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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended: September 30, 2006
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: 0-29709
HARLEYSVILLE SAVINGS FINANCIAL CORPORATION
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(Exact name of Registrant as specified in its charter)
Pennsylvania 23-3028464
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
271 Main Street, Harleysville, Pennsylvania 19438
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (215) 256-8828
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, $.01 par value per share Nasdaq Global Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. YES [_] NO [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES [_] NO [X]
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 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 the 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). YES [_] NO [X]
The aggregate market value of the 3,404,325 shares of the Registrant's Common
Stock held by non-affiliates 3,864,665 shares outstanding less 460,340 shares
held by affiliates), based upon the closing price of $17.45 for the Common Stock
on March 31, 2006, as reported by the Nasdaq Stock Market, was approximately
$59.4 million. Shares of Common Stock held by each executive officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded since such persons may be deemed affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
Number of shares of Common Stock outstanding as of December 19, 2006: 3,859,958
DOCUMENTS INCORPORATED BY REFERENCE
Set forth below are the documents incorporated by reference and the part of the
Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the year ended
September 30, 2006 are incorporated by reference into Part II, Items
5-8 and Part IV, Item 15 of this Form 10-K.
(2) Portions of the definitive Proxy Statement for the 2007 Annual Meeting
of Stockholders are incorporated by reference into Part III, Items
10-14 of this Form 10-K.
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HARLEYSVILLE SAVINGS FINANICAL CORPORATION
2006 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
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PART I
Item 1. Business.................................................................................. 1
Item 1A. Risk Factors.............................................................................. 22
Item 1B. Unresolved Staff Comments................................................................. 24
Item 2. Properties................................................................................ 24
Item 3. Legal Proceedings......................................................................... 25
Item 4. Submission of Matters to a Vote of Security Holders....................................... 25
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities..................................................... 25
Item 6. Selected Financial Data................................................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................ 25
Item 8. Financial Statements and Supplementary Data............................................... 26
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...... 26
Item 9A. Controls and Procedures................................................................... 26
Item 9B. Other Information......................................................................... 26
PART III
Item 10. Directors and Executive Officers of the Registrant........................................ 26
Item 11. Executive Compensation.................................................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters................................................................................... 27
Item 13. Certain Relationships and Related Transactions............................................ 27
Item 14. Principal Accounting Fees and Services.................................................... 27
PART IV
Item 15. Exhibits, Financial Statement Schedules................................................... 27
SIGNATURES
i
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward looking
statements (as defined in the Securities Exchange Act of 1934 and the
regulations hereunder). Forward looking statements are not historical facts but
instead represent only the beliefs, expectations or opinions of Harleysville
Savings Financial Corporation and its management regarding future events, many
of which, by their nature, are inherently uncertain. Forward looking statements
may be identified by the use of such words as: "believe", "expect",
"anticipate", "intend", "plan", "estimate", or words of similar meaning, or
future or conditional terms such as "will", "would", "should", "could", "may",
"likely", "probably", or "possibly." Forward looking 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, uncertainties
and assumption, many of which are difficult to predict and generally are beyond
the control of Harleysville Savings Financial Corporation and its management,
that could cause actual results to differ materially from those expressed in, or
implied or projected by, forward looking 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)
competitive pressure among depository institutions increasing significantly; (4)
changes in the interest rate environment causing reduced interest margins; (5)
general economic conditions, either nationally or in the markets in which
Harleysville Savings Financial Corporation is or will be doing business, being
less favorable than expected;(6) political and social unrest, including acts of
war or terrorism; or (7) legislation or changes in regulatory requirements
adversely affecting the business in which Harleysville Savings Financial
Corporation will be engaged. Harleysville Savings Financial Corporation
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.
As used in this report, unless the context otherwise requires, the
terms "we," "us," or the "Company" refer to Harleysville Savings Financial
Corporation, a Pennsylvania corporation, and the term the "Bank" refers to
Harleysville Savings Bank, a Pennsylvania chartered savings bank and wholly
owned subsidiary of the Company. In addition, unless the context otherwise
requires, references to the operations of the Company include the operations of
the Bank.
PART I
Item 1. Business.
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General
Harleysville Savings Financial Corporation is a Pennsylvania
corporation headquartered in Harleysville, Pennsylvania. The Company became the
bank holding company for Harleysville Savings Bank in connection with the
holding company reorganization of the Bank in February 2000 (the
"Reorganization"). In August 1987, the Bank's predecessor, Harleysville Savings
Association, converted to the stock form of organization. The Bank, whose
predecessor was originally incorporated in 1915, converted from a Pennsylvania
chartered, permanent reserve fund savings association to a Pennsylvania
chartered stock savings bank in June 1991. The Bank operates from six
full-service offices located in Montgomery County, Pennsylvania. The Bank's
primary market area includes Montgomery County, which has the third largest
population and the second highest per capita income in the Commonwealth of
Pennsylvania, and, to a lesser extent, Bucks County. As of September 30, 2006,
the Company had $775.6 million of total assets, $429.3
1
million of deposits and $48.5 million of stockholders' equity. The Company's
stockholders' equity constituted 6.25% of total assets as of September 30, 2006.
The Bank's primary business consists of attracting deposits from the
general public through a variety of deposit programs and investing such deposits
principally in first mortgage loans secured by residential properties in the
Bank's primary market area. The Bank also originates a variety of consumer
loans, predominately home equity loans and lines of credit also secured by
residential properties in the Bank's primary lending area. The Bank serves its
customers through its full-service branch network as well as through remote ATM
locations, the internet and telephone banking.
Deposits with the Bank are insured to the maximum extent provided by
law through the Savings Association Insurance Fund ("SAIF") administered by the
Federal Deposit Insurance Corporation ("FDIC"). The Bank is subject to
examination and comprehensive regulation by the FDIC and the Pennsylvania
Department of Banking ("Department"). It is also a member of the Federal Home
Loan Bank of Pittsburgh ("FHLB of Pittsburgh" or "FHLB"), which is one of the 12
regional banks comprising the Federal Home Loan Bank System ("FHLB System"). The
Bank is also subject to regulations of the Board of Governors of the Federal
Reserve System ("Federal Reserve Board") governing reserves required to be
maintained against deposits and certain other matters.
The Company's principal executive offices are located at 271 Main
Street, Harleysville, Pennsylvania 19438 and its telephone number is (800)
243-8700.
Competition
The Company faces significant competition in attracting deposits. Its
most direct competition for deposits has historically come from commercial banks
and other savings institutions located in its market area. The Company faces
additional significant competition for investors' funds from other financial
intermediaries. The Company competes for deposits principally by offering
depositors a variety of deposit programs, convenient branch locations, hours and
other services. The Company does not rely upon any individual group or entity
for a material portion of its deposits.
The Company's competition for real estate loans comes principally from
mortgage banking companies, other savings institutions, commercial banks and
credit unions. The Bank competes for loan originations primarily through the
interest rates and loan fees it charges, the efficiency and quality of services
it provides borrowers, referrals from real estate brokers and builders, and the
variety of its products. Factors which affect competition include the general
and local economic conditions, current interest rate levels and volatility in
the mortgage markets.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") eliminated many of the distinctions between commercial banks and
savings institutions and holding companies and allowed bank holding companies to
acquire savings institutions. FIRREA has generally resulted in an increase in
the competition encountered by savings institutions and has resulted in a
decrease in both the number of savings institutions and the aggregate size of
the savings industry.
Lending Activities
Loan Portfolio Composition. The Company's loan portfolio is
predominantly comprised of loans secured by first mortgages on single-family
residential properties. As of September 30, 2006, first mortgage loans on
residential properties, including loans on single-family and multi-family
residential properties and construction loans on such properties, amounted to
$97.8 million or 16.0% of the Company's total loan and
2
mortgage-backed securities portfolio. Loans on the Company's residential
properties are primarily long-term and are conventional (i.e., not insured or
guaranteed by a federal agency). At September 30, 2006, mortgage-backed
securities totaled $220.3 million and comprised 35.9% of the portfolio.
As of September 30, 2006, loans secured by commercial real estate
comprised $5.9 million or 1.0% of the total loan and mortgage-backed securities
portfolio. Consumer loans, including installment home equity loans, home equity
lines of credit, automobile loans, loans on savings accounts and education
loans, constituted $97.8 million or 16.0% of the total loan and mortgage-backed
securities portfolio as of September 30, 2006.
As of September 30, 2006, the Company had $220.3 million, or 35.9%, of
the total portfolio invested in Federal Home Loan Mortgage Corporation
("FHLMC"), Government National Mortgage Association ("GNMA") or Federal National
Mortgage Association ("FNMA") backed securities. FHLMC securities are guaranteed
by the FHLMC, GNMA securities by the Federal Housing Administration and FNMA
securities by the FNMA, which are an instrumentality of the United States
government, and, pursuant to federal regulations, are deemed to be part of the
Company's loan portfolio.
The following table sets forth information concerning the Company's
loan and mortgage-backed securities portfolio by type of loan at the dates
indicated.
