UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
-------------------------------------------------
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 0-16668
WSFS FINANCIAL CORPORATION
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 22-2866913
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
500 Delaware Avenue, Wilmington, Delaware 19801
-------------------------------------------- ---------------------------------
(Address of principal executive offices) (Zip Code)
(302) 792-6000
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO ___
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act (Check one): Large accelerated filer Accelerated filer X Non-accelerated
filer
Indicate by check mark whether the registrant is a shell company (as
defined in Exchange Act Rule 12b-2). YES ___ NO X
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of November 2, 2007:
Common Stock, par value $.01 per share 6,215,066
-------------------------------------- --------------------
(Title of Class) (Shares Outstanding)
1
WSFS FINANCIAL CORPORATION
FORM 10-Q
INDEX
PART I. Financial Information
Page
----
Item 1. Financial Statements (Unaudited)
--------------------------------
Consolidated Statement of Operations for the Three and Nine Months
Ended September 30, 2007 and 2006.................................................. 3
Consolidated Statement of Condition as of September 30, 2007
and December 31, 2006.............................................................. 4
Consolidated Statement of Cash Flows for the Nine Months Ended
September 30, 2007 and 2006 ....................................................... 5
Notes to the Consolidated Financial Statements for the Three and Nine
Months Ended September 30, 2007 and 2006 .......................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations.......................................................... 16
-------------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................... 27
----------------------------------------------------------
Item 4. Controls and Procedures ............................................................. 27
-----------------------
PART II. Other Information
Item 1. Legal Proceedings.................................................................... 28
-----------------
Item 1A. Risk Factors......................................................................... 28
------------
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ......................... 28
-----------------------------------------------------------
Item 3. Defaults upon Senior Securities...................................................... 28
-------------------------------
Item 4. Submission of Matters to a Vote of Security Holders.................................. 28
---------------------------------------------------
Item 5. Other Information ................................................................... 28
-----------------
Item 6. Exhibits ............................................................................ 28
---------
Signatures ................................................................................... 29
Exhibit 31 Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .......... 30
Exhibit 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ........... 32
2
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2007 2006 2007 2006
---- ---- ---- ----
(Unaudited)
(In Thousands, Except Per Share Data)
Interest income:
Interest and fees on loans ..................... $ 40,747 $ 37,577 $ 118,601 $ 105,005
Interest on mortgage-backed securities ......... 5,799 7,186 18,037 21,989
Interest and dividends on investment securities. 457 616 2,894 1,639
Other interest income .......................... 576 752 1,802 1,843
--------- --------- --------- ---------
47,579 46,131 141,334 130,476
--------- --------- --------- ---------
Interest expense:
Interest on deposits ........................... 15,066 11,392 43,753 29,682
Interest on Federal Home Loan Bank advances .... 9,280 12,384 27,740 35,131
Interest on trust preferred borrowings ......... 1,217 1,736 3,555 3,859
Interest on other borrowings ................... 1,917 1,499 4,987 3,995
--------- --------- --------- ---------
27,480 27,011 80,035 72,667
--------- --------- --------- ---------
Net interest income ................................. 20,099 19,120 61,299 57,809
Provision for loan losses ........................... 1,001 319 2,645 1,702
--------- --------- --------- ---------
Net interest income after provision for loan losses.. 19,098 18,801 58,654 56,107
--------- --------- --------- ---------
Noninterest income:
Credit/debit card and ATM income ............... 5,205 4,982 14,762 14,000
Deposit service charges ........................ 3,937 2,979 11,393 8,382
Investment advisory income ..................... 603 573 1,795 1,821
Loan fee income ................................ 615 458 1,757 1,292
Bank owned life insurance income ............... 543 2,401 1,642 3,411
Gain on sale of credit card loans .............. 882 - 882 -
Mortgage banking activities, net ............... 68 136 218 219
Securities losses .............................. - (1,940) - (1,981)
Other income ................................... 956 720 2,709 2,083
--------- --------- --------- ---------
12,809 10,309 35,158 29,227
--------- --------- --------- ---------
Noninterest expenses:
Salaries, benefits and other compensation ...... 11,347 10,189 32,448 28,802
Occupancy expense .............................. 2,287 1,387 6,202 4,034
Equipment expense .............................. 1,597 1,162 4,188 3,219
Data processing and operations expenses ........ 1,089 886 2,978 2,632
Marketing expense .............................. 1,283 676 2,892 2,017
Professional fees .............................. 646 587 1,953 1,349
Other operating expense ........................ 3,084 2,700 9,057 8,708
--------- --------- --------- ---------
21,333 17,587 59,718 50,761
--------- --------- --------- ---------
Income before minority interest and taxes ........... 10,574 11,523 34,094 34,573
Less minority interest .............................. - 9 - 40
--------- --------- --------- ---------
Income before taxes ................................. 10,574 11,514 34,094 34,533
Income tax provision ................................ 3,431 3,511 11,941 11,691
--------- --------- --------- ---------
Net income .......................................... $ 7,143 $ 8,003 $ 22,153 $ 22,842
========= ========= ========= =========
Earnings per share:
Basic ............................................... $ 1.14 $ 1.20 $ 3.48 $ 3.45
Diluted ............................................. $ 1.11 $ 1.16 $ 3.38 $ 3.31
The accompanying notes are an integral part of these consolidated Financial
Statements.
3
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CONDITION
September 30, December 31,
2007 2006
----------- -----------
(Unaudited)
(In Thousands)
Assets
Cash and due from banks .................................................... $ 69,948 $ 73,989
Cash in non-owned ATMs ..................................................... 168,162 166,092
Federal funds sold ......................................................... 3,000 1,500
Interest-bearing deposits in other banks ................................... 361 243
----------- -----------
Total cash and cash equivalents ........................................ 241,471 241,824
Investment securities held-to-maturity ..................................... 2,896 4,219
Investment securities available-for-sale including reverse mortgages ....... 24,634 50,272
Mortgage-backed securities available-for-sale .............................. 473,313 504,347
Mortgage-backed securities trading ......................................... 12,364 12,364
Loans held-for-sale ........................................................ 1,541 919
Loans, net of allowance for loan losses of $28,768 at September 30, 2007
and $27,384 at December 31, 2006 ......................................... 2,156,483 2,018,822
Bank owned life insurance .................................................. 56,924 55,282
Stock in Federal Home Loan Bank of Pittsburgh, at cost ..................... 39,156 39,872
Assets acquired through foreclosure ........................................ 703 388
Premises and equipment ..................................................... 35,204 30,218
Accrued interest receivable and other assets ............................... 39,089 38,869
----------- -----------
Total assets ............................................................... $ 3,083,778 $ 2,997,396
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing demand ............................................. $ 272,678 $ 276,338
Interest-bearing demand ................................................ 172,680 146,719
Money market ........................................................... 311,132 246,645
Savings ................................................................ 203,560 226,853
Time ................................................................... 355,107 326,009
Jumbo certificates of deposit - customer ............................... 133,628 121,142
----------- -----------
Total customer deposits .............................................. 1,448,785 1,343,706
Other jumbo certificates of deposit .................................... 93,580 111,388
Brokered deposits ...................................................... 268,724 301,254
----------- -----------
Total deposits ..................................................... 1,811,089 1,756,348
Federal funds purchased and securities sold under agreements to repurchase . 75,000 73,400
Federal Home Loan Bank advances ............................................ 798,560 784,028
Trust preferred borrowings ................................................. 67,011 67,011
Other borrowed funds ....................................................... 94,109 78,240
Accrued interest payable and other liabilities ............................. 34,901 26,256
----------- -----------
Total liabilities .......................................................... 2,880,670 2,785,283
----------- -----------
Minority Interest .......................................................... 34 54
Stockholders' Equity:
Serial preferred stock $.01 par value, 7,500,000 shares authorized; none
issued and outstanding ................................................. - -
Common stock $.01 par value, 20,000,000 shares authorized; issued
15,671,635 at September 30, 2007 and 15,584,580 at December 31, 2006 ... 157 156
Capital in excess of par value ............................................. 82,428 81,580
Accumulated other comprehensive loss ....................................... (7,285) (8,573)
Retained earnings .......................................................... 369,805 347,448
Treasury stock at cost, 9,456,569 shares at September 30, 2007 and 8,942,969
shares at December 31, 2006 ............................................ (242,031) (208,552)
----------- -----------
Total stockholders' equity ................................................. 203,074 212,059
----------- -----------
Total liabilities, minority interest and stockholders' equity .............. $ 3,083,778 $ 2,997,396
=========== ===========
The accompanying notes are an integral part of these consolidated Financial
Statements.
