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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
 
____________________________________
(Mark One)

[ x ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 31, 2005
     
OR
     
[    ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File No. 000-50426
 
 
(Exact Name of Registrant as Specified in its Charter)


Pennsylvania
  
38-3681905
(State or Other Jurisdiction of Incorporation or Organization)
  
(I.R.S. Employer Identification No.)

90 Highland Avenue, Bethlehem, PA
  
18017
(Address of Principal Executive Office)
  
(Zip Code)

Registrant’s Telephone Number, Including Area Code: 610-861-5000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES   X   
NO _____

Indicate by check mark whether the registrant is an accelerated filer as defined in Rrule 12b-2 of the Exchange Act.

YES   X  
NO _____

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of May 6, 2005, 30,791,761 shares of the Registrant’s common stock were outstanding.


 
KNBT BANCORP, INC. AND SUBSIDIARIES
 
 
INDEX
 
 
Page
 
 
 
       
 
   
   
   
   
   
       
   
   
     
 
 
       
 
       
       
 
       
 
       
 
       
 
       
 
       
 
       
       



PART I.

Item 1.     Financial Statements

KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 

   
March 31,
  
December 31,
  
   
2005
  
2004
  
   
(unaudited)
      
   
(dollars in thousands)
  
ASSETS
          
Cash and due from banks
 
$
30,569
  
$
30,218
  
Interest-bearing deposits with banks
   
95,341
   
56,002
 
Cash and cash equivalents
   
125,910
   
86,220
 
Investment securities available-for-sale
    
1,008,145
   
1,057,109
 
Investment securities held to maturity
    
54,999
   
56,586
 
(Fair value of $54,987 at March 31, 2005 and
             
$57,034 at December 31, 2004)
              
Federal Home Loan Bank of Pittsburgh stock
    
35,099
   
36,456
 
Mortgage loans held-for-sale
   
954
   
718
 
Loans
    
1,031,042
   
1,013,202
 
Less: Allowance for loan losses
    
(10,450
)
  
(10,461
)
Net loans
   
1,020,592
   
1,002,741
 
Bank owned life insurance
    
61,153
   
60,501
 
Premises and equipment, net
    
40,281
   
40,790
 
Accrued interest receivable
   
9,398
   
9,509
 
Goodwill and other intangible assets
   
52,798
   
53,255
 
Other assets
   
9,251
   
11,218
 
TOTAL ASSETS
  
$
2,418,580
  
$
2,415,103
  
               
LIABILITIES
              
Non-interest-bearing deposits
 
$
129,354
  
$
128,498
  
Interest-bearing deposits
   
1,215,026
   
1,194,555
 
Total deposits
   
1,344,380
   
1,323,053
 
Securities sold under agreements to repurchase
   
24,496
   
22,643
 
Advances from the Federal Home Loan Bank
    
646,852
   
660,674
 
Subordinated debt
   
15,464
   
15,464
 
Accrued interest payable
    
6,507
   
5,811
 
Other liabilities
    
12,231
   
10,104
 
TOTAL LIABILITIES
   
2,049,930
   
2,037,749
 
               
SHAREHOLDERS' EQUITY
              
Preferred stock, par value $0.01 per share
              
Authorized: 20,000,000 shares, none issued
    
-
   
-
 
Common stock, par value $0.01 a share
   
297
   
297
 
Authorized: 100,000,000 shares
              
Issued:
             
30,664,861 shares at March 31, 2005
              
30,656,840 shares at December 31, 2004
              
Additional paid-in capital
   
296,433
   
296,403
 
Retained earnings
    
117,122
   
113,748
 
Treasury stock, at cost; 964,000 and 650,000 shares at
              
March 31, 2005 and December 31, 2004, respectively
   
(16,265
)
  
(11,179
)
Unallocated common stock held
              
by Employee Stock Ownership Plan
    
(14,974
)
  
(15,176
)
Unearned common stock held
              
by Management Recognition and Retention Plan
    
(8,576
)
  
(9,107
)
Accumulated other comprehensive income (loss) net
    
(5,387
)
  
2,368
 
TOTAL SHAREHOLDERS' EQUITY
    
368,650
   
377,354
 
               
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
2,418,580
  
$
2,415,103
  
               
See accompanying notes to consolidated financial statements.
              

1



KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
 

   
 Three Months Ended March 31,
 
   
 2005
  
2004
  
   
 (dollars in thousands, except per share data)
  
   
 (unaudited)
  
INTEREST INCOME
           
Loans, including fees
  
$
14,892
  
$
14,093
  
Investment securities
    
11,728
   
8,116
 
Other interest
    
346
   
142
 
Total interest income
    
26,966
   
22,351
 
               
INTEREST EXPENSE
              
Deposits
    
5,099
   
4,535
 
Securities sold under agreements to repurchase
    
51
   
35
 
Advances from the Federal Home Loan Bank
    
5,444
   
2,124
 
Subordinated debt
    
233
   
181
 
Total interest expense
    
10,827
   
6,875
 
               
NET INTEREST INCOME
    
16,139
   
15,476
 
Provision for loan losses
    
734
   
1,500
 
Net interest income after provision
              
for loan losses
    
15,405
   
13,976
 
               
NON-INTEREST INCOME
              
Trust revenue
    
398
   
353
 
Brokerage services revenue
    
548
   
160
 
Deposit service charges
    
1,105
   
1,311
 
Bank owned life insurance
    
652
   
667
 
Net gains (losses) on sales of investment securities
    
432
   
(8
)
Net gains on sales of residential mortgage loans
    
218
   
159
 
Net gains on sales of credit card loans
    
-
   
298
 
Net (losses) on sale of assets
    
(11
)
  
-
 
Net gains (losses) on sale of other real estate owned
    
(17
)
  
44
 
Non-interest operating income
    
1,117
   
983
 
Total non-interest income
    
4,442
   
3,967
 
               
NON-INTEREST EXPENSES
              
Compensation and employee benefits
    
7,848
   
7,245
 
Net occupancy and equipment expense
    
2,113
   
1,825
 
Professional fees
    
427
   
572
 
Advertising
    
222
   
153
 
Data processing
    
433
   
531
 
Impairment of mortgage servicing rights
    
84
   
58
 
Amortization of intangible assets
    
547
   
547
 
Other operating expenses
    
1,751
   
1,574
 
Total non-interest expenses
    
13,425
   
12,505
 
               
Income before income taxes
    
6,422
   
5,438
 
Income taxes
   
1,592
   
1,323
 
NET INCOME
 
$
4,830
  
$
4,115
  
               
PER SHARE DATA
             
Net income - basic
  
$
0.17
  
$
0.14
  
Net income - diluted
  
$
0.17
  
$
0.14
  
Cash dividends per common share
  
$
0.05
  
$
-
  
               
See accompanying notes to consolidated financial statements.
              


