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ESB Financial 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For Quarter Ended: September 30, 2010

Commission File Number: 0-19345

 

 

ESB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1659846

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

600 Lawrence Avenue, Ellwood City, PA   16117
(Address of principal executive offices)   (Zip Code)

(724) 758-5584

(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 has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨    Not applicable  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b2 of the Exchange Act)    Yes  ¨    No  x

Number of shares of common stock outstanding as of October 31, 2010:

 

Common Stock, $0.01 par value

  

12,032,799 shares

(Class)    (Outstanding)

 

 

 


Table of Contents

 

ESB FINANCIAL CORPORATION

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION   

Item 1.

  

Financial Statements

  
  

Consolidated Statements of Financial Condition as of September 30, 2010 and December 31, 2009 (Unaudited)

     1   
  

Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009 (Unaudited)

     2   
  

Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2010 (Unaudited)

     3   
  

Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (Unaudited)

     4   
  

Notes to Unaudited Consolidated Financial Statements

     6   

Item 2.

  

Management’s Discussion and Analysis of Results of Operations and Financial Condition

     25   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     39   

Item 4.

  

Controls and Procedures

     39   
PART II - OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     39   

Item 1A.

  

Risk Factors

     40   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     40   

Item 3.

  

Defaults Upon Senior Securities

     40   

Item 4.

  

(Removed and Reserved)

     40   

Item 5.

  

Other Information

     40   

Item 6.

  

Exhibits

     40   
  

Signatures

     41   


Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

ESB Financial Corporation and Subsidiaries

Consolidated Statements of Financial Condition

As of September 30, 2010 (Unaudited) and December 31, 2009

(Dollar amounts in thousands)

 

     September 30,
2010
    December 31,
2009
 

Assets

    

Cash on hand and in banks

   $ 6,309      $ 5,894   

Interest-earning deposits

     31,072        10,390   

Federal funds sold

     12        16   
                

Cash and cash equivalents

     37,393        16,300   

Securities available for sale; cost of $1,036,014 and $1,071,735

     1,079,351        1,106,910   

Loans receivable, net of allowance for loan losses of $6,377 and $6,027

     660,492        671,387   

Loans held for sale

     84        201   

Accrued interest receivable

     9,350        10,312   

Federal Home Loan Bank (FHLB) stock

     27,470        27,470   

Premises and equipment, net

     13,748        13,043   

Real estate acquired through foreclosure, net

     1,639        725   

Real estate held for investment

     24,914        27,479   

Goodwill

     41,599        41,599   

Intangible assets

     991        1,313   

Bank owned life insurance

     29,927        29,381   

Securities receivable

     3,050        2,947   

Prepaid expenses and other assets

     9,527        11,610   
                

Total assets

   $ 1,939,535      $ 1,960,677   
                

Liabilities and Stockholders’ Equity

    

Liabilities:

    

Deposits

   $ 1,003,412      $ 944,347   

FHLB advances

     309,393        420,422   

Repurchase agreements

     363,000        343,000   

Other borrowings

     16,302        19,826   

Junior subordinated notes

     46,393        46,393   

Advance payments by borrowers for taxes and insurance

     1,313        2,661   

Accounts payable for land development

     3,696        4,608   

Accrued expenses and other liabilities

     21,347        14,668   
                

Total liabilities

     1,764,856        1,795,925   
                

Stockholders’ Equity:

    

Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued

     —          —     

Common stock, $.01 par value, 30,000,000 shares authorized; 13,805,812 shares issued; 12,039,315 and 12,036,553 shares outstanding

     138        138   

Additional paid-in capital

     101,751        101,571   

Treasury stock, at cost; 1,766,497 and 1,769,259 shares

     (20,385     (20,302

Unearned Employee Stock Ownership Plan (ESOP) shares

     (200     (814

Retained earnings

     68,594        61,660   

Accumulated other comprehensive income, net

     25,086        22,658   
                

Total ESB Financial Corporation’s stockholders’ equity

     174,984        164,911   

Noncontrolling interest

     (305     (159
                

Total stockholders’ equity

     174,679        164,752   
                

Total liabilities and stockholders’ equity

   $ 1,939,535      $ 1,960,677   
                

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

 

ESB Financial Corporation and Subsidiaries

Consolidated Statements of Operations

For the three and nine months ended September 30, 2010 and 2009 (Unaudited)

(Dollar amounts in thousands, except share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Interest income:

        

Loans receivable

   $ 9,367      $ 9,733      $ 28,364      $ 29,530   

Taxable securities available for sale

     10,246        11,797        31,863        36,243   

Tax free securities available for sale

     1,510        1,362        4,420        4,003   

Deposits with banks and federal funds sold

     5        6        10        16   
                                

Total interest income

     21,128        22,898        64,657        69,792   
                                

Interest expense:

        

Deposits

     3,470        4,333        10,884        13,759   

Borrowed funds

     6,075        8,186        19,365        26,255   

Junior subordinated notes and guaranteed preferred beneficial interest in subordinated debt

     619        622        1,844        1,905   
                                

Total interest expense

     10,164        13,141        32,093        41,919   
                                

Net interest income

     10,964        9,757        32,564        27,873   

Provision for loan losses

     550        236        1,104        752   
                                

Net interest income after provision for loan losses

     10,414        9,521        31,460        27,121   
                                

Noninterest income:

        

Fees and service charges

     1,019        1,052        2,918        2,949   

Net gain on sale of loans

     10        25        15        191   

Increase of cash surrender value of bank owned life insurance

     171        227        546        688   

Net realized gain on securities available for sale

     —          —          —          246   

Total other-than-temporary impairment losses

     (454     (210     (1,455     (463

Portion of loss recognized in other comprehensive income before taxes

     35        —          454        —     
                                

Net impairment losses on investment securities

     (419     (210     (1,001     (463

Net realized gain (loss) on derivatives

     (303     (154     (1,036     88   

Income from real estate joint ventures

     511        215        1,006        618   

Other

     147        166        445        469   
                                

Total noninterest income

     1,136        1,321        2,893        4,786   
                                

Noninterest expense:

        

Compensation and employee benefits

     4,092        3,597        11,748        10,755   

Premises and equipment

     615        586        1,922        1,838   

Federal deposit insurance premiums

     449        450        1,428        2,096   

Data processing

     561        538        1,619        1,577   

Amortization of intangible assets

     102        122        312        373   

Advertising

     135        142        416        407   

Other

     1,235        979        3,131        2,882   
                                

Total noninterest expense

     7,189        6,414        20,576        19,928   
                                

Income before income taxes

     4,361        4,428        13,777        11,979   

Provision for income taxes

     695        848        2,615        2,142   
                                

Net income

     3,666        3,580        11,162        9,837   

Less: net income attributable to the noncontrolling interest

     201        74        349        173   
                                

Net income Attributable to ESB Financial Corporation

   $ 3,465      $ 3,506      $ 10,813      $ 9,664   
                                

Net income per share

        

Basic

   $ 0.29      $ 0.29      $ 0.90      $ 0.81   

Diluted

   $ 0.29      $ 0.29      $ 0.90      $ 0.80   

Cash dividends declared per share

   $ 0.10      $ 0.10      $ 0.30      $ 0.30   

Weighted average shares outstanding

     11,996,241        11,940,076        11,981,798        11,939,619   

Weighted average shares and share equivalents outstanding

     12,071,182        12,035,005        12,050,299        12,036,093   

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

 

ESB Financial Corporation and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity

For the nine months ended September 30, 2010 (Unaudited)

(Dollar amounts in thousands)

 

     Common
stock
     Additional
paid-in
capital
    Treasury
stock
    Unearned
ESOP
shares
    Retained
earnings
    Accumulated
other
comprehensive
income,

net of tax
     Noncontrolling
Interest
    Total
stockholders’
equity
 

Balance at January 1, 2010

   $ 138       $ 101,571      $ (20,302   $ (814   $ 61,660      $ 22,658       $ (159   $ 164,752   

Comprehensive results:

                  

Net income

     —           —          —          —          10,813        —           349        11,162   

Other comprehensive results, net

     —           —          —          —          —          1,768         —          1,768   

Reclassification adjustment

     —           —          —          —          —          660         —          660   
                                                                  

Total comprehensive results

     —           —          —          —          10,813        2,428         349        13,590   

Cash dividends at $0.30 per share

     —           —          —          —          (3,589     —           —          (3,589

Purchase of treasury stock, at cost (46,191 shares)

     —           —          (647     —          —          —           —          (647

Reissuance of treasury stock for stock option exercises (42,437 shares)

     —           —          564        —          (290     —           —          274   

Compensation expense ESOP

     —           308        —          614        —          —           —          922   

Additional ESOP shares purchased

     —           (189     —          —          —          —           —          (189

Tax effect of compensatory stock options

     —           35        —          —          —          —           —          35   

Capital disbursement for noncontrolling interest

     —           —          —          —          —          —           (495     (495