4
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended September 30,
-------------------------------
2007 2006
---- ----
(Unaudited)
(In Thousands)
Operating activities:
Net income ...................................................................... $ 22,153 $ 22,842
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ................................................... 2,645 1,702
Depreciation, accretion and amortization .................................... 5,140 3,622
Decrease (increase) in accrued interest receivable and other assets ......... 1,245 (11,918)
Origination of loans held-for-sale .......................................... (20,103) (17,134)
Proceeds from sales of loans held-for-sale .................................. 19,143 15,216
Gain on mortgage banking activity ........................................... (218) (219)
Loss on sale of investments ................................................. - 1,981
Gain on sale of credit card portfolio ....................................... (882) -
Stock-based compensation expense ............................................ 691 992
Excess tax liability (benefits) from share-based payment arrangements .. .... 2,437 (1,529)
Minority interest net income ................................................ - 40
Increase in accrued interest payable and other liabilities .................. 4,937 7,609
(Gain) loss on sale of assets acquired through foreclosure .................. (20) 44
Increase in value of bank owned life insurance .............................. (1,642) (3,411)
Increase in capitalized interest, net ....................................... (1,860) (562)
------------ ------------
Net cash provided by operating activities ....................................... 33,666 19,275
------------ ------------
Investing activities:
Maturities of investment securities ............................................. 26,340 440
Sale of investment securities available-for-sale ................................ 10,170 23,950
Purchase of investments available-for-sale ...................................... (7,487) (20,718)
Repayments of mortgage-backed securities available-for-sale ..................... 60,262 81,590
Sales of mortgage-backed securities available-for-sale .......................... - 49,412
Purchases of mortgage-backed securities available-for-sale ...................... (27,081) (47,721)
Repayments of reverse mortgages ................................................. 1,366 586
Disbursements for reverse mortgages ............................................. (1,391) (393)
Purchase of Cypress Capital Management LLC ...................................... (240) (466)
Purchase of Creative Strategic Solutions, Inc. .................................. (440) -
Sale of loans ................................................................... 869 10,253
Purchase of loans ............................................................... (2,404) (9,124)
Net increase in loans ........................................................... (145,362) (213,036)
Net decrease (increase) in stock of Federal Home Loan Bank of Pittsburgh ........ 716 (1,863)
Sales of assets acquired through foreclosure, net ............................... 120 60
Investment in partnership ....................................................... - 23
Sale of credit care portfolio ................................................... 6,295 -
Deferred gain on sale of investment in partnership .............................. 1,282 -
Investment in premises and equipment, net ....................................... (7,965) (7,687)
------------ ------------
Net cash used for investing activities .......................................... (84,950) (134,694)
------------ ------------
Financing activities:
Net increase in demand and savings deposits ..................................... 79,364 5,969
Net increase in time deposits ................................................... (9,444) 185,560
Net increase (decrease) in securities sold under agreement to repurchase ........ 1,600 (9,750)
Net decrease in federal funds purchased ......................................... - (10,000)
Receipts from FHLB advances ..................................................... 17,021,130 6,173,923
Repayments of FHLB advances ..................................................... (17,006,598) (6,225,889)
Dividends paid on common stock .................................................. (1,785) (1,521)
Issuance of common stock and exercise of employee stock options ................. 2,600 2,284
Excess tax (liability) benefit from share-based payment arrangements ............ (2,437) 1,529
Purchase of treasury stock, net of reissuance ................................... (33,479) (1,937)
Decrease in minority interest ................................................... (20) (199)
------------ ------------
Net cash provided by financing activities ....................................... 50,931 119,969
------------ ------------
(Decrease) increase in cash and cash equivalents ................................ (353) 4,550
Cash and cash equivalents at beginning of period ................................ 241,824 233,951
------------ ------------
Cash and cash equivalents at end of period ...................................... $ 241,471 $ 238,501
============ ============
(Continued on next page)
5
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
Nine months ended September 30,
-------------------------------
2007 2006
---- ----
(Unaudited)
(In Thousands)
Supplemental Disclosure of Cash Flow Information:
------------------------------------------------
Cash paid for interest during the year .......................................... $ 73,661 $ 66,213
Cash paid for income taxes, net ................................................. 11,133 10,332
Loans transferred to assets acquired through foreclosure ........................ 415 62
Net change in accumulated other comprehensive loss, net of taxes................. 1,288 (2,219)
Transfer of loans held-for-sale to loans ........................................ 333 1,837
The accompanying notes are an integral part of these consolidated Financial
Statements.
6
WSFS FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(UNAUDITED)
1. BASIS OF PRESENTATION
Our consolidated Financial Statements include the accounts of WSFS
Financial Corporation ("the Company", "our Company", "we", "our" or "us"),
Wilmington Savings Fund Society, FSB ("WSFS Bank" or the "Bank") and Montchanin
Capital Management, Inc. ("Montchanin") and its wholly owned subsidiary, Cypress
Capital Management, LLC ("Cypress"). We also have one unconsolidated affiliate,
WSFS Capital Trust III ("the Trust"). Founded in 1832, the Bank is one of the
ten oldest banks continuously operating under the same name in the United
States. We provide residential and commercial real estate, commercial and
consumer lending services, as well as retail deposit and cash management
services. In addition, we offer a variety of wealth management and personal
trust services through the Bank's new division, Wilmington Advisors, which was
formed during 2006. Lending activities are funded primarily with retail deposits
and borrowings. The Federal Deposit Insurance Corporation ("FDIC") insures our
customers' deposits to their legal maximum. We serve customers from our main
office, twenty-nine retail banking offices, four loan production offices and
operations centers located in Delaware and southeastern Pennsylvania. Montchanin
was formed in 2003 to provide asset management products and services in the
Bank's primary market area. The Trust was formed in 2005 to issue Pooled
Floating Rate Capital Securities. Cypress is a Wilmington-based investment
advisory firm servicing high net-worth individuals and institutions.
The Bank's fully-owned and consolidated subsidiaries include WSFS
Investment Group, Inc. and WSFS Reit, Inc. WSFS Investment Group, Inc. markets
various third-party insurance products and securities directly to the public and
through the Bank's retail banking system. WSFS Reit, Inc. is a real estate
investment trust formed to hold qualifying real estate assets and may be used to
raise capital in the future.
Our accounting and reporting policies conform with U.S. generally
accepted accounting principles and prevailing practices within the banking
industry for interim financial information and Rule 10-01 of Regulation S-X.
According to that rule, we are not required to include all information and notes
for complete financial statements. Operating results for the three and nine
month periods ended September 30, 2007 are not necessarily indicative of the
results that may be expected for any future quarters or for the year ending
December 31, 2007. For further information, refer to the Consolidated Financial
Statements and notes thereto included in our Annual Report of Form 10-K for the
year ended December 31, 2006 as filed with the Securities and Exchange
Commission.
Accounting for Stock-Based Compensation
The impact of expensing stock options for the three months ended
September 30, 2007, was an increase of $206,000 (pre-tax) or $0.03 (after-tax)
per share, to salaries, benefits and other compensation. This compares to
$301,000 (pre-tax) or $0.04 (after-tax) per share for the three months ended
September 30, 2006. The impact of expensing stock options for the nine months
ended September 30, 2007, was an increase of $687,000 (pre-tax) or $0.09
(after-tax) per share, to salaries, benefits and other compensation. This
compares to $992,000 (pre-tax) or $0.12 (after-tax) per share for the nine
months ended September 30, 2006.
We have stock options outstanding under two plans (collectively, "Stock
Incentive Plans") for officers, directors and Associates of the Corporation and
its subsidiaries. After shareholder approval in 2005, the 1997 Stock Option Plan
("1997 Plan"), was replaced by the 2005 Incentive Plan ("2005 Plan"). No future
awards may be granted under the 1997 Plan. The 2005 Plan will terminate on the
tenth anniversary of its effective date, after which no awards may be granted.
The number of shares reserved for issuance under the 2005 Plan is 862,000. At
September 30, 2007, there were 494,536 available for future grants under the
2005 Plan.
The Stock Incentive Plans provide for the granting of incentive stock
options as defined in Section 422 of the Internal Revenue Code as well as
nonincentive stock options (collectively, "Stock Options"). Additionally, the
2005 Plan provides for the granting of stock appreciation rights, performance
awards, restricted stock and restricted stock unit awards, deferred stock units,
dividend equivalents, other stock-based awards and cash awards. All Stock
Options are to be granted at not less than the market price of the Corporation's
common stock on the date of the grant. All Stock Options granted during 2007
vest in 20% or 25% per annum increments, start to become exercisable one year
from the grant date and expire between five and ten years from the grant date.
Generally, all awards become immediately exercisable in the event of a change in
control and termination without cause or constructive termination of the
Associate.
During the second quarter of 2007, the Board of Directors adopted an
administrative policy directing that future awards of stock options under the
2005 Plan will have a minimum vesting period of four years and maximum option
life of five years from the date of grant.
7
Summarized below is the status of our Stock Incentive Plans and changes
during the quarters shown.
September 2007 September 2006
--------------------------------- ---------------------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Stock Options:
Outstanding at beginning of period 623,429 $41.49 688,962 33.38
Granted 2,120 66.11 2,700 61.63
Exercised (3,703) 52.52 (44,080) 16.31
Forfeited or canceled (7,599) 60.39 (410) 61.59
------- -----
Outstanding at end of period 614,247 41.27 647,172 34.64
Exercisable at end of period 351,882 28.09 361,435 22.54
Weighted-average fair value
of awards granted $ 14.12 16.54
On July 1, 2007, 352,775 stock options were exercisable with an
intrinsic value of $12.1 million. In addition, at July 1, 2007, there were
270,654 nonvested options with a weighted average grant date fair value of
$12.94. During the third quarter of 2007, 2,810 options vested with an intrinsic
value of $20,000, and a weighted average grant date fair value of $13.40 per
option. Also during the quarter, 3,703 options were exercised with an intrinsic
value of $42,000. There were 351,882 exercisable options remaining at September
30, 2007, with an intrinsic value of $12.1 million and an average remaining
contractual term of 4.3 years. At September 30, 2007 there were 614,247 stock
options outstanding with an intrinsic value of $13.4 million and an average
remaining contractual term of 4.5 years. During the third quarter of 2006,
44,080 options were exercised with an intrinsic value of $2.0 million and 9,795
options vested with a weighted average grant date fair value of $10.85 per
option.
Summarized below is the status of our Stock Incentive Plans and changes
during the nine months shown.
September 2007 September 2006
--------------------------------- ---------------------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Stock Options:
Outstanding at beginning of period 703,427 $39.52 742,404 $31.92
Granted 7,100 68.14 9,720 62.23
Exercised (78,606) 24.04 (103,426) 17.58
Forfeited or canceled (17,674) 59.03 (1,526) 43.99
-------- -------
Outstanding at end of period 614,247 41.27 647,172 34.64
Exercisable at end of period 351,882 28.09 361,435 22.54
Weighted-average fair value
of awards granted $14.70 16.27
On January 1, 2007, 416,773 stock options were exercisable. During the
nine months ended September 30, 2007, 14,480 options vested with an intrinsic
value of $307,000, and a weighted average grant date fair value of $10.06 per
option. Also, during the first nine months of 2007, 78,606 options were
exercised with an intrinsic value of $3.2 million. During the first nine months
of 2006, 103,426 options were exercised with an intrinsic value of $4.6 million
and 29,927 options vested with a weighted average grant date fair value of $8.71
per option.
The total amount of compensation cost related to nonvested stock
options as of September 30, 2007 was $1.4 million. This amount has not yet been
recorded in our financial statements. The weighted-average period over which it
is expected to be recognized is 1.4 years. We issue new shares upon the exercise
of options.
During the third quarter of 2007, we granted 2,120 options with a
five-year life and a four-year vesting period. The Black-Scholes option-pricing
model was used to determine the grant date fair value of these options, which
was $14.12 per option. Significant assumptions used in the model included a
weighted-average risk-free rate of return of 4.2% in 2007; an expected option
life of three and three-quarter years; and an expected stock price volatility of
20.4% in 2007. For the purposes of this option-pricing model, an average
dividend yield of 0.6% was assumed. During the first nine months of 2007, we
granted 7,045 options with a five-
8
year life and a four-year vesting period. The Black-Scholes option-pricing model
was used to determine the grant date fair value of these options, which was
$14.64 per option. Significant assumptions used in the model included a
weighted-average risk-free rate of return of 4.6% in 2007; an expected option
life of three and three-quarter years; and an average expected stock price
volatility of 19.2% in 2007. For the purposes of this option-pricing model, an
average dividend yield of 0.5% was assumed.