2



KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY



   
Three Months Ended March 31, 2005 (unaudited)
  
   
(dollars in thousands)
  
   
Common
 
Treasury
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Stock
 
Stock
 
Common
 
Add'l
 
 
 
Unallocated
 
Unearned
 
Other
 
 
 
 
 
 
 
Number of
 
Number of
 
Stock
 
Paid In
 
Retained
 
ESOP
 
Compensation
 
Comprehensive
 
Treasury
 
 
 
 
 
Shares
 
Shares
 
Value
 
Capital
 
Earnings
 
Shares
 
MRRP
 
Income
 
Stock
 
Total
  
Balance January 1, 2005
 
 
29,764,319
 
 
(650,000
)
$
297
 
$
296,403
 
$
113,748
 
 
($15,176
)
 
($9,107
)
$
2,368
 
 
($11,179
)
$
377,354
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4,830
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4,830
 
Other comprehensive loss net of taxes
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
and reclassification adjustments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(7,755
)
 
 
 
 
(7,755
)
Total comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($2,925
)
Cash dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1,456
)
 
 
 
 
 
 
 
 
 
 
 
 
 
(1,456
)
Unallocated ESOP shares committed to employees
 
 
11,900
 
 
 
 
 
 
 
 
(15
)
 
 
 
 
202
 
 
 
 
 
 
 
 
 
 
 
187
 
Shares issued upon exercise of stock options
 
 
8,021
 
 
 
 
 
 
 
 
45
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
45
 
Purchases of treasury stock
 
 
 
 
 
(314,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(5,086
)
 
(5,086
)
Amortization of compensation related to
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Management Recognition and Retention Plan ("MRRP")
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
531
 
 
 
 
 
 
 
 
531
 
Balance at March 31, 2005
    
29,784,240
   
(964,000
)
$
297
  
$
296,433
  
$
117,122
    
($14,974
)
  
($8,576
)
  
($5,387
)
  
($16,265
)
$
368,650
  
                                                               




3
 
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS 
 

   
Three months ended
  
   
March 31, 2005
  
March 31, 2004
  
   
(dollars in thousands)
  
OPERATING ACTIVITIES:
          
Net income
  
$
4,830
  
$
4,115
  
Adjustments to reconcile net income to net cash
              
Provided by operating activities:
              
Provision for possible loan losses
    
734
   
1,500
  
Depreciation and amortization
    
1,782
   
1,182
  
Compensation expense stock option plan
    
6
   
-
 
Management Recognition and Retention Plan expense
    
525
   
-
 
ESOP expense
    
187
   
326
  
Amortization and accretion of securities premiums and discounts, net
    
551
   
608
 
(Gain) Loss on sale of other real estate owned
    
17
   
(44
)
Net (Gain) loss on sales of investment securities
    
(432
)
  
8
 
Gain on sale of credit card portfolio
    
-
   
(298
)
Loss on sale of other assets
    
11
   
-
 
Gain on sale of mortgage loans
    
(218
)
  
(159
)
Mortgage loans originated for sale
    
(13,336
)
  
(1,255
)
Mortgage loan sales
    
13,790
   
2,715
 
Changes in assets and liabilities:
              
Increase in Bank Owned Life Insurance
    
(652
)
  
(667
)
Decrease (Increase) in accrued interest receivable
    
111
   
(1,629
)
Decrease in other assets
    
5,157
   
2,449
 
Increase (Decrease) in other liabilities and accrued interest payable
    
2,823
   
(4,173
)
Net cash provided by operating activities
    
15,886
   
4,678
 
               
INVESTING ACTIVITIES:
              
Proceeds from calls and maturities of securities available-for-sale
   
39,067
   
32,573
 
Proceeds from calls and maturities of securities held-to maturity
    
1,774
   
-
 
Proceeds from sales of securities available-for-sale
   
22,334
   
249
 
Purchase of securities available-for-sale
   
(24,374
)
  
(160,343
)
Purchase of securities held to maturity
    
(148
)
  
-
 
Purchase of Federal Home Loan Bank of Pittsburgh stock
    
(89
)
  
(4,248
)
Redemption of Federal Home Loan Bank of Pittsburgh stock
    
1,446
   
-
 
Proceeds from the sale of credit card loans
    
-
   
1,831
 
Net (Increase) in loans
    
(18,585
)
  
(34,323
)
Purchase of premises & equipment
    
(642
)
  
(2,902
)
Proceeds from the sale of other assets
    
57
   
-
 
Proceeds from the sale of other real estate owned
    
103
   
161
 
Net cash provided by (used in) investing activities
    
20,943
   
(167,002
)
               
FINANCING ACTIVITIES:
              
Net increase in deposits
    
21,327
   
4,805
 
Net increase in repurchase agreements
    
1,853
   
3,843
 
Proceeds from long -term debt
    
22,000
   
109,562
 
Payments on long -term debt
    
(35,822
)
  
(8,175
)
Purchase of treasury stock
    
(5,086
)
  
-
 
Proceeds from the exercise of stock options
    
45
   
564
 
Cash dividends paid
    
(1,456
)
  
-
 
Net cash provided by financing activities
    
2,861
   
110,599
 
Increase (Decrease) in cash and cash equivalents
    
39,690
   
(51,725
)
Cash and cash equivalents January 1,
    
86,220
   
138,977
 
Cash and cash equivalents March 31,
  
$
125,910
  
$
87,252
  
               
Supplemental disclosure of cash flow information
              
Cash paid during the period for
             
Income taxes
  
$
1,100,000
  
$
-
  
Interest on deposits, advances and other borrowed money
  
$
10,131
  
$
6,454
  
Supplemental disclosure of non-cash activities
          
 
Reclassification of loans receivable to other real estate owned
  
$
765
  
$
97
  
               
See accompanying notes to consolidated financial statements.
              


4
 
KNBT BANCORP, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
NOTE A - BASIS OF PRESENTATION

KNBT Bancorp, Inc. (“KNBT” or the “Company”) is a Pennsylvania corporation and registered bank holding company organized in 2003. KNBT’s business consists primarily of being the parent holding company for Keystone Nazareth Bank & Trust Company, a Pennsylvania chartered savings bank. Keystone Nazareth Bank & Trust Company (the “Bank”) is the stock-form successor to Keystone Savings Bank upon the mutual-to-stock conversion of Keystone Savings Bank, which was completed on October 31, 2003. Concurrently with the mutual-to-stock conversion, KNBT acquired, through a merger, First Colonial Group, Inc. (“First Colonial”), the parent bank holding company for Nazareth National Bank and Trust Company (“Nazareth National Bank”) which was merged with and into the Bank in connection with the acquisition of First Colonial.


NOTE B - BASIS OF CONSOLIDATION

The accompanying consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles (“GAAP”). However, all normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of these financial statements have been included. These financial statements should be read in conjunction with the audited financial statements and the notes thereto for the Company for the year ended December 31, 2004, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The financial information presented herein is unaudited; however, in the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present fairly the unaudited financial information have been made. The Company has prepared its accompanying consolidated financial statements in accordance with GAAP as applicable to the banking industry. Certain amounts in prior years are reclassified for comparability to the current year’s presentation. Such reclassifications, when applicable have no effect on net income. The consolidated financial statements include the balances of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. References to the Company include the Bank unless otherwise noted.