Accrued compensation expense MRP

     —           26        —          —          —          —           —          26   
                                                                  

Balance at September 30, 2010

   $ 138       $ 101,751      $ (20,385   $ (200   $ 68,594      $ 25,086       $ (305   $ 174,679   
                                                                  

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

 

ESB Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

For the nine months ended September 30, 2010 and 2009 (Unaudited)

(Dollar amounts in thousands)

 

     Nine months ended
September 30,
 
     2010     2009  

Operating activities:

    

Net income

   $ 11,162      $ 9,837   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization for premises and equipment

     681        676   

Provision for loan losses

     1,104        752   

Amortization of premiums and accretion of discounts

     1,650        1,601   

Origination of loans available for sale

     (1,562     (17,612

Proceeds from sale of loans available for sale

     1,694        17,547   

Gain on sale of loans available for sale

     (15     (191

Other than temporary impairment on securities available for sale

     1,001        463   

Gain on sale of securities available for sale

     —          (246

Amortization of intangible assets

     312        373   

Compensation expense on ESOP and MRP

     948        814   

Compensation expense on stock options

     212        112   

Increases in bank owned life insurance

     (546     (688

Decrease in accrued interest receivable

     962        309   

Increase in deferred tax liability

     (379     802   

Increase in prepaid expenses and other assets

     (103     (3,957

Increase in accrued expenses and other liabilities

     3,101        4,117   

Gain on sale of real estate acquired through foreclosure

     99        44   

Writedown of real estate held for investment

     852        —     

Other

     (1,707     (1,438
                

Net cash provided by operating activities

     19,466        13,315   
                

Investing activities:

    

Loan originations

     (132,584     (125,392

Purchases of:

    

Securities available for sale

     (165,951     (151,251

Interest rate cap contracts

     —          (189

Premises and equipment

     (1,389     (2,008

Principal repayments of:

    

Loans receivable

     145,025        146,272   

Securities available for sale

     199,995        162,692   

Proceeds from the sale of:

    

Securities available for sale

     —          992   

Real estate acquired through foreclosure

     420        8   

Funding of real estate held for investment

     (8,984     (6,830

Proceeds from real estate held for investment

     4,757        6,141   
                

Net cash provided by investing activities

     41,289        30,435   
                

Financing activities:

    

Net increase in deposits

     59,065        49,138   

Proceeds from long-term borrowings

     79,375        165,956   

Repayments of long-term borrowings

     (156,872     (213,788

Net decrease in short-term borrowings

     (17,056     (22,764

Proceeds received from exercise of stock options

     274        767   

Dividends paid

     (3,612     (3,623

Payments to acquire treasury stock

     (647     (2,642

Stock purchased by ESOP

     (189     (56
                

Net cash used in financing activities

     (39,662     (27,012
                

Net increase in cash equivalents

     21,093        16,738   

Cash equivalents at beginning of period

     16,300        18,893   
                

Cash equivalents at end of period

   $ 37,393      $ 35,631   
                

 

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Table of Contents

ESB Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows, (Continued)

For the nine months ended September 30, 2010 and 2009 (Unaudited)

(Dollar amounts in thousands)

 

     Nine months ended
September 30,
 
     2010      2009  

Supplemental information:

     

Interest paid

   $ 31,798       $ 42,487   

Income taxes paid

     3,379         2,385   

Supplemental schedule of non-cash investing and financing activities:

     

Transfers from loans receivable to real estate acquired through foreclosure

     1,508         245   

Transfers from securities to deferred tax asset - FASB 115

     1,204         1,813   

Transfers from loans receivable to real estate held for investment

     5,028         1,305   

Dividends declared but not paid

     1,196         1,190   

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

ESB Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Principles of Consolidation

ESB Financial Corporation (the Company) is a publicly traded Pennsylvania thrift holding company. The consolidated financial statements include the accounts of the Company and its direct and indirect wholly-owned subsidiaries, which are ESB Bank (ESB or the Bank), THF, Inc. (THF), ESB Financial Services, Inc. (EFS) and AMSCO, Inc. (AMSCO). ESB is a Pennsylvania chartered, Federal Deposit Insurance Corporation (FDIC) insured stock savings bank.

AMSCO is engaged in real estate development and construction of 1-4 family residential units independently or in conjunction with its joint ventures. AMSCO is currently involved in nine real estate joint ventures, all of which are owned 51% or greater by AMSCO. The Bank has provided all development and construction financing. These joint ventures have been included in the consolidated financial statements and reflected within the consolidated statements of financial condition as real estate held for investment and related operating income and expenses reflected within other non-interest income or expense. The Bank’s loans to AMSCO and related interest have been eliminated in consolidation.

In addition to the elimination of the loans and interest to the joint ventures described above, all other significant intercompany transactions and balances have been eliminated in consolidation.

Basis of Presentation

The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting only of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Company’s financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission’s Form 10-Q and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with U.S. generally accepted accounting principles (GAAP). For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2009, as contained in the Company’s 2009 Annual Report to Stockholders.

The results of operations for the three and nine month periods ended September 30, 2010 is not necessarily indicative of the results that may be expected for the entire year. Certain amounts previously reported have been reclassified to conform to the current periods’ reporting format, such reclassifications did not have an effect on stockholders’ equity or net income.

The accounting principles followed by the Company and the methods of applying these principles conform with GAAP and with general practice within the banking industry. In preparing the consolidated financial statements management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the Statement of Financial Condition date and revenues and expenses for the period. Actual results could differ significantly from those estimates.

Operating Segments

An operating segment is defined as a component of an enterprise that engages in business activities that generate revenue and incur expense, the operating results of which are reviewed by management. At September 30, 2010, the Company was doing business through 24 full service banking branches, one loan production office and through its various other subsidiaries. Loans and deposits are primarily generated from the areas where banking branches are located. The Company derives its income predominantly from interest on loans and securities and to a lesser extent, non-interest income. The Company’s principal

 

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Table of Contents

ESB Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements—(Continued)

 

expenses are interest paid on deposits and borrowed funds and normal operating costs. The Company’s operations are principally in the banking industry. Consistent with internal reporting, the Company’s operations are reported in one operating segment, which is community banking.

Stock Based Compensation

During the three and nine months ended September 30, 2010, the Company recorded approximately $71,000 and $212,000, respectively, in compensation expense and a tax benefit of approximately $5,000 and $15,000 respectively, related to its share-based compensation awards that are expected to vest in 2010. During the three and nine months ended September 30, 2009, the Company recorded approximately $37,000 and $112,000, respectively, in compensation expense and a tax benefit of approximately $3,000 and $10,000 respectively, related to its share-based compensation awards that were expected to vest in 2009. As of September 30, 2010, there was approximately $404,000 of unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next four years.

As required by GAAP, cash flows from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for stock-based awards (excess tax benefits) are classified as financing cash flows.

Financial Instruments

When the Company establishes a derivative position, it is recorded in accordance with GAAP on the Consolidated Statement of Financial Condition as either assets or liabilities at fair value through adjustments to either the hedged items, accumulated other comprehensive income or current earnings. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized in earnings.

As part of its overall interest rate risk management activities, the Company utilizes derivative instruments to manage its exposure to various types of interest rate risk. These derivative instruments consist of interest rate caps and interest rate swaps. There were nine interest rate cap contracts and two interest rate swap contracts outstanding as of September 30, 2010.

At September 30, 2010 there were nine interest rate cap contracts outstanding with notional amounts totaling $90.0 million. These derivative instruments are not hedged and therefore adjustments to fair value are recorded in current earnings.

During the second and third quarters of fiscal 2009, the Company entered into two interest rate swap contracts to manage its exposure to interest rate risk. This interest rate swap transaction involved the exchange of the Company’s interest payment on $35.0 million in junior subordinated notes which become floating rate notes in 2011 for a fixed rate interest payment without the exchange of the underlying principal amount. Entering into interest rate derivatives potentially exposes the Company to the risk of counterparties’ failure to fulfill their legal obligations including, but not limited to, potential amounts due

 

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ESB Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements—(Continued)

 

or payable under each derivative contract. Notional principal amounts are often used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller.

Consistent with the GAAP requirements and with the risk management objective of hedging the variability of expected future cash flows, the Company accounts for this hedge relationship as a cash flow hedge.

The cumulative change in fair value of the hedging derivative, to the extent that it is expected to be offset by the cumulative change in anticipated interest cash flows from the hedged exposure, will be deferred and reported as a component of accumulated other comprehensive income. Any hedge ineffectiveness will be charged to current earnings. Consistent with the risk management objective and the hedge accounting designation, management measured the degree of hedge effectiveness by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Management will utilize the “Change in Variable Cash Flows Method” to compute the cumulative change in anticipated interest cash flows from the hedged exposure. To the extent that the cumulative change in anticipated cash flows from the hedging derivative offsets from 80% to 125% of the cumulative change in anticipated interest cash flows from the hedged exposure, the hedge will be deemed effective. The Company will use the Change in Variable Cash Flows Method to measure ineffectiveness. Under this method, the calculation of ineffectiveness, as required under GAAP, will be done by using the change in the variable cash flows of the hedging derivative and the hedged exposure. That is, the swap will be recorded at fair value on the consolidated statement of financial condition and other comprehensive income will be adjusted to an amount that reflects the cumulative change in fair value of the hedging derivative. Management will determine the ineffectiveness of the hedging relationship by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Any difference between these two measures will be deemed hedge ineffectiveness and recorded in current earnings. As of September 30, 2010 the hedge instrument was deemed to be effective, therefore, no amounts were charged to current earnings. The Company does not expect to reclassify any hedge-related amounts from accumulated other comprehensive income to earnings over the next twelve months.