As of September 30,
------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------------ ------------------ ------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
Residential:
Single-family $278,621 45.4% $267,246 41.8% $255,023 41.7% $234,748 43.6% $233,057 46.7%
Multi-family 2,933 0.5 2,893 0.5 914 0.2 1,515 0.3 1,056 0.2
Construction 6,987 1.1 7,640 1.2 7,971 1.3 10,028 1.9 8,607 1.7
Lot loans 626 0.1 801 0.1 576 0.1 923 0.2 1,247 0.2
Mortgage-backed
securities 220,314 35.9 265,009 41.5 265,087 43.2 230,247 42.6 193,330 38.8
Commercial 5,894 1.0 2,002 0.3 2,141 0.4 1,015 0.2 496 0.1
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Total real estate
loans and mortgage-
backed securities 515,375 84.0 545,591 85.4% 531,712 86.9% 478,476 88.8% 437,793 87.7%
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Consumer loans:
Education loans -- -- -- -- -- -- 1 -- 334 0.1%
Installment equity loans 70,515 11.5 59,724 9.4% 46,257 7.6% 29,726 5.5% 41,451 8.3
Line of credit loans 25,500 4.3 31,580 5.0 32,329 5.3 29,420 5.5 18,530 3.7
Savings account loans 1,003 0.2 921 0.1 811 0.1 733 0.1 479 0.1
Automobile and other
loans 812 0.1 772 0.1 732 0.1 578 0.1 726 0.1
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Total consumer loans 97,830 16.0% 92,997 14.6% 80,129 13.1% 60,458 11.2% 61,520 12.3%
Total loans receivable
and mortgage-backed
securities 613,205 100.0% 638,588 100.0% 611,841 100.0% 538,934 100.0% 499,313 100.0%
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
Less:
Loans in process (4,941) (4,934) (5,238) (7,829) (6,503)
Deferred loan fees (544) (671) (955) (1,520) (2,091)
Allowance for loan
losses (1,956) (1,968) (1,977) (1,991) (2,035)
-------- -------- -------- -------- --------
Total loans receivable
and mortgage-backed
securities, net $605,764 $631,015 $603,671 $527,594 $488,684
======== ======== ======== ======== ========
Contractual Maturities. The following table sets forth scheduled
contractual maturities of the loan and mortgage-backed securities portfolio of
the Company as of September 30, 2006 by categories of loans and securities. The
principal balance of the loan is set forth in the period in which it is
scheduled to mature. This table does not reflect loans in process or unamortized
premiums, discounts and fees.
3
Principal Repayments Contractually Due in Year(s) Ended September 30,
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Principal Balance
at September 30, 2009- 2012- 2016- 2021-and
2006 2007 2008 2011 2015 2020 Thereafter
------------ ------------ ------------ ------------ ------------ ------------ ------------
(In Thousands)
Real estate loans:
Residential
Single-family $ 278,621 $ 4,179 $ 4,458 $ 15,046 $ 34,270 $ 49,037 $ 171,631
Multi-family 2,933 44 47 158 361 516 1,807
Construction 6,987 105 112 377 859 1,230 4,304
Lot loans 626 34 37 126 284 145 --
Mortgage-backed Securities 220,314 3,305 3,745 12,338 27,760 38,996 134,171
Commercial 5,894 212 230 807 1,868 2,776 --
Consumer and other loans 97,830 12,033 12,914 44,782 22,012 6,090 --
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total(1) $ 613,205 $ 19,912 $ 21,542 $ 73,634 $ 87,414 $ 98,790 $ 311,912
============ ============ ============ ============ ============ ============ ============
---------------
(1) With respect to the $593.3 million of loans with principal maturities
contractually due after September 30, 2006, $573.0 million have fixed
rates of interest and $20.3 million have adjustable or floating rates
of interest.
Contractual principal maturities of loans do not necessarily reflect
the actual term of the Company's loan portfolio. The average life of mortgage
loans is substantially less than their contractual terms because of loan
prepayments and because of enforcement of due-on-sale clauses, which give the
Company the right to declare a loan immediately due and payable in the event,
among other things, that the borrower sells the real property subject to the
mortgage and the loan is not repaid. The average life of mortgage loans tends to
increase when current mortgage loan rates substantially exceed rates on existing
mortgage loans and, conversely, decrease when rates on existing mortgage loans
substantially exceed current mortgage loan rates.
Interest rates charged by the Company on loans are affected principally
by the demand for such loans and the supply of funds available for lending
purposes. These factors are, in turn, affected by general economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, legislative tax policies and government budgetary matters. The interest
rates charged by the Company are competitive with those of other local financial
institutions.
Origination, Purchase and Sale of Loans. Although the Company has
general authority to originate, purchase and sell loans secured by real estate
located throughout the United States, the Company's lending activities are
focused in its assessment area of Montgomery County, Pennsylvania and
surrounding suburban counties.
The Company accepts loan applications through its branch network, and
also accepts mortgage applications from mortgage brokers who are approved by the
Board of Directors to do business with the Company. The Company generally does
not engage in the purchase of whole loans or loan participations.
The Company sold $921,000 and $2.6 million of loans during fiscal 2005
and 2004, resulting in a gain of approximately $17,000 and $61,000,
respectively. During the year ended September 30, 2006, the Company did not sell
any loans.
The Company's total loan originations decreased by $6.1 million or 5.4%
in fiscal 2006 and decreased by $24.2 million or 17.6% in fiscal 2005. Of the
$107.3 million and $113.4 million of single-family loans originated in fiscal
2006 and 2005, respectively, $7.4 million and $8.7 million, respectively, were
loans originated to fund multi-family and construction properties, $54.2 million
and $60.6 million, respectively, were loans to acquire residential property.
During this period, the Company's originations of consumer loans amounted to
$45.7 million and $44.1 million or 42.6% and 38.9% of total loan originations
during fiscal 2006
4
and 2005, respectively. Management intends to continue to emphasize origination
of consumer loans which may have adjustable rates, and generally have shorter
terms than residential real estate loans.
The following table shows total loans originated, sold and repaid
during the periods indicated.
Year Ended September 30,
----------------------------------
2006 2005 2004
--------- --------- ---------
(In Thousands)
Real estate loan originations:
Residential:
Single-family $ 54,249 $ 60,608 $ 69,124
Multi-family 493 1,300 300
Construction 6,886 7,433 9,526
Lot loans -- -- --
--------- --------- ---------
Total real estate loan originations 61,628 69,341 78,950
Consumer loan originations(1) 45,688 44,057 58,655
--------- --------- ---------
Total loan originations 107,316 113,398 137,605
Purchases of mortgage-backed securities 2,001 62,027 121,201
--------- --------- ---------
Total loan originations, and purchases 109,317 175,425 258,806
Principal loan and mortgage-backed securities repayments 134,700 147,757 183,321
Sales of loans and mortgage-backed securities -- 921 2,578
--------- --------- ---------
Total principal repayments and sales 134,700 148,678 185,899
--------- --------- ---------
Net (decrease) increase in loans $ (25,383) $ 26,747 $ 72,907
========= ========= =========
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(1) Includes installment home equity loans, home equity lines of credit,
vehicle loans, Pennsylvania Higher Education Assistance loans, secured
and unsecured personal loans and lines of credit.
Loan Underwriting Policies. Each loan application received by the
Company is underwritten to the standards of the Company's written underwriting
policies as adopted by the Company's Board of Directors. The Company's Board of
Directors has granted loan approval authority to several officers and employees
of the Company, provided that the loan meets the guidelines set out in its
written underwriting policies. Individual approval authority of $500,000 has
been granted to the Company's Chief Executive Officer, the Company's President,
and the Company's Chief Lending Officer. Joint approval authority of $1.0
million has been granted to a combination of at least two of the above named
individuals. Individual lending authority of $250,000 has been granted to the
Bank's Assistant Vice President/Loan Administration Manager, the Assistant Vice
President/Loan Customer Service Manager and to the Bank's Consumer Loan and
Residential Mortgage Underwriter, employed by the Company. Additional consumer
loan lending authority of $50,000 has been granted to several delegated
underwriters, employed by the Bank. Loans with policy exceptions require
approval by the next highest approval authority. Loans over $1.0 million must be
approved by the Company's Board of Directors.
In the exercise of any loan approval authority, the officers of the
Company will take into account the risk associated with the extension of credit
to a single borrower, borrowing entity, or affiliation. The Company has an
aggregate loans to one borrower limit of 15% of the Company's unimpaired capital
and unimpaired surplus in accordance with federal regulations. At September 30,
2006, the largest aggregate amount of loans outstanding to any borrower,
including related entities, was $2.0 million, which did not exceed the Company's
loan to one borrower limitation.
5
Real Estate Lending. The Company is permitted to lend up to 100% of the
appraised value of the real property securing a loan. The Company will generally
lend up to 95% of the lesser of the appraised value or the sale price for the
purchase of single-family, owner-occupied dwellings which conform to the
secondary market underwriting standards. Refinancings are limited to 90% or
less. Loans over $417,000 and other non-conforming loans, secured by 1-4
residential, owner-occupied dwellings, are limited to 90% of the lesser of the
purchase price or appraised value. The purchase of non-owner occupied, 1-4 unit
dwellings may be financed to 80% of the lower of the appraisal or sale price; a
refinance is limited to 70% of the appraised value if the borrower's FICO score
is less than 720 and the transaction's purpose is cash-out.
All appraisals and other property valuations are performed by
independent fee appraisers approved by the Company's Senior Loan Committee. On
all amortizing real estate loans, the Company requires borrowers to obtain title
insurance, insuring the Company has a valid first lien on the mortgaged real
estate. Borrowers must also obtain and maintain a hazard insurance policy prior
to closing and, when the real estate is located in a flood hazard area
designated by the Federal Emergency Management Agency, a flood insurance policy
is required. Generally, borrowers advance funds on a monthly basis together with
payment of principal and interest into a mortgage escrow account from which the
Company makes disbursements for items such as real estate taxes and insurance
premiums when appropriate as they fall due.
The Company presently originates fixed-rate loans on single-family
residential properties pursuant to underwriting standards consistent with
secondary market guidelines, and which may or may not be sold into the secondary
mortgage market as conditions warrant. Adjustable rate mortgages ("ARMs"), as
well as non-conforming and jumbo fixed-rate loans in amounts up to $1.0 million,
are held in the portfolio. It is the Company's policy to originate both
fixed-rate loans and ARMs for terms up to 30 years. As of September 30, 2006,
$285.6 million or 46.6% and $2.9 million or 0.5% of the Company's total loan and
mortgage-backed securities portfolio consisted of single-family (including
construction loans) and multi-family residential loans, respectively. As of
September 30, 2006, approximately $478.5 million or 92.8% of the Company's total
mortgage loans and mortgage-backed securities portfolio consisted of fixed-rate,
single-family residential mortgage loans. As of such date, $36.9 million or 7.2%
of the total mortgage loan portfolio consisted of adjustable-rate single-family
residential mortgage loans and mortgage-backed securities. Most of the Company's
residential mortgage loans include "due on sale" clauses.