In preparing the consolidated financial statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenue and expense for the period. Actual results could differ significantly from those estimates. A material estimate that is particularly susceptible to significant changes in the near-term is the determination of the allowance for loan losses.

In addition to the Bank, KNBT’s subsidiaries include KNBT Inv. I, Inc. and KNBT Inv. II, Inc. The Bank has four wholly owned subsidiaries, KLV, Inc., KLVI, Inc., Traditions Settlement Services LLC and KNBT Securities. KLV, Inc. is inactive.
5

NOTE C - CONVERSION AND ACQUISITIONS


Oakwood Financial Corp.

On November 11, 2004, the Bank acquired Oakwood Financial Corp. (“Oakwood”), a full-service securities brokerage firm based in Allentown, Pennsylvania, for $650,000. The Bank 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 since the date of acquisition on November 11, 2004.

Oakwood provides a full menu of securities brokerage, insurance and investment advisory products and services. Oakwood now operates as KNBT Securities Inc. and is a wholly owned subsidiary of the Bank.

Caruso Benefits Group, Inc.

On April 1, 2005, the Bank acquired Caruso Benefits Group, Inc. (“Caruso”) , a benefits management firm based in Bethlehem, Pennsylvania. Since the date of acquisition on April 1, 2005, Caruso has been operating as a wholly owned subsidiary of the Bank.

Caruso specializes in benefits management with an emphasis on group medical, life and disability. Under the terms of the definitive agreement, the Bank acquired all of the capital stock of Caruso for a purchase price of $28 million in cash of which $20 million was paid at time of closing and $8 million will be payable over a three-year period, subject to Caruso maintaining certain levels of profitability.

Northeast Pennsylvania Financial Corp.

On December 9, 2004, KNBT announced entering 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”). 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 Merger.

All required regulatory approvals have been obtained and the transaction was approved by stockholders of NEPF at their special meeting held on April 14, 2005. KNBT expects the transaction to close during the middle of the second quarter of 2005.

6

NOTE D - EARNINGS PER SHARE

The Company calculates earnings per share as provided by the provisions of Statement of Financial Accounting Standards No. 128, “Earnings Per Share (SFAS 128)”. Basic and diluted earnings per share for the three months ended March 31, 2005 and 2004 were calculated as follows:

   
Net
 
Average
 
 
 
 
 
Income
 
Shares
 
Per Share
 
 
 
(numerator)
 
(denominator)
 
Amount
  
For the Three Months Ended March 31, 2005
  
(dollars in thousands, except per share amounts)
  
               
Basic earnings per share
              
Income available to common shareholders
 
$
4,830
    
28,226,025
 
$
0.17
  
Effect of dilutive securities
                    
Stock options
         
217,581
   
-
 
Management Recognition and Retention Plan
         
94,162
   
-
 
Total effect of dilutive securities
         
311,743
   
-
 
Diluted earnings per share
                    
Income available to common shareholders
                    
plus assumed exercise of options
 
$
4,830
    
28,537,768
 
$
0.17
  
                     
For the Three Months Ended March 31, 2004
                    
                     
Basic earnings per share
                    
Income available to common shareholders
 
$
4,115
    
29,555,238
 
$
0.14
  
Effect of dilutive securities
                    
Stock options
         
456,026
   
-
 
Diluted earnings per share
                
-
 
Income available to common shareholders
                    
plus assumed exercise of options
 
$
4,115
    
30,011,264
 
$
0.14
  

KNBT also had outstanding stock options for the three months ended March 31, 2005, equal to 1,108,500 shares of common stock at an exercise price per share of $16.50. These options were not included in the computation of diluted earnings per share for the three months ended March 31, 2005, because the option exercise price was greater than the average market price. There were no anti-dilutive securities as of March 31, 2004.

Common stock outstanding for the purpose of calculating basic earnings per share does not include 880,620 and 928,222 unallocated shares held by the Employee Stock Ownership Pan (“ESOP”) at March 31, 2005 and March 31, 2004 respectively. The exclusion of these unallocated shares held by the ESOP is in accordance with the provision of 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”).

Unearned and uncommitted Management Recognition and Retention Plan (“MRRP”) shares to be released are not considered to be outstanding for basic earnings per share calculations. At March 31, 2005, unearned MRRP shares totaled 629,500 and uncommitted MRRP shares totaled 178,547.

7


NOTE E - INVESTMENT SECURITIES

The amortized cost, unrealized gains and losses and fair value of KNBT’s investment securities held-to-maturity and available-for-sale at March 31, 2005 (unaudited) and December 31, 2004 are as follows:

   
At March 31, 2005 (unaudited)
  
   
 
 
Gross
 
Gross
 
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
 
Cost
 
Gains
 
Losses
 
Value
  
       
(dollars in thousands)
      
Held to maturity:
                  
U.S. Government and agencies
  
$
149
  
$
-
  
$
(1
)
$
148
  
Obligations of states and political
                         
subdivisions
    
5,507
   
19
   
(6
)
  
5,520
 
Mortgage-backed securities
                          
FNMA
    
25,211
   
-
   
(57
)
  
25,154
 
CMOs
    
24,132
   
83
   
(50
)
  
24,165
 
Total mortgage-backed securities
    
49,343
   
83
   
(107
)
  
49,319
 
Total held to maturity
    
54,999
   
102
   
(114
)
  
54,987
 
                           
Available for sale:
                          
U.S. Government and agencies
    
158,394
   
310
   
(1,920
)
  
156,784
 
Obligations of states and political
                         
subdivisions
    
101,638
   
1,703
   
(421
)
  
102,920
 
Asset-managed funds
   
4,904
   
-
   
(108
)
  
4,796
 
Federated liquid cash trust
    
36
   
-
   
-
   
36
 
Mortgage-backed securities
                          
GNMA
    
1,293
   
35
   
-
   
1,328
 
FHLMC
    
99,129
   
112
   
(1,168
)
  
98,073
 
FNMA
    
300,792
   
1,064
   
(3,798
)
  
298,058
 
CMOs
    
261,079
   
3
   
(4,630
)
  
256,452
 
Total mortgage-backed securities
    
662,293
   
1,214
   
(9,596
)
  
653,911
 
Corporate and other debt securities
    
75,231
   
398
   
(55
)
  
75,574
 
Equity securities
    
13,810
   
745
   
(431
)
  
14,124
 
Total available for sale
    
1,016,306
   
4,370
   
(12,531
)
  
1,008,145
 
                           
Total investment securities
  
$
1,071,305
  
$
4,472
  
$
(12,645
)
$
1,063,132
  
                           

8

 

   
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
  
Mortgage-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
 
Mortgage-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
  
 
NOTE F - STOCK BASED COMPENSATION

Stock Option Plans

KNBT maintains the 2004 Stock Option Plan adopted by its stockholders at the 2004 annual meeting, as well as the stock option plans previously maintained by First Colonial acquired as a part of the acquisition of First Colonial in October 2003. KNBT’s stock option plans are accounted for under Statement of Financial Accounting Standards No. 123 (SFAS No. 123), “Accounting for Stock-Based Compensation.” This standard contains a fair value-based method for valuing stock-based compensation, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, through December 31, 2005, the standard permits entities to continue accounting for employee stock options and similar instruments under the intrinsic value method of APB Opinion No. 25. Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Company has elected to account for options, except as discussed below, in accordance with APB Opinion No. 25.