The pay fixed interest rate swap contract outstanding at September 30, 2010 is being utilized to hedge $35.0 million in floating rate junior subordinated notes. Below is a summary of the interest rate swap contract and the terms at September 30, 2010:

 

     Notional
Amount
     Effective
Date
     Pay
Rate
    Receive
Rate (*)
    Maturity
Date
     Unrealized  

(Dollars in thousands)

                Gain      Loss  

Cash Flow Hedge

   $ 20,000         2/10/2011         4.18     0.53     2/10/2018         —         $ 2,675   

Cash Flow Hedge

     15,000         2/10/2011         3.91     0.53     2/10/2018         —           1,734   
                                    
   $ 35,000                   —         $ 4,409   
                                    

 

* Variable receive rate based upon contract rates in effect at September 30, 2010

Recent Accounting and Regulatory Pronouncements

In August, 2010, the Financial Accounting Standards Board (FASB) issued ASU 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This ASU amends various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules, and Codification of Financial Reporting Policies and is not expected to have a significant impact on the Company’s financial statements.

In August, 2010, the FASB issued ASU 2010-22, Technical Corrections to SEC Paragraphs – An announcement made by the staff of the U.S. Securities and Exchange Commission. This ASU amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

or rescinds portions of certain SAB topics and is not expected to have a significant impact on the Company’s financial statements.

In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. The Company is currently evaluating the impact the adoption of this guidance will have on the Company’s financial position or results of operations.

In April 2010, FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force. ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets. Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said. The amendment will be effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15,2010 or later and is not expected to have a significant impact on the Company’s financial statements.

In March 2010, the FASB issued ASU 2010-11, Derivatives and Hedging. ASU 2010-11 provides clarification and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in ASC 815-15-15-8. ASU 2010-11 is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. The Company is currently evaluating the impact the adoption of this standard will have on the Company’s financial position or results of operation.

In January 2010, the FASB issued ASU 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that for certain shareholders escrowed share arrangements represent compensation. ASU 2010-05 is effective January 15, 2010. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company has presented the necessary disclosures in footnote 9 “Fair Value” and is currently evaluating the impact of the remaining disclosures.

In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash – a consensus of the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend. ASU 2010-01 is effective for interim and annual periods ending on or after December 15, 2009 and should be applied on a retrospective basis. The adoption of this guidance did not have a material impact on the Company’s financial position.

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

 

2. Securities

The Company’s securities available for sale portfolio is summarized as follows:

 

(Dollar amounts in thousands)

   Amortized
cost
     Unrealized
gains
     Unrealized
losses
    Fair
value
 

September 30, 2010:

          

Trust preferred securities

   $ 46,465       $ 269       $ (8,560   $ 38,174   

Municipal securities

     157,947         8,294         (145     166,096   

Equity securities

     1,445         189         (105     1,529   

Corporate bonds

     118,727         5,157         —          123,884   

Mortgage-backed securities

     711,430         38,348         (110     749,668   
                                  
   $ 1,036,014       $ 52,257       $ (8,920   $ 1,079,351   
                                  

December 31, 2009:

          

Trust preferred securities

   $ 47,272       $ 66       $ (6,761   $ 40,577   

Municipal securities

     145,642         5,014         (562     150,094   

Equity securities

     775         189         (57     907   

Corporate bonds

     84,332         4,052         (203     88,181   

Mortgage-backed securities

     793,714         34,322         (885     827,151   
                                  
   $ 1,071,735       $ 43,643       $ (8,468   $ 1,106,910   
                                  

The following table shows the Company’s investments gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010:

 

As of September 30, 2010

                          

(Dollar amounts in thousands)

   Less than 12 Months      12 Months or more      Total  
     # of
Securities
     Fair
Value
     Unrealized
losses
     # of
Securities
     Fair
Value
     Unrealized
losses
     # of
Securities
     Fair
Value
     Unrealized
losses
 

Trust Preferred Securities

     1       $ 550       $ 35         9       $ 35,854       $ 8,525         10       $ 36,404       $ 8,560   

Municipal securities

     —           —           —           3         2,585         145         3         2,585         145   

Equity Securities

     3         679         66         2         213         39         5         892         105   

Mortgage-backed securities

     2         7,786         17         4         6,075         93         6         13,861         110   
                                                                                
     6       $ 9,015       $ 118         18       $ 44,727       $ 8,802         24       $ 53,742       $ 8,920   
                                                                                

The following table shows the Company’s investments gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2009:

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

 

As of December 31, 2009                                                               

(Dollar amounts in thousands)

   Less than 12 Months      12 Months or more      Total  
     # of
Securities
     Fair
Value
     Unrealized
losses
     # of
Securities
     Fair
Value
     Unrealized
losses
     # of
Securities
     Fair Value      Unrealized
losses
 

Trust Preferred Securities

     —         $ —         $ —           9       $ 37,608       $ 6,761         9       $ 37,608       $ 6,761   

Municipal securities

     1         2,222         54         13         16,336         508         14         18,558         562   

Equity Securities

     —           —           —           4         350         57         4         350         57   

Corporate bonds

     1         2,996         33         1         3,613         170         2         6,609         203   

Mortgage-backed securities

     13         53,402         494         5         10,289         391         18         63,691         885   
                                                                                
     15       $ 58,620       $ 581         32       $ 68,196       $ 7,887         47       $ 126,816       $ 8,468   
                                                                                

The Company primarily invests in mortgage-backed securities, variable and fixed rate corporate bonds, municipal bonds, government bonds and to a lesser extent equity securities. The policy of the Company is to recognize other than temporary impairment (OTTI) on equity securities where the fair value has been significantly below cost for three consecutive quarters. Declines in the fair value of the debt securities that can be attributed to specific adverse conditions affecting the credit quality of the investment would be recorded as OTTI and charged to earnings. In order to determine if a decline in fair value is other than temporary, the Company reviews corporate ratings of the investment, analyst reports and SEC filings of the issuers. For fixed maturity investments with unrealized losses due to interest rates where the Company expects to recover the entire amortized cost basis of the security, declines in value below cost are not assumed to be other than temporary. The Company reviews its position quarterly and has asserted that at September 30, 2010, the declines outlined in the above table represent temporary declines due to changes in interest rates and are not reflections of an impairment in the credit quality of the securities. Additionally, the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis.

The Company reviews investment debt securities on an ongoing basis for the presence of OTTI with formal reviews performed quarterly. Credit-related OTTI losses on individual securities are recognized in earnings while noncredit-related OTTI on securities not expected to be sold is recognized in accumulated other comprehensive income (OCI). The $419,000 credit-related OTTI recognized during the third quarter 2010 consisted of a $384,000 write-down on a pooled trust preferred security having a remaining book value of $585,000 and $35,000 on two of the Company’s equity investments in community banks that had experienced a decline in its market value for the last several quarters. There was no noncredit-related OTTI on these securities recognized in OCI during the third quarter, the write-down of $384,000 on the pooled trust preferred security was a transfer from OCI to income. The write-down on the pooled trust preferred security for the nine months ended September 30, 2010 was approximately $811,000.

One pooled trust preferred security has been determined to be other than temporarily impaired due solely to credit related factors. This security is a collateralized debt obligation currently comprised of trust preferred securities of 16 financial institutions and has a Moody’s rating of Ca, which is below investment grade. The Company utilized a discounted cash flow method to determine the amount of impairment. During this analysis, the Company determined that seven of these financial institutions are currently deferring interest payments. In addition, two financial institutions have defaulted. Currently seven of the sixteen financial institutions are performing. Six of the seven financial institutions that are deferring interest payments as of September 2010 either lost money or reported no income for the most recently reported quarter. Five of the seven financial institutions on deferral had a Tier 1 Risk Ratio at or less than the required well capitalized institution level under prompt corrective action provisions of 6%. Also, there were six financial institutions (including five of the seven deferrals) within this pool that the non-performing assets to loans plus real estate owned ratio was greater than 10%. In addition, there is one institution that is not deferring interest payments but has a non-performing assets to loans plus real estate owned ratio greater than 15% and had a decrease in Tier 1 capital during the most recently reported quarter of approximately 3.4%.