During the years ended September 30, 2006 and 2005, the Company
originated $9.1 million and $5.9 million of ARM mortgages, respectively. ARMs
represented 20.0% and 9.7% of the Company's total mortgage loan portfolio
originations in fiscal 2006 and 2005, respectively. The ARM mortgages offered by
the Company are originated with initial adjustment periods varying from one to
10 years, and provide for initial rates of interest below the rates which would
prevail were the index used for repricing applied initially. The Company expects
to emphasize the origination of ARMs as market conditions permit, in order to
reduce the impact of rising interest rates in the market place. Such loans,
however, may not adjust as rapidly as changes in the Company's cost of funds.
The Company also originates, to a lesser extent, loans secured by
multi-family rental units or properties with some commercial usage. The primary
method used by the Company to evaluate a multi-family residential or commercial
mortgage loan is based on both the fair market value of the property and an
income approach pursuant to which the Company determines if the income from the
project will be sufficient to support the related debt and other associated
costs. The Company also considers a review of the costs to develop the project
and the overall financial strength of the borrower. Multi-family residential
loans are made on an adjustable rate basis for a maximum term of 25 years or a
fixed rate of 10 years or less.
Construction Loans. The Company offers fixed-rate and adjustable-rate
construction loans on residential properties. Residential construction loans are
originated for individuals who are building their
6
primary residence as well as to selected local builders for construction of
single-family dwellings. As of September 30, 2006, $6.9 million or 1.1% of the
total loan and mortgage-backed securities portfolio consisted of construction
loans.
Construction loans to homeowners are usually made in connection with
the permanent financing on the property. The permanent loans have amortizing
terms up to 30 years, following the initial construction phase during which time
the borrower pays interest on the funds advanced. These loans are reclassified
as permanent mortgage loans when the residences securing the loans are
completed. The Company will make construction/permanent loans up to a maximum of
90% of the fair market value of the completed project. The rate on the loan
during construction is the same rate as the Company will charge on the permanent
loan on the completed project. Advances are made on a percentage of completion
basis with the Company's receipt of a satisfactory inspection report of the
project.
Historically, the Company has been active in on-your-lot home
construction lending and intends to continue to emphasize such lending. Although
construction lending is generally considered to involve a higher degree of risk
of loss than long-term financing on improved, occupied real estate, the Company
historically has not experienced any significant problems.
The Company also offers mortgage loans on undeveloped single lots held
for residential construction. These loans are generally fixed-rate loans with
terms not exceeding 15 years; they are not a significant part of the Company's
lending activities.
Consumer and Other Loans. The Company actively originates consumer
loans to provide a wider range of financial services to its customers and to
improve the interest rate sensitivity of its interest-earning assets.
Originations of consumer loans as a percent of total loan originations amounted
to 42.6% and 38.9% during fiscal 2006 and 2005, respectively. The shorter-term
and normally higher interest rates on such loans help the Company to maintain a
profitable spread between its average loan yield and its cost of funds. The
Company's consumer loan department offers a variety of loans, including home
equity installment loans and lines of credit, vehicle loans, personal loans and
lines of credit. Loans secured by deposit accounts at the Company are also made
to depositors in an amount up to 90% of their account balances with terms of up
to 15 years.
Home equity loans continue to be a popular product and represented $96
million or 15.7% of the loan and mortgage-backed securities portfolio at
September 30, 2006. After taking into account first mortgage balances, the
Company will lend up to 80% of the value of owner-occupied property on fixed
rate terms up to 15 years. This amount may be raised to 100% when considering
other factors, such as excellent credit history and income stability. At
September 30, 2006, the Company had outstanding 3,041 home equity loans of which
1,773 were installment equity loans and 1,268 were line of credit loans. As of
such date, the Company had an outstanding balance on line of credit loans of
approximately $25.5 million and there was approximately $40.8 million of unused
credit available on such loans.
Consumer loans generally involve more risk of collectibility than
mortgage loans because of the type and nature of the collateral and, in certain
cases, the absence of collateral. As continued payments are dependent on the
borrower's continuing financial stability, these loans may be more likely to be
adversely affected by job loss, divorce, personal bankruptcy or by adverse
economic conditions.
Loan Fee and Servicing Income. The Company receives fees both for the
origination of loans and for making commitments to originate and purchase
residential and commercial mortgage loans. The Company also receives servicing
fees with respect to residential mortgage loans it has sold. It also receives
loan fees related to existing loans, including late charges, and credit life
insurance commissions. Loan origination and
7
commitment fees and discounts are a volatile source of income, varying with the
volume and type of loans and commitments made and purchased and with competitive
and economic conditions.
Loans fees generated on origination of real estate mortgage loans under
accounting principles generally accepted in the United States of America are
deferred to the extent that they exceed the costs of originating such loans.
Deferred loan fees and discounts on mortgage loans purchased are amortized to
income as a yield adjustment over the estimated remaining terms of such loans
using the interest method. The Company recorded servicing income of $52,000,
$138,000 and $459,000 in deferred loan fees in fiscal 2006, 2005 and 2004,
respectively.
In its real estate lending, the Company charges loan fees which are
calculated as a percentage of the amount borrowed. The fees received in
connection with the origination of residential real estate loans and commercial
real estate loans generally do not exceed 3% of the principal amount. All
origination fees in excess of loan origination costs are deferred and amortized
into income over the estimated life of the related loans.
As of September 30, 2006, the Company was servicing $3.9 million of
loans for others, which related to loans sold by the Company to the FHLMC and
Federal Home Loan Bank of Pittsburgh in the amounts of $270,000 and $3.6
million, respectively. The Company receives a servicing fee of 0.25% on such
loans.
Non-performing Loans and Real Estate Owned. When a borrower fails to
make a required loan payment, the Company attempts to cure the default by
contacting the borrower; generally, after a payment is more than 15 days past
due, at which time a late charge is assessed. Defaults are cured promptly in
most cases. If the delinquency on a mortgage loan exceeds 60 days and is not
cured through the Company's normal collection procedures, or an acceptable
arrangement is not worked out with the borrower, the Company will institute
measures to remedy the default. This may include commencing a foreclosure action
or, in special circumstances, accepting from the borrower a voluntary deed of
the secured property in lieu of foreclosure with respect to mortgage loans and
equity loans, or title and possession of collateral in the case of other
consumer loans. Substantial delays may occur in instituting and completing
residential foreclosure proceedings due to the extensive procedures and time
periods required to be complied with under Pennsylvania law.
All interest accrued but not collected for loans that are placed
nonaccrual or charged off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all
the principal and interest amounts contractually due are brought current and
future payments are reasonably assured. Interest income is recognized using the
interest method when the collection is reasonably assured. The Company had no
loans outstanding which were recorded as loans accounted for on a non-accrual
basis as of the end of fiscal 2006 and 2005.
If foreclosure is effected, the property is sold at a public auction in
which the Company may participate as a bidder. If the Company is the successful
bidder, the acquired real estate property is then included in the Company's real
estate owned ("REO") account until it is sold. When property is acquired, it is
recorded at the lower of cost or market value at the date of acquisition less
estimated cost to sell and any write-down resulting is charged to the allowance
for loan losses. Interest accrual, if any, ceases on the date of acquisition and
all costs incurred in maintaining the property from that date forward are
expended. Costs incurred for the improvement or development of such property are
capitalized. The Company is permitted under Department regulations to finance
sales of real estate owned by "loans to facilitate," which may involve more
favorable interest rates and terms than generally would be granted under the
Company's underwriting guidelines. The Company had no REO at the end of fiscal
2006 and 2005.
8
The following table sets forth information regarding non-accrual loans,
loans which are 90 days or more delinquent but on which the Company is accruing
interest, troubled debt restructuring, and other real estate owned held by the
Company at the dates indicated. The Company continues to accrue interest on
loans which are 90 days or more overdue where management believes that such
interest is collectible.
As of September 30,
--------------------------
2006 2005 2004
------ ------ ------
(Dollars in Thousands)
Residential real estate loans:
Non-accrual loans $ -- $ -- $ --
Accruing loans 90 days overdue 18 260 291
Troubled debt restructurings -- -- --
------ ------ ------
Total 18 260 291
------ ------ ------
Consumer loans:
Non-accrual loans -- -- --
Accruing loans 90 days overdue -- -- --
Troubled debt restructurings -- -- --
------ ------ ------
Total -- -- --
------ ------ ------
Total non-performing loans:
Non-accrual loans -- -- --
Accruing loans 90 days overdue 18 260 291
Troubled debt restructurings -- -- --
------ ------ ------
Total $ 18 $ 260 $ 291
====== ====== ======
Total non-performing loans to total loans .004% .07% .09%
Total real estate owned, net of related reserves -- -- --
Total non-performing loans and other real
estate owned to total assets .002% .03% .04%
Management establishes reserves for losses on delinquent loans when it
determines that losses are probable. The Company did not record a provision for
general loan losses in fiscal 2006, 2005 or 2004 due to the overall performance
of the loan portfolio and management's assessment of the overall adequacy of the
allowance for loan losses. Although management believes that it uses the best
information available to make determinations with respect to loan loss reserves,
future adjustments to reserves may be necessary if economic conditions differ
substantially from the assumptions used in making the initial determinations.
Residential mortgage lending generally entails a lower risk of default than
other types of lending. Consumer loans and commercial real estate loans
generally involve more risk of collectibility because of the type and nature of
the collateral and, in certain cases, the absence of collateral. It is the
Company's policy to establish specific reserves for losses on delinquent
consumer loans and commercial loans when it determines that losses are probable.
In addition, consumer loans are charged against reserves if they are more than
120 days delinquent unless a satisfactory repayment schedule is arranged.
Although management has currently established no specific reserves for losses,
no assurance can be given as to whether future provisions may be required. The
establishment of any such reserves could affect net income.
The following table summarizes activity in the Company's allowance for
loan losses during the periods indicated.