Also during the first nine months of 2007, we granted 55 options with a
ten-year life and a five-year vesting period. The Black-Scholes option-pricing
model was used to determine the grant date fair value of these options, which
was $22.07 per option. Significant assumptions used in the model included a
weighted-average risk-free rate of return of 4.7% in 2007; an expected option
life of six and one-half years; and an expected stock price volatility of 21.1%
in 2007. For the purposes of this option-pricing model, a dividend yield of 0.5%
was assumed.
Prior to adoption of Statement of Financial Accounting Standards
("SFAS") No. 123 (revised 2004), Share-Based Payment ("SFAS 123R") we used a
graded-vesting schedule to calculate the expense related to stock options. Since
the adoption of SFAS 123R we have used a straight-line schedule to calculate the
expense related to new stock options issued.
The Black-Scholes option-pricing model assumes that options are freely
tradable and immediately vested. Since options are not transferable, have
vesting provisions, and are subject to trading blackout periods imposed by us,
the value calculated by the Black-Scholes model may significantly overstate the
true economic value of the options.
During the third quarter of 2007 and 2006 we issued 35 and 15,228
shares, respectively, of restricted stock. During the first nine months of 2007
and 2006 we issued 94 and 15,244 shares, respectively, of restricted stock.
These awards vest over five years: 0% during the first two years, 25% at the end
of each of the third and fourth years and 50% at the end of the fifth year. The
impact of expensing restricted stock for the three months ended September 30,
2007, was an increase of $75,000 (pre-tax) or $0.01 (after-tax) per share, to
salaries, benefits and other compensation. This compares to $41,000 (pre-tax) or
less than $0.01 (after-tax) per share impact for the three months ended
September 30, 2006. The impact of expensing restricted stock for the nine months
ended September 30, 2007, was an increase of $238,000 (pre-tax) or $0.02
(after-tax) per share, to salaries, benefits and other compensation. This
compares to $82,000 (pre-tax) or $0.01 (after-tax) per share for the nine months
ended September 30, 2006.
2. EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings
per share:
For the three months For the nine months
ended September 30, ended September 30,
------------------- -------------------
2007 2006 2007 2006
---- ---- ---- -----
(In Thousands, Except Per Share Data)
Numerator:
---------
Net income ........................................................... $ 7,143 $ 8,003 $22,153 $22,842
======= ======= ======= =======
Denominator:
-----------
Denominator for basic earnings per share - weighted average shares ... 6,248 6,657 6,359 6,626
Effect of dilutive employee stock options ............................ 179 258 203 278
------- ------- ------- -------
Denominator for diluted earnings per share - adjusted weighted average
shares and assumed exercise ....................................... 6,427 6,915 6,562 6,904
======= ======= ======= =======
Basic earnings per share ............................................. $ 1.14 $ 1.20 $ 3.48 $ 3.45
======= ======= ======= =======
Diluted earnings per share ........................................... $ 1.11 $ 1.16 $ 3.38 $ 3.31
======= ======= ======= =======
Outstanding common stock equivalents having no dilutive effect ....... 200 101 120 101
3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
We have an interest-rate cap with a notional amount of $50.0 million,
which limits three-month London InterBank Offered Rate ("LIBOR") to 6.00% for
the ten years ending December 1, 2008. The fair value of the cap is estimated
using a standard option model. The fair value of the interest rate cap at
September 30, 2007 was $2,000. The cap is considered a free standing derivative
and all changes in the fair value of the cap are recorded in the Statement of
Operations. During the first nine months of 2007, we recognized $28,000 of
related interest expense.
9
4. COMPREHENSIVE INCOME
The following schedule reconciles net income to total comprehensive
income as required by SFAS No. 130, Reporting Comprehensive Income:
For the three months For the nine months
ended September 30, ended September 30,
------------------- -------------------
2007 2006 2007 2006
---- ---- ---- -----
(In Thousands, Except Per Share Data)
Net income ........................................................... $ 7,143 $ 8,003 $ 22,153 $ 22,842
Other Comprehensive Income:
Unrealized holding gains on securities
available-for-sale arising during the period .................... 5,047 16,057 2,077 5,073
Tax expense .......................................................... (1,918) (6,101) (789) (1,927)
-------- -------- -------- --------
Net of tax amount .................................................... 3,129 9,956 1,288 3,146
Unrealized holding gains arising during the
period on derivative used for cash flow hedge .. ................ - 411 - 465
Tax expense .......................................................... - (144) - (164)
-------- -------- -------- --------
Net of tax amount .................................................... - 267 - 301
Reclassification adjustment for losses included in net income......... - (1,940) - (1,981)
Tax benefit .......................................................... - 737 - 753
-------- -------- -------- --------
Net of tax amount .................................................... - (1,203) - (1,228)
-------- -------- -------- --------
Total comprehensive income ........................................... $ 10,272 $ 17,023 $ 23,441 $ 25,061
======== ======== ======== ========
5. TAXES ON INCOME
We account for income taxes in accordance with SFAS No. 109, Accounting
for Income Taxes, which requires the recording of deferred income taxes that
reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. We have assessed valuation allowances on
the deferred income taxes due to, among other things, limitations imposed by
Internal Revenue Code and uncertainties, including the timing of settlement and
realization of these differences.
In July 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement 109 ("FIN 48"). FIN 48 prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement of tax positions taken or expected to be taken in a tax return.
Benefits from tax positions are recognized in the financial statements only when
it is more-likely-than-not that the tax position will be sustained upon
examination by the appropriate taxing authority that would have full knowledge
of all relevant information. A tax position that meets the more-likely-than-not
recognition threshold is measured at the largest amount of benefit that is
greater than fifty-percent likely of being realized upon ultimate settlement.
Tax positions that previously failed to meet the more-likely-than-not
recognition threshold are recognized in the first subsequent financial reporting
period in which that threshold is met. Previously recognized tax positions that
no longer meet the more-likely-than-not recognition threshold are derecognized
in the first subsequent financial reporting period in which that threshold is no
longer met. FIN 48 also provides guidance on the accounting for and disclosure
of unrecognized tax benefits, interest and penalties. FIN 48 became effective
for us on January 1, 2007, and resulted in a $2.0 million increase to our
retained earnings during the quarter ended March 31, 2007.
The total amount of unrecognized tax benefits as of January 1, 2007 was
$2.2 million, all of which would affect our effective tax rate if recognized.
The total amount of accrued interest and penalties associated with such
unrecognized tax benefits were $400,000 and $0, respectively. Approximately
$600,000 of these tax benefits was recognized during the quarter ended September
30, 2007 as a result of our changes to estimates of future sustainability of our
tax positions. We record interest and penalties on potential income tax
deficiencies as income tax expense. Federal tax years 2004 through 2006 remain
subject to examination as of September 30, 2007, while tax years 2004 through
2006 remain subject to examination by state taxing jurisdictions.
During the quarter ended September 30, 2007, an additional $3.6 million
tax reserve was established related primarily to the Internal Revenue Service
("IRS") disallowance of the deduction for certain compensation. This adjustment
was the result of a routine IRS audit of our 2004 through 2006 tax years.
Because the original tax benefit for this item was recorded as an increase to
equity, $3.4 million of the tax liability was recorded as a reduction to equity
in the three months ended September 30, 2007. There was
10
$200,000 reflected in the provision for income taxes during the quarter for
interest expense related to the IRS audit. Even though this matter is not yet
settled, standards under FIN 48 require this reserve to be established during
the quarter ended September 30, 2007.
6. SEGMENT INFORMATION
Under the definition of SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, we have three operating segments at
September 30, 2007. There is one segment for WSFS and one for CashConnect, the
ATM division of WSFS. The third segment, "All Others", represents the combined
contributions of Montchanin, WSFS Investment Group, Inc., and our Wealth
Management Services Division. Montchanin, WSFS Investment Group, Inc., and the
Wealth Management Services Division each offer different products, to a separate
customer base, through distinct distribution methods. All prior years'
information has been updated to reflect this presentation.
The WSFS segment provides financial products through its banking
offices to commercial and retail customers.
The CashConnect segment provides turnkey ATM services through strategic
partnerships with several of the largest networks, manufacturers, and service
providers in the ATM industry. The balance sheet category "Cash in non-owned
ATMs" includes cash in which fee income is earned through bailment arrangements
with customers of CashConnect.
Montchanin provides asset management products and services to customers
in the Bank's primary market area. Montchanin has one wholly-owned subsidiary,
Cypress. Cypress is a Wilmington-based investment advisory firm serving high
net-worth individuals and institutions. WSFS Investment Group, Inc. markets
various third-party insurance products and securities directly to the public and
through WSFS' retail banking system. The Wealth Management Services Division
provides wealth management and personal trust services to customers in the
Bank's primary market area.
An operating segment is a component of an enterprise that engages in
business activities from which it may earn revenues and incur expenses, whose
operating results are regularly reviewed by the enterprise's chief operating
decision makers to make decisions about resources to be allocated to the segment
and assess its performance, and for which discrete financial information is
available. We evaluate performance based on pretax ordinary income relative to
resources used, and allocate resources based on these results. Segment
information for the three and nine months ended September 30, 2007 and 2006
follows:
11
For the Three Months Ended September 30,
--------------------------------------------------------------------------------------------------------
2007 2006
-------------------------------------------------- ---------------------------------------------------
WSFS CashConnect All Others (1) Total WSFS CashConnect All Others (1) Total
---------- ----------- -------------- ---------- ---------- ---------- -------------- -----------
(in Thousands)
External customer revenues:
Interest income $ 47,579 $ - $ - $ 47,579 $ 46,131 $ - $ - $ 46,131
Noninterest income 7,420 4,501 888 12,809 5,342 4,164 803 10,309
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total external customer
revenues 54,999 4,501 888 60,388 51,473 4,164 803 56,440
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Inter-segment revenues:
Interest income 2,316 - - 2,316 2,174 - - 2,174
Noninterest income 635 168 - 803 426 179 - 605
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total inter-segment
revenues 2,951 168 - 3,119 2,600 179 - 2,779
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total revenue 57,950 4,669 888 63,507 54,073 4,343 803 59,219
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
External expenses:
Interest expense 27,480 - - 27,480 27,011 - - 27,011
Noninterest expenses 18,924 1,228 1,181 21,333 15,548 1,122 917 17,587
Provision for loan loss 1,001 - - 1,001 319 - - 319
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total external customer
expenses 47,405 1,228 1,181 49,814 42,878 1,122 917 44,917
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Inter-segment expenses
Interest expense - 2,316 - 2,316 - 2,174 - 2,174
Noninterest expenses 168 256 379 803 179 172 254 605
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total inter-segment expenses 168 2,572 379 3,119 179 2,346 254 2,779
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total expenses 47,573 3,800 1,560 52,933 43,057 3,468 1,171 47,696
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before minority
interest and taxes $ 10,377 $ 869 $ (672) $ 10,574 $ 11,016 $ 875 $ (368) $ 11,523
Provision for income taxes 3,431 3,511
Minority interest - 9
---------- ----------
Consolidated net income $ 7,143 $ 8,003
========== ==========
Cash and cash equivalents $ 71,885 $ 168,162 $ 1,424 $ 241,471 $ 82,513 $ 155,257 $ 731 $ 238,501
Other segment assets 2,825,974 14,275 2,058 2,842,307 2,746,268 12,922 2,011 2,761,201
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total segment assets $2,897,859 $ 182,437 $ 3,482 $3,083,778 $2,828,781 $ 168,179 $ 2,742 $2,999,702
========== ========== ========== ========== ========== ========== ========== ==========
Capital expenditures $ 2,352 $ 53 $ 1 $ 2,406 $ 2,386 $ 174 $ 3 $ 2,563
(1) Includes Montchanin Capital Management, Inc., WSFS Investment Group Inc.
and the Wealth Management Services Division.