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

 

One of the Company’s private-label mortgage-backed securities was determined to be other than temporarily impaired due solely to credit related factors during the second quarter of 2010. Management considered several factors including whether the fair value was below the cost, if the decline in the fair value was attributable to specific adverse conditions in either the investment, the industry or the geographic area, whether the decline in the fair value has existed for an extended time, the current rating of the investment and the current financial condition of the issuer. As a result of this analysis the Company believed that the security exhibited enough indicators of other than temporary impairment to write the security down to the value derived using third party Intex reports utilizing the current six-month Constant Default Rates, Voluntary Prepayment Rates and Loss Severity with an implied forward curve. This write-down reflected an impairment of approximately $115,000 on the original $2.1 million investment. The Company reviewed the security in the third quarter and concluded that no further impairment existed. The Company will continue to monitor this bond to determine if additional other than temporary impairment charges are necessary.

Because of the subprime crisis, current markets for variable rate corporate trust preferred securities are illiquid. This includes the Company’s nine stand alone trust preferred securities and the Company’s one pooled trust preferred security. The Company used a discounted cash flow method to price these securities due to the lack of liquidity for resale of this investment type and the absence of reliable pricing information. The present value of expected future cash flows is discounted at the effective purchase yield, which in the case of the floating rate securities is equal to the credit spread at the time of purchase plus the current three month LIBOR rate. We then compare the present value to the current book value for purposes of determining if there is an other-than-temporary impairment. This method is described more fully in footnote 9, “Fair Value”.

The following is a roll forward for the three and nine months ended September 30, 2010 of the amounts recognized in earnings related to credit losses on securities which the Company has recorded other-than-temporary impairment charges through earnings and other comprehensive income:

 

(Dollars in thousands)

   Three Months
Ended
September 30, 2010
     Nine Months
Ended
September 30, 2010
 

Beginning Balance

   $ 128       $ —     

Credit losses on debt securities for which other-than-temporary impairment was not previously recognized

     —           128   

Additional increases as a result of impairment charges recognized on investments for which an OTTI charge was previously recognized

     384         384   
                 

September 30, 2010

   $ 512       $ 512   
                 

The following table summarizes scheduled maturities of the Company’s securities as of September 30, 2010 and December 31, 2009 excluding equity securities which have no maturity dates:

 

(Dollar amounts in thousands)

   Available for sale as of September 30, 2010  
     Weighted
Average Yield
    Amortized
cost
     Fair
value
 

Due in one year or less

     6.31   $ 33,266       $ 34,012   

Due from one year to five years

     4.82     70,676         74,810   

Due from five to ten years

     4.85     130,199         137,264   

Due after ten years

     4.36     800,428         831,736   
                         
     4.52   $ 1,034,569       $ 1,077,822   
                         

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

 

(Dollar amounts in thousands)

   Available for sale as of December 31, 2009  
     Weighted
Average Yield
    Amortized
cost
     Fair value  

Due in one year or less

     11.44   $ 3,882       $ 4,145   

Due from one year to five years

     5.48     68,954         71,716   

Due from five to ten years

     4.71     126,635         132,081   

Due after ten years

     4.76     871,489         898,061   
                         
     4.83   $ 1,070,960       $ 1,106,003   
                         

For purposes of the maturity table, mortgage backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

3. Loans Receivable

The Company’s loans receivable as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)

   September 30,
2010
    December 31,
2009
 

Mortgage loans:

    

Residential - single family

   $ 327,892      $ 329,984   

Residential - multi family

     37,110        37,664   

Commercial real estate

     81,903        84,409   

Construction

     58,583        51,109   
                

Subtotal mortgage loans

     505,488        503,166   
                

Other loans:

    

Consumer loans:

    

Home equity loans

     73,033        73,195   

Dealer auto and RV loans

     53,204        56,876   

Other loans

     10,400        10,421   

Commercial business

     37,180        43,377   
                

Subtotal other loans

     173,817        183,869   
                

Total Loans Receivable

     679,305        687,035   

Less:

    

Allowance for loan losses

     6,377        6,027   

Deferred loan fees and net discounts

     (2,069     (2,334

Loans in process

     14,505        11,955   
                

Net Loans Receivable

   $ 660,492      $ 671,387   
                

Loans Held for Sale

    

Residential - single family

   $ 84      $ 201   
                

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

 

The following is a summary of the changes in the allowance for loan losses:

 

(Dollar amounts in thousands)

   2010     2009  

Balance, January 1,

   $ 6,027      $ 6,006   

Provision for loan losses

     1,104        752   

Charge offs

     (845     (615

Recoveries

     91        96   
                

Balance September 30,

   $ 6,377      $ 6,239   
                

4. Deposits

The Company’s deposits as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)                           
      September 30, 2010     December 31, 2009  

Type of accounts

   Amount      %     Amount      %  

Noninterest-bearing deposits

   $ 83,605         8.3   $ 68,404         7.2

NOW account deposits

     130,477         13.0     110,379         11.8

Money Market deposits

     35,514         3.5     32,256         3.4

Passbook account deposits

     136,181         13.6     119,556         12.7

Time deposits

     617,635         61.6     613,752         64.9
                                  
   $ 1,003,412         100.0   $ 944,347         100.0
                                  

Time deposits mature as follows:

          

Within one year

   $ 418,557         67.8   $ 410,882         66.9

After one year through two years

     85,355         13.8     120,073         19.6

After two years through three years

     59,587         9.6     43,791         7.1

After three years through four years

     22,715         3.7     6,953         1.1

After four years through five years

     27,862         4.5     29,181         4.8

Thereafter

     3,559         0.6     2,872         0.5
                                  
   $ 617,635         100.0   $ 613,752         100.0
                                  

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

5. Borrowed Funds

The Company’s borrowed funds as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)

   September 30, 2010      December 31, 2009  
     Weighted
average
rate
    Amount      Weighted
average
rate
    Amount  

FHLB advances:

         

Due within 12 months

     3.57   $ 70,000         4.61   $ 180,400   

Due beyond 12 months but within 2 years

     2.43     42,550         2.87     71,866   

Due beyond 2 years but within 3 years

     3.51     61,259         2.80     30,684   

Due beyond 3 years but within 4 years

     3.10     108,317         3.71     69,027   

Due beyond 4 years but within 5 years

     3.32     16,702         3.24     47,876   

Due beyond 5 years

     3.63     10,565         3.86     20,569   
                     
     $ 309,393         $ 420,422   
                     

Repurchase agreements:

         

Due within 12 months

     0.91   $ 28,000         2.02   $ 28,000   

Due beyond 12 months but within 2 years

     3.73     65,000         2.65     20,000   

Due beyond 2 years but within 3 years

     3.29     130,000         3.74     75,000   

Due beyond 3 years but within 4 years

     3.28     60,000         3.34     120,000   

Due beyond 4 years but within 5 years

     4.12     10,000         2.86     20,000   

Due beyond 5 years

     4.42     70,000         4.38     80,000   
                     
     $ 363,000         $ 343,000   
                     

Other borrowings:

         

ESOP borrowings

         

Due within 12 months

     4.25   $ 236         4.25   $ 945   
                     

Corporate borrowings

         

Due within 12 months

     6.30   $ 1,400         6.30   $ 1,400   

Due beyond 12 months but within 2 years

     6.30     1,400         6.30     1,400   

Due beyond 2 years but within 3 years

     6.30     1,400         6.30     1,400   

Due beyond 3 years but within 4 years

     6.30     1,400         6.30     1,400   

Due beyond 4 years but within 5 years

     6.30     5,600         6.30     1,400   

Due beyond 5 years

     —          —           6.30     5,600   
                     
     $ 11,200         $ 12,600   
                     

Treasury tax and loan note payable

         

Due within 12 months

     —        $ 169         —        $ 135   
                     

Borrowings for joint ventures

         

Due beyond 2 years but within 3 years

     3.75   $ 4,697         3.75   $ 6,146   
                     

Junior subordinated notes

         

Due beyond 5 years

     5.46   $ 46,393         5.44   $ 46,393   
                     

Included in the $309.4 million of FHLB advances at September 30, 2010 is a $10.0 million convertible select advance. This advance resets quarterly to the three month London Interbank Offer Rate Index (LIBOR) index plus a spread. At the reset date, if the three month LIBOR plus the spread is lower than the contract rate on the advance, the advance will remain at the contracted rate. The FHLB has the right to call this convertible select advance on the call date or quarterly thereafter. In addition, the Company has $20.0 million in structured FHLB advances in which the rate is fixed for four years, and after four years on a specified date, the FHLB has the one time right (European Call) to call the advance. If the FHLB does not call these advances on the specified date, the rate remains the same for the remaining term. Should these

 

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Notes to Unaudited Consolidated Financial Statements—(Continued)

 

advances be called, the Company has the right to pay off the advances without penalty. The Company also has $50.0 million in structured advances with imbedded caps at various strike rates based on the three month LIBOR rate. If during the term of the advance, the three month LIBOR rate exceeds the strike rate, the interest rate on the structured advance is reduced by the difference between the rate and the strike rate. Additionally, the Company has $20.0 million in putable borrowings. The Company has the one-time option to terminate these advances on the put date. If the Company does not terminate these advances on the specified date, the rate remains the same for the remaining term.

