Fidelity Bancorp 10-K 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended September 30, 2009
For the transition period from to .
Commission File Number: 0-22288
FIDELITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (412) 367-3300
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ YES x NO
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ YES x NO
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. x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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
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 definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act) ¨ Yes x No
The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the closing sales price of the Registrants Common Stock reported on the Nasdaq Global Market on March 31, 2009 was $24.3 million. Solely for purposes of this calculation, the term affiliate includes all directors and executive officers of the Registrant and all beneficial owners of more than 5% of the Registrants voting securities.
As of December 2, 2009, the Registrant had outstanding 3,046,510 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrants definitive Proxy Statement for the 2010 Annual Meeting of Stockholders. (Part III)
ANNUAL REPORT ON FORM 10-K
for the fiscal year ended September 30, 2009
Fidelity Bancorp, Inc. (the Company) may from time to time make written or oral forward-looking statements, including statements contained in the Companys filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties such as statements of the Companys plans, objectives, expectations, estimates and intentions, that are subject to change based on various important factors (some of which are beyond the Companys control). The following factors, among others, could cause the Companys financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rates, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors products and services; the willingness of users to substitute competitors products and services for the Companys products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes, acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing the risks resulting from these factors.
The Company cautions that the listed factors are not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
Item 1. Business
The Company, a Pennsylvania corporation headquartered in Pittsburgh, Pennsylvania, provides a full range of banking services through its wholly owned banking subsidiary, Fidelity Bank, PaSB (the Bank). The Company conducts no significant business or operations of its own other than holding all the outstanding stock of the Bank. Because the primary activities of the Company are those of the Bank, references to the Bank used throughout this document, unless the context indicates otherwise, generally refer to the consolidated entity.
The Bank is a Pennsylvania-chartered stock savings bank which is headquartered in Pittsburgh, Pennsylvania. Deposits in the Bank are insured to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (FDIC). The Bank is a member of the Federal Home Loan Bank (FHLB) of Pittsburgh. The Bank, incorporated in 1927, conducts business from fourteen full service offices located in Allegheny and Butler counties, two of the five Pennsylvania counties which comprise the metropolitan and suburban areas of greater Pittsburgh. The Banks wholly owned subsidiary, FBIC, Inc., was incorporated in the State of Delaware in July 2000. FBIC, Inc. was formed to hold and manage the Banks fixed-rate residential mortgage loan portfolio which may include engaging in mortgage securitization transactions. FBIC, Inc. has not completed any mortgage securitization transactions to date. Total assets of FBIC, Inc. as of September 30, 2009 were $93.4 million.
The Companys executive offices are located at 1009 Perry Highway, Pittsburgh, Pennsylvania 15237 and its telephone number is (412) 367-3300. The Company maintains a website at www.fidelitybancorp-pa.com.
The Bank is one of many financial institutions serving its market area. The competition for deposit products and loan originations comes from other depository institutions such as commercial banks, thrift institutions, and credit unions in the Banks market area. Competition for deposits also includes insurance products sold by local agents and investment products such as mutual funds and other securities sold by local and regional brokers. The Bank competes for loans with a variety of non-depository institutions such as mortgage brokers, finance companies, and insurance companies. Based on data compiled by the FDIC, the Bank had a 0.63% share of all FDIC-insured deposits in the Pittsburgh Metropolitan Statistical Area as of June 30, 2009, the latest date for which such data was available, ranking it 16th among 59 FDIC-insured institutions. This data does not reflect deposits held by credit unions with which the Bank also competes.
The Banks principal lending activity is the origination of loans secured primarily by first mortgage liens on existing single-family residences in the Banks market area. At September 30, 2009, the Banks loan portfolio included $164.7 million of residential loans, $1.7 million of residential construction loans, $97.2 million of commercial and multi-family real estate loans, and $26.9 million of commercial construction loans. The Bank also engages in consumer installment lending primarily in the form of home equity loans. At September 30, 2009, the Bank had $80.5 million in home equity loans in the portfolio. Substantially all of the Banks borrowers are located in the Banks market area and would be expected to be affected by economic and other conditions in this area. The Company does not believe that there are any other concentrations of loans or borrowers exceeding 10% of total loans.
Loan Portfolio Composition. The following table sets forth the composition of the Companys loan portfolio by loan type in dollar amounts and in percentages of the total portfolio at the dates indicated.