9
Year Ended September 30,
---------------------------------------------------------------------------
2006 2005 2004 2003 2002
----------- ----------- ----------- ----------- -----------
Allowances at beginning of year $ 1,967,607 $ 1,976,849 $ 1,990,672 $ 2,034,832 $ 2,036,188
Provision for loan losses charged to
operating expenses -- -- -- -- --
Recoveries 8,524 83,707 1,571 -- 5,113
Loans charged off (20,326) (92,949) (15,394) (44,160) (6,469)
----------- ----------- ----------- ----------- -----------
Allowances at end of year $ 1,955,805 $ 1,967,607 $ 1,976,849 $ 1,990,672 $ 2,034,832
=========== =========== =========== =========== ===========
Ratio of net charge-offs to average loans
outstanding -- -- -- -- --
Ratio of allowances to period-end loans .50% .54% .58% .66% .68%
Investment Activities
The Company is required to maintain certain liquidity ratios and does
so by investing in securities that qualify as liquid assets under FDIC
regulations. Such securities include obligations issued or fully guaranteed by
the United States government, certain federal agency obligations, certain time
deposits and certificates of deposit as well as other specified investments. See
"Regulation - Federal Home Loan Bank System."
The Company's investment portfolio consists primarily of United States
Treasury securities and obligations of United States government agencies. The
other investments include interest-bearing deposits in other banks, tax-exempt
obligations, money market mutual funds, and stock of the FHLB of Pittsburgh. The
Company has primarily invested in instruments that reprice within five years;
the amount of such investments as of September 30, 2006 was $57.3 million.
The following table sets forth the Company's investment portfolio at
carrying value as of the dates indicated.
2006 2005 2004
-------- -------- --------
Interest-bearing deposits at
other depository institutions $ 8,453 $ 6,742 $ 3,040
Tax-exempt obligations 24,596 24,799 24,966
Money market mutual funds 7,110 1,976 6,685
Equities 997 859 1,029
U.S. Government and agency
obligations held to maturity 86,503 62,566 43,196
FHLB of Pittsburgh stock 15,499 16,036 15,184
-------- -------- --------
Total $143,158 $112,978 $ 94,100
======== ======== ========
The Company's investment strategy is set and reviewed periodically by
the entire Board of Directors.
Sources of Funds
General. Deposits are the primary source of the Company's funds for use
in lending and for other general business purposes. In addition to deposits, the
Company obtains funds from loan payments and prepayments, FHLB advances and
other borrowings, and, to a lesser extent, sales of loans. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general market interest rates and economic
conditions.
10
Deposits. The Company has a number of different programs designed to
attract both short-term and long-term deposits from the general public by
providing an assortment of accounts and rates consistent with FDIC regulations.
These programs include passbook and club savings accounts, NOW and regular
checking accounts, money market deposit accounts, retirement accounts,
certificates of deposit ranging in terms from 90 days to 60 months and jumbo
certificates of deposit in denominations of $98,000 or more. The interest rates
on the Company's various accounts are determined weekly by the Interest Rate
Risk Management Officer based on reports prepared by members of senior
management. The Company attempts to control the flow of deposits by pricing its
accounts to remain competitive with other financial institutions in its market
area.
The Company's deposits are obtained primarily from residents of
Montgomery and Bucks Counties; the Company does not utilize brokered deposits.
The principal methods used by the Company to attract deposit accounts include
local advertising, offering a wide variety of services and accounts, competitive
interest rates and convenient office locations. The Company also is a member of
the "STAR" ATM network.
The following table shows the distribution of, and certain other
information relating to, the Company's deposits by type as of the dates
indicated.
As of September 30,
-----------------------------------------------------------------
2006 2005 2004
------------------- ------------------- -------------------
Percent of Percent of Percent of
Amount Deposits Amount Deposits Amount Deposits
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Passbook and club accounts $ 3,325 0.8% $ 3,807 0.9% $ 4,047 1.0%
NOW accounts 15,720 3.7 18,283 4.4 19,839 4.9
Checking accounts 30,749 7.2 18,721 4.5 11,767 2.9
Money market demand accounts 58,174 13.6 75,874 18.1 99,225 24.5
Certificates of deposit:
6 month 5,019 1.2 8,126 1.9 8,650 2.1
9 month 25,508 5.9 10,630 2.5 3,031 0.8
12 month 22,747 5.3 10,110 2.4 16,471 4.1
15 month 45,565 10.6 17,063 4.1 4,554 1.1
17 month 1,215 0.3 1,485 0.3 2,474 0.6
18 month 6,443 1.5 11,125 2.7 18,967 4.7
20 month 7,810 1.8 9,685 2.3 -- --
24 month 4,796 1.1 7,740 1.8 12,297 3.0
27 month 4,112 1.0 4,966 1.2 12,326 3.0
36 month 24,892 5.8 29,302 7.0 35,024 8.7
48 month 71,565 16.7 82,402 19.7 60,392 14.9
60 month 32,321 7.5 38,431 9.2 38,901 9.6
Other 13,104 3.1 16,924 4.0 7,057 1.7
Retirement accounts:
Money market deposit accounts 815 0.2 707 0.2 1,224 0.3
Certificates of deposit 55,374 12.9 53,599 12.8 48,985 12.1
-------- -------- -------- -------- -------- --------
Total deposits $429,254 100.00% $418,980 100.0% $405,231 100.0%
======== ======== ======== ======== ======== ========
The large variety of deposit accounts offered by the Company has
increased the Company's ability to retain deposits and has allowed it to be
competitive in obtaining new funds, although the threat of disintermediation
(the flow of funds away from savings institutions into direct investment
vehicles such as government and corporate securities and non-deposit products)
still exists. The new types of accounts; however, have been more costly than
traditional accounts during periods of high interest rates. In addition, the
Company has become more vulnerable to short-term fluctuations in deposit flows
as customers have become more rate-conscious and willing to move funds into
higher yielding accounts. The ability of the Company to
11
attract and retain deposits and the Company's cost of funds have been, and will
continue to be, significantly affected by money market conditions.
The following table presents certain information concerning the
Company's deposit accounts as of September 30, 2006 and the scheduled quarterly
maturities of its certificates of deposit.
Weighted
Percentage of Average
Amount Total Deposits Nominal Rate
------ -------------- ------------
(Dollars in Thousands)
Passbook and club accounts $ 3,325 0.8% 1.17%
NOW accounts 15,720 3.7 0.25
Checking accounts 30,749 7.2 1.63
Money market deposits accounts(1) 58,989 13.7 1.58
---------- ---------- ----------
Total $ 108,783 25.3% 1.39%
========== ========== ==========
Certificate accounts maturing by quarter:
December 31, 2006 $ 68,436 15.9% 3.62%
March 31, 2007 62,135 14.5 3.80
June 30, 2007 45,441 10.6 4.46
September 30, 2007 33,095 7.7 4.67
December 31, 2007 13,087 3.0 4.40
March 31, 2008 15,442 3.6 3.85
June 30, 2008 14,616 3.4 3.73
September 30, 2008 28,199 6.6 3.99
December 31, 2008 16,760 3.9 3.95
March 31, 2009 7,969 1.9 3.92
June 30, 2009 5,496 1.3 3.88
September 30, 2009 2,265 0.5 3.77
Thereafter 7,530 1.8 4.05
---------- ---------- ----------
Total certificate accounts(1) 320,471 74.7 4.00
---------- ---------- ----------
Total deposits $ 429,254 100.0% 3.34%
========== ========== ==========
-----------------------
(1) Includes retirement accounts.
Management of the Company expects, based on historical experience and
its pricing policies, to retain a significant portion of the $209.1 million of
certificates of deposit which mature during the 12 months ending September 30,
2007.
The following table sets forth the net deposit flows of the Company
during the periods indicated.
Year Ended September 30,
-------------------------------
2006 2005 2004
-------- -------- --------
(In Thousands)
Increase (decrease) before interest credited $ (978) $ 5,112 $ 1,770
Interest credited 11,252 8,637 7,474
-------- -------- --------
Net deposit increase $ 10,274 $ 13,749 $ 24,544
======== ======== ========
12
The following table presents by various interest rate categories the
amounts of certificate accounts as of the dates indicated and the amounts of
certificate accounts as of September 30, 2006 which mature during the periods
indicated.
Amounts at September 30, 2006 Maturing
-------------------------------------------------
As of
September 30, One Year
2006 or Less Two Years Three Years Thereafter
---------- ---------- ---------- ----------- ----------
(In Thousands)
Certificate accounts:
0.01% to 2.00% $ 385 $ 199 $ 86 $ -- $ 100
2.01% to 4.00% 155,992 81,492 46,564 25,259 2,677
4.01% to 6.00% 162,668 125,990 24,695 7,230 4,753
6.01% to 8.00% 1,426 1,426 -- -- --
---------- ---------- ---------- ---------- ----------
Total certificate accounts(1) $ 320,471 $ 209,107 $ 71,345 $ 32,489 $ 7,530
========== ========== ========== ========== ==========
-----------------
(1) Includes retirement accounts.
The following table sets forth the maturity of certificate deposits in
excess of $100,000 as of September 30, 2006.
Amount
(In Thousands)
1 to 3 months $ 6,875
4 to 6 months 9,033
7 to 12 months 8,689
Thereafter 18,576
-------
Total $43,173
=======
Borrowings. The Bank obtains advances from the FHLB of Pittsburgh upon
the security of its capital stock in the FHLB of Pittsburgh and a portion of its
first mortgages. See "Regulation - Regulation of the Bank - Federal Home Loan
Bank System." At September 30, 2006, the Bank had FHLB advances with maturities
of one year or less totaling $79.5 million at an interest rate of 4.92% and FHLB
advances with maturities of 13 months to 10 years totaling $215.1 million at
interest-rates ranging from 3.80% to 5.38%. Such advances are made pursuant to
several different credit programs, each of which has its own interest rate and
range of maturities.
Depending on the program, limitations on the amount of advances are
based on either a fixed percentage of assets or the FHLB of Pittsburgh's
assessment of the Bank's creditworthiness. FHLB advances are generally available
to meet seasonal and other withdrawals of deposit accounts, to purchase
mortgage-backed securities, investment securities and to expand lending.