12
For the Nine Months Ended September 30,
--------------------------------------------------------------------------------------------------------
2007 2006
-------------------------------------------------- ---------------------------------------------------
WSFS CashConnect All Others (1) Total WSFS CashConnect All Others (1) Total
---------- ----------- -------------- ---------- ---------- ---------- -------------- -----------
(in Thousands)
External customer revenues:
Interest income $ 141,334 $ - $ - $ 141,334 $ 130,476 $ - $ - $ 130,476
Noninterest income 20,115 12,387 2,656 35,158 15,179 11,629 2,419 29,227
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total external customer
revenues 161,449 12,387 2,656 176,492 145,655 11,629 2,419 159,703
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Inter-segment revenues:
Interest income 6,391 - - 6,391 5,976 - - 5,976
Noninterest income 1,817 498 - 2,315 1,254 519 - 1,773
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total inter-segment
revenues 8,208 498 - 8,706 7,230 519 - 7,749
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total revenue 169,657 12,885 2,656 185,198 152,885 12,148 2,419 167,452
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
External expenses:
Interest expense 80,035 - - 80,035 72,667 - - 72,667
Noninterest expenses 52,812 3,526 3,380 59,718 45,104 3,011 2,646 50,761
Provision for loan loss 2,645 - - 2,645 1,702 - - 1,702
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total external customer
expenses 135,492 3,526 3,380 142,398 119,473 3,011 2,646 125,130
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Inter-segment expenses
Interest expense - 6,391 - 6,391 - 5,976 - 5,976
Noninterest expenses 498 787 1,030 2,315 519 508 746 1,773
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total inter-segment expenses 498 7,178 1,030 8,706 519 6,484 746 7,749
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total expenses 135,990 10,704 4,410 151,104 119,992 9,495 3,392 132,879
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before minority
interest and taxes $ 33,667 $ 2,181 $ (1,754) $ 34,094 $ 32,893 $ 2,653 $ (973) $ 34,573
Provision for income taxes 11,941 11,691
Minority interest - 40
---------- ----------
Consolidated net income $ 22,153 $ 22,842
========== ==========
Cash and cash equivalents $ 71,885 $ 168,162 $ 1,424 $ 241,471 $ 82,513 $ 155,257 $ 731 $ 238,501
Other segment assets 2,825,974 14,275 2,058 2,842,307 2,746,268 12,922 2,011 2,761,201
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total segment assets $2,897,859 $ 182,437 $ 3,482 $3,083,778 $2,828,781 $ 168,179 $ 2,742 $2,999,702
========== ========== ========== ========== ========== ========== ========== ==========
Capital expenditures $ 7,532 $ 58 $ 5 $ 7,595 $ 7,275 $ 369 $ 37 $ 7,681
(1) Includes Montchanin Capital Management, Inc., WSFS Investment Group Inc.
and the Wealth Management Services Division.
13
7. INDEMNIFICATIONS AND GUARANTEES
Secondary Market Loan Sales. Generally, we do not sell loans with
recourse except to the extent arising from standard loan sale contract
provisions covering violations of representations and warranties and, under
certain circumstances, first payment default by borrowers. These are customary
repurchase provisions in the secondary market for conforming mortgage loan
sales. We sell fixed-rate, conforming first mortgage loans to Freddie Mac as
part of our ongoing asset/liability management program. Loans held-for-sale are
carried at the lower of cost or market of the aggregate or, in some cases,
individual loans. Gains and losses on sales of loans are recognized at the time
of the sale.
As is customary in such sales, we provide indemnifications to the
buyers under certain circumstances. These indemnifications may include our
repurchase of the loans. Repurchases and losses have been rare, and no provision
is made for losses at the time of sale. From January 2005 through the third
quarter of 2007, we have had no repurchases under these indemnifications.
During the third quarter of 2007 we sold our entire credit card loan
portfolio. As part of this sale we were required to make certain standard
industry representations. These included, but were not limited to,
representations relating to fraud, delinquency, and bankruptcy.
Swap Guarantees. We entered into agreements with two unrelated
financial institutions, whereby those financial institutions entered into
interest rate derivative contracts (interest rate swap transactions) with
customers referred to them by us. By the terms of the agreements, those
financial institutions have recourse to us for any exposure created under each
swap transaction in the event the customer defaults on the swap agreement and
the agreement is in a paying position to the third-party financial institution.
This is a customary arrangement that allows financial institutions, such as
ours, to provide access to interest rate swap transactions for its customers
without creating the swap itself.
At September 30, 2007, there were twenty-three variable-rate to
fixed-rate swap transactions between the third party financial institutions and
customers of ours, compared to twenty-two at December 31, 2006. The initial
notional amount aggregated approximately $85.9 million at September 30, 2007
compared with $77.4 million at December 31, 2006, with maturities ranging from
approximately one to fifteen years. The aggregate fair value of these swaps to
the customers was a liability of $1.8 million at September 30, 2007 compared to
a liability of $291,000 at December 31, 2006. The amount of liability recorded
by us for these guarantees that were in a liability position at September 30,
2007 and December 31, 2006 was $19,000 and $7,000, respectively. This amount
represented the fair value of the guarantee to perform under the terms of the
swap agreements.
ATM Cash Management. We entered into an agreement with a financial
institution, whereby they provide cash for distribution/cash management by Cash
Connect, our ATM division. Under this agreement we accept the operational risk
associated with this cash and are legally bound to reimburse the financial
institution for any related operational losses. We have taken steps to mitigate
the risk of loss to us by purchasing a multi-layer insurance policy and
instituting strong operational controls. Additionally, Cash Connect has the
ability to recover losses from its vault cash customers based on the strength of
our ATM cash bailment agreements, which hold the ATM vault cash customers
responsible for any loss of cash, which is not a result of our gross negligence.
8. ASSOCIATE (EMPLOYEE) BENEFIT PLANS
Postretirement Benefits
We share certain costs of providing health and life insurance benefits
to retired Associates (and their eligible dependents). Associates may become
eligible for these benefits if they reach normal retirement age while working
for us.
We account for our obligations under the provisions of SFAS No. 106,
Employers' Accounting for Postretirement Benefits Other Than Pensions ("SFAS
106"). SFAS 106 requires that the costs of these benefits be recognized over an
Associate's active working career. Disclosures for 2007 are in accordance with
SFAS No. 158, Employer's Accounting for Defined Benefit Pension and Other
Postretirement Plans ("SFAS 158") while disclosures for previous years are in
accordance with SFAS No. 132 (Revised), Employers' Disclosure About Pensions and
Other Postretirement Benefits.
14
The following disclosures of the net periodic benefit cost components
of post-retirement benefits were measured at January 1, 2007 and 2006:
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2007 2006 2007 2006
---- ---- ---- ----
Service cost ............................. $ 34 $ 27 $103 $ 81
Interest cost ............................ 32 23 94 70
Amortization of transition obligation .... 15 15 45 45
Net loss recognition ..................... 5 -- 15 --
---- ---- ---- ----
Net periodic benefit cost....... $ 86 $ 65 $257 $196
==== ==== ==== ====
Supplemental Pension Plan
We provide a nonqualified supplemental pension plan that gives credit
for 25 years of service based on the qualified plan formula. This plan is
provided to two of our retired executives. The plan is no longer being provided
to our Associates. Unrecognized net gains or losses resulting from experience
different from that assumed and from changes in assumptions is recognized
immediately as a component of net periodic benefit cost.
The following disclosures of the net periodic benefit cost components
of the supplemental pension plan are in accordance with SFAS 132 (Revised) and
were measured at January 1, 2007 and 2006:
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
2007 2006 2007 2006
---- ---- ---- ----
Interest cost ............................ $ 10 $ 11 $ 30 $ 33
Net loss recognition...................... 6 15 20 43
---- ---- ---- ----
Net periodic benefit cost ...... $ 16 $ 26 $ 50 $ 76
==== ==== ==== ====
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
WSFS Financial Corporation (`the Company", "our Company", "we", "our"
or "us") is a thrift holding company headquartered in Wilmington, Delaware.
Substantially all of our assets are held by our subsidiary, Wilmington Savings
Fund Society, FSB ("WSFS Bank" or the "Bank"). Founded in 1832, we are one of
the ten oldest banks continuously operating under the same name in the United
States. As a federal savings bank, which was formerly chartered as a state
mutual savings bank, the Bank enjoys broader investment powers than most other
financial institutions. We have served the residents of the Delaware Valley for
175 years. We are the largest thrift institution headquartered in Delaware and
the third largest financial institution in the state on the basis of total
deposits traditionally garnered in-market. Our primary market area is the
mid-Atlantic region of the United States, which is characterized by a
diversified manufacturing and service economy. Our long-term business strategy
is to serve small and mid-size businesses through loans, deposits, investments,
and related financial services, and to gather retail core deposits. Our
strategic focus is to exceed customer expectations, deliver stellar service and
build customer advocacy through highly trained, relationship oriented, friendly,
knowledgeable, and empowered Associates.
We provide residential and commercial real estate, commercial and
consumer lending services, as well as cash management and retail deposit
services. In addition, we offer a variety of wealth management and personal
trust services through the Bank's new division, Wilmington Advisors, which was
formed during 2006. Lending activities are funded primarily with retail deposits
and borrowings. The Federal Deposit Insurance Corporation ("FDIC") insures our
customers' deposits to their legal maximum. We serve customers from our main
office and twenty-nine retail banking offices, four loan production offices and
operations centers located in Delaware and southeastern Pennsylvania.