Loan Portfolio Sensitivity. The following table sets forth the estimated maturity of the Companys loan portfolio at September 30, 2009. The table does not include prepayments or scheduled principal repayments. Prepayments and scheduled principal repayments on loans totaled $117.3 million for the year ended September 30, 2009. All loans are shown as maturing based on contractual maturities. Demand loans, loans which have no stated maturity and overdrafts are shown as due in one year or less.
The following table sets forth the dollar amount of all loans at September 30, 2009, due after September 30, 2010, which have fixed interest rates and floating or adjustable interest rates.
Contractual principal repayments of loans do not necessarily reflect the actual term of the Banks loan portfolio. The average lives of mortgage loans are substantially less than their contractual maturities because of loan payments and prepayments and because of enforcement of due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average lives of mortgage loans, however, tend to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan rates are substantially lower than rates on existing mortgage loans.
Residential Real Estate Lending. The Bank originates single-family residential loans and residential construction loans which provide for periodic interest rate adjustments. The adjustable-rate residential mortgage loans offered by the Bank in recent years have 10, 15, 20, or 30-year terms and interest rates which adjust every one, three, five, seven, or ten years generally in accordance with the index of average yield on U.S. Treasury Securities adjusted to a constant maturity of the applicable time period. There is generally a two percentage point cap or limit on any increase or decrease in the interest rate per year with a five or six percentage point limit on the amount by which the interest rate can increase over the life of the loan. The Bank has not engaged in the practice of using a cap on the payments that could allow the loan balance to increase rather than decrease, resulting in negative amortization. At September 30, 2009 approximately $65.3 million or 39.7% of the residential mortgage loans in the Banks loan portfolio consisted of loans which provide for adjustable rates of interest.
The Bank also originates fixed-rate, single-family residential loans with terms of 10, 15, 20 or 30 years in order to provide a full range of products to its customers, but generally only under terms, conditions and documentation which permit the sale of these loans in the secondary market. Additionally, the Bank also offers a 10-year balloon loan with payments based on 30-year amortization. At September 30, 2009, approximately $99.5 million or 60.3% of the residential mortgage loans in the Banks loan portfolio consisted of loans which provide for fixed rates of interest. Although these loans provide for repayments of principal over a fixed period of up to 30 years, it is the Banks experience that such loans have remained outstanding for a substantially shorter period of time. The Banks policy is to enforce the due-on-sale clauses contained in most of its fixed-rate, adjustable-rate, and conventional mortgage loans which generally permit the Bank to require payment of the outstanding loan balance if the mortgaged property is sold or transferred and thus contributes to shortening the average lives of such loans.
The Bank will lend generally up to 80% of the appraised value of the property securing the loan (referred to as the loan-to-value ratio) up to a maximum amount of $417,000 but will lend up to 95% of the appraised value up to the same amount if the borrower obtains private mortgage insurance on the portion of the principal amount of the loan that exceeds 80% of the value of the property securing the loan. The Bank also originates residential mortgage loans in amounts over $417,000. The Bank will generally lend up to 80% of the appraised value of the property securing such loans. These loans may have terms of up to 30 years, but frequently have terms of 10 or 15 years or are 10-year balloon loans with payments based on 15-year to 30-year amortization. Generally, such loans will not exceed a maximum loan amount of $1.0 million, although the Bank may consider loans above that limit on a case-by-case basis.
The Bank also, in recent years, has developed single-family residential mortgage loan programs targeted to the economically disadvantaged and minorities in the Banks primary lending area. Under these programs, the Bank will lend up to 95% of the appraised value of the property securing the loan as well as reducing the closing costs the borrower is normally required to pay. The Bank does not believe that these loans pose a significantly greater risk of non-performance than similar single-family residential mortgage loans underwritten using the Banks normal criteria.
The Bank requires the properties securing mortgage loans it originates and purchases to be appraised by independent appraisers who are approved by or who meet certain prescribed standards established by the Board of Directors. The Bank also requires title, hazard, and (where applicable) flood insurance in order to protect the properties securing its residential and other mortgage loans. Borrowers are subject to employment verification, credit evaluation reports, and must meet established underwriting criteria with respect to their ability to make monthly mortgage payments.
Commercial and Multi-family Real Estate Lending. In addition to loans secured by single-family residential real estate, the Bank also originates, to a lesser extent, loans secured by commercial real estate and multi-family residential real estate. Over 95% of this type of lending is done within the Banks primary market area. At September 30, 2009, the Banks portfolio included $97.1 million of commercial real estate and $82,000 of multi-family residential real estate loans.