The following table sets forth certain information regarding the
borrowings of the Company as of the dates indicated.
September 30,
-----------------------------------------------------------------------------
2006 2005 2004
----------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Balance Rate Balance Rate Balance Rate
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Advances from FHLB of Pittsburgh $ 294,611 4.67% $ 297,268 4.38% $ 265,953 4.34%
13
The following table sets forth certain information concerning the
short-term borrowings of the Company for the periods indicated.
Year Ended September 30,
--------------------------
2006 2005 2004
------- ------- -------
(Dollars in Thousands)
Advances from FHLB of Pittsburgh:
Average balance outstanding $29,278 $29,355 $20,267
Maximum amount outstanding at any
month-end during the period 59,400 36,100 25,600
Weighted average interest rate during the period 4.89% 2.98% 1.38%
Employees
The Company had 67 full-time employees and 37 part-time employees as of
September 30, 2006. None of these employees is represented by a collective
bargaining agent, and the Company believes that it enjoys good relations with
its personnel.
Regulation
The references to laws and regulations which are applicable to the
Company and the Bank set forth below and elsewhere herein are brief summaries
thereof which do not purport to be complete and are qualified in their entirety
by reference to such laws and regulations.
Regulation of the Company
General. The Company is a registered bank holding company pursuant to
the Bank Holding Company Act ("BHCA") and, as such, is subject to regulation and
supervision by the Federal Reserve Board and the Department. The Company is
required to file annually a report of its operations with, and will be subject
to examination by, the Federal Reserve Board and the Department.
BHCA Activities and Other Limitations. The BHCA prohibits a bank
holding company from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any bank, or increasing such ownership or
control of any bank, without prior approval of the Federal Reserve Board. The
BHCA also generally prohibits a bank holding company from acquiring any bank
located outside of the state in which the existing bank subsidiaries of the bank
holding company are located unless specifically authorized by applicable state
law. No approval under the BHCA is required; however, for a bank holding company
already lawfully owning or controlling 50% of the voting shares of a bank to
acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company that
is not a bank and from engaging in any business other than banking or managing
or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to
approve the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve Board has determined to be so closely
related to banking or to managing or controlling banks as to be a proper
incident thereto. In making such determinations, the Federal Reserve Board is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The 1999 Act
permits a bank holding company
14
to elect to be considered a financial holding company ("FHC"). A bank holding
company that makes an FHC election is permitted to engage in activities that are
financial in nature or incidental to such financial activities. The 1999 Act
lists certain activities that are considered financial in nature and permits the
Federal Reserve Board to expand that list to include other activities that are
complementary to the activities on the preapproved list. The preapproved
activities include (1) securities underwriting, dealing and market making; (2)
insurance underwriting; (3) merchant banking; and (4) insurance company
portfolio investments. The Company has not made the FHC election.
The Federal Reserve Board has by regulation determined that certain
activities are closely related to banking within the meaning of the BHCA. These
activities include 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.
The Federal Reserve Board also has determined that certain other activities,
including real estate brokerage and syndication, land development, property
management and underwriting of life insurance not related to credit
transactions, are not closely related to banking and a proper incident thereto.
However, under the 1999 Act certain of these activities are permissible for a
bank holding company that becomes an FHC.
Limitations on Transactions with Affiliates. Transactions between
savings banks and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings bank is any company or entity
which controls, is controlled by or is under common control with the savings
bank. In a holding company context, the parent holding company of a savings bank
(such as the Company) and any companies which are controlled by such parent
holding company are affiliates of the savings bank. Generally, Section 23A (i)
limits the extent to which the savings bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
bank's capital stock and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus. Section 23B applies to "covered transactions" as well as certain
other transactions and requires that all transactions be on terms substantially
the same, or at least favorable, to the bank or subsidiary as those provided to
a non-affiliate. The term "covered transaction" includes the making of loans to,
purchase of assets from, issuance of a guarantee to an affiliate and similar
transactions. Section 23B transactions also apply to the provision of services
and the sale of assets by a savings bank to an affiliate.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings bank, and certain affiliated
interests of either, may not exceed, together with all other outstanding loans
to such person and affiliated interests, the savings bank's loans to one
borrower limit (generally equal to 15% of the bank's unimpaired capital and
surplus). Section 22(h) also requires that loans to directors, executive
officers and principal stockholders be made on terms substantially the same as
offered in comparable transactions to other persons and also requires prior
board approval for certain loans. In addition, the aggregate amount of
extensions of credit by a savings bank to all insiders cannot exceed the bank's
unimpaired capital and surplus. Furthermore, Section 22(g) places additional
restrictions on loans to executive officers.
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 BHCA. The Federal Reserve Board capital adequacy guidelines
generally require bank holding companies to maintain total capital equal to 8%
of total risk-adjusted assets,
15
with at least one-half of that amount consisting of Tier I or core capital and
up to one-half of that amount consisting of Tier II or supplementary capital.
Tier I capital for bank holding companies generally consists of the sum of
common stockholders' equity and perpetual preferred stock (subject in the case
of the latter to limitations on the kind and amount of such stocks which may be
included as Tier I capital), less goodwill and, with certain exceptions,
intangibles. Tier II capital generally consists of hybrid capital instruments;
perpetual preferred stock which is not eligible to be included as Tier I
capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for the bulk of assets which are
typically held by a bank holding company, including multi-family residential and
commercial real estate loans, commercial business loans and consumer loans.
Single-family residential first mortgage loans which are not past-due (90 days
or more) or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system, as
are certain privately-issued mortgage-backed securities representing indirect
ownership of such loans. Off-balance sheet items also are adjusted to take into
account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve
Board requires bank holding companies to maintain a minimum leverage capital
ratio of Tier I capital to total assets of 3.0%. Total assets for this purpose
does not include goodwill and any other intangible assets and investments that
the Federal Reserve Board determines should be deducted from Tier I capital. The
Federal Reserve Board has announced that the 3.0% Tier I leverage capital ratio
requirement is the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies or those which
are not experiencing or anticipating significant growth. Other bank holding
companies will be expected to maintain Tier I leverage capital ratios of at
least 4.0% to 5.0% or more, depending on their overall condition.
Financial Support of Affiliated Institutions. Under Federal Reserve
Board policy, the Company is expected to act as a source of financial strength
to the Bank and to commit resources to support the Bank in circumstances when it
might not do so absent such policy. The Congress attempted to clarify the
application of this "source-of-strength" doctrine by an amendment to Section 18
of the Federal Deposit Insurance Act ("FDIA") that was included in the
Gramm-Leach-Bliley Act of 1999. The amendment describes the circumstances under
which a Federal banking agency would be protected from a claim by an affiliate
or a controlling shareholder of an insured depository institution seeking the
return of assets of such an affiliate or controlling shareholder. Under the
amended provision, a claim would not be permitted if (1) the insured depository
institution was under a written Federal directive to raise capital, (2) the
institution was undercapitalized, and (3) the subject Federal banking agency
followed the procedures set forth in Section 5(g) of the BHCA.
Sarbanes-Oxley Act of 2002. On July 30, 2002, President George W. Bush
signed into law the Sarbanes-Oxley Act of 2002, which generally establishes a
comprehensive framework to modernize and reform the oversight of public company
auditing, improve the quality and transparency of financial reporting by those
companies and strengthen the independence of auditors. Among other things, the
new legislation (i) created a public company accounting oversight board which is
empowered to set auditing, quality control and ethics standards, to inspect
registered public accounting firms, to conduct investigations and to take
disciplinary actions, subject to SEC oversight and review; (ii) strengthened
auditor independence from corporate management by, among other things, limiting
the scope of consulting services that auditors can offer their public company
audit clients; (iii) heightened the responsibility of public company directors
and senior managers for the quality of the financial reporting and disclosure
made by their companies; (iv) adopted a number of provisions to deter wrongdoing
by corporate management; (v) imposed a number of new corporate disclosure
requirements; (vi) adopted provisions which generally seek to limit and expose
to public view possible conflicts of interest affecting securities analysts; and
(vii) imposed a range of new criminal penalties
16
for fraud and other wrongful acts, as well as extended the period during which
certain types of lawsuits can be brought against a company or its insiders.
Regulation of the Bank
General. The Bank is subject to extensive regulation and examination by
the Department and by the FDIC, which insures its deposits to the maximum extent
permitted by law. The federal and state laws and regulations which are
applicable to banks regulate, among other things, the scope of their business,
their investments, their reserves against deposits, the timing of the
availability of deposited funds and the nature and amount of and collateral for
certain loans. There are periodic examinations by the Department and the FDIC to
test the Bank's compliance with various regulatory requirements. This regulation
and supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities 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. Any change in such regulation, whether by
the Department, the FDIC or the Congress could have a material adverse impact on
the Bank and their operations.
Pennsylvania Savings Bank Law. The Pennsylvania Banking Code of 1965,
as amended (the "Banking Code") contains detailed provisions governing the
organization, location of offices, rights and responsibilities of directors,
officers, employees and members, as well as corporate powers, savings and
investment operations and other aspects of the Bank and its affairs. The Banking
Code delegates extensive rulemaking power and administrative discretion to the
Department 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.
One of the purposes of the Banking Code is to provide savings banks
with the opportunity to be competitive with each other and with other financial
institutions existing under other Pennsylvania laws and other state, federal and
foreign laws. A Pennsylvania savings bank may locate or change the location of
its principal place of business and establish an office anywhere in
Pennsylvania, with the prior approval of the Department.
The Department generally examines each savings bank not less frequently
than once every two years. Although the Department may accept the examinations
and reports of the FDIC in lieu of the Department's examination, the present
practice is for the Department to conduct individual examinations. The
Department may order any savings bank to discontinue any violation of law or
unsafe or unsound business practice and may direct any trustee, officer,
attorney or employee of a savings bank engaged in an objectionable activity,
after the Department has ordered the activity to be terminated, to show cause at
a hearing before the Department why such person should not be removed.