We have two consolidated subsidiaries, WSFS Bank and Montchanin Capital
Management, Inc. ("Montchanin"). We also have one unconsolidated affiliate, WSFS
Capital Trust III. Fully-owned consolidated subsidiaries of the Bank include
WSFS Investment Group, Inc. which markets various third-party insurance products
and securities directly to the public and through the Bank's retail banking
system, and WSFS Reit, Inc., which holds qualifying real estate assets and may
be used in the future to raise capital.
Montchanin has one consolidated wholly-owned subsidiary, Cypress
Capital Management, LLC ("Cypress"). Cypress is a Wilmington-based investment
advisory firm serving high net-worth individuals and institutions. Cypress has
more than $511 million in assets under management at September 30, 2007.
FORWARD-LOOKING STATEMENTS
Within this report and financial statements, management has included
certain "forward-looking statements" concerning our future operations. It is
management's desire to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. This statement is for the
express purpose of availing the Company of the protections of such safe harbor
with respect to all "forward-looking statements". Management has used
"forward-looking statements" to describe the future plans and strategies
including expectations of our future financial results. Management's ability to
predict results or the effect of future plans and strategy is inherently
uncertain. Factors that could affect results include interest rate trends,
competition, the general economic climate in Delaware, the mid-Atlantic region
and the country as a whole, asset quality, loan growth, loan delinquency rates,
operating risk, uncertainty of estimates in general and changes in federal and
state regulations, among other factors. These factors should be considered in
evaluating the "forward-looking statements," and undue reliance should not be
placed on such statements. Actual results may differ materially from management
expectations. We do not undertake, and specifically disclaim any obligation to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the financial condition and results of
operations are based on the Consolidated Financial Statements, which are
prepared in conformity with U.S. generally accepted accounting principles. The
preparation of these Financial Statements requires management to make estimates
and assumptions affecting the reported amounts of assets, liabilities, revenue
and expenses. Management evaluates these estimates and assumptions on an ongoing
basis, including those related to the allowance for loan losses, contingencies
(including indemnifications), and deferred taxes. Management bases its estimates
on historical experience and various other factors and assumptions that are
believed to be reasonable under the circumstances. These form the basis for
making judgments on the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
16
The following are critical accounting policies that involve more
significant judgments and estimates:
Allowance for Loan Losses
We maintain allowances for credit losses and charge losses to these allowances
when realized. The determination of the allowance for loan losses requires
significant judgment reflecting management's best estimate of probable loan
losses related to specifically identified loans as well as those in the
remaining loan portfolio. Management's evaluation is based upon a continuing
review of these portfolios.
Contingencies (Including Indemnifications)
In the ordinary course of business we are subject to legal actions
which involve claims for monetary relief. Based upon information presently
available to us and our counsel, it is our opinion that any legal and financial
responsibility arising from such claims will not have a material adverse effect
on our results of operations.
We maintain a loss contingency for standby letters of credit and charge
losses to this reserve when such losses are realized. The determination of the
loss contingency for standby letters of credit requires significant judgment
reflecting management's best estimate of probable losses. The balance in this
reserve at September 30, 2007 was $387,000.
The Bank, as successor to originators of reverse mortgages is, from
time to time, involved in arbitration or litigation with various parties
including borrowers or the heirs of borrowers. There can be no assurances about
how the courts or arbitrators may apply existing legal principles to the
interpretation and enforcement of the terms and conditions of the Bank's reverse
mortgage obligations.
Income Taxes
We account for income taxes in accordance with Statement of Financial
Account Standards ("SFAS") No. 109, Accounting for Income Taxes ("SFAS 109"),
which requires the recording of deferred income taxes that reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. Management has assessed the Company's valuation allowances on deferred
income taxes resulting from, among other things, limitations imposed by Internal
Revenue Code and uncertainties, including the timing of settlement and
realization of these differences. We adopted Financial Accounting Standards
Board ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement 109 ("FIN 48") on January 1, 2007.
The impact of the adoption of this interpretation is more fully discussed in
Note 5 to the consolidated financial statements.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Financial Condition
Our total assets increased $86.4 million or 3% during the nine months ended
September 30, 2007. Net loans increased $138.3 million or 7% mainly attributable
to a $163.0 million or 12% increase in commercial and commercial real estate
loans offset by a decrease in residential mortgage loans of $27.5 million or 6%.
Mortgage-backed securities decreased $31.0 million or 6% due to scheduled
repayments and prepayments. Investment securities decreased $27.0 million or 49%
primarily due to $25.0 million in agency notes maturing during the first quarter
of 2007.
Total liabilities increased $95.4 million or 3% between December 31,
2006 and September 30, 2007 to $2.9 billion. This increase was due to an
increase in customer deposits of $105.1 million or 8%. The increase included
$64.5 million in money market accounts and $41.6 million in customer time
deposits. Decreases in brokered deposits of $32.5 million and other jumbo
certificates of deposits of $17.8 million offset these increases. There were
also increases in other borrowed funds of $15.9 million and $14.5 million in
Federal Home Loan Bank ("FHLB") advances.
Capital Resources
Stockholders' equity decreased $9.0 million between December 31, 2006
and September 30, 2007. This decrease was mainly due to our purchase of 513,600
shares of our common stock for $33.5 million ($65.18 per share average). In
addition, equity was reduced by $3.4 million related to income taxes, which is
more fully discussed in Note 5 to the consolidated financial statements. We also
declared cash dividends totaling $1.8 million during the nine months ended
September 30, 2007. These decreases were partially offset by net income of $22.2
million and an increase of $4.2 million from the issuance of common stock and
exercise of employee stock options. In addition, stockholders' equity increased
$2.0 million as a result of the implementation of the FIN 48. The impact of the
adoption of this interpretation is more fully discussed in Note 5 to the
Consolidated Financial Statements. Finally, accumulated
17
other comprehensive loss decreased $1.3 million during the first nine months of
2007 due to an increase in the fair value of securities available-for-sale.
Below is a table comparing the Bank's consolidated capital position to
the minimum regulatory requirements as of September 30, 2007 (dollars in
thousands):
To be Well-Capitalized
Consolidated For Capital Under Prompt Corrective
Bank Capital Adequacy Purposes Action Provisions
------------------------ ---------------------- ----------------------
% of % of % of
Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------
Total Capital
(to Risk-Weighted Assets) ........ $295,059 12.22% $193,142 8.00% $241,428 10.00%
Core Capital (to Adjusted
Total Assets)..................... 268,070 8.68 123,591 4.00 154,489 5.00
Tangible Capital (to Tangible
Assets) .......................... 268,070 8.68 46,347 1.50 N/A N/A
Tier 1 Capital (to Risk-Weighted
Assets)........................... 268,070 11.10 96,571 4.00 144,857 6.00
Under Office of Thrift Supervision ("OTS") capital regulations, savings
institutions such as our bank must maintain "tangible" capital equal to 1.5% of
adjusted total assets, "core" capital equal to 4.0% of adjusted total assets,
"Tier 1" capital equal to 4.0% of risk weighted assets and "total" or
"risk-based" capital (a combination of core and "supplementary" capital) equal
to 8.0% of risk-weighted assets. Failure to meet minimum capital requirements
can initiate certain mandatory actions and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect
on our bank's financial statements. At September 30, 2007 the Bank was in
compliance with regulatory capital requirements and is considered a
"well-capitalized" institution.
Liquidity
We manage our liquidity risk and funding needs through our treasury
function and our Asset/Liability Committee. We have a policy that separately
addresses liquidity, and management monitors our adherence to policy limits.
Also, liquidity risk management is a primary area of examination by the OTS. We
comply with guidance promulgated under Thrift Bulletin 77 that requires thrift
institutions to maintain adequate liquidity to assure safe and sound operations.
As a financial institution, the Bank has ready access to several
sources to fund growth and meet its liquidity needs. Among these are: net
income, deposit programs, loan repayments, borrowing from the FHLB, repurchase
agreements and the brokered deposit market. The Bank's branch expansion is
intended to enter us into new, but contiguous, markets, attract new customers
and provide funding for its business loan growth. In addition, we have a large
portfolio of high-quality, liquid investments, primarily short-duration,
AAA-rated, mortgage-backed securities and Agency notes that are positioned to
provide a near-continuous source of cash flow to meet current cash needs, or can
be sold to meet larger discrete needs for cash. Management believes these
sources are sufficient to maintain the required and prudent levels of liquidity.
During the nine months ended September 30, 2007, net loan growth
resulted in the use of $146.9 million in cash. The loan growth was primarily the
result of the successful implementation of specific strategies designed to
increase corporate and small business lending. While our loan to deposit ratio
has been well above 100% for many years, management has significant experience
managing the Bank's funding needs through borrowings, primarily through the
FHLB.
During the nine months ended September 30, 2007, $33.7 million in cash
was provided by operating activities, while $79.4 million in cash was provided
through the net increase in demand and savings deposits and $9.4 million in cash
was provided by the net increase in time deposits. During this period, cash and
cash equivalents decreased $353,000 to $241.5 million.
NONPERFORMING ASSETS
The following table shows our nonperforming assets and past due loans
at the dates indicated. Nonperforming assets include nonaccruing loans,
nonperforming real estate investments and assets acquired through foreclosure.
Nonaccruing loans are those on which the accrual of interest has ceased. Loans
are placed on nonaccrual status immediately if, in the opinion of management,
collection is doubtful, or when principal or interest is past due 90 days or
more and the value of the collateral is insufficient to cover principal and
interest. Interest accrued but not collected at the date a loan is placed on
nonaccrual status is reversed and charged against interest income. In addition,
the amortization of net deferred loan fees is suspended when a loan is placed on
nonaccrual status. Subsequent cash
18
receipts are applied either to the outstanding principal balance or recorded as
interest income, depending on management's assessment of the ultimate
collectibility of principal and interest. Past due loans are loans contractually
past due 90 days or more as to principal or interest payments but which remain
on accrual status because they are considered well secured and in the process of
collection.
September 30, December 31,
2007 2006
------- -------
(In Thousands)
Nonaccruing loans:
Commercial ........................................ $ 1,872 $ 1,282
Consumer .......................................... 617 557
Commercial mortgage ............................... 3,328 500
Residential mortgage .............................. 1,914 1,493
Construction ...................................... 7,996 -
------- -------
Total nonaccruing loans ................................ 15,727 3,832
Assets acquired through foreclosure .................... 703 388
------- -------
Total nonperforming assets ............................. $16,430 $ 4,220
======= =======
Past due loans:
Residential mortgages ............................. $ 333 $ 219
Commercial and commercial mortgages ............... 389 3
Consumer .......................................... 11 29
------- -------
Total past due loans ................................... $ 733 $ 251
======= =======
Ratios:
Nonaccruing loans to total loans (1) .............. 0.72% 0.19%
Allowance for loan losses to gross loans (1)....... 1.32% 1.34%
Nonperforming assets to total assets .............. 0.53% 0.14%
Loan loss allowance to nonaccruing loans (2)....... 172% 705%
Loan and foreclosed asset allowance to total
nonperforming assets (2) ........................ 164% 640%
(1) Total loans exclude loans held for sale.