Included in the $363.0 million of Repurchase Agreements (REPOs) are $90.0 million in structured REPOs with imbedded caps at various strike rates based on the three month LIBOR rate. The terms and conditions of $30.0 million of these structured REPOs are that the rate is fixed for the entire term of the REPO and the terms and conditions of $60.0 million of these structured REPOs are that the rate is fixed for three years and after three years, on a specified date the counterparty has the one time right (European Call) to call the REPO. If the counterparty does not call the REPO on the specified date, the rate remains the same for the remaining two years. These structured REPOs also include an imbedded cap for the first three year period with a strike rate to the three month LIBOR rate. If during the first three years, the three month LIBOR rate exceeds the strike rate, the interest rate on the structured REPO is reduced by the difference between the rate and the strike rate. In addition, the Company has $25.0 million in structured REPOs with double, or $50.0 million notional amount of imbedded caps, at a strike rate of 3.75% based on the three month LIBOR rate. The terms and conditions of these structured REPOs are that the rate is fixed for five years and after 5 years, on a specified date the counterparty has the one time right (European Call) to call the REPO. If the counterparty does not call the REPO on the specified date, the rate remains the same for the remaining five years. These structured REPOs also include a double imbedded cap for the first five year period with a strike rate to the three month LIBOR rate. If during the first five years, the three month LIBOR rate exceeds the strike rate, the interest rate on the structured REPO is reduced by two times the difference between the rate and the strike rate. At no point shall the interest rate on these structured REPOs with imbedded caps be less than zero.

Also included in the $363.0 million of REPOs is a $25.0 million structured REPO in which the Company pays a fixed rate of interest. At the reset date and every quarterly period thereafter, the counterparty has the right to terminate the transaction. In addition, the Company has $30.0 million in structured REPOs in which the rate is fixed for four years, and after four years on a specified date, the counterparty has the one time right (European Call) to call the REPO. If the counterparty does not call the REPO on the specified date, the rate remains the same for the remaining term. It has historically been the Company’s position to pay off any borrowings and replace them with fixed rate funding if converted by the counterparty.

The junior subordinated notes have various maturities, interest rate structures and call dates. The characteristics of these notes are detailed in the following paragraphs.

On April 10, 2003, ESB Capital Trust II (Trust II), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $10.0 million variable rate preferred securities with a stated value and liquidation preference of $1,000 per share. The Company purchased $310,000 of common securities of Trust II. The preferred securities reset quarterly to equal the LIBOR plus 3.25%. Trust II’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by the Trust II to invest in $10.3 million of variable rate subordinated debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of the Trust II. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the subordinated debt prior to the maturity date of April 24, 2033, on or after April 24, 2008, at the redemption price, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated April 10, 2003, the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the

 

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principal amount of the subordinated debt redeemed. On July 23, 2008, the Company redeemed $5.0 million of the preferred securities of ESB Capital Trust II with proceeds from a $14.0 million loan with First Tennessee Bank National Association (“First Tennessee”). The remainder of the First Tennessee loan was used to repay an existing loan with First Tennessee with a remaining balance of $9.0 million, which had an interest rate of 5.55% and was due on December 31, 2008. No unamortized deferred debt issuance costs remain on this issuance.

On December 17, 2003, ESB Statutory Trust (Trust III), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $5.0 million variable rate preferred securities with a stated value and liquidation preference of $1,000 per share. The Company purchased $155,000 of common securities of Trust III. The preferred securities reset quarterly to equal the LIBOR Index plus 2.95%. Trust III’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by Trust III to invest in $5.2 million of variable rate subordinated debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of Trust III. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the subordinated debt prior to the maturity date of December 17, 2033, on or after December 17, 2008, at the redemption price, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated December 17, 2003; the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the principal amount of the subordinated debt redeemed. No unamortized deferred debt issuance costs remain on this issuance.

On February 10, 2005, ESB Capital Trust IV (Trust IV), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $35.0 million fixed rate preferred securities. The Company purchased $1.1 million of common securities of Trust IV. The preferred securities are fixed at a rate of 6.03% for six years and then are variable at three month LIBOR plus 1.82%. The preferred securities have a stated maturity of thirty years. Trust IV’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by Trust IV to invest in $36.1 million of fixed/variable rate subordinated debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of Trust IV. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the subordinated debt prior to the maturity date of February 10, 2035, on or after February 10, 2011, at the redemption price, which is equal to the liquidation amount, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated February 10, 2005, the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the principal amount of the subordinated debt redeemed. The Company did not have any deferred debt issuance costs associated with the preferred securities.

 

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6. Net Income Per Share

The following table summarizes the Company’s net income per share:

 

(Amounts, except earnings per share, in thousands)

   Three Months Ended
September 30, 2010
     Three Months Ended
September 30, 2009
 

Net income

   $ 3,465       $ 3,506   

Weighted-average common shares outstanding

     11,996         11,940   
                 

Basic earnings per share

   $ 0.29       $ 0.29   
                 

Weighted-average common shares outstanding

     11,996         11,940   

Common stock equivalents due to effect of stock options

     75         95   
                 

Total weighted-average common shares and equivalents

     12,071         12,035   
                 

Diluted earnings per share

   $ 0.29       $ 0.29   
                 
     Nine Months Ended
September 30, 2010
     Nine Months Ended
September 30, 2009
 

Net income

   $ 10,813       $ 9,664   

Weighted-average common shares outstanding

     11,982         11,940   
                 

Basic earnings per share

   $ 0.90       $ 0.81   
                 

Weighted-average common shares outstanding

     11,982         11,940   

Common stock equivalents due to effect of stock options

     68         96   
                 

Total weighted-average common shares and equivalents

     12,050         12,036   
                 

Diluted earnings per share

   $ 0.90       $ 0.80   
                 

The shares controlled by the Company’s Employee Stock Ownership Plan (ESOP) of 74,349 and 152,687 at September 30, 2010 and September 30, 2009, respectively, are not considered in the weighted average shares outstanding until the shares are committed for allocation to an employee’s individual account.

Options to purchases 79,830 shares at $15.35 per diluted share expiring November 2013 and 83,560 shares at $14.50 per diluted share expiring November 2014 were outstanding as of September 30, 2010 but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares.

Options to purchases 80,310 shares at $15.35 per diluted share expiring November 2013 and 84,040 shares at $14.50 per diluted share expiring November 2014 were outstanding as of September 30, 2009 but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares.

7. Comprehensive Income

In accordance with GAAP the Company has developed the following table, which includes the tax effects of the components of other comprehensive income. Other comprehensive income consists of fair value adjustments on securities available for sale, realized gains or losses on securities available for sale, the net fair value adjustment on derivatives and the amortization of pension and post retirement benefits. Other comprehensive income and related tax effects for the indicated periods, consists of:

 

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(Dollar amounts in thousands)

   Three Months
Ended
September 30, 2010
    Three Months
Ended
September 30, 2009
 

Net Income:

   $ 3,666      $ 3,580   

Other comprehensive income (loss) - net of tax

    

Fair value adjustment on securities available for sale, net of tax (benefit) expense of ($107) in 2010, $6,639 in 2009.

     (208     12,887   

Net securities losses (gains) reclassified into earnings, net of tax (benefit) expense of $142 in 2010 and ($71) in 2009.

     276        (138

Comprehensive loss on securities for which an other-than-temporary impairment has been recognized in earnings, net of tax benefit of $11 in 2010

     (22     —     

Pension and postretirement amortization, net of tax expense of $16 in 2010 and $13 in 2009.

     30        26   

Fair value adjustment on derivatives, net of tax benefit of $516 in 2010 and $230 in 2009.

     (1,002     (446
                

Other comprehensive income - net of tax

     (926     12,329   
                

Comprehensive income

     2,740        15,909   

Comprehensive income attributable to the noncontrolling interest

     (201     (74
                

Comprehensive income attributable to ESB Financial Corporation

   $ 2,539      $ 15,835   
                

(Dollar amounts in thousands)

   Nine Months
Ended
September 30, 2010
    Nine Months
Ended
September 30, 2009
 

Net Income:

   $ 11,162      $ 9,837   

Other comprehensive income (loss) - net of tax

    

Fair value adjustment on securities available for sale, net of tax expense of $2,590 in 2010 and $10,489 in 2009.

     5,027        20,361   

Net securities losses (gains) reclassified into earnings, net of tax expense (benefit) of $340 in 2010 and ($74) in 2009.

     660        (143

Comprehensive loss on securities for which an other-than-temporary impairment has been recognized in earnings, net of tax benefit of $154 in 2010

     (299     —     

Pension and postretirement amortization, net of tax expense of $47 in 2010 and $40 in 2009.

     91        78   

Fair value adjustment on derivatives, net of tax benefit of $1,572 in 2010 and $225 in 2009.