Interstate Acquisitions. The Interstate Banking Act allows federal
regulators to approve mergers between adequately capitalized banks from
different states regardless of whether the transaction is prohibited under any
state law, unless one of the banks' home states has enacted a law expressly
prohibiting out-of-state mergers before June 1997. This act also allows a state
to permit out-of-state banks to establish and operate new branches in this
state. The Commonwealth of Pennsylvania has "opted in" to this interstate merger
provision. Therefore, the prior requirement that interstate acquisitions would
only be permitted when another state had "reciprocal" legislation that allowed
acquisitions by Pennsylvania-based bank holding companies has been eliminated.
The new Pennsylvania legislation, however, retained the requirement that an
acquisition of a Pennsylvania institution by a Pennsylvania or a
non-Pennsylvania-based holding company must be approved by the Banking
Department.
17
FDIC Insurance Premiums. The deposits of the Bank are insured by the
Deposit Insurance Fund, which is administered by the FDIC. Under current FDIC
regulations, insured institutions are assigned to one of three capital groups
which are based solely on the level of an institution's capital. Deposit
Insurance Fund assessment rates are then tied to the level of an institution's
supervisory concern based on risk classifications derived from the capital
groups. Rates during the last six months of 2006 ranged 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 a predecessor to the Deposit Insurance Fund. The assessment rate
for the third quarter of 2006 was .00315% of insured deposits and is adjusted
quarterly. These assessments will continue until the Financing Corporation bonds
mature in 2019.
Under the FDIA, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged or is engaging in unsafe and
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition imposed
by the FDIC or written agreement entered into with the FDIC. The management of
the Bank does not know of any practice, condition or violation that might lead
to termination of deposit insurance. At September 30, 2006, the Bank's
regulatory capital exceeded all of its capital requirements.
Deposit Insurance Reform. On February 8, 2006, President George W. Bush
signed into law legislation that merged the Bank Insurance Fund and the Savings
Association Insurance Fund to form the Deposit Insurance Fund, eliminated any
disparities in bank and thrift risk-based premium assessments, reduced the
administrative burden of maintaining and operating two separate funds and
established certain new insurance coverage limits and a mechanism for possible
periodic increases. The legislation also gave the Federal Deposit Insurance
Corporation greater discretion to identify the relative risks all institutions
present to the Deposit Insurance Fund and set risk-based premiums.
Major provisions in the legislation include:
o merging the Savings Association Insurance Fund and Bank
Insurance Fund, which became effective March 31, 2006;
o maintaining basic deposit and municipal account insurance
coverage at $100,000 but providing for a new basic insurance
coverage for retirement accounts of $250,000. Insurance
coverage for basic deposit and retirement accounts could be
increased for inflation every five years in $10,000 increments
beginning in 2011;
o providing the Federal Deposit Insurance Corporation with the
ability to set the designated reserve ratio within a range of
between 1.15% and 1.50%, rather than maintaining 1.25% at all
times regardless of prevailing economic conditions;
o providing a one-time assessment credit of $4.7 billion to
banks and savings associations in existence on December 31,
1996, which may be used to offset future premiums with certain
limitations; and
o requiring the payment of dividends of 100% of the amount that
the insurance fund exceeds 1.5% of the estimated insured
deposits and the payment of 50% of the amount that the
insurance fund exceeds 1.35% of the estimated insured deposits
(when the reserve is greater than 1.35% but no more than
1.5%).
18
Capital Requirements. The FDIC has promulgated regulations and adopted
a statement of policy regarding the capital adequacy of state-chartered banks
which, like the Bank, are not members of the Federal Reserve System. The FDIC's
capital regulations establish a minimum 3.0% Tier I 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 will increase the minimum Tier I leverage
ratio for such other banks to 4.0% to 5.0% or more. Under the FDIC's regulation,
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.
Leverage or core capital is defined as the sum of common stockholders' equity
(including retained earnings), noncumulative perpetual preferred stock and
related surplus, and minority interests in consolidated subsidiaries, minus all
intangible assets other than certain qualifying supervisory goodwill, and
certain purchased mortgage servicing rights and purchased credit and
relationships.
The FDIC also requires that savings banks meet a risk-based capital
standard. The risk-based capital standard for savings banks requires the
maintenance of total capital which is defined as Tier I 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 I capital are equivalent to those discussed
above under the 3% leverage standard. The components of supplementary (Tier 2)
capital include certain perpetual preferred stock, certain mandatory convertible
securities, certain subordinated debt and intermediate preferred stock and
general allowances 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 capital counted toward supplementary capital cannot
exceed 100% of core capital. At September 30, 2006, the Bank met each of its
capital requirements.
A bank which has less than the minimum leverage capital requirement
shall, within 60 days of the date as of which it fails to comply with such
requirement, submit to its FDIC regional director for review and approval a
reasonable plan describing the means and timing by which the bank shall achieve
its minimum leverage capital requirement. A bank which fails to file such plan
with the FDIC is deemed to be operating in an unsafe and unsound manner, and
could subject the bank to a cease-and-desist order from the FDIC. The FDIC's
regulation also provides that any insured depository institution with a ratio of
Tier I 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 FDIA and is
subject to potential termination of deposit insurance. However, such an
institution will not be subject to an enforcement proceeding thereunder solely
on account of its capital ratios if it has entered into and is in compliance
with a written agreement with the FDIC to increase its Tier I leverage capital
ratio to such level as the FDIC deems appropriate and to take such other action
as may be necessary for the institution to be operated in a safe and sound
manner. The FDIC capital regulation also provides, among other things, for the
issuance by the FDIC or its designee(s) of a capital directive, which is a final
order issued to a bank that fails to maintain minimum capital to restore its
capital to the minimum leverage capital requirement within a specified time
period. Such directive is enforceable in the same manner as a final
cease-and-desist order.
The Bank is also subject to more stringent Department capital
guidelines. Although not adopted in regulation form, the Department utilizes
capital standards requiring a minimum of 6% leverage capital and 10% risk-based
capital. The components of leverage and risk-based capital are substantially the
same as those defined by the FDIC.
19
Loans-to-One Borrower Limitation. Under federal regulations, with
certain limited exceptions, a Pennsylvania chartered savings bank may lend to a
single or related group of borrowers on an "unsecured" basis an amount equal to
15% of its unimpaired capital and surplus. An additional amount may be lent,
equal to 10% of unimpaired capital and surplus, if such loan is secured by
readily-marketable collateral, which is defined to include certain securities
and bullion, but generally does not include real estate.
Activities and Investments of Insured State-Chartered Banks. Section 24
of the FDIA, as amended by the Federal Deposit Insurance Corporation Improvement
Act of 1991, generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for national
banks. Under regulations dealing with equity investments, an insured state bank
generally may not directly or indirectly acquire or retain any equity investment
of a type, or in an amount, that is not permissible for a national bank. An
insured state bank is not prohibited from, among other things, (i) acquiring or
retaining a majority interest in a subsidiary, (ii) investing as a limited
partner in a partnership the sole purpose of which is direct or indirect
investment in the acquisition, rehabilitation or new construction of a qualified
housing project, provided that such limited partnership investments may not
exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the voting
stock of a company that solely provides or reinsures directors', trustees' and
officers' liability insurance coverage or bankers' blanket bond group insurance
coverage for insured depository institutions, and (iv) acquiring or retaining
the voting shares of a depository institution if certain requirements are met.
The FDIC has adopted final regulations pertaining to the other activity
restrictions imposed upon insured savings banks and their subsidiaries by
Section 24. Pursuant to such regulations, insured savings banks engaging in
impermissible activities may seek approval from the FDIC to continue such
activities. Savings banks not engaging in such activities but that desire to
engage in otherwise impermissible activities may apply for approval from the
FDIC to do so; however, if such bank fails to meet the minimum capital
requirements or the activities present a significant risk to the FDIC insurance
funds, such application will not be approved by the FDIC. The FDIC has
authorized the bank's subsidiary HARL, LLC, to invest up to 15% of its capital
in the equity securities of bank holding companies, banks or thrifts. $997,000
was invested by HARL, LLC as of September 30, 2006 in such equity securities.
Regulatory Enforcement Authority. FIRREA included substantial
enhancement to the enforcement powers available to federal banking regulators.
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. FIRREA significantly increased the amount of and grounds
for civil money penalties and requires, except under certain circumstances,
public disclosure of final enforcement actions by the federal banking agencies.
Federal and State Taxation
General. The Bank is subject to federal income taxation in the same
general manner as other corporations with some exceptions, including
particularly the reserve for bad debts discussed below. The following discussion
of federal taxation is intended only to summarize certain pertinent federal
income tax matters and is not a comprehensive description of the tax rules
applicable to the Bank.
Method of Accounting. For federal income tax purposes, the Bank
currently reports its income and expenses on the accrual method of accounting
and uses a tax year ending September 30 for filing its federal income tax
returns.
20
Bad Debt Reserves. The Company computes its reserve for bad debts under
the specific charge-off method. The bad debt deduction allowable under this
method is available to large banks with assets greater than $500 million.
Generally, this method allows the Company to deduct an annual addition to the
reserve for bad debts equal to its net charge-offs. Retained earnings at
September 30, 2006 and 2005 includes approximately $1.3 million representing bad
debt deductions for which no deferred income taxes have been provided.
Distributions. If the Bank distributes cash or property to its
stockholders, and the distribution is treated as being from its accumulated
pre-1988 tax bad debt reserves, the distribution will cause the Bank to have
additional taxable income. A distribution to stockholders is deemed to have been
made from accumulated bad debt reserves to the extent that (a) the reserves
exceed the amount that would have been accumulated on the basis of actual loss
experience, and (b) the distribution is a "non-dividend distribution." A
distribution in respect of stock is a non-dividend distribution to the extent
that, for federal income tax purposes, (i) it is in redemption of shares, (ii)
it is pursuant to a liquidation of the institution, or (iii) in the case of a
current distribution, together with all other such distributions during the
taxable year, it exceeds the Bank's current and post-1951 accumulated earnings
and profits. The amount of additional taxable income created by a non-dividend
distribution is an amount that when reduced by the tax attributable to it is
equal to the amount of the distribution.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of
20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is
payable to the extent such AMTI is in excess of an exemption amount. The Code
provides that an item of tax preference is the excess of the bad debt deduction
allowable for a taxable year pursuant to the percentage of taxable income method
over the amount allowable under the experience method. The other items of tax
preference that constitute AMTI include (a) tax exempt interest on newly-issued
(generally, issued on or after August 8, 1986) private activity bonds other than
certain qualified bonds and (b) for taxable years beginning after 1989, 75% of
the excess (if any) of (i) adjusted current earnings as defined in the Code,
over (ii) AMTI (determined without regard to this preference and prior to
reduction by net operating losses). Net operating losses can offset no more than
90% of AMTI. Certain payments of alternative minimum tax may be used as credits
against regular tax liabilities in future years.