(2) The applicable allowance represents general valuation allowances only.
Nonperforming assets increased $12.2 million between December 31, 2006
and September 30, 2007. This increase resulted primarily from a $10.3 million
lending relationship that was placed on nonaccrual status. The relationship
consists of $7.0 million in construction loans and $3.3 million in commercial
mortgages. The analysis of the change in nonperforming assets is presented on
the following table:
For the nine
months ended For the year ended
September 30, 2007 December 31, 2006
------------------ ------------------
(In Thousands)
Beginning balance................................. $ 4,220 $ 3,469
Additions ................................... 14,945 5,697
Collections.................................. (1,642) (3,916)
Transfers to accrual/restructured status..... (634) (453)
Charge-offs / write-downs, net............... (459) (577)
-------- -------
Ending balance.................................... $ 16,430 $ 4,220
======== ========
The timely identification of problem loans is a key element in our
strategy to manage our loan portfolio. Timely identification enables us to take
appropriate action and, accordingly, minimize losses. An asset review system
established to monitor the asset quality of our loans and investments in real
estate portfolios facilitates the identification of problem assets. In general,
this system utilizes guidelines established by federal regulation. However,
there can be no assurance that the levels or the categories of problem loans and
assets established by the Bank are the same as those which would result from a
regulatory examination.
19
INTEREST SENSITIVITY
The matching of maturities or repricing periods of interest
rate-sensitive assets and liabilities to promote a favorable interest rate
spread and mitigate exposure to fluctuations in interest rates is our primary
tool for achieving our asset/liability management strategies. Management
regularly reviews our interest-rate sensitivity and adjusts the sensitivity
within acceptable tolerance ranges established by management. At September 30,
2007, interest-bearing liabilities exceeded interest-earning assets that mature
or reprice within one year (interest-sensitive gap) by $34.4 million. Our
interest-sensitive assets as a percentage of interest-sensitive liabilities
within the one-year window decreased to 98% at September 30, 2007 from 99% at
June 30, 2007. Likewise, the one-year interest-sensitive gap as a percentage of
total assets changed to -1.12% at September 30, 2007 from -0.67% at June 30,
2007. The change in sensitivity since June 30, 2007 is the result of the current
interest rate environment and our continuing effort to effectively manage
interest rate risk.
Market risk is the risk of loss from adverse changes in market prices
and rates. During the past several months, market risk has been evident in the
repricing of risk in sub-prime mortgage-backed securities and collateralized
loan obligations. We have not been impacted by this market event because our
mortgage-backed securities portfolio is short in duration and comprised almost
exclusively of securities collateralized by prime credit mortgages. Our market
risk arises primarily from interest rate risk inherent in its lending,
investing, and funding activities. To that end, management actively monitors and
manages its interest rate risk exposure. One measure, required to be performed
by OTS-regulated institutions, is the test specified by OTS Thrift Bulletin No.
13a "Management of Interest Rate Risk, Investment Securities and Derivative
Activities." This test measures the impact of an immediate change in interest
rates in 100 basis point increments on the net portfolio value ratio. The net
portfolio value ratio is defined as the net present value of the estimated cash
flows from assets and liabilities as a percentage of net present value of cash
flows from total assets (or the net present value of equity). The table below
shows the estimated impact of immediate changes in interest rates on our net
interest margin and net portfolio value ratio at the specified levels at
September 30, 2007 and 2006, calculated in compliance with Thrift Bulletin No.
13a:
At September 30,
-----------------------------------------------------------------------
2007 2006
------------------------------- ---------------------------------
Change in % Change in % Change in
Interest Rate Net Interest Net Portfolio Net Interest Net Portfolio
(Basis Points) Margin (1) Value Ratio (2) Margin (1) Value Ratio (2)
------------- ------------- --------------- ----------- ---------------
+300 -3% 8.93% 3% 8.55%
+200 -1% 9.56% 2% 9.15%
+100 0% 10.06% 1% 9.82%
0 0% 10.33% 0% 9.97%
-100 1% 10.40% -2% 10.24%
-200 3% 10.55% -6% 10.66%
-300 3% 10.61% -10% 10.72%
(1) The percentage difference between net interest margin in a stable interest
rate environment and net interest margin as projected under the various
rate change environments.
(2) The net portfolio value ratio of the Company in a stable interest rate
environment and the net portfolio value ratio as projected under the
various rate change environments.
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
Results of Operations
We recorded net income of $7.1 million or $1.11 per diluted share for
the third quarter of 2007. This compares to $8.0 million or $1.16 per diluted
share for the same quarter last year. Results for the third quarter of 2007 were
impacted by an $882,000 gain ($0.09 per share) on the sale of our credit card
portfolio and a related $518,000 reduction ($0.05 per share) to the allowance
for loan losses. Additionally, one commercial lending relationship totaling
$10.3 million was placed on nonaccrual status. This resulted in a $618,000
increase ($0.06 per share) in our provision for loan losses and a $256,000
reversal ($0.03 per share) of interest income.
Net income for the nine months ended September 30, 2007 was $22.2
million or $3.38 per diluted share. This compares to $22.8 million or $3.31 per
diluted share for the same period last year.
20
Net Interest Income
The net interest margin for the third quarter of 2007 was 3.04%, up
0.16% from the third quarter of 2006. Net interest income for the third quarter
of 2007 was $20.1 million compared to $19.1 million for the same quarter in
2006. During the third quarter of 2007, one commercial lending relationship
totaling $10.3 million, secured by real estate, was placed on nonaccrual status.
This resulted in a $256,000 reversal of interest income. This negatively
affected the net interest margin by 4 basis points, 0.04%. The third quarter of
2006 included a $411,000 (6 basis points, 0.06%) non-cash charge related to the
refinancing of our trust preferred securities. The overall improvement in the
net interest margin over last year reflects growth, and our continued efforts to
refocus the mix of our balance sheet. Loans, with a yield of 7.65%, increased
$149.8 million while mortgage-backed securities, with a yield of 4.96%, declined
$125.6 million mostly due to scheduled repayments. In addition, interest-bearing
deposits, with a rate of 3.83%, increased $238.8 million while FHLB advances,
with a rate of 5.05%, decreased $282.8 million. The yield on earning assets
increased 0.26% in comparison to the third quarter of 2006 while the rate on
interest-bearing liabilities increased by 0.08%.
The net interest margin for the first nine months of 2007 was 3.13%, up
0.18% from the same period of 2006. Net interest income for the nine-month
period ending September 30, 2007 was $61.3 million compared to $57.8 million for
the same period in 2006. Consistent with the quarterly trend discussed above,
the increase in net interest income was mostly due to improved balance sheet mix
of earning assets and interest-bearing liabilities. The yield on earning assets
increased 0.56% in comparison to the first nine months of 2006 while the rate on
interest-bearing liabilities increased by 0.41%. Additionally, income from
reverse mortgages increased $1.6 million in comparison to the first nine months
of 2006.
21
AVERAGE BALANCE SHEET
Three months ended September 30,
----------------------------------------------------------------------------
2007 2006
--------------------------------- --------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
------- -------- -------- ------- -------- --------
(Dollars in Thousands)
Assets:
Interest-earning assets:
Loans (2) (3):
Commercial real estate loans ............ $ 697,945 $14,286 8.19% $ 639,307 $13,537 8.47%
Residential real estate loans............ 454,010 6,551 5.77 492,408 6,808 5.53
Commercial loans ........................ 721,080 14,707 8.13 601,763 12,294 8.18
Consumer loans........................... 272,881 5,203 7.56 262,600 4,938 7.46
---------- ------- ---------- -------
Total loans............................ 2,145,916 40,747 7.65 1,996,078 37,577 7.59
Mortgage-backed securities (4)................ 467,998 5,799 4.96 593,589 7,186 4.84
Investment securities (4) (5)................. 27,704 457 6.60 52,935 616 4.65
Other interest-earning assets ................ 38,030 576 6.01 55,668 752 5.36
---------- ------- ---------- -------
Total interest-earning assets............ 2,679,648 47,579 7.14 2,698,270 46,131 6.88
------- -------
Allowance for loan losses..................... (28,503) (26,938)
Cash and due from banks....................... 64,834 57,372
Cash in non-owned ATMs........................ 169,775 158,396
Bank owned life insurance..................... 56,571 55,414
Other noninterest-earning assets.............. 70,447 63,607
---------- ----------
Total assets............................. $3,012,772 $3,006,121
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Interest-bearing deposits:
Interest-bearing demand.................. $ 154,474 $ 401 1.03% $ 121,160 $ 229 0.75%
Money market............................. 313,825 3,057 3.86 227,285 2,080 3.63
Savings.................................. 208,811 437 0.83 241,823 667 1.09
Retail time deposits .................... 490,133 5,848 4.73 415,792 4,183 3.99
---------- ------- ---------- -------
Total interest-bearing retail deposits. 1,167,243 9,743 3.31 1,006,060 7,159 2.82
Jumbo certificates of deposits .......... 94,535 1,268 5.32 77,255 1,039 5.34
Brokered deposits........................ 299,337 4,055 5.38 238,983 3,194 5.30
---------- ------- ---------- -------
Total interest-bearing deposits........ 1,561,115 15,066 3.83 1,322,298 11,392 3.42
FHLB of Pittsburgh advances................... 719,175 9,280 5.05 1,002,001 12,384 4.84
Trust preferred borrowings.................... 67,011 1,217 7.11 67,011 1,736 10.14
Other borrowed funds.......................... 160,752 1,917 4.77 123,377 1,499 4.86
---------- ------- ---------- -------
Total interest-bearing liabilities....... 2,508,053 27,480 4.38 2,514,687 27,011 4.30
------- -------
Noninterest-bearing demand deposits........... 273,990 265,594
Other noninterest-bearing liabilities......... 26,884 25,970
Minority interest ............................ 34 68
Stockholders' equity.......................... 203,811 199,802
---------- ----------
Total liabilities and stockholders' equity.... $3,012,772 $3,006,121
========== ==========
Excess of interest-earning over
interest-bearing liabilities............. $ 171,595 $ 183,583
========== ==========
Net interest and dividend income.............. $20,099 $19,120
======= =======
Interest rate spread.......................... 2.76% 2.58%
===== =====
Net interest margin........................... 3.04% 2.88%
===== ====
(1) Weighted average yields have been computed on a tax-equivalent basis.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale.