     (3,051     (436
                

Other comprehensive income - net of tax

     2,428        19,860   
                

Comprehensive income

     13,590        29,697   

Comprehensive income attributable to the noncontrolling interest

     (349     (173
                

Comprehensive income attributable to ESB Financial Corporation

   $ 13,241      $ 29,524   
                

8. Retirement Plans

Supplemental Executive Retirement Plan and Directors’ Retirement Plan

The Company maintains a Supplemental Executive Benefit Plan (SERP) in order to provide supplemental retirement and death benefits for certain key employees of the Company. Under the SERP, participants shall receive an annual retirement benefit following retirement at age 65 equal to 25% of the participant’s final average pay multiplied by a ratio, ranging from 1.25% to 25.0%, based on the participant’s total years of service. Final average pay is based upon the participant’s last three year’s compensation. The maximum ratio of 25% requires twenty or more years of credited service and the minimum ratio of 1.25% requires one year of credited service. Benefits under the plan are payable in either a lump sum or ten equal annual payments and a lesser benefit is payable upon early retirement at age 50 with at least twelve years of service. If a participant dies prior to retirement, the participant’s estate will receive a lump sum payment

 

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equal to the net present value of future benefit payments under the plan. At September 30, 2010 the participants in the plan had credited service under the SERP ranging from 19 to 31 years.

The Company and the Bank maintain the ESB Financial Corporation Directors’ Retirement Plan and have entered into director retirement agreements with each director of the Company and the Bank. The plan provides that any retiring director with a minimum of five or more years of service with the Company or the Bank and a minimum of 10 total years of service, including years of service with any bank acquired by the Company or the Bank, that remains in continuous service as a board member until age 75 will be entitled to receive an annual retirement benefit equal to his or her director’s fees earned during the last full calendar year prior to his or her retirement date, multiplied by a ratio, ranging from 25% to 80%, based on the director’s total years of service. The maximum ratio of 80% of fees requires 20 or more years of service and the minimum ratio of 25% of fees requires 10 years of service. Retirement benefits may also be payable under the plan if a director retires from service as a director prior to attaining age 75. Three directors are currently receiving monthly benefits under the plan.

The following table illustrates the components of the net periodic pension cost for the SERP and Directors Retirement Plan as of September 30, 2010 and 2009:

 

(Dollar amounts in thousands)

   SERP      SERP  
     Three Months
Ended
September 30, 2010
     Three Months
Ended
September 30, 2009
     Nine Months
Ended
September 30, 2010
     Nine Months
Ended
September 30, 2009
 

Components of net periodic pension cost

           

Service cost

   $ 15       $ 12       $ 45       $ 36   

Interest cost

     31         26         93         78   

Amortization of unrecognized gains and losses

     14         8         42         24   

Amortization of prior service cost

     11         10         33         30   
                                   

Net periodic pension cost

   $ 71       $ 56       $ 213       $ 168   
                                   

(Dollar amounts in thousands)

   Directors’ Retirement Plan      Directors’ Retirement Plan  
     Three Months
Ended

September 30, 2010
     Three Months
Ended

September 30, 2009
     Nine Months
Ended

September 30, 2010
     Nine Months
Ended

September 30, 2009
 

Components of net periodic pension cost

           

Service cost

   $ 6       $ 7       $ 18       $ 21   

Interest cost

     11         12         33         36   

Amortization of prior service cost

     22         22         66         66   
                                   

Net periodic pension cost

   $ 39       $ 41       $ 117       $ 123   
                                   

9. Fair Value

GAAP requires, among other things, enhanced disclosures about assets and liabilities carried at fair value. Disclosures follow a hierarchal framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels are as follows:

 

Level I:

   Quoted prices are available in the active markets for identical assets or liabilities as of the reported date.

Level II:

   Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items

 

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   that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level III:    Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

The following table presents the assets and liabilities reported on the consolidated statements of financial condition at their fair value on a recurring basis as of September 30, 2010 and December 31, 2009 by level within the fair value hierarchy. As required by GAAP, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

     As of September 30, 2010  

(Dollar amounts in thousands)

   Level 1      Level II      Level III      Total  

Assets:

           

Securities available for sale

           

Trust preferred securities

   $ —         $ 1,770       $ 36,404       $ 38,174   

Municipal securities

     —           166,096         —           166,096   

Equity securities

     1,529         —           —           1,529   

Corporate bonds

     —           123,884         —           123,884   

Mortgage backed securities

     —           749,668         —           749,668   
                                   

Total securities available for sale

   $ 1,529       $ 1,041,418       $ 36,404       $ 1,079,351   
                                   

Other Assets

           

Interest rate caps

   $ —         $ 334       $ —         $ 334   
                                   

Total other assets

   $ —         $ 334       $ —         $ 334   
                                   

Liabilities

           

Other Liabilities

           

Interest rate swaps

   $ —         $ 4,409       $ —         $ 4,409   
                                   

Total other liabilities

   $ —         $ 4,409       $ —         $ 4,409   
                                   
     As of December 31, 2009  

(Dollar amounts in thousands)

   Level 1      Level II      Level III      Total  

Assets:

           

Securities available for sale

           

Trust preferred securities

   $ —         $ 1,574       $ 39,003       $ 40,577   

Municipal securities

     —           150,094         —           150,094   

Equity securities

     907         —           —           907   

Corporate bonds

     —           88,181         —           88,181   

Mortgage backed securities

     —           827,151         —           827,151   
                                   

Total securities available for sale

   $ 907       $ 1,067,000       $ 39,003       $ 1,106,910   
                                   

Other Assets

           

Interest rate caps

   $ —         $ 466       $ —         $ 466   

Interest rate swaps

     —           213         —           213   
                                   

Total other assets

   $ —         $ 679       $ —         $ 679   
                                   

Due to recent uncertainties in the credit markets broadly, and the lack of both trading and new issuance of floating rate trust preferred securities, market price indications generally reflect the lack of liquidity in these markets. Due to this lack of practical quoted prices, fair value for floating rate trust preferred securities has been determined using a discounted cash-flow technique. Cash flows are estimated based upon the contractual terms of each instrument. Market rates have been calculated based upon the five year historical discount margin for these instruments from August 2002 through August 2007, when the market was more liquid. These market rates were then adjusted for credit spreads and liquidity risk given the

 

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current markets. Credit spreads are based upon the Moody’s rating for each bond and range from 35 to 150 basis points. Liquidity risk adjustments ranged from 25 to 90 basis points where the securities of the 10 largest banks in the United States are assigned 25 basis points and banks outside of the top 10 were given a higher liquidity risk adjustment. Approximately $18.4 million or 50.7% of the $36.4 million in floating rate trust preferred securities represent investments in three of the four largest banks in the United States.

The following table presents the changes in the Level III fair-value category for the periods ended September 30, 2010 and 2009. The Company classifies financial instruments in Level III of the fair-value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.

Fair value measurements using significant unobservable inputs (Level III)

 

     Securities available for sale
September 30,
 
     2010     2009  

Beginning balance January 1,

   $ 39,003      $ 38,211   

Total net realized/unrealized gains (losses)

    

Included in earnings:

    

Interest income on securities

     10        10   

Net realized loss on securities available for sale

     (810     (407

Included in other comprehensive income

     (1,799     896   

Transfers in and/or out of Level III

     —          —     

Purchases, issuances and settlements

     —          —     
                

Ending balance, September 30,

   $ 36,404      $ 38,710   
                

The following table summarizes changes in unrealized gains and losses recorded in earnings for the nine month period ended September 30, 2010 and 2009 for Level III assets and liabilities that are still held at September 30, 2010 and 2009.

 

     Securities available for sale
September 30,
 
     2010     2009  

Interest income on securities

   $ 10      $ 10   

Net realized loss on securities available for sale

     (810     (407
                

Total

   $ (800   $ (397
                

The following table presents the assets and liabilities reported on the consolidated statements of financial condition at their fair value on a non-recurring basis as of September 30, 2010 and December 31, 2009 by level within the fair value hierarchy. As required by GAAP, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

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     As of September 30, 2010  

(Dollar amounts in thousands)

   Level 1      Level II      Level III      Total  

Assets:

           

Impaired Loans

   $ —         $ —         $ 1,249       $ 1,249   

Loans held for sale

     —           84         —           84   

Real estate acquired through foreclosure

     —           —           1,639         1,639   

Servicing assets

     —           —           19         19   
     As of December 31, 2009  

(Dollar amounts in thousands)

   Level 1      Level II      Level III      Total  

Assets:

           

Impaired Loans

   $ —         $ —         $ 1,039       $ 1,039   

Loans held for sale

     —           201         —           201   

Real estate acquired through foreclosure

     —           —           725         725   

Servicing assets

     —           —           29         29   

10. Financial Instruments

In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, consisting of commitments to extend credit, commitments under line of credit lending arrangements and letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are received.

The following methods and assumptions were used in estimating fair values of financial instruments.

Cash and cash equivalents – The carrying amounts of cash equivalents approximate their fair values.