9

 
The Company accounts for stock-based compensation on awards granted pursuant to the former First Colonial option plans and to directors, officers and employees under KNBT’s 2004 Stock Option Plan using the intrinsic value method, except as discussed below. Since each option granted had an exercise price per share equal to the fair market value of one share of the Company’s stock on the date of the grant, no compensation cost at date of grant has been recognized.

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 three months ended
 
   
March 31, 2005
  
   
(in thousands, except per share amounts)
  
 
Net Income
      
As reported
 
$
4,830
  
Add: Stock-based employee compensation expense
        
included in reported net income, net
       
of related tax effects
   
6
 
Less: Stock-based compensation cost determined
        
under fair value method for all awards, net
        
of related tax effects
   
167
 
Pro-forma
 
$
4,669
  
         
Earnings per share (Diluted)
        
As reported
 
$
0.17
  
Pro-forma
 
$
0.16
  
         
Earnings per share (Basic)
        
As reported
 
$
0.17
  
Pro-forma
 
$
0.17
  


KNBT granted options for 214,650 and 1,132,000 shares in the first three months of 2005 and 2004, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in 2005 and 2004, respectively: dividend yield of 2% for each period; expected volatility of 26.75% and 25.00%; risk-free interest rates for each plan of 3.95% and 3.91%; and expected lives of 7.33 years and 6.67 years. The weighted average fair value of each option grant under KNBT’s 2004 Stock Option Plan is $4.64 in 2005 and $4.69 in 2004.

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 recognizes compensation expense in accordance with the fair value-based method of accounting described in SFAS No. 123 with respect to options granted to advisory directors. The fair value of each option is expensed over its vesting period. Compensation expense of $6,000 was recognized for the three months ended March 31, 2005 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 goods 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.



10



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.

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).

Staff Accounting Bulletin No. 107, “Share-Based Payment,” (SAB 107), issued March 29, 2005, expresses views of the SEC staff regarding the application of Statement 123(R). Among other things, SAB 107 provides interpretive guidance related to the interaction between Statement 123(R) and certain SEC rules and regulations, as well as provides the staff’s views regarding the valuation of share-based payment arrangements, for public companies. On April 14, 2005, the SEC adopted a new rule amending the effective dates of Statement 123(R) for public companies by issuing Release 33-8568. The new rule allows registrants to implement Statement 123(R) at the beginning of their next fiscal year, instead of the next interim period, that begins after June 15, 2005. Statement 123(R) will therefore be effective for the Company beginning the first quarter of 2006. The anticipated annual impact on the Company is expected to be similar to the amounts disclosed in this Footnote. 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 Statement 123(R) will have on its financial statements.

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, 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 60-month vesting period and is based on the market value of the Company’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 three months ended March 31, 2005 was $525,000.



11
 
 

NOTE G - LOANS

A summary of KNBT’s loans receivable at March 31, 2005 (unaudited) and December 31, 2004 is as follows:

 
   
March 31,
 
December 31,
 
 
 
2005
 
2004
 
 
 
(unaudited)
 
 
  
   
(dollars in thousands)
  
Real Estate
          
Residential
  
$
327,668
  
$
326,552
  
Construction
    
104,966
   
106,361
 
Commercial
    
244,307
   
231,132
 
Total real estate
    
676,941
   
664,045
 
               
Consumer loans
    
299,390
   
297,935
 
Commercial (non-real estate)
    
54,370
   
50,691
 
States and political subdivisions
    
1,103
   
1,170
 
Total gross loans
    
1,031,804
   
1,013,841
 
               
Less:
              
Mortgage loans held-for-sale
    
(954
)
  
(718
)
Deferred fees
    
192
   
79
 
Total loans
    
1,031,042
   
1,013,202
 
               
Less: Allowance for loan losses
    
(10,450
)
  
(10,461
)
Total net loans
  
$
1,020,592
  
$
1,002,741
  
  
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 March 31, 2005 and December 31, 2004. 
 
   
At Mar. 31,
 
At Dec. 31,
 
 
 
2005
 
2004
  
   
(unaudited)
     
   
(dollars in thousands)
  
           
Non-accrual loans
  
$
3,768
  
$
4,544
  
Accruing loans 90 days or more past due
    
292
   
511
 
Total non-performing loans
    
4,060
   
5,055
 
               
Other real estate owned
    
-
   
71
 
Total non-performing assets
  
$
4,060
  
$
5,126
  
               
Total non-performing loans
              
as a percentage of loans, net
    
0.40
%
  
0.50
%
               
Total non-performing loans
              
as a percentage of total assets
    
0.17
%
  
0.21
%
               
Total non-performing assets
              
as a percentage of total assets
    
0.17
%
  
0.21
%
               
Interest on non-accrual loans which would have been
              
recorded at the original rate
  
$
38
  
$
125
  
               
Interest on non-accrual loans that was reflected in income
    
-
   
-
 
Net decrease in interest income
  
$
(38
)
$
(125
)

12




KNBT’s recorded investment in impaired loans was $288,000 at March 31, 2005 and $424,000 at December 31, 2004. The valuation allowance for loan losses related to impaired loans is a part of the allowance for loan losses and was $87,000 at March 31, 2005 and $61,000 at December 31, 2004. The average impaired loan balance for the three months ended March 31, 2005 was $325,000. During the quarter ended March 31, 2005, the Bank received principal payments of $149,000 on impaired loans, which payments are recognized on a cash basis. The Bank recognized no income on impaired loans in the three-month period ended March 31, 2005. For the three months ended March 31, 2005, KNBT received principal payments of $38,000 on impaired loans and recognized no income. 