(5) Includes reverse mortgages.
22
AVERAGE BALANCE SHEET
Nine months ended September 30,
----------------------------------------------------------------------------
2007 2006
--------------------------------- --------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate (1)
------- -------- -------- ------- -------- --------
(Dollars in Thousands)
Assets:
Interest-earning assets:
Loans (2) (3):
Commercial real estate loans ............ $ 672,630 $ 41,784 8.28% $ 627,838 $ 38,157 8.10%
Residential real estate loans ........... 462,366 19,818 5.71 481,632 19,732 5.46
Commercial loans ........................ 686,950 41,771 8.18 567,265 33,085 7.89
Consumer loans........................... 269,264 15,228 7.56 257,172 14,031 7.29
---------- -------- ---------- --------
Total loans............................ 2,091,210 118,601 7.61 1,933,907 105,005 7.30
Mortgage-backed securities (4)................ 488,696 18,037 4.92 611,454 21,989 4.79
Investment securities (4) (5)................. 29,549 2,894 13.06 55,102 1,639 3.97
Other interest-earning assets ................ 38,333 1,802 6.29 52,279 1,843 4.71
---------- -------- ---------- --------
Total interest-earning assets............ 2,647,788 141,334 7.16 2,652,742 130,476 6.60
-------- --------
Allowance for loan losses..................... (28,003) (26,288)
Cash and due from banks....................... 67,616 54,767
Cash in non-owned ATMs........................ 156,523 153,522
Bank-owned life insurance..................... 56,030 54,884
Other noninterest-earning assets.............. 67,857 61,928
---------- ----------
Total assets............................. $2,967,811 $2,951,555
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Interest-bearing deposits:
Interest bearing demand.................. $ 145,900 $ 993 0.91% $ 122,618 $ 531 0.58%
Money market............................. 312,995 9,146 3.91 227,340 5,772 3.39
Savings.................................. 215,239 1,321 0.82 242,797 1,622 0.89
Retail time deposits .................... 468,440 16,418 4.69 367,891 10,367 3.77
---------- -------- ---------- --------
Total interest-bearing retail deposits. 1,142,574 27,878 3.26 960,646 18,292 2.55
Jumbo certificates of deposits .......... 98,793 3,935 5.33 73,959 2,736 4.95
Brokered deposits........................ 294,874 11,940 5.41 236,787 8,654 4.89
---------- -------- ---------- --------
Total interest-bearing deposits........ 1,536,241 43,753 3.81 1,271,392 29,682 3.12
FHLB of Pittsburgh advances................... 719,255 27,740 5.09 1,014,156 35,131 4.57
Trust preferred borrowings.................... 67,011 3,555 7.00 67,011 3,859 7.59
Other borrowed funds.......................... 140,072 4,987 4.75 119,468 3,995 4.46
---------- -------- ---------- --------
Total interest-bearing liabilities....... 2,462,579 80,035 4.33 2,472,027 72,667 3.92
-------- --------
Noninterest-bearing demand deposits........... 273,259 264,233
Other noninterest-bearing liabilities......... 25,887 23,205
Minority interest ............................ 40 95
Stockholders' equity.......................... 206,046 191,995
---------- ----------
Total liabilities and stockholders' equity.... $2,967,811 $2,951,555
========== ==========
Excess of interest-earning assets over
interest-bearing liabilities............. $ 185,209 $ 180,715
========== ==========
Net interest and dividend income.............. $ 61,299 $ 57,809
======== ==========
Interest rate spread.......................... 2.83% 2.68%
==== =====
Net interest margin........................... 3.13% 2.95%
==== =====
(1) Weighted average yields have been computed on a tax-equivalent basis.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale.
(5) Includes reverse mortgages.
23
Allowance for Loan Losses
We maintain allowances for credit losses and charge losses to these
allowances when such losses are realized. The determination of the allowance for
loan losses requires significant judgment reflecting management's best estimate
of probable loan losses related to specifically identified loans as well as
probable loan losses in the remaining loan portfolio. Management's evaluation is
based upon a continuing review of these portfolios.
Management establishes the loan loss allowance in accordance with
guidance provided in the Securities and Exchange Commission's Staff Accounting
Bulletin 102 ("SAB 102"). Its methodology for assessing the appropriateness of
the allowance consists of several key elements which include: specific
allowances for identified problem loans; formula allowances for commercial and
commercial real estate loans; and allowances for pooled homogenous loans.
Specific reserves are established for certain loans in cases where
management has identified significant conditions or circumstances related to a
specific credit that indicate the probability that a loss has been incurred.
The allowance formula for commercial and commercial real estate loans
is calculated in each case by applying loss factors to outstanding loans based
on the internal risk grade of loans. Based on this internal risk grade the loss
factor may include an analysis of both the probability of default and the
probability of loss should default occur. As a result, changes in risk grades of
both performing and nonperforming loans affect the amount of the formula
allowance. Loss factors by risk grade have a basis in our historical default
experience for such loans and an assessment of the probability of default. Loss
adjustment factors are applied based on criteria discussed below.
Pooled loans are loans that are usually smaller,
not-individually-graded and homogenous in nature, such as consumer installment
loans and residential mortgages. Loan loss allowances for pooled loans are based
on a ten-year net charge-off history. The average loss allowance per homogenous
pool is based on the product of average annual historical loss rate and the
average estimated duration of the pool multiplied by the pool balances. These
separate risk pools are then assigned a reserve for losses based upon this
historical loss information and historical loss adjustment factors.
Historical loss adjustment factors are based upon management's
evaluation of various current conditions, including those listed below.
o General economic and business conditions affecting the Bank's key lending
areas,
o Credit quality trends,
o Recent loss experience in particular segments of the portfolio,
o Collateral values and loan-to-value ratios,
o Loan volumes and concentrations, including changes in mix,
o Seasoning of the loan portfolio,
o Specific industry conditions within portfolio segments,
o Bank regulatory examination results, and
o Other factors, including changes in quality of the loan origination,
servicing and risk management processes.
Our loan officers and risk managers meet at least quarterly to discuss
and review these conditions and risks associated with individual problem loans.
The provision for loan losses was $2.6 million for the first nine months of
2007, an increase from $1.7 million during the first nine months of 2006. During
the quarter, one commercial lending relationship totaling $10.3 million, secured
by real estate, was placed on nonaccrual status. This resulted in a $618,000
increase in our provision for loan losses. In addition, growth in our commercial
loan portfolio, an increase in net charge-offs, and a migration of a small
amount of loans to lower quality credit grades contributed to the increased
provision. Partially offsetting these increases was the third quarter sale of
essentially our entire credit card portfolio. This resulted in a $518,000
decrease to the provision for loan losses. During the second quarter of 2007, we
extended our "loss given default" methodology to include "eight rated" loans
(one grade above classified). Additionally, we began applying adjustment factors
against all loan balances. Deposit overdraft charge-offs have been included in
net charge-offs since the second quarter of 2006.
We maintain allowances for credit losses and charge losses to these
allowances when such losses are realized. The allowances for losses are
maintained at a level which management considers adequate to provide for losses
based upon an evaluation of known and inherent risks in the portfolios.
24
The table below represents a summary of changes in the allowance for
loan losses during the periods indicated.
Nine months ended Nine months ended
September 30, 2007 September 30, 2006
------------------ ------------------
(Dollars in Thousands)
Beginning balance .............................. $27,384 $25,381
Provision for loan losses ...................... 2,645 1,702
Charge-offs:
Residential real estate ................... 41 70
Commercial real estate (1) ................ - -
Commercial ................................ 347 145
Overdrafts (2) ............................ 1,078 257
Consumer .................................. 509 365
------- -------
Total charge-offs .............................. 1,975 837
------- -------
Recoveries:
Residential real estate ................... 8 14
Commercial real estate (1) ................ 125 166
Commercial ................................ 144 189
Overdrafts (2) ............................ 355 -
Consumer .................................. 82 132
------- -------
Total recoveries ............................... 714 501
------- -------
Net charge-offs ................................ 1,261 336
------- -------
Ending balance ................................. $28,768 $26,747
======= =======
Net charge-offs to average gross loans
outstanding, net of unearned income (3)....... 0.08% 0.02%
======= =======
(1) Includes commercial mortgage and construction loans.
(2) Overdraft charge-offs and recoveries have been included in the allowance
for loan losses since April 2006.
(3) Ratio for nine months ended September 30, 2007 and September 30, 2006 are
annualized.
Noninterest Income
Noninterest income for the quarter ended September 30, 2007 was $12.8
million compared to $10.3 million for the third quarter of 2006 an increase of
$2.5 million or 24%. The increase over the third quarter 2006 was mainly
attributable to a $958,000 increase in deposit service charges and an $882,000
gain on the sale of the credit card portfolio. Deposit service charges continue
to benefit from an increase in deposit accounts and additional fee-based
services offered by WSFS. Included in the third quarter of 2006 was $1.8 million
in unanticipated income related to the Bank's investment in bank-owned life
insurance (BOLI). This was offset by a $1.9 million loss on the sale of $51.4
million in below-market yielding mortgage-backed securities as part of the
Company's efforts to improve its earning asset mix and return on assets.
For the nine months ended September 30, 2007, noninterest income was
$35.2 million, an increase of $5.9 million or 20% over the same period in 2006.
Consistent with the quarter over quarter trend, the increase was mainly due to a
$3.0 million increase in deposit service charges as a result of our continued
success in personal and business checking initiatives. Adding to the increase
over the nine months ended September 30, 2006 was the gain on the sale of the
credit card portfolio and a seasonal increase in credit/debit card and ATM
income.
Noninterest Expense
Noninterest expense for the quarter ended September 30, 2007 was $21.3
million for an increase of $3.7 million over the $17.6 million reported for the
same period in 2006. The 21% increase over the third quarter of 2006 was
primarily a result of our continued growth efforts. Since September 2006, we
have opened four branch offices, renovated/relocated two branch offices, began
originating reverse mortgages, continued expansion of the commercial division,
and continued growth efforts in the Wealth Management Division (the Wealth
Management Division acquired its initial accounts during the first quarter of
2007). Additionally, the Company moved into its new corporate headquarters in
the WSFS Bank Center in March 2007. This corporate expansion is reflected in all
areas of expenses, but primarily in higher compensation, occupancy and equipment
expense. The number of full-time equivalent Associates increased from 592 in the
third quarter of 2006 to 612 in the third quarter of 2007. In addition,
marketing expenses increased $607,000 over the third quarter of 2006. In the
third quarter of 2007 we introduced a new multi-year brand campaign, which
accounted for the majority of the increased spending. "We Stand For Service" is
the external representation of our
25
business model and service value presentation. We also conducted significant
core marketing initiatives to support key growth objectives. Also during the
third quarter of 2007, the Company had a one-time charge of $228,000 relating to
a branch closure. This franchise growth is the main reason for our increased
levels of operating expenses.