Net Operating Loss Carryovers. A financial institution may carry back
net operating losses to the preceding three taxable years and forward to the
succeeding 15 taxable years. Effective for net operating losses arising in tax
years beginning after October 1, 1997, the carryback period is reduced from
three years to two years and the carryforward period is extended from 15 years
to 20 years. At September 30, 2006, the Bank had no net operating loss
carryforwards for federal income tax purposes.
Corporate Dividends-Received Deduction. The corporate
dividends-received deduction is 80% in the case of dividends received from
corporations with which a corporate recipient does not file a consolidated tax
return, and corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends received or accrued on
their behalf. However, a corporation may deduct 100% of dividends from a member
of the same affiliated group of corporations.
Other Matters. The Company's federal income tax returns for its tax
years 1993 and beyond are open under the statute of limitations and are subject
to review by the Internal Revenue Service ("IRS").
Pennsylvania Taxation. The Bank is subject to tax under the
Pennsylvania Mutual Thrift Institutions Tax Act, which imposes a tax at the rate
of 11.5% on the Bank's net earnings, determined in accordance with accounting
principles generally accepted in the United States of America, as shown on its
books. For fiscal years beginning in 1983, and thereafter, net operating losses
may be carried forward and allowed as a
21
deduction for three succeeding years. This Act exempts the Bank from all other
corporate taxes imposed by Pennsylvania for state tax purposes, and from all
local taxes imposed by political subdivisions thereof, except taxes on real
estate and real estate transfers.
Subsidiary
The Bank is the only direct wholly owned subsidiary of the Company. The
Bank formed HSB, Inc., a Delaware company, as a wholly owned subsidiary of the
Bank during fiscal 1997. HSB, Inc. was formed in order to accommodate the
transfer of certain assets that are legal investments for the Bank and to
provide for a greater degree of protection to claims of creditors. The laws of
the State of Delaware and the court system create a more favorable environment
for the proposed business affairs of the subsidiary. HSB, Inc. currently manages
the investment securities for the Bank, which as of September 30, 2006 amounted
to approximately $146.3 million. The Bank formed two limited liability companies
in 2002, Freedom Financial Solutions LLC ("FFS") and HARL LLC ("HARL"). FFS was
established to engage in the sale of insurance products through a third party.
HARL was established for the purpose of investing in FDIC insured financial
institutions/holding company equity securities.
Item 1A. Risk Factors.
----------------------
In analyzing whether to make or to continue an investment in our
securities, investors should consider, among other factors, the following risk
factors.
Our results of operations are significantly dependent on economic conditions and
related uncertainties.
Commercial banking is affected, directly and indirectly, by domestic
and international economic and political conditions and by governmental monetary
and fiscal policies. Conditions such as inflation, recession, unemployment,
volatile interest rates, real estate values, government monetary policy,
international conflicts, the actions of terrorists and other factors beyond our
control may adversely affect our results of operations. Changes in interest
rates, in particular, could adversely affect our net interest income and have a
number of other adverse effects on our operations, as discussed in the
immediately succeeding risk factor. Adverse economic conditions also could
result in an increase in loan delinquencies, foreclosures and nonperforming
assets and a decrease in the value of the property or other collateral which
secures our loans, all of which could adversely affect our results of
operations. We are particularly sensitive to changes in economic conditions and
related uncertainties in Eastern Pennsylvania because we derive substantially
all of our loans, deposits and other business from this area. Accordingly, we
remain subject to the risks associated with prolonged declines in national or
local economies.
Changes in interest rates could have a material adverse effect on our
operations.
The operations of financial institutions such as ours are dependent to
a large extent on net interest income, which is the difference between the
interest income earned on interest-earning assets such as loans and investment
securities and the interest expense paid on interest-bearing liabilities such as
deposits and borrowings. Changes in the general level of interest rates can
affect our net interest income by affecting the difference between the weighted
average yield earned on our interest-earning assets and the weighted average
rate paid on our interest-bearing liabilities, or interest rate spread, and the
average life of our interest-earning assets and interest-bearing liabilities.
Changes in interest rates also can affect our ability to originate loans; the
value of our interest-earning assets and our ability to realize gains from the
sale of such assets; our ability to obtain and retain deposits in competition
with other available investment alternatives; the ability of our borrowers to
repay adjustable or variable rate loans; and the fair value of the derivatives
carried on our balance sheet, derivative hedge effectiveness testing and the
amount of ineffectiveness recognized in our earnings.
22
Interest rates are highly sensitive to many factors, including governmental
monetary policies, domestic and international economic and political conditions
and other factors beyond our control. Although we believe that the estimated
maturities of our interest-earning assets currently are well balanced in
relation to the estimated maturities of our interest-bearing liabilities (which
involves various estimates as to how changes in the general level of interest
rates will impact these assets and liabilities), there can be no assurance that
our profitability would not be adversely affected during any period of changes
in interest rates.
There are increased risks involved with multi-family residential, commercial
real estate, commercial business and consumer lending activities.
Our lending activities include loans secured by existing multi-family
residential and commercial real estate. In addition, from time to time we
originate loans for the construction of multi-family residential real estate and
land acquisition and development loans. Multi-family residential, commercial
real estate and construction lending generally is considered to involve a higher
degree of risk than single-family residential lending due to a variety of
factors, including generally larger loan balances, the dependency on successful
completion or operation of the project for repayment, the difficulties in
estimating construction costs and loan terms which often do not require full
amortization of the loan over its term and, instead, provide for a balloon
payment at stated maturity. Our lending activities also include commercial
business loans and leases to small to medium businesses, which generally are
secured by various equipment, machinery and other corporate assets, and a wide
variety of consumer loans, including home improvement loans, home equity loans,
education loans and loans secured by automobiles, boats, mobile homes,
recreational vehicles and other personal property. Although commercial business
loans and leases and consumer loans generally have shorter terms and higher
interests rates than mortgage loans, they generally involve more risk than
mortgage loans because of the nature of, or in certain cases the absence of, the
collateral which secures such loans.
We are subject to extensive regulation which could adversely affect our business
and operations.
We and our subsidiaries are subject to extensive federal and state
governmental supervision and regulation, which are intended primarily for the
protection of depositors. In addition, we and our subsidiaries are subject to
changes in federal and state laws, as well as changes in regulations,
governmental policies and accounting principles. The effects of any such
potential changes cannot be predicted but could adversely affect the business
and operations of us and our subsidiaries in the future.
We face strong competition which may adversely affect our profitability.
We are subject to vigorous competition in all aspects and areas of our
business from banks and other financial institutions, including savings and loan
associations, savings banks, finance companies, credit unions and other
providers of financial services, such as money market mutual funds, brokerage
firms, consumer finance companies and insurance companies. We also compete with
non-financial institutions, including retail stores that maintain their own
credit programs and governmental agencies that make available low cost or
guaranteed loans to certain borrowers. Certain of our competitors are larger
financial institutions with substantially greater resources, lending limits,
larger branch systems and a wider array of commercial banking services.
Competition from both bank and non-bank organizations will continue.
Our ability to successfully compete may be reduced if we are unable to make
technological advances.
The banking industry is experiencing rapid changes in technology. In
addition to improving customer services, effective use of technology increases
efficiency and enables financial institutions to reduce costs. As a result, our
future success will depend in part on our ability to address our customers'
needs by using technology. We cannot assure you that we will be able to
effectively develop new technology-driven products
23
and services or be successful in marketing these products to our customers. Many
of our competitors have far greater resources than we have to invest in
technology.
We and our banking subsidiary are subject to capital and other requirements
which restrict our ability to pay dividends.
Our ability to pay dividends to our shareholders depends to a large
extent upon the dividends we receive from Harleysville Savings Bank. Dividends
paid by the Bank are subject to restrictions under Pennsylvania and federal laws
and regulations. In addition, Harleysville Savings Bank must maintain certain
capital levels, which may restrict the ability of the Bank to pay dividends to
us and our ability to pay dividends to our shareholders.
Holders of our common stock have no preemptive rights and are subject to
potential dilution.
Our articles of incorporation do not provide any shareholder with a
preemptive right to subscribe for additional shares of common stock upon any
increase thereof. Thus, upon the issuance of any additional shares of common
stock or other voting securities of the Company or securities convertible into
common stock or other voting securities, shareholders may be unable to maintain
their pro rata voting or ownership interest in us.
Item 1B. Unresolved Staff Comments.
-----------------------------------
Not applicable.
Item 2. Properties.
-------------------
As of September 30, 2006, the Company conducted its business from its
main office in Harleysville, Pennsylvania and five other full service branch
offices. The Company is also part of the STAR ATM System, which provides
customers with access to their deposits at locations worldwide.
Net Book Value of
Lease Property and Leasehold
Owned or Expiration Improvements at
County Address Leased Date September 30, 2006 Deposits
------------------- --------------------------- --------- ---------------- ----------------------- ---------
(In Thousands)
Montgomery 1889 Ridge Park
Royersford, Pennsylvania Owned -- $3,266 $ 2,448
Montgomery 271 Main Street
Harleysville, Pennsylvania Owned -- 1,092 148,152
Montgomery 640 East Main Street
Lansdale, Pennsylvania Leased May 2043(1) 906 42,901
Montgomery 1550 Hatfield Valley Road
Hatfield, Pennsylvania Leased January 2064(1) 825 88,126
Montgomery 2301 West Main Street
Norristown, Pennsylvania Owned -- 550 95,424
Montgomery 3090 Main Street
Sumneytown, Pennsylvania Owned -- 318 52,203
------ --------
Total $6,957 $429,254
====== ========
-------------
(1) The land at this office is leased; however, the Bank owns the
building.