The following table shows the activity in KNBT’s allowance for loan losses during the periods indicated:
   
At or for the   
  
   
Three Months Ended March 31,  
  
   
(unaudited)  
  
   
2005
 
2004
  
   
(dollars in thousands)   
  
           
Balance, beginning of period
  
$
10,461
  
$
7,910
  
Provision charged to operations
    
734
   
1,500
 
Charge-offs:
              
One-to-four family residential
    
(15
)
  
-
 
Multi-family
    
-
   
-
 
Commercial real estate
    
-
   
-
 
Construction and land development
    
-
   
-
 
Commercial business
    
-
   
-
 
Consumer
    
(748
)
  
(491
)
Total charge offs
    
(763
)
  
(491
)
Recoveries of loans previously charged off:
              
One-to-four family residential
    
1
   
26
 
Commercial business
    
2
   
1
 
Consumer
    
15
   
54
 
Total recoveries
    
18
   
81
 
Net loans charged-off
    
(745
)
  
(410
)
               
Balance, end of period
  
$
10,450
  
$
9,000
  

NOTE H - 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 plan years prior to October 2003. In October 2003, KNBT froze the future accrual of benefits under this plan. KNBT continues to contribute to this plan for benefits accrued prior to October 2003. KNBT’s contribution to this plan in the three months ended March 31, 2005 was $248,000. During the three months ended March 31, 2004, the contribution to this plan amounted to $215,000. KNBT currently expects to contribute approximately $77,000 to this plan during the remainder of 2005.

13


2.
Directors’ Deferred Plan.
 
KNBT, as a part of the merger with First Colonial, assumed the deferred compensation plan for certain former directors of First Colonial. The plan requires defined annual payments for five to fifteen years beginning at age 65 or death. The annual benefit is based upon the amount deferred plus interest. KNBT has recorded the deferred compensation liabilities using the present value method. The net periodic defined benefit expense for the three months ended March 31, 2005 and March 31, 2004 was as follows:


   
March 31,
 
March 31,
 
 
  
2005
  
2004
  
   
(dollars in thousands)  
  
           
Service cost
  
$
-
  
$
-
  
Interest cost
    
19
   
6
 
Expected return on plan assets
    
-
   
-
 
Amortization of unrecognized net
          
transition asset or obligation
    
-
   
-
 
Amortization of Unrecognized Prior Service Cost
    
-
   
-
 
Amortization of Unrecognized Net Gain or Loss
    
-
   
-
 
           
Total Net Periodic Pension Cost for the Quarter
  
$
19
  
$
6
  
 
KNBT currently expects to contribute a total of approximately $19,000 to this plan in the year ended December 31, 2005.

 
NOTE I - NEW ACCOUNTING PRONOUNCEMENTS


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 KNBT 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 with respect to loans being acquired from the NEPF acquisition.


NOTE J - RECLASSIFICATIONS

Certain reclassifications of prior years’ amounts have been made to conform to the March 31, 2005 presentation.
 
14


Item 2.  Management's Discussion and Analysis of  Financial Condition and Results of Operations


CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION

The information contained in this Form 10-Q 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”) or 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; or (10) factors which result in a condition to the acquisition of 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.

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.


15

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.

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 and Oakwood Securities in November 2004.

Comparison of Financial Condition as of March 31, 2005 and December 31, 2004

Assets. KNBT’s total assets were $2.4 billion at both March 31, 2005 and December 31, 2004. KNBT’s total loans receivable were $1.03 billion at March 31, 2005, an increase of $17.8 million or 1.8% over the $1.01 billion reported for December 31, 2004. The growth in loans receivable was primarily due to an increase of $13.2 million or 5.7% in commercial real estate loans, $3.7 million or 7.3% in other commercial loans and $1.5 million or 0.5% in consumer loans. Single-family residential loans increased $1.1 million or 0.3% while construction loans decreased $1.4 million or 1.3%. KNBT sold $13.8 million of single-family residential loans during the three month period ended March 31, 2005. KNBT believes that rising interest rates reduced the level of activity in both the single-family residential and construction loan categories during the quarter ended March 31, 2005. Total investment securities decreased $50.6 million or 4.5% to $1.06 billion as compared with $1.11 billion at December 31, 2004. During the quarter ended March 31, 2005, there was a decrease in both the available-for-sale and held-to-maturity investments. The available-for-sale category decreased $49.0 million or 4.6% while the held to maturity category decreased $1.6 million or 2.8%. This decrease in the investment portfolio will continue to be used to fund the growth in the loan portfolio, maturing Federal Home Loan Bank (“FHLB”) advances, common stock purchases made through the stock repurchase program and for payment in part, of the cash portion of the NEPF acquisition anticipated to be consummated in the second quarter of 2005. Cash and cash equivalents increased $39.7 million or 46.0% chiefly as a result of reduction in investment securities.


16
 

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.

   Non-performing loans decreased $995,000 or 19.7% to $4.1 million at March 31, 2005 as compared with $5.1 million at December 31, 2004. The decrease was principally due to an $811,000 or 25.6% decline in non-performing residential mortgage loans, and a $136,000 or 32.1% decrease in non-performing commercial loans. Non-performing consumer loan levels were relatively unchanged at March 31, 2005 compared to December 31, 2004. Indirect vehicle non-performing levels were $879,000 at March 31, 2005 compared with $864,000 at December 31, 2004. 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. Total non-performing loans as a percentage of net loans improved to 0.40% at March 31, 2005 compared with 0.50% at December 31, 2004.
 
Allowance for Loan Losses. KNBT’s allowance for loan losses decreased $11,000 or .1% during the first three months of 2005. 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 assesses 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.

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. KNBT’s allowance for loan losses was 1.02% and 1.03% of total loans receivable at March 31, 2005 and December 31, 2004, respectively. See “Comparison of Operating Results for the three months ended March 31, 2005 and 2004 - Provision for Loan Losses.”


17

Liabilities. KNBT’s total liabilities equaled $2.05 billion at March 31, 2005, an increase of $12.2 million or .6% compared to total liabilities of $2.04 billion at December 31, 2004. Total deposits increased $21.3 million or 1.6% to $1.34 billion at March 31, 2005 compared to $1.32 billion at December 31, 2004. This increase reflected, in part, KNBT’s continuing efforts to boost the level of checking accounts and other core deposits. Core deposits consists of all deposits other than certificates of deposit. Also, contributing to the increase in deposits in the first quarter of 2005 was the increased market penetration of branches opened in 2003 and KNBT’s marketing efforts. FHLB advances declined $13.8 million or 2.1% to $646.9 million at March 31, 2005 compared to $660.7 million at December 31, 2004. Maturing advances was the primary reason for the decline.

Shareholders’ Equity. Shareholders’ equity totaled $368.7 million at March 31, 2005 compared to $377.4 million at December 31, 2004, a decrease of $8.7 million or 2.3%. The decrease in shareholders’ equity was primarily the result of the repurchase of KNBT common stock through the Company’s stock repurchase program. A total of 314,000 shares were repurchased during the three months ended, March 31, 2005, at an average price of $16.20 per share. A total of 964,000 shares have been repurchased at an average price of $16.65 since the program was approved in the third quarter of 2004. Also contributing to the decline in shareholders’ equity was a decrease in accumulated other comprehensive income of $7.8 million relating to a decline in unrealized gains on investment securities available-for-sale. KNBT also declared and paid a cash dividend of $.05 per share during the quarter ended March 31, 2005. This resulted in a decrease in retained earnings of $1.5 million. Net income for the three months ended March 31, 2005 was $4.8 million.  KNBT committed to release 11,900 shares of the Company’s common stock during the three months ended March 31, 2005 pursuant to the ESOP for a value of $187,000 and issued 8,021 common shares upon the exercise of stock options for proceeds of $45,000. Regulatory capital for KNBT and the Bank at March 31, 2005 and December 31, 2004 are shown in the following tables.
 