Noninterest expense for the nine months ended September 30, 2007 was
$59.7 million, an increase of $9.0 million or 18% over the $50.8 million
reported for the same period in 2006. The increase was mainly due to our growth
efforts mentioned above. As a result of our continued investment in the
franchise, increases can be found mainly in salaries, benefits and other
compensation as well as occupancy expense. These increases were offset during
the second quarter of 2007 by a reduction in expenses relating to a reserve for
standby letters of credit.
Income Taxes
The Company and its subsidiaries, with the exception of WSFS Reit,
Inc., file a consolidated federal income tax return and separate state income
tax returns. WSFS Reit, Inc. files separate federal and state income tax
returns. Income taxes are accounted for in accordance with SFAS 109, which
requires the recording of deferred income taxes for tax consequences of
"temporary differences." We recorded a provision for income taxes during the
three and nine months ended September 30, 2007 of $3.4 million and $11.9
million, respectively, compared to an income tax provision of $3.5 million and
$11.7 million for the same periods in 2006. The effective tax rate for the three
and nine month periods ended September 30, 2007 was 32% and 35%, respectively,
compared to 31% and 34%, respectively, for the comparable periods in 2006. This
increased effective tax rate was primarily due to the receipt of $1.8 million
tax-free death benefit pursuant to the Bank-Owned Life Insurance ("BOLI") plan
in September 2006 combined with the effects of new tax accounting guidance under
FIN 48. While the impact of FIN 48 adds volatility to our quarterly effective
tax rate, we believe it will have a minimal impact to the rate over the full
year.
The effective tax rate reflects the recognition of certain tax benefits
in the financial statements including those benefits from tax-exempt interest
income, BOLI income and fifty-percent interest income exclusion on a loan to an
Employee Stock Ownership Plan. These tax benefits are offset by the tax effect
of stock-based compensation expense related to incentive stock options and a
provision for state income tax expense.
We frequently analyze our projections of taxable income and make
adjustments to our provision for income taxes accordingly.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain
Hybrid Financial Instruments - An Amendment of Statements No. 133 and 140 ("SFAS
155"). This Statement permits fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation. It also clarifies which interest-only strips are not subject to the
requirements of SFAS 133. In addition, it establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation. SFAS 155 becomes effective in
fiscal years beginning after September 15, 2006. The adoption of this Statement
did not have a material impact on our Consolidated Financial Statements.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing
of Financial Assets - An Amendment of Statement No. 140 ("SFAS 156"). This
Statement will modify the accounting for servicing assets and liabilities, such
as those common with mortgage securitization activities. The new Standard
addresses the recognition and measurement of separately recognized servicing
assets and liabilities and provides an approach to lessen the efforts to obtain
hedge-like (offset) accounting. SFAS 156 becomes effective in fiscal years
beginning after September 15, 2006. The adoption of this Statement did not have
a material impact on our Consolidated Financial Statements.
In September 2006, the Emerging Issues Task Force ("EITF") reached a
final consensus on Issue 06-04, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance
Arrangements. In accordance with the EITF consensus, an agreement by an employer
to share a portion of the proceeds of a life insurance policy with an employee
during the postretirement period is a postretirement benefit arrangement
required to be accounted for in accordance with SFAS No. 106 Employers'
Accounting for Postretirement Benefits Other Than Pensions ("SFAS 106") or
Accounting Principles Board Opinion ("APB") No. 12, Omnibus Opinion -- 1967.
Furthermore, the purchase of a split dollar life insurance policy does not
constitute a settlement under SFAS 106 and, therefore, a liability for the
postretirement obligation must be recognized under SFAS 106 if the benefit is
offered under an arrangement that constitutes a plan or under Accounting
Principles Board No. 12 if it is not part of a plan. The provisions of EITF
Issue 06-04 are to be applied through either a cumulative-effect adjustment to
retained earnings as of the beginning of the year of adoption or retrospective
application. We are required to adopt this statement in the fiscal year
beginning after December 15, 2007, with early adoption permitted. We plan to
adopt this statement on January 1, 2008 and are currently assessing the impact
the adoption will have on our Consolidated Financial Statements.
26
In September 2006, the FASB ratified the consensus reached by the EITF
in Issue No. 06-5, Accounting for Purchases of Life Insurance - Determining the
Amount That Could Be Realized in Accordance with FASB Technical Bulletin No.
85-4, Accounting for Purchases of Life Insurance," ("EITF 06-5"). EITF 06-5
concluded that companies purchasing a life insurance policy should record the
amount that could be realized, considering any additional amounts beyond cash
surrender value included in the contractual terms of the policy. The amount that
could be realized should be based on assumed surrender at the individual policy
or certificate level, unless all policies or certificates are required to be
surrendered as a group. When it is probable that contractual restrictions would
limit the amount that could be realized, such contractual limitations should be
considered and any amounts recoverable at the insurance company's discretion
should be excluded from the amount that could be realized. Companies are
permitted to recognize the effects of applying the consensus through either (1)
a change in accounting principle through a cumulative-effect adjustment to
retained earnings or to other components of equity or net assets as of the
beginning of the year of adoption or (2) a change in accounting principle
through retrospective application to all prior periods. EITF 06-5 was effective
for fiscal years beginning after December 15, 2006. We adopted EITF 06-5 at the
beginning of 2007, and the adoption had no impact on our Consolidated Financial
Statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115 ("SFAS 159"). SFAS 159 permits entities to choose to measure
eligible items at fair value at specified election dates. Unrealized gains and
losses on items for which the fair value option has been elected are to be
reported in earnings at each subsequent reporting date. The fair value option
(i) may be applied instrument by instrument, with certain exceptions, (ii) is
irrevocable (unless a new election date occurs) and (iii) is applied only to
entire instruments and not to portions of instruments. SFAS 159 is effective for
us on January 1, 2008. We are currently evaluating the impact the adoption of
SFAS 159 will have on our Consolidated Financial Statements.
In March 2007, the EITF reached a final consensus on Issue No. 06-10
("EITF 06-10"), "Accounting for Deferred Compensation and Postretirement Benefit
Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements." EITF
06-10 requires employers to recognize a liability for the post-retirement
benefit related to collateral assignment split-dollar life insurance
arrangements in accordance with SFAS No. 106 or APB Opinion No. 12. EITF 06-10
also requires employers to recognize and measure an asset based on the nature
and substance of the collateral assignment split-dollar life insurance
arrangement. The provisions of EITF 06-10 are effective for us on January 1,
2008, with earlier application permitted, and are to be applied as a change in
accounting principle either through a cumulative-effect adjustment to retained
earnings or other components of equity or net assets in the statement of
financial position as of the beginning of the year of adoption; or as a change
in accounting principle through retrospective application to all prior periods.
We are currently assessing the impact the adoption of EITF 06-10 will have on
our Consolidated Financial Statements.
In May 2007, the FASB issued a Staff Position on FIN No. 48-1
"Definition of Settlement in FASB Interpretation No. 48" (FSP FIN 48-1), FSP FIN
48-1 provides three conditions a tax position will have to meet to be considered
"effectively settled": (a) the taxing authority has completed all required
examination procedures; (b) the company does not intend to appeal any aspect of
the tax position; and (c) the chance that the taxing authority would reexamine
any aspect of its position is remote. FSP FIN 48-1 is effective for us upon the
initial adoption of FIN 48 (January 1, 2007) and should be applied
retrospectively if a company did not apply FIN 48 in a manner consistent with
FSP FIN 48-1. We have adopted the provisions of FSP FIN 48-1 and the initial
adoption had no effect on our Consolidated Financial Statements.
In June 2007, the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue No. 06-11 ("EITF 06-11"), "Accounting for Income Tax Benefits
of Dividends on Share-Based Payment Awards." EITF 06-11 requires realized income
tax benefits from dividends paid to employees for equity classified nonvested
equity shares to be recognized as an increase in additional paid in capital and
be included in the pool of excess tax benefits available to absorb potential
future tax deficiencies on share-based payment awards. The provisions of EITF
06-11 are to be applied prospectively to the income tax benefits resulting from
dividends declared in fiscal years beginning after December 15, 2007. We are
currently assessing the impact the adoption of EITF 06-11 will have on our
Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Incorporated herein by reference from Item 2, of this quarterly report
on Form 10-Q.
Item 4. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act")), our principal executive officer and the
principal financial officer have concluded that as of the end of
the period covered by this Quarterly Report on Form 10-Q such
disclosure controls and procedures are effective to ensure that
information required to be disclosed by us in the reports that we
file or submit under the Securities and Exchange Commission's
rules and forms and is accumulated and communicated to our
management, including the principal executive officer and
principal financial officer, as appropriate to allow timely
decisions regarding required disclosures.
27
(b) Changes in internal control over financial reporting. During the
quarter under report, there was no change in our internal control
over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over
financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
We are not engaged in any legal proceedings of a material nature at
September 30, 2007. From time to time, we are party to legal
proceedings in the ordinary course of business wherein we enforce our
security interest in loans.
Item 1A. Risk Factors
------------
Our management does not believe there have been any material changes
to the risk factors previously disclosed under Item 1A. of the
Company's Form 10-K for the year ended December 31, 2006, previously
filed with the Securities and Exchange Commission.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table lists purchases of our Common Stock during the
third quarter of 2007.
Total Total Number of Maximum Number
Number Average Shares Purchased of Shares that May
of Shares Price Paid As Part of Publicly Yet Be Purchased
Purchased Per Share Announced Plan Under the Plan
--------- --------- -------------- --------------
July 1, to July 31, 2007 10,500 $55.42 10,500 108,600
August 1, to August 31, 2007 75,600 $56.51 75,600 33,000
September 1, to September 30, 2007 - - - 630,000
Total for the quarter ended September 30, 2007 86,100 $56.38
In September 2007, the Board of Directors approved an authorization
to repurchase up to an additional 10% of its outstanding shares of
common stock, or 630,000 shares.
There is no expiration date under the Plan.
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not applicable
Item 5. Other Information
-----------------
Not applicable
Item 6. Exhibits
--------
(a) Exhibit 31 - Certifications pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
(b) Exhibit 32 - Certifications pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WSFS FINANCIAL CORPORATION
Date: November 8, 2007 /s/ MARK A. TURNER
-------------------------------------------
Mark A. Turner
President and Chief Executive Officer
Date: November 8, 2007 /s/ STEPHEN A. FOWLE
-------------------------------------------
Stephen A. Fowle
Executive Vice President and
Chief Financial Officer
29