Although terms vary, commercial and multi-family residential real estate loans are generally made for terms of up to 10 years with a longer period for amortization and in amounts of up to 75% of the lesser of appraised value or sales price. These loans may be made with adjustable rates of interest, but the Bank also will make fixed-rate commercial or multi-family real estate loans on a 10 or 7 year payment basis, with the period of amortization negotiated on a case-by-case basis.
Commercial and multi-family mortgage loans generally are larger and are considered to entail significantly greater risk than one-to-four family real estate lending. The repayment of these loans typically is dependent on the successful operations and income stream of the borrower and the real estate securing the loan as collateral. These risks can be significantly affected by economic conditions. In addition, non-residential real estate lending generally requires substantially greater evaluation and oversight efforts compared to residential real estate lending.
Construction Lending. The Bank also engages in loans to finance the construction of one-to-four family dwellings. This activity is generally limited to individual units and may, to a limited degree, include speculative construction by developers. The inspections, for approval of payment vouchers, are performed by third parties and are based on stages of completion. Applications for construction loans primarily are received from former borrowers and builders who have worked with the Bank in the past. Construction loans are originated with permanent financing terms consistent with the Banks residential loan products; however, construction loans require only interest payments for the
first six months. Beginning in the seventh month, monthly payments of both interest and principal are required for the remaining term (e.g., 29 1/2 years for a 30 year term).
Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing of residential properties. If the estimate of construction cost proves to be inaccurate, the Bank may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Bank is forced to foreclose on a project prior to completion, there is no assurance that it will be able to recover all of the unpaid portion of the loan. In addition, the Bank may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time.
Installment Lending. The Bank offers a wide variety of installment loans, including home equity loans and consumer loans. At September 30, 2009, home equity loans amounted to $80.5 million or 95.3% of the Banks total installment loan portfolio. These loans are made on the security of the unencumbered equity in the borrowers residence. Home equity loans are made at fixed and adjustable rates for terms of up to 20 years and home equity lines of credit are made at variable rates. Home equity loans generally may not exceed 80% of the value of the security property when aggregated with all other liens, although a limited number of loans up to 100% value may be made at increased rates.
Consumer loans consist of motor vehicle loans, other types of secured consumer loans, and unsecured personal loans. At September 30, 2009, these loans amounted to $1.5 million, which represented 1.8% of the Banks total installment loan portfolio. At September 30, 2009, motor vehicle loans amounted to $55,000 and unsecured loans and loans secured by property other than real estate amounted to $1.4 million.
The Bank also makes other types of installment loans such as savings account loans, personal lines of credit, and overdraft loans. At September 30, 2009, these loans amounted to $2.4 million or 2.9% of the total installment loan portfolio. That total consisted of $477,000 of savings account loans, $1.8 million of personal lines of credit and $77,000 of overdraft loans.
Consumer and overdraft loans and, to a lesser extent, home equity loans may involve a greater risk of nonpayment than traditional first mortgage loans on single-family residential dwellings. Consumer loans may be unsecured or secured by depreciating collateral which may not provide an adequate source for repayment in the event of default. However, such loans generally provide a greater rate of return and the Bank underwrites the loans in conformity to standards adopted by its Board of Directors.
Commercial Business Loans and Leases. Commercial business loans of both a secured and unsecured nature are made by the Bank for business purposes to incorporated and unincorporated businesses. Typically, these are loans made for the purchase of equipment, to finance accounts receivable, and to finance inventory as well as other business purposes. At September 30, 2009, commercial business loans amounted to $54.3 million or 13.3% of the total net loan portfolio. In addition, the Bank makes commercial leases to businesses, typically for the purchase of equipment. All leases are funded as capital leases and the Bank does not assume any residual risk at the end of the lease term. At September 30, 2009, commercial leases amounted to $205,000 or 0.05% of the total net loan portfolio.
Loan Servicing and Sales. In addition to interest earned on loans, the Bank receives income through the servicing of loans and loan fees charged in connection with loan originations and modifications, late payments, changes of property ownership, and for miscellaneous services related to its loans. Income from these activities varies from period to period with the volume and type of loans made. The Bank did not recognize any loan servicing fee income for the year ended September 30, 2009. As of September 30, 2009, there were no outstanding loans serviced for others.