   
At March 31, 2005     
  
           
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)
  
$
348,064
    
24.69
%
$
112,764
    
8.00
%
  
N/A
   
N/A
 
Bank
  
$
262,742
    
18.79
%
$
111,878
    
8.00
%
$
139,848
    
10.00
%
Tier I Capital
                          
(To risk-weighted assets)
                          
Company (consolidated)
  
$
337,614
    
23.95
%
$
56,382
    
4.00
%
  
N/A
   
N/A
 
Bank
  
$
252,292
    
18.04
%
$
55,939
    
4.00
%
$
83,909
    
6.00
%
Tier I Capital
                          
(To average assets, leverage)
                          
Company (consolidated)
  
$
337,614
    
14.29
%
$
56,382
    
4.00
%
  
N/A
   
N/A
 
Bank
  
$
252,292
    
10.85
%
$
55,939
    
4.00
%
$
69,924
    
5.00
%

 

   
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
%

 

18




Liquidity. KNBT’s primary sources of funds are from deposits, amortization of loans, loan prepayments and the maturity of loans, mortgage-backed securities and other investments, and other funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. KNBT also maintains excess funds in short-term, interest-bearing assets that provide additional liquidity and also utilizes outside borrowings, primarily from the FHLB, as an additional funding source.  KNBT uses its liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, and to meet operating expenses. In addition to cash flow from loan and securities payments and prepayments as well as from sales of available-for-sale securities and mortgage loans, KNBT has significant borrowing capacity available to fund liquidity needs. KNBT has increased its utilization of FHLB borrowings in recent years as a cost efficient addition to deposits as a source of funds. The average balance of FHLB borrowings was $651.9 million and $248.5 million for the three months ended March 31, 2005 and March 31, 2004, respectively.

“GAP” Analysis. The following interest rate sensitivity “GAP” table sets forth the amounts of KNBT’s interest-earning assets and interest-bearing liabilities outstanding at March 31, 2005, 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 March 31, 2005, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be repaid and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans. Annual prepayment rates for adjustable-rate and fixed-rate single-family and multi-family mortgage loans are assumed to range from 14% to 32%. The annual prepayment rate for mortgage-backed securities is assumed to range from 14% to 32%. Money market deposit accounts, savings accounts and interest-bearing checking accounts are assumed to have annual rates of withdrawal, or “decay rates,” of 30%, 8% and 10%, respectively.

19


   
At March 31, 2005      
  
 
      
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
  
$
95,341
  
$
-
  
$
-
  
$
-
  
$
-
  
$
-
  
$
95,341
  
Loans receivable (2)
    
177,945
   
68,031
   
114,647
   
319,770
   
197,229
   
153,419
   
1,031,042
 
Investment securities, debt
    
107,983
   
36,000
   
72,001
   
333,525
   
208,481
   
299,603
   
1,057,593
 
Investment securities, equity
                                     
40,650
   
40,650
 
 Total interest-earning
                              
 assets
  
$
381,270
  
$
104,032
  
$
186,648
  
$
653,295
  
$
405,710
  
$
493,672
  
$
2,224,626
  
Cumulative total interest-
                              
earning assets
  
$
381,270
  
$
485,301
  
$
671,949
  
$
1,325,244
  
$
1,730,954
  
$
2,224,626
  
$
2,224,626
  
Interest-bearing
                              
liabilities: 
                              
Savings deposits
  
$
-
  
$
8,449
  
$
8,449
  
$
11,229
  
$
14,118
  
$
168,984
  
$
211,230
  
Interest-bearing checking deposits 
    
-
   
10,817
   
7,210
   
7,210
   
3,605
   
151,414
   
180,257
 
Money market deposits
    
25,416
   
30,498
   
20,332
   
33,887
   
16,944
   
127,077
   
254,154
 
Certificates of deposit
    
81,216
   
60,462
   
100,093
   
285,957
   
40,913
   
743
   
569,385
 
FHLB advances and other 
                              
 borrowings
    
127,672
   
16,163
   
59,375
   
262,370
   
159,369
   
61,863
   
686,812
 
 Total interest-bearing
                              
 liabilities
  
$
234,305
  
$
126,389
  
$
195,460
  
$
600,653
  
$
234,949
  
$
510,081
  
$
1,901,837
  
Cumulative total interest-
                              
bearing liabilities
  
$
234,305
  
$
360,694
  
$
556,154
  
$
1,156,807
  
$
1,391,756
  
$
1,901,837
  
$
1,901,837
  
Interest-earning assets
                              
less interest-bearing 
                              
liabilities
  
$
146,965
  
$
(22,357
)
$
(8,812
)
$
52,641
  
$
170,761
  
$
(16,409
)
$
322,789
  
Cumulative interest-rate
                              
sensitivity gap (3)
  
$
146,965
  
$
124,607
  
$
115,795
  
$
168,437
  
$
339,198
  
$
322,789
      
Cumulative interest-rate gap as a
                              
percentage of total assets at 
                              
March 31, 2005
    
6.08
%
  
5.15
%
  
4.79
%
  
6.96
%
  
14.02
%
  
13.35
%
    
Cumulative interest-earning assets
                              
as a percentage of 
                              
cumulative interest-bearing 
                              
liabilities at March 31, 2005 
    
162.72
%
  
134.55
%
  
120.82
%
  
114.56
%
  
124.37
%
  
116.97
%
    
                               
(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 or 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.
 
20
 
Comparison of Operating Results for the Three Months Ended March 31, 2005 and 2004

General. KNBT’s net income increased by $715,000, or 17.4% to $4.8 million for the three months ended March 31, 2005 compared to $4.1 million for the three months ended March 31, 2004. Net income increased during 2005 due to higher levels of net interest income and non-interest income in addition to a lower loan loss provision. These increases were partially offset by increases in non-interest expense. The increase in net interest income primarily reflects increased interest income in the 2005 period due to an increase in the average balance of interest-earning assets. Earning assets increased as a result of the growth of the investment portfolio, due to the implementation of a leverage strategy during 2004, as well as growth of the loan portfolio. KNBT made efforts to control the growth of non-interest expense while growing non-interest income. As result, for the three-month period ended March 31, 2005 compared to the three-month period ended March 31, 2004, non-interest income increased by 12.0% while non-interest expense increased by 7.4%.