Securities – With the exception of floating rate trust preferred securities, fair values for securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique which is widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

Loans receivable – Fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Loan commitments – The fair value of loan commitments at September 30, 2010 and December 31, 2009 approximated the carrying value of those commitments at those dates.

Accrued interest receivable and payable – The carrying amounts of accrued interest approximate their fair values.

FHLB stock – FHLB stock is restricted for trading purposes, and thus, the carrying value approximates fair value.

Bank owned life insurance (BOLI) – The fair value of BOLI at September 30, 2010 and December 31, 2009 approximated the cash surrender value of the policies at those dates.

Interest rate cap and interest rate swap contracts – Fair values of interest rate cap contracts are based on dealer quotes.

Deposits – The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies current market interest rates to a schedule of aggregated expected monthly maturities.

 

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Borrowed funds and subordinated debt – For variable rate borrowings, fair values are based on carrying values. For fixed rate borrowings, fair values are based on the discounted value of contractual cash flows and on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Fair values of structured borrowings are based on dealer quotes.

Advance payments by borrowers for taxes and insurance- The fair value of the advance payments by borrowers for taxes and insurance approximated the carrying value of those commitments at those dates.

The following table sets forth the carrying amount and fair value of the Company’s financial instruments included in the consolidated statements of financial condition as of the respective dates below:

 

(Dollar amounts in thousands)

   September 30, 2010      December 31, 2009  
     Carrying
amount
     Fair
value
     Carrying
amount
     Fair
value
 

Financial assets:

           

Cash and cash equivalents

   $ 37,393       $ 37,393       $ 16,300       $ 16,300   

Securities

     1,079,351         1,079,351         1,106,910         1,106,910   

Loans receivable and held for sale

     660,576         690,724         671,588         690,024   

Accrued interest receivable

     9,350         9,350         10,312         10,312   

FHLB stock

     27,470         27,470         27,470         27,470   

Bank owned life insurance

     29,927         29,927         29,381         29,381   

Interest rate cap contracts

     334         334         466         466   

Interest rate swap contracts

     —           —           213         213   

Financial liabilities:

           

Deposits

     1,003,412         1,014,462         944,347         954,568   

Borrowed funds

     688,695         732,364         783,248         808,984   

Junior subordinated notes

     46,393         18,970         46,393         31,195   

Advance payment by borrowers for taxes and insurance

     1,313         1,313         2,661         2,661   

Accrued interest payable

     3,476         3,476         3,182         3,182   

Interest rate swap contracts

     4,409         4,409         —           —     

 

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

The following discussion and analysis provides further detail to the financial condition and results of operations of the Company. The section should be read in conjunction with the notes and financial statements presented elsewhere in this report.

The Company’s critical accounting policies involving the significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of September 30, 2010 have remained unchanged from the disclosures presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 under the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements in this report relating to the Company’s plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The information contained in this report should be read in conjunction with ESB’s most recent annual report filed with the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2009, which is available at the SEC’s website, www.sec.gov, or at ESB’s website, www.esbbank.com. Investors are cautioned that forward-looking statements, which are not historical fact, involve risks and uncertainties that could cause actual results to differ materially from those contemplated by such statements, including without limitation, the effect of changing regional and national economic conditions; changes in interest rates, spreads on earning assets and interest-bearing liabilities, and associated interest rate sensitivity; sources of liquidity available to the parent company and its related subsidiary operations; potential future credit losses and the credit risk of commercial, real estate, and consumer loan customers and their borrowing activities; actions of the Federal Reserve Board, Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and other regulatory bodies; potential legislative and federal and state regulatory actions and reform; competitive conditions in the financial services industry; rapidly changing technology affecting financial services, and/or other external developments materially impacting the Company’s operational and financial performance. The Company does not assume any duty to update forward-looking statements.

OVERVIEW

ESB Financial Corporation is a Pennsylvania corporation and thrift holding company that provides a wide array of retail and commercial financial products and services to customers in Western Pennsylvania through its wholly-owned subsidiary ESB Bank. ESB Bank currently operates 24 branches.

During the three months ended September 30, 2010 the Company reported net income of $3.5 million, a decrease of approximately $41,000, or 1.2%, over the same period last year. The Company realized a decrease to interest income of approximately $1.8 million over the same quarter last year. However, interest expense decreased by approximately $3.0 million during the same period. The result was an increase of $1.2 million in net interest income and an increase of 32 basis points to the Company’s net interest margin.

The Company is continuing efforts to improve the net interest margin by employing strategies to minimize the impact on the cost of funds, while attempting to increase the yield from the investment portfolio. Over the past two years the Company has been actively pursuing lower rate core deposits, and the effort is reflected in the deposit growth for the nine months ended September 30, 2010. Additionally, the Company employs a strategy of purchasing cash-flowing fixed and variable rate mortgage-backed securities funded by wholesale borrowings, which are comprised of FHLB advances and repurchase agreements. This is referred to as the Company’s wholesale strategy. As part of the wholesale strategy, the Company uses a laddered maturity schedule of two to five years on the wholesale borrowings. Recently, as part of its ongoing interest rate risk strategy, the Company purchased structured repurchase agreements (repo’s) with imbedded interest rate caps. These interest rate caps will aid in insulating the Company’s net interest margin against a rapid rise in interest rates which can cause significant pressure to the Company’s interest rate margin. During the nine months ended September 30, 2010, the Company had approximately $155.0 million of wholesale borrowings maturing with a weighted average rate of 5.00% and an original call/maturity of 3.3 years. These borrowings were replaced during the nine months ended September 30, 2010 with $79.4 million of borrowings with a weighted average rate of 2.66% and a weighted average call/maturity

 

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of 3.9 years. For purposes of determining the average life of the borrowings, the Company utilizes the call date if applicable.

The wholesale strategy operates with a lower cost of operations, although with lower interest rate spreads and therefore at a lower margin than the retail operations of the Company. The Company has utilized this strategy for several years. The Company manages this strategy through its interest rate risk management on a macro level. This strategy historically produces wider margins during periods of lower short-term interest rates, reflected in a steep yield curve and can be susceptible to net interest margin strain in both rapidly rising rates and rapidly declining rates as well as a sustained inverted yield curve.

Management continues to pursue methods of insulating this wholesale strategy from significant fluctuations in interest rates by: (1) incorporating a laddered maturity schedule of up to five years on the wholesale borrowings; (2) the purchase of off-balance sheet interest rate caps and interest rate caps imbedded in structured borrowing’s, which help to insulate the Company’s interest rate risk position from increases in interest rates; (3) providing structure in the investment portfolio in the form of corporate bonds and municipals securities; (4) utilizing cash flows from fixed and adjustable rate mortgage-backed securities; and (5) the placing of the Company’s securities in the available for sale portfolio thereby creating the flexibility to change the composition of the portfolio through restructuring as management deems it necessary due to interest rate fluctuations. Management believes that this insulation affords them the ability to react to measured changes in interest rates and restructure the Company’s statement of financial condition accordingly. This strategy is continually evaluated by management on an ongoing basis.

RESULTS OF OPERATIONS

Earnings Summary. The Company’s net income remained relatively unchanged at $3.5 million for the three months ended September 30, 2010 as compared to the same period in the prior year. The nominal $41,000, or 1.2%, decrease in net income for the quarter ended September 30, 2010, as compared to the same period in the prior year was primarily attributable to decreases in noninterest income of $185,000 and increases in noninterest expense and net income attributable to the noncontrolling interest of $775,000 and $127,000, respectively, partially offset by an increase in net interest income after provision for loan losses of $893,000 and a decrease in provision for income taxes of $153,000.

The Company recorded net income of $10.8 million for the nine months ended September 30, 2010, as compared to net income of $9.7 million for the same period in the prior year. The $1.1 million, or 11.9% increase in net income for the nine months ended September 30, 2010, as compared to the same period in the prior year was primarily attributable to increases in net interest income after provision for loan losses of $4.3 million, partially offset by a decrease in noninterest income of $1.9 million and increases in noninterest expense, provision for income taxes and net income attributable to the non controlling interest of $648,000, $473,000 and $176,000, respectively.

Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the Company’s interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest earning assets and interest bearing liabilities. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities in order to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest earning assets and liabilities affect the Company’s net interest income. Historically from an interest rate risk perspective, it has been management’s perception that differing interest rate environments, these being, extended low long-term interest rates, rapidly rising short-term interest rates as well as a sustained inverted yield curve, can cause sensitivity to the Company’s net interest income.

Net interest income increased $1.2 million, or 12.4%, to $11.0 million for the three months ended September 30, 2010, compared to $9.8 million for the same period in the prior year. This increase in net interest income was the result of interest expense decreasing by $3.0 million, partially offset by a decrease to interest income of $1.8 million.

Net interest income increased by $4.7 million, or 16.8%, to $32.6 million for the nine months ended September 30, 2010 compared to $27.9 million for the same period in the prior year. This increase in net interest income was the

 

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result of interest expense decreasing by $9.8 million, partially offset by a decrease to interest income of $5.1 million.