The Bank charges loan origination fees which are calculated as a percentage of the amount loaned. The fees received in connection with the origination of conventional single-family residential real estate loans have generally amounted to one to three points (one point being equivalent to 1% of the principal amount of the loan). In addition, the Bank typically receives fees of one half to one point in connection with the origination of conventional, multi-family residential loans, and commercial real estate loans. Loan fees and certain direct costs are deferred and the net fee or cost is amortized into income using the interest method over the expected life of the loan.
The Bank sells fixed-rate residential mortgage loans in the secondary market through an arrangement with several investors. This program allows the Bank to offer more attractive rates in its highly competitive market. The Bank does not service those loans sold in the secondary market. Customers may choose to have their loan serviced by the Bank, however, the loan is priced slightly higher and retained in the Banks loan portfolio. For the year ended September 30, 2009, the Bank sold $38.8 million of fixed-rate mortgage loans.
Loan Approval Authority and Underwriting. Applications for all types of loans are taken at the Banks home office and branch offices by branch managers and loan originators and forwarded to the administrative office for processing. In most cases, an interview with the applicant is conducted at the branch office by a branch manager. Residential and commercial real estate loan originations are primarily attributable to walk-in and existing customers, real estate brokers, and mortgage loan brokers. Installment loans are primarily obtained through existing and walk-in customers. The Board of Directors has delegated authority to the Loan Committee consisting of the Chairman, President, Chief Lending Officer, and Chief Financial Officer, to approve first mortgages on single-family residences of up to $750,000, commercial first mortgages of up to $750,000, home equity loans of up to $300,000, secured consumer loans of up to $75,000, unsecured consumer loans of up to $50,000, and commercial loans up to $500,000. Any loan in excess of those amounts must be approved by the Board of Directors. The Board of Directors has further delegated authority to the Banks President to approve first mortgages on single-family residences, commercial first mortgages, home equity, secured consumer, unsecured consumer, and commercial loans up to the FNMA conforming loan limit (currently $417,000), $200,000, $200,000, $75,000, $50,000, and $200,000, respectively. The terms of the delegation also permit the President to delegate authority to any other Bank officer under the same or more limited terms. Pursuant to this authority, the President has delegated to the Chief Lending Officer, subject to certain conditions, the authority to approve motor vehicle loans, secured personal loans and unsecured personal loans up to $75,000, $75,000, and $50,000, respectively; to approve one-to-four family first mortgage loans up to the FNMA conforming loan limit (currently $417,000); to approve home equity loans up to $200,000 if the amount of the loan plus prior indebtedness is not in excess of an 80% loan-to-value ratio; to approve home equity loans up to $100,000 if the amount of the loan plus prior indebtedness is in excess of 80%; to approve commercial loans up to $200,000; and to approve checking account overdraft protection loans that conform to the parameters of the program.
Classified Assets. Federal bank examiners require insured depository institutions to use a classification system for monitoring their problem assets. Under this classification system, problem assets are classified as substandard, doubtful, or loss. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses present make collection of principal in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the Company to risk sufficient to warrant classification in one of the above categories, but which possess some weakness, are required to be designated as special mention by management.
When an insured depository institution classifies problem assets as either substandard or doubtful, it may establish allowances for loan losses in an amount deemed prudent by management. When an insured institution classifies problem assets as loss, it is required either to establish an allowance for losses equal to 100% of that portion of the assets so classified or to charge off such amount. An institutions determination as to the classification of its assets and the amount of its allowances is subject to review by the FDIC which may order the establishment of additional loss allowances.
Included in non-accrual loans at September 30, 2009 are thirteen single-family residential real estate loans totaling $1.4 million, seven commercial real estate loans totaling $11.8 million, thirteen home equity and installment loans totaling $350,000, and eleven commercial business loans totaling $1.4 million. Certain other loans, while performing as of September 30, 2009, were classified as special mention, substandard, doubtful, or loss. Performing loans, which were classified as of September 30, 2009, included one single-family residential real estate loan totaling $37,000, nine commercial real estate loans totaling $9.2 million, eleven home equity and installment loans totaling $368,000, and seven commercial business loans totaling $678,000. While these loans are currently performing, they have been classified for one of the following reasons: the loan is ninety days past due, however, interest is less than ninety days past due; other loans to the borrower are non-performing; internal loan review has identified a deterioration of the borrowers financial capacity or a collateral shortfall; the loan was previously nonperforming but will retain its
classification status until the loan continues to perform for at least a six-month period; or the loan was previously nonperforming but will retain its classification status because the loan is now thirty to ninety days past due. See Nonperforming Loans and Foreclosed Real Estate.