24
Item 3. Legal Proceedings.
---------------------------
The Company is not involved in any legal proceedings except nonmaterial
litigation incidental to the ordinary course of business.
Item 4. Submission of Matters to a Vote of Security Holders.
------------------------------------------------------------
Not Applicable.
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
-------------------------------------------------------------------------------
and Issuer Purchases of Equity Securities.
------------------------------------------
(a) The information required herein is incorporated by reference from
page 31 of the Company's 2006 Annual Report to Stockholders ("Annual Report")
and from Part III, Item 12 hereof.
(b) Not applicable.
(c) The following table sets forth information with respect to
purchases made by or on behalf of the Company of shares of Common Stock of the
Company during the indicated periods.
Total Number of
Shares Purchased as Maximum Number of
Total Number Average Part of Publicly Shares that May Yet Be
of Shares Price Paid Announced Plans or Purchased Under the
Period Purchased per Share Programs Plans or Programs(1)
------------------------------ ------------ ----------- ------------------- ----------------------
July 1-31, 2006 -- $ -- -- 39,787
August 1-31, 2006 -- -- -- 39,787
September 1-30, 2006 -- -- -- 39,787
----- ----- ------ ------
Total -- $ -- -- 39,787
===== ===== ====== ======
------------
(1) On June 18, 2003, the Company announced its current program to
repurchase up to 5.0% of the outstanding shares of Common Stock of the
Company, or 191,667 shares. The program does not have an expiration
date and all shares are purchased in the open market.
Item 6. Selected Financial Data.
---------------------------------
The information required herein is incorporated by reference from page
1 of the Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations.
--------------
The information required herein is incorporated by reference from pages
4 to 10 of the Annual Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
---------------------------------------------------------------------
The information required herein is incorporated by reference from pages
8 to 10 of the Annual Report.
25
Item 8. Financial Statements and Supplementary Data.
----------------------------------------------------
The information required herein is incorporated by reference from pages
12 to 30 of the Annual Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure.
---------------------
Not Applicable.
Item 9A. Controls and Procedures.
---------------------------------
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of September 30, 2006. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit 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.
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934)
occurred during the fourth fiscal quarter of fiscal 2006 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
Item 9B. Other Information.
---------------------------
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
------------------------------------------------------------
The information required herein is incorporated by reference from the
information contained in the section captioned "Information with Respect to
Nominees for Director, Directors Whose Terms Continue and Executive Officers" in
the Company's definitive Proxy Statement for the Annual Meeting of Stockholders
to be held January 24, 2007 (the "Proxy Statement"), a copy of which will be
filed with the Securities and Exchange Commission before the meeting date.
The Company 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 the Company and the Bank. A copy of the Code of
Ethics, was included as an exhibit to the Company's Form 10-K for the year ended
September 30, 2003 and filed with the Securities and Exchange Commission, may
also be found on the Company's website at www.harleysvillesavingsbank.com.
Item 11. Executive Compensation.
--------------------------------
The information required herein is incorporated by reference from the
information contained in the section captioned "Management Compensation" in the
Proxy Statement.
26
Item 12. Security Ownership of Certain Beneficial Owners and Management and
---------------------------------------------------------------------------
Related Stockholder Matters.
----------------------------
The information required herein is incorporated by reference from the
information contained in the section captioned "Beneficial Ownership of Common
Stock by Certain Beneficial Owners and Management" in the Proxy Statement.
Equity Compensation Plan Information
The following table sets forth certain information for all equity
compensation plans and individual compensation arrangements (whether with
employees or non-employees, such as directors), in effect as of September 30,
2006.
Number of Shares to be
issued upon the Exercise Weighted-Average Number of Shares Remaining Available for
of Outstanding Options, Exercise Price of Future Issuance (Excluding Shares
Plan Category Warrants and Rights(1) Outstanding Options Reflected in the First Column)(2)
----------------------------- ---------------------- -------------------- ---------------------------------------
Equity compensation plans
approved by security holders 243,100 $ 15.01 313,675
Equity compensation plans not
approved by security holders -- -- --
------- ------- -------
Total 243,100 $ 15.01 313,675
======= =======
-----------
(1) Does not take into account purchase rights accruing under the Company's
1995 Employee Stock Purchase Plan, which was approved by stockholders and
provides for up to 87,281 shares to be issued. Under the Employee Stock
Purchase Plan, each eligible employee may purchase shares of common stock
at semi-annual intervals each year at a purchase price determined by the
committee of the board of directors which administers the plan, which shall
not be less than the lesser of (i) 85% of the fair market value of a share
of common stock on the first business day of the applicable semi-annual
offering period or (ii) 85% of the fair market value of a share of common
stock on the last business day of such offering period. In no event may the
amount of common stock purchased by a participant in the Employee Stock
Purchase Plan in a calendar year exceed $25,000, measured as of the time an
option under the plan is granted.
(2) Includes shares available for future issuance under the Employee Stock
Purchase Plan. As of September 30, 2006, an aggregate of 53,583 shares of
common stock were available for issuance under this plan.
Item 13. Certain Relationships and Related Transactions.
--------------------------------------------------------
The information required herein is incorporated by reference from the
information contained in the section captioned "Management Compensation -
Indebtedness of Management" in the Proxy Statement.
Item 14. Principal Accounting Fees and Services.
------------------------------------------------
The information required herein is incorporated by reference from the
information contained in the section captioned "Relationship with Independent
Registered Public Accounting Firm" in the Proxy Statement.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
------------------------------------------------
(a) (1) The following financial statements are incorporated by reference from
Item 8 hereof (see Exhibit 13.0):
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of September 30, 2006
and 2005
Consolidated Statements of Income for the Years Ended September 30,
2006, 2005 and 2004
27
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended September 30,
2006, 2005 and 2004
Notes to Consolidated Financial Statements
(2) All schedules are omitted because they are not required or
applicable, or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) Exhibits
The following exhibits are filed as part of this Form 10-K and this
list includes the Exhibit Index.
No. Exhibits Location
--------- ----------------------------------------------------------------------------- ------------------
3.1 Articles of Incorporation (1)
3.2 Bylaws (1)
4.0 Common Stock Certificate (1)
10.1 1995 Employee Stock Purchase Plan* (2)
10.2 1995 Stock Option Plan* (2)
10.3 2000 Stock Option Plan* (3)
10.4 2005 Stock Option Plan* (4)
10.5 Profit Sharing Incentive Plan* (2)
10.6 Employment Agreement with Edward J. Molnar and Marian Bickerstaff* (5)
10.7 Amended and Restated Employment Agreement between the Company,
the Bank and Ronald B. Geib* (6)
13.0 Annual Report to Stockholders Filed herewith
22.0 Subsidiaries of the Registrant - Reference is made to "Item 1. Business
- Subsidiaries" of this Form 10-K for the required information --
23.0 Consent of Deloitte & Touche LLP Filed herewith
31.1 Certification of Chief Executive Officer Filed herewith
31.2 Certification of Chief Financial Officer Filed herewith
32.0 Section 1350 Certification of the Chief Executive Officer and
Chief Financial Officer Filed herewith
99.0 Code of Conduct and Ethics (3)
------------
* Denotes management compensation plan or arrangement.
(1) Incorporated herein by reference to the Company's Current Report on
Form 8-K filed with the Securities and Exchange Commission ("SEC") on
February 25, 2000.
(2) Incorporated herein by reference to the Company's Annual Report on Form
10-K for the year ended September 30, 2003, filed with the SEC on
December 23, 2003.
(3) Incorporated by reference to the Company's definitive proxy statement
dated December 19, 2000 filed with the SEC.
(4) Incorporated by reference from the Company's definitive proxy statement
for the 2005 Annual Meeting of Stockholders filed with the SEC on
December 16, 2005.
(5) Incorporated herein by reference to Harleysville Savings Bank's
Registration Statement on Form 10 filed with the Federal Home Loan Bank
Board, the predecessor to the Office of Thrift Supervision, on July 1,
1987.
(6) Incorporated by reference to the Company's Current Report on Form 8-K
filed with the SEC on November 1, 2006.
(b) Exhibits
The exhibits listed under (a)(3) of this Item 15 are filed herewith.
(c) Reference is made to (a)(2) of this Item 15.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HARLEYSVILLE SAVINGS
FINANCIAL CORPORATION
December 20, 2006 By: /s/ Edward J. Molnar
------------------------------------
Edward J. Molnar
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
Name Title Date
------------------------------------ ---------------------------------- -----------------
/s/ Edward J. Molnar Chairman and December 20, 2006
------------------------------------ Chief Executive Officer
Edward J. Molnar (principal executive officer)
/s/ Ronald B. Geib President and December 20, 2006
------------------------------------ Chief Operating Officer
Ronald B. Geib
/s/ Brendan J. McGill Senior Vice President, Treasurer December 20, 2006
------------------------------------ and Chief Financial Officer
Brendan J. McGill (principal financial and principal
accounting officer)
/s/ Sanford L. Alderfer December 20, 2006
------------------------------------
Sanford L. Alderfer Director
/s/ Philip A. Clemens Director December 20, 2006
------------------------------------
Philip A. Clemens
/s/ Mark R. Cummins Director December 20, 2006
------------------------------------
Mark R. Cummins
29
Name Title Date
------------------------------------ ---------------------------------- -----------------
/s/ David J. Friesen Director December 20, 2006
------------------------------------
David J. Friesen
/s/ Charlotte A. Hunsberger Director December 20, 2006
------------------------------------
Charlotte A. Hunsberger
/s/ George W. Meschter Director December 20, 2006
------------------------------------
George W. Meschter
/s/ James L. Rittenhouse Director December 20, 2006
------------------------------------
James L. Rittenhouse
30