Analysis of Net Interest Income. For the three months ended March 31, 2005, KNBT’s net interest income was $16.1 million, a $663,000 or 4.3% increase compared to $15.5 million for the three months ended March 31, 2004. KNBT’s average interest-earning assets totaled $2.2 billion for the three months ended March 31, 2005 as compared to $1.8 billion for the three months ended March 31, 2004. Growth in earning assets was primarily the result of an increase in both the investment securities and loan portfolios. During the first three months of 2005, the average balance of the investment portfolio grew $311.0 million or 38.1% and the average balance of the loan portfolio (gross loans) increased $110.0 million or 12.1%. Growth in interest-bearing liabilities in the first quarter of 2005 compared to the first quarter of 2004 was primarily focused on the increase in FHLB advances to fund the leverage strategy and support the loan growth. For the three months ended March 31, 2005, the average balance of FHLB advances increased by $403.4 million or 162.4% compared to the same period in 2004. Total interest income increased $4.6 million or 20.6% to $27.0 million for the three months ended March 31, 2005 as compared with $22.4 million for the three months ended March 31, 2004. For the three months ended March 31, 2005, total interest expense increased $4.0 million or 57.5% to $10.8 million as compared with $6.9 million for the three months ended March 31, 2004. The major factors in the increase in both interest income and interest expense were the increased average balances of interest-earning assets and interest-bearing liabilities.
 
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 Company’s net interest margin was 2.94% for the three months ended March 31, 2005 as compared with 3.53% for the same period in 2004. The net interest margin on a tax equivalent basis was 3.05% for the three months ended March 31, 2005 compared to 3.68% for the prior year comparable period. Net interest spread on a tax equivalent basis was 2.72% three months ended March 31, 2005 compared to 3.36% for the prior year. The lower interest margin and interest spread in the 2005 periods was the result of the rates paid on interest-bearing liabilities increasing by 42 basis points while interest rates on earning assets declined 22 basis points.

 Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The table includes information adjusted to a tax equivalent basis for the Company’s tax-exempt investment securities. The presentation on a tax-equivalent basis may be considered to include non-GAAP information. Management believes that it is a common industry practice in the banking industry to present such information on a fully tax equivalent basis and that such information is useful to investors in making peer comparisons. The tax-exempt adjustments and comparable GAAP information also is included in the table.




21
 

   
For the Three Months Ended March 31,
  
   
2005
  
2004
  
       
Interest
  
Average
      
Interest
  
Average
  
   
Average
  
Income/
  
Yield/
  
Average
  
Income/
  
Yield/
  
   
Balance
  
Expense
  
Rate
  
Balance
  
Expense
  
Rate
  
Assets
  
(dollars in thousands)
 
Interest-earning assets
                          
Interest-bearing balances with banks
  
$
60,543
  
$
346
    
2.29
%
$
36,390
  
$
142
    
1.56
%
Investment securities
                                      
Taxable (1)
    
1,017,927
   
10,566
   
4.15
%
  
699,329
   
6,871
   
3.93
%
Non-taxable (2)
    
108,544
   
1,759
   
6.48
%
  
116,178
   
1,886
   
6.49
%
Loans receivable (2) (3)
    
1,021,335
   
14,920
   
5.84
%
  
911,362
   
14,104
   
6.19
%
Allowance for loan losses
    
(10,393
)
              
(8,079
)
            
Net loans
    
1,010,942
   
14,920
   
5.90
%
  
903,283
   
14,104
   
6.25
%
Total interest-earning assets
   
2,197,956
   
27,591
   
5.02
%
  
1,755,180
   
23,003
   
5.24
%
Non-interest-earning assets
    
202,307
   
-
         
224,006
   
-
       
Total assets, interest income
  
$
2,400,263
    
27,591
       
$
1,979,186
    
23,003
       
Liabilities
                                      
Interest-bearing liabilities
                                      
Interest-bearing deposits
                                      
Demand deposits
  
$
176,622
    
71
   
0.16
%
$
178,104
    
64
   
0.14
%
Money market deposits
    
247,648
   
792
   
1.28
%
  
238,371
   
542
   
0.91
%
Savings deposits
    
209,538
   
249
   
0.48
%
  
224,034
   
263
   
0.47
%
Certificates of deposit
    
564,659
   
3,987
   
2.82
%
  
536,535
   
3,666
   
2.73
%
Total interest-bearing deposits
    
1,198,467
   
5,099
   
1.70
%
  
1,177,044
   
4,535
   
1.54
%
                                       
Securities sold under agreements
                                      
to repurchase
    
18,732
   
51
   
1.09
%
  
23,296
   
35
   
0.60
%
FHLB advances
    
651,901
   
5,444
   
3.34
%
  
248,470
   
2,124
   
3.42
%
Other debt
    
15,464
   
233
   
6.03
%
  
15,464
   
181
   
4.68
%
Total interest-bearing liabilities
    
1,884,564
   
10,827
   
2.30
%
  
1,464,274
   
6,875
   
1.88
%
                                       
Non-interest-bearing liabilities
                                      
Non-interest-bearing deposits
    
123,805
   
-
   
-
   
115,925
   
-
   
-
 
Other liabilities
   
13,969
   
-
   
-
   
5,594
   
-
   
-
 
Total liabilities
    
2,022,338
   
10,827
         
1,585,793
   
6,875
       
Shareholders' equity /retained earnings
    
377,925
   
-
   
-
   
393,393
   
-
   
-
 
Total liabilities and shareholders'
                                      
equity, interest expense
  
$
2,400,263
    
10,827
       
$
1,979,186
    
6,875
       
                                       
Net interest income on tax equivalent basis (2)
          
16,764
               
16,128
       
Net interest spread on
                                      
tax equivalent basis (4)
                
2.72
%
              
3.36
%
Effect of interest-free sources
                                      
used to fund earning assets
                
0.11
%
              
0.15
%
Net interest margin
                                      
tax equivalent basis (5)
                
3.05
%
              
3.68
%
Tax-exempt adjustment
          
(625
)
              
(652
)
      
                                       
Net interest income and margin (4)
        
$
16,139
    
2.94
%
      
$
15,476
    
3.53
%
Average interest-earning assets
                                      
to average interest-bearing liabilities
                
116.63
%
              
119.87
%
 
   
(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 $625,000 and $652,000 for the three months ended March 31, 2005 and 2004, respectively. The effective tax rate used for the taxable equivalent adjustment was 34%.
(3)
Loan (expenses) fees of $(24,041) and $(34,000) for the three months ended March 31, 2005 and 2004, respectively, are included in interest income. Average loan balances include non-accruing loans of $3.8 million and $2.1 million and
average loans held-for-sale of $1.4 million and $3.3 million for the three months ended March 31, 2005 and 2004, 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.


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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.
 