Included in non-accrual loans at September 30, 2008 are ten single-family residential real estate loans totaling $701,000, three commercial real estate loans totaling $3.0 million, twenty-three home equity and installment loans totaling $676,000, and eight commercial business loans totaling $1.4 million. Certain other loans, while performing as of September 30, 2008, were classified as special mention, substandard, doubtful or loss. Performing loans, which were classified as of September 30, 2008, included one single-family residential real estate loan totaling $636,000, four commercial real estate loans totaling $3.9 million and seven commercial business loans totaling $418,000. While these loans are currently performing, they have been classified for one of the following reasons: the loan was previously nonperforming but will retain its classification status until the loan continues to perform for at least a six-month period; or the loan was previously nonperforming but will retain its classification status because the loan is now thirty to ninety days past due. See Nonperforming Loans and Foreclosed Real Estate.
At September 30, 2007, non-accrual loans consisted of thirteen single-family residential real estate loans totaling $831,000, three commercial real estate loans totaling $5.6 million, twenty-one home equity and installment loans totaling $340,000, and nine commercial business loans totaling $1.9 million. Certain other loans, while performing as of September 30, 2007, were classified as special mention, substandard, doubtful or loss. Performing loans which were classified as of September 30, 2007, included one single-family residential real estate loan totaling $647,000, two commercial real estate loans totaling $425,000, three home equity and installment loans totaling $9,000, and six commercial business loans totaling $530,000. While these loans were performing, they have been classified for one of the following reasons: other loans to the borrower are non-performing; or internal loan review has identified a deterioration of the borrowers financial capacity or a collateral shortfall. See Nonperforming Loans and Foreclosed Real Estate.
The following table sets forth the Companys classified assets in accordance with its classification system.
Classified assets increased during fiscal 2009 as compared to fiscal 2008 primarily due to twelve commercial real estate loans totaling $17.2 million that were classified as of September 30, 2009 and not classified as of September 30, 2008. Classified assets were relatively unchanged during fiscal 2008 as compared to fiscal 2007.
Nonperforming Loans and Foreclosed Real Estate. When a borrower fails to make a required payment on a loan, the Bank attempts to cause the default to be cured by contacting the borrower. In general, contacts are made after a payment is more than 15 days past due, and a late charge is assessed at that time. In most cases, defaults are cured promptly. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Banks normal collection procedures or an acceptable arrangement is not worked out with the borrower, the Bank will normally institute measures to remedy the default, including commencing a foreclosure action or, in special circumstances, accepting from the mortgagor a voluntary deed of the secured property in lieu of foreclosure.
The remedies available to a lender in the event of a default or delinquency with respect to residential mortgage loans and the procedures by which such remedies may be exercised are subject to Pennsylvania laws and regulations. Under Pennsylvania law, a lender is prohibited from accelerating the maturity of a residential mortgage loan, commencing any legal action (including foreclosure proceedings) to collect on such loan, or taking possession of any loan collateral until the lender has first provided the delinquent borrower with at least 30 days prior written notice
specifying the nature of the delinquency and the borrowers right to correct such delinquency. Additionally, a lender is restricted in exercising any remedies it may have with respect to loans for one and two-family principal residences located in Pennsylvania (including the lenders right to foreclose on such property) until the lender has provided the delinquent borrower with written notice detailing the borrowers rights to seek consumer credit counseling and state financial assistance.
Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual, generally when a loan is ninety days or more delinquent. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. The President, Chief Lending Officer, Chief Financial Officer, Vice President of Residential Lending, Compliance Officer, and the Collection Manager meet monthly to review non-performing assets and any other assets that may require classification or special consideration. Adjustments to the carrying values of such assets are made as needed and a detailed report is submitted to the Board of Directors on a monthly basis.
Foreclosed real estate is recorded at fair value less estimated cost to sell. Costs relating to development and improvement of the property are capitalized whereas costs of holding such real estate are expensed as incurred. Additional write downs are charged to income and the carrying value of the property reduced when the carrying value exceeds fair value less estimated cost to sell.