Interest income. Interest income decreased $1.8 million, or 7.7%, for the three months ended September 30, 2010, compared to the same period in the prior year. This decrease was primarily attributable to decreases in interest earned on loans receivable and securities available for sale of $366,000 and $1.4 million, respectively.

Interest earned on loans receivable decreased $366,000, or 3.8%, for the three months ended September 30, 2010, compared to the same period in the prior year. This decrease was primarily attributable to a decrease in the yield on loans receivable of 21 basis points to 5.62% at September 30, 2010 from 5.83% at September 30, 2009, as well as a decrease in the average balance of loans outstanding of $1.4 million, or 0.20%, to $671.5 million for the three months ended September 30, 2010, compared to $672.8 million for the same period in the prior year.

Interest earned on securities decreased $1.4 million, or 10.7%, for the three months ended September 30, 2010, compared to the same period in the prior year. This decrease was primarily the result of a decrease in the tax equivalent yield on securities to 4.82% for the three months ended September 30, 2010 from 5.17% for the three months ended September 30, 2009, as well as a decrease in the average balance of the securities portfolio of $31.5 million, or 2.9%, to $1.0 billion at September 30, 2010.

Interest income decreased $5.1 million, or 7.4%, for the nine months ended September 30, 2010, compared to the same period in the prior year. This decrease was primarily attributable to decreases in interest earned on loans receivable and securities available for sale of $1.2 million and $4.0 million, respectively.

Interest earned on loans receivable decreased $1.2 million, or 3.9%, for the nine months ended September 30, 2010 compared to the same period in the prior year. This decrease was primarily attributable to a decrease in the yield on loans receivable of 15 basis points to 5.67% at September 30, 2010 from 5.82% at September 30, 2009, as well as a decrease in the average balance of loans outstanding of $9.4 million, or 1.4%, to $674.9 million for the nine months ended September 30, 2010 as compared to $684.2 million for the same period in the prior year.

Interest earned on securities decreased $4.0 million, or 9.8%, for the nine months ended September 30, 2010 compared to the same period in the prior year. This decrease was primarily the result of a decrease in the tax equivalent yield on securities of 35 basis points to 4.88% at September 30, 2010 as compared to 5.23% at September 30, 2009, as well as a decrease in the average balance of the securities portfolio of $24.7 million, or 2.3%, to $1.1 billion at September 30, 2010.

These changes are reflected in the quarterly and period to date rate volume tables presented below which depict that the decreases to the expense associated with the Company’s interest bearing liabilities are the primary sources of the overall increase to net interest income.

Interest expense. Interest expense decreased $3.0 million, or 22.7%, for the three months ended September 30, 2010, compared to the same period in the prior year. This decrease in interest expense was attributable to decreases in interest incurred on deposits and borrowed funds of $863,000 and $2.1 million, respectively.

Interest incurred on deposits decreased $863,000, or 19.9%, for the three months ended September 30, 2010, compared to the same period in the prior year. This decrease was due to a decrease in the cost of interest-bearing deposits to 1.50% from 2.01% for the quarters ended September 30, 2010 and 2009, respectively, partially offset by an increase in the average balance of interest-bearing deposits of $63.8 million, or 7.5% to $920.4 million for the three months ended September 30, 2010, compared to $856.6 million for the same period in the prior year. The Company manages its cost of interest bearing deposits by diligently monitoring the interest rates on its products as well as the rates being offered by its competition through weekly interest rate committee meetings and utilizing rate surveys and hence subsequently adjusting rates accordingly.

Interest incurred on borrowed funds decreased $2.1 million, or 25.8%, for the three months ended September 30, 2010 compared to the same period in the prior year. This decrease was primarily attributable to a decrease in the

 

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average balance of borrowed funds of $114.8 million, or 14.2%, as well as a decrease in the cost of these funds to 3.47% from 4.02%, for the quarters ended September 30, 2010 and 2009.

Interest expense decreased $9.8 million, or 23.4%, for the nine months ended September 30, 2010, compared to the same period in the prior year. This decrease in interest expense was attributable to decreases in interest incurred on deposits, borrowed funds and junior subordinated notes of $2.9 million, $6.9 million and $61,000, respectively.

Interest incurred on deposits decreased $2.9 million, or 20.9%, for the nine months ended September 30, 2010, compared to the same period in the prior year. This decrease was due to a decrease in the cost of interest-bearing deposits to 1.60% from 2.20% for the nine months ended September 30, 2010 and 2009, respectively, partially offset by an increase in the average balance of interest-bearing deposits of $72.2 million, or 8.6%, to $908.2 million for the nine months ended September 30, 2010, compared to $836.0 million for the same period in the prior year.

Interest incurred on borrowed funds decreased $6.9 million, or 26.2%, for the nine months ended September 30, 2010 compared to the same period in the prior year. This decrease was primarily attributable to a decrease in the average balance of borrowed funds of $120.5 million, or 14.2%, to $725.6 million for the nine months ended September 30, 2010, compared to $846.1 million for the same period in the prior year, as well as a decrease in the cost of these funds between the periods to 3.57% from 4.15% for the periods ended September 30, 2010 and 2009.

In addition to its wholesale strategy, the Company manages its cost of borrowings through the use of debt associated with the issuance of trust preferred securities. During the quarter ended September 30, 2010, the interest incurred on these borrowings decreased by $3,000, or 0.5%, due to a decrease in the cost of these funds to 5.29% from 5.32% for the same period in the prior year. During the nine months ended September 30, 2010, the interest incurred on these borrowings decreased by $61,000, or 3.2%, due to a decrease in the cost of these funds to 5.31% from 5.49% for the same period in the prior year.

Average Balance Sheet and Yield/Rate Analysis. The following tables set forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of these tables, average balances are calculated using monthly averages and the average loan balances include non-accrual loans and exclude the allowance for loan losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis utilizing a federal tax rate of 34%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

 

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(Dollar amounts in thousands)

   Three months ended September 30,  
     2010     2009  
     Average
Balance
     Interest      Yield /
Rate
    Average
Balance
     Interest      Yield /
Rate
 

Interest-earning assets:

                

Taxable securities available for sale

   $ 750,356       $ 8,521         4.54   $ 821,290       $ 10,382         5.06

Taxable corporate bonds available for sale

     154,934         1,725         4.42     127,663         1,415         4.40

Tax-exempt securities available for sale

     134,374         1,510         6.81 %(1)      122,230         1,362         6.75 %(1) 
                                                    
     1,039,664         11,756         4.82 %(1)      1,071,183         13,159         5.17 %(1) 
                                                    

Mortgage loans

     493,966         6,916         5.60     480,772         7,004         5.83

Other loans

     160,244         2,268         5.62     174,008         2,531         5.77

Tax-exempt loans

     17,240         183         6.38 %(1)      18,030         198         6.60 %(1) 
                                                    
     671,450         9,367         5.62 %(1)      672,810         9,733         5.83 %(1) 
                                                    

Cash equivalents

     27,348         5         0.07     26,137         6         0.09

FHLB stock

     27,470         —           —          27,470         —           —     
                                                    
     54,818         5         0.04     53,607         6         0.04
                                                    

Total interest-earning assets

     1,765,932         21,128         4.98 %(1)      1,797,600         22,898         5.27 %(1) 

Other noninterest-earning assets

     177,234         —           —          166,808         —           —     
                                                    

Total assets

   $ 1,943,166       $ 21,128         4.52 %(1)    $ 1,964,408       $ 22,898         4.82 %(1) 
                                                    

Interest-bearing liabilities:

                

Interest-bearing demand deposits

   $ 300,877       $ 262         0.35   $ 261,422       $ 197         0.30

Time deposits

     619,551         3,208         2.05     595,196         4,136         2.76
                                                    
     920,428         3,470         1.50     856,618         4,333         2.01
                                                    

FHLB advances

     313,873         2,706         3.42     439,029         4,794         4.33

Repurchase Agreements

     363,000         3,176         3.47     343,500         3,160         3.65

Other borrowings

     16,991         193         4.51     26,167         232         3.52
                                                    
     693,864         6,075         3.47     808,696         8,186         4.02
                                                    

Preferred securities- fixed

     36,083         528         5.81     36,083         528         5.81

Preferred securities- adjustable

     10,310         91         3.50     10,310         94         3.62
                                                    
     46,393         619         5.29     46,393         622         5.32
                                                    

Total interest-bearing liabilities

     1,660,685         10,164         2.43     1,711,707         13,141         3.05

Noninterest-bearing demand deposits

     82,600         —           —          70,328         —           —     

Other noninterest-bearing liabilities

     24,329         —           —          21,528         —           —     
                                                    

Total liabilities

     1,767,614         10,164         2.28     1,803,563         13,141         2.89

Stockholders’ equity

     175,552         —           —          160,845         —           —     
                                                    

Total liabilities and equity

   $ 1,943,166       $ 10,164         2.08   $ 1,964,408       $ 13,141         2.65
                                                    

Net interest income

      $ 10,964            $ 9,757      
                            

Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)

           2.55 %(1)         <