancorp and Scott V. Fainor (2)
10.2 Amendment No. 1 to the Employment Agreement between KNBT Bancorp, Inc., Keystone
Nazareth Bank & Trust Company, and Scott V. Fainor. (3)
10.3 Employment Agreement between Keystone Savings Bank, KNBT Bancorp and Eugene T. Sobol (2)
10.4 Amendment No. 1 to the Employment Agreement between KNBT Bancorp, Inc., Keystone
Nazareth Bank & Trust Company, and Eugene T. Sobol. (3)
10.5 Keystone Savings Bank Supplemental Executive Retirement Plan (2)
10.6 Keystone Savings Bank Trustee and Executive Deferred Compensation Program (2)
10.7 First Colonial Group, Inc. 1994 Stock Option Plan for Non-Employee Directors (4)
10.8 First Colonial Group, Inc. 1996 Employee Stock Option Plan (5)
10.9 First Colonial Group, Inc. 2001 Stock Option Plan (6)
10.10 Nazareth National Bank Directors' Deferred Compensation Plan #2 (7)
10.11 KNBT Bancorp, Inc. 2004 Stock Option Plan (8)
10.12 KNBT Bancorp, Inc. 2004 Recognition and Retention Plan and Trust Agreement (8)
21.0 Subsidiaries of the Registrant - Reference is made to "Item 1. Business" for the
required information
23.0 Consent of Grant Thornton LLP Filed herewith
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer Filed herewith
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer Filed herewith
88
32.0 Section 1350 Certifications Filed herewith
____________
(1) Incorporated by reference from KNBT's Current Report on Form 8-K/A filed on December 14, 2004 with the Securities
and Exchange Commission (File No. 000-50426).
(2) Incorporated by reference from KNBT's Registration Statement on Form S-1 filed on June 6, 2003, as amended, and declared
effective on August 12, 2003 (Registration No. 333-105899).
(3) Incorporated by reference from KNBT's Current Report on Form 8-K/A filed on January 27, 2005, with the Securities and
Exchange Commission (File No. 000-50426).
(4) Incorporated by reference from First Colonial's Annual Report on Form 10-KSB, for the fiscal year ended December 31, 1994
(File No. 000-11526).
(5) Incorporated by reference from First Colonial's Annual Report on Form 10-KSB, for the fiscal year ended December 31, 1995
(File No. 000-11526).
(6) Incorporated by reference from First Colonial's quarterly report on Form 10-Q, for the quarter ended June 30, 2001
(File No. 000-11526).
(7) Incorporated by reference from KNBT's Annual Report on Form 10-K, for the fiscal year ended December 31, 2003 (File
No. 000-50426).
(8) Incorporated by reference from KNBT's Definitive Schedule 14A filed on April 2, 2004 with the Securities and
Exchange Commission (File No. 000-50426).
(c) Financial Statement Schedules
All financial statement schedules are omitted as the required information
is not applicable or presented in the consolidated financial statements or
related notes included in Item 8, "Financial Statements and Supplementary
Data."
89
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
KNBT BANCORP, INC.
Dated: March 16, 2005 By: /s/ Scott V. Fainor
----------------------------------
SCOTT V. FAINOR, President and
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities as of
March 16, 2005.
By: /s/ Jeffrey P. Feather
-----------------------------------------------------------
JEFFREY P. FEATHER
Chairman of the Board
and Director
March 16, 2005
By: /s/ Scott V. Fainor
-----------------------------------------------------------
SCOTT V. FAINOR
President, Chief Executive Officer
and Director (Principal Executive Officer)
March 16, 2005
By: /s/ Eugene T. Sobol
-----------------------------------------------------------
EUGENE T. SOBOL
Senior Executive Vice President and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
March 16, 2005
By: /s/ Michael J. Gausling
-----------------------------------------------------------
MICHAEL J. GAUSLING
Director
March 16, 2005
By: /s/ Donna D. Holton
-----------------------------------------------------------
DONNA D. HOLTON
Director
March 16, 2005
By: /s/ Christian F. Martin, IV
-----------------------------------------------------------
CHRISTIAN F. MARTIN, IV
Director
March 16, 2005
90
By: /s/ John A. Mountain
-----------------------------------------------------------
JOHN A. MOUNTAIN
Director
March 16, 2005
By: /s/ Daniel B. Mulholland
-----------------------------------------------------------
DANIEL B. MULHOLLAND
Director
March 16, 2005
By: /s/ R. Chadwick Paul, Jr.
-----------------------------------------------------------
R. CHADWICK PAUL, JR.
Director
March 16, 2005
By: /s/ Charles J. Peischl, Esquire
-----------------------------------------------------------
CHARLES J. PEISCHL, ESQUIRE
Director
March 16, 2005
By: /s/ Robert R. Scholl
-----------------------------------------------------------
ROBERT R. SCHOLL
Director
March 16, 2005
By: /s/ Kenneth R. Smith
-----------------------------------------------------------
KENNETH R. SMITH
Director
March 16, 2005
By: /s/ R. Charles Stehly
-----------------------------------------------------------
R. CHARLES STEHLY
Director
March 16, 2005
By: /s/ Richard Stevens, III
-----------------------------------------------------------
RICHARD STEVENS, III
Director
March 16, 2005
By: /s/ Richard L. Strain
-----------------------------------------------------------
RICHARD L. STRAIN
Director
March 16, 2005
By: /s/ Maria Z. Thulin
-----------------------------------------------------------
MARIA Z. THULIN
Director
March 16, 2005
91