   
Three Months Ended March 31, 2005
 
   
Compared to Three Months Ended March 31, 2004
  
   
Increase (Decrease)
  
Total
  
   
Due to
  
Increase
  
   
Rate
  
Volume
  
(Decrease)
  
   
(Dollars in Thousands)
  
Interest Income:
              
Cash and cash equivalents
  
$
110
  
$
94
  
$
204
  
Investment securities
    
229
   
3,339
   
3,568
 
Loans receivable, net
    
(886
)
  
1,702
   
816
 
Total interest-earning assets
    
(547
)
  
5,135
   
4,588
 
                     
Interest Expense:
                    
Demand deposits
    
8
   
(1
)
  
7
 
Money market deposits
    
229
   
21
   
250
 
Savings deposits
    
3
   
(17
)
  
(14
)
Certificates of deposit
    
129
   
192
   
321
 
Total interest-bearing deposits
    
369
   
195
   
564
 
                     
Securities sold under agreements
                    
to repurchase
    
23
   
(7
)
  
16
 
FHLB advances and other borrowings
    
(128
)
  
3,448
   
3,320
 
Other debt
    
52
   
-
   
52
 
Total interest-bearing liabilities
    
316
   
3,636
   
3,952
 
                     
Increase (decrease) in net
                    
interest income
  
$
(863
)
$
1,499
  
$
636
  
 
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.

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KNBT made a provision for loan losses of $734,000 for the three months ended March 31, 2005 as compared to $1.5 million for the three months ended March 31, 2004. KNBT believes that it has made provisions to its allowance for loan loss in amounts which are consistent with the reasonably estimable losses in its loan portfolio. During the twelve-month period ending December 31, 2004, KNBT increased the provision for loan loss to $4.3 million; a $1.3 million or 46.0% increase as compared to a provision of $3.0 million for twelve months ending December 31, 2003. The allowance for loan loss to loans at period end increased to 1.03% from ..89% over the same period. A primary factor in the increased provision over the comparable 2004 periods over 2003 was the acquisition of $271.2 million of net loans from the First Colonial acquisition of which commercial loans totaled $61.5 million. Commercial loans and commercial real estate loans are deemed to have higher levels of known and inherent losses than one to four-family residential loans due to, among other things, the nature of the collateral and the dependency on economic conditions for successful completion or operation of the project. KNBT has made provisions in order to maintain the allowance for loan losses at a level, we believe, to the best of our knowledge, covers all known and inherent losses in the portfolio that are both probable and reasonable to estimate at this time. During the three months ended March 31, 2005, most charge-offs were primarily related to consumer loans. Non-performing loans totaled $4.1 million, and $5.1 million at March 31, 2005, and December 31, 2004, respectively.  At March 31, 2005, KNBT’s allowance for loan losses equaled 257.4% of non-performing loans as compared to 206.9% at December 31, 2004. The Company’s allowance for loan losses as a percentage of loans at period end was 1.01% and 1.03% at March 31, 2005 and December 31, 2004, respectively.

Non-Interest Income. Non-interest income increased $475,000 or 12.0% to $4.4 million for the three months ended March 31, 2005 as compared to $4.0 million for the three months ended March 31, 2004. The primary reasons for the increase were increased brokerage service revenues of $388,000 as a result of the acquisition of Oakwood Securities and the hiring of additional, experienced sales professionals, and increased trust revenues from the Company’s Trust Department of $45,000. Non-interest operating income increased $134,000 during the three months ended March 31, 2005 compared to the three months ended March 31, 2004, principally because of a $70,000 increase in check card interchange fees. The increase in non-interest operating income helped offset a $206,000 decline in deposit service charge revenue in the 2005 period. During the three months ended March 31, 2005, KNBT’s net gain on sale of residential mortgage loans increased $59,000 to $218,000 and net gain on sales of investment securities was $432,000 as compared to a net loss of $8,000 for three months ended March 31, 2004.

Non-Interest Expense. Non-interest expense increased by $920,000, or 7.4%, to $13.4 million for the three months ended March 31, 2005 as compared to $12.5 million for the three months ended March 31, 2004. This was the result of higher compensation and benefit costs and higher occupancy and equipment expenses. Compensation and benefit expenses increased $603,000 or 8.3% to $7.8 million for the three months ended March 31, 2005 as compared with $7.2 million for the same period in 2004. The increase reflects the addition of staff members from the fourth quarter 2004 acquisition of Oakwood Securities, amortization of the Management Recognition and Retention Plan, and merit increases. Net occupancy and equipment costs increased $288,000 or 15.8% to $2.1 million for the three months ended March 31, 2005. Building maintenance costs increased $200,000 or 249.9% during the three months ended March 31, 2005 compared to the three months ended March 31, 2004, due to preventive maintenance measures performed on KNBT’s buildings and costs associated with weather. Depreciation expense on equipment increased $446,000 or 211.6% to $846,000 for the three months ended March 31, 2005. This increase reflects costs associated with the addition of equipment and systems necessitated by KNBT’s core system conversion and integration completed during March 2004. KNBT’s core system is now internally operated instead of contracted with a third-party service bureau provider.


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Income Tax Expense. KNBT’s income tax expense was $1.6 million for the three months ended March 31, 2005 compared with $1.3 million for the three months ended March 31, 2004. The effective income tax rate for the three months ended March 31, 2005 was 24.8% as compared to 24.3% for the three-month period ended March 31, 2004.


Item 3.  Quantitative and Qualitative Disclosures About Market Risk

For a discussion of KNBT’s asset and liability management policies as well as the methods used to manage its exposure to the risk of loss from adverse changes in market prices and interest rates see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Interest Rate Sensitivity” in KNBT’s annual report on Form 10-K for the year ended December 31, 2004. There have been no material changes in KNBT’s assessment of its sensitivity to market risk since December 31, 2004.


Item 4.  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 March 31, 2005 that has materially affected or is reasonably likely to materially affect, KNBT’s internal control over financial reporting.


PART II -  OTHER INFORMATION

Item 1. Legal Proceedings

There are no matters required to be reported under this item.


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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information regarding KNBT’s repurchases of its common stock during the quarter ended March 31, 2005.


Period
  
Total Number of Shares Purchased
  
Average Price Paid
Per Share
  
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
  
Maximum Number of Shares that may yet be Purchased Under the Plan or Program(s) (1)
                 
January 1 - 31, 2005
  
-
  
-
  
-
  
2,412,486 (2)
February 1 - 28, 2005
  
-
  
-
  
-
  
2,412,486 (2)
March 1 - 31, 2005
  
314,000
  
$16.20
 
964,000
  
2,098,486 (2)
Total
  
314,000
  
$16.20
 
964,000
  
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 a        
(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
 
 
Item 3. Defaults Upon Senior Securities

There are no matters required to be reported under this item.


Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

There are no matters required to be reported under this item.
 
Item 6. Exhibits

 
(a)
List of exhibits:
   
31.1
Section 302 Certification of the Chief Executive Officer
   
31.2
Section 302 Certification of the Chief Financial Officer
   
32.1
Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


26

SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


 
KNBT BANCORP, INC.
     
     
DATE: May 10, 2005
BY:
/S/ Scott V. Fainor
   
Scott V. Fainor
   
President and Chief Executive Officer
     
     
     
DATE: May 10, 2005
BY:
/S/ Eugene T. Sobol
   
Eugene T. Sobol
   
Senior Executive Vice President,
   
Chief Operating Officer and
   
Chief Financial Officer

 
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