The following table sets forth information regarding the Companys non-accrual loans and foreclosed real estate at the dates indicated. The Company had no loans categorized as troubled debt restructurings at the dates indicated. The Company had accruing loans past due 90 days or more of $2.4 million, $653,000, and $150,000, at September 30, 2009, 2008, and 2007, respectively. Such loans consisted of commercial business loans and commercial lines of credit which were outstanding past their contractual maturity dates. In each case, such loans were otherwise current in accordance with their terms and the Company does not consider them nonperforming. The recorded investment in loans that are considered to be impaired under U.S. generally accepted accounting principles was $15.6 million at September 30, 2009, for which the related allowance for credit losses was $1.4 million. Interest income that would have been recorded and collected on loans accounted for on a non-accrual basis under the original terms of such loans was $1.2 million for the year ended September 30, 2009. During the year ended September 30, 2009, $625,000 in interest income was recorded on such loans.
Nonperforming loans increased to $14.9 million (3.64% of net loans receivable) at September 30, 2009 compared to $5.7 million (1.24% of net loans receivable) at September 30, 2008. At September 30, 2009, non-accrual loans consisted of thirteen 1-4 family residential real estate loans totaling $1.4 million, seven commercial real estate loans totaling $11.8 million, thirteen installment loans totaling $350,000, and eleven commercial business loans totaling $1.4 million. Significant additions to non-performing loans included:
The decrease in non-performing loans during fiscal 2008 as compared to fiscal 2007 is primarily attributed to one commercial real estate loan that totaled $2.6 million, which was non-performing in fiscal 2007 but was subsequently cured via sale in fiscal 2008.
At September 30, 2009, the Company did not have any potential problem loans that were not reflected in the above table where known information about possible credit problems of borrowers caused management to have serious doubts about the ability of such borrowers to comply with present repayment terms.
Allowance for Loan Losses
Management establishes reserves for estimated losses on loans based upon its evaluation of the inherent risks in the loan portfolio. The adequacy of the allowance is determined by management through the evaluation of such pertinent factors as the growth and composition of the loan portfolio, historical loss experience, the level and trend of past due and non-performing loans, the general economic conditions affecting the collectibility of loans in the portfolio, and other relevant factors. Large groups of smaller balance homogenous loans, such as residential real estate, small commercial real estate, and home equity and consumer loans are evaluated in the aggregate using historical loss factors and other data. Large balance and/or more complex loans, such as multi-family and commercial real estate loans may be evaluated on an individual basis and are also evaluated in the aggregate to determine adequate reserves. As individually significant loans become impaired, specific reserves are assigned to the extent of impairment. The Company analyzes its loan portfolio each quarter to determine the appropriateness of its allowance for loan losses. Management believes that the Companys allowance for losses as of September 30, 2009 of $5.7 million is adequate to absorb probable loan losses in the portfolio.
The following table sets forth the rollforward of the Banks allowance for loan losses.
Allocation of the Allowance for Loan Losses
The following table sets forth the allocation of the allowance by category and the percent of loans in each category to total loans which management believes can be allocated only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future loss and does not restrict the use of the allowance to absorb losses in any category.
The Bank is required to maintain a sufficient level of liquid assets (including specified short-term securities and certain other investments) as determined by management and defined and reviewed for adequacy by the FDIC during its regular examinations. The FDIC, however, does not prescribe by regulation a minimum amount or percentage of liquid assets. The level of liquid assets varies depending upon several factors, including (i) the yields on investment alternatives, (ii) managements judgment as to the attractiveness of the yields then available in relation to other opportunities, (iii) expectation of future yield levels, and (iv) managements projections as to the short-term demand for funds to be used in loan origination and other activities. Securities, including mortgage-backed securities, are classified at the time of purchase, based upon managements intentions and abilities, as securities held-to-maturity or securities available-for-sale. Debt securities acquired with the intent and ability to hold to maturity are classified as held-to-maturity and are stated at cost and adjusted for amortization of premium and accretion of discount which are computed using the level yield method and recognized as adjustments of interest income. All other debt securities are classified as available-for-sale to serve principally as a source of liquidity.
Current regulatory and accounting guidelines regarding securities (including mortgage-backed securities) require us to categorize securities as held-to-maturity, available-for-sale, or trading. At September 30, 2009, the Bank had securities classified as held-to-maturity and available-for-sale in the amount of $72.4 million and $166.1 million, respectively and had no securities classified as trading. Securities classified as available-for-sale are reported for financial reporting purposes at fair value with net changes in the market value from period to period included as a separate component of stockholders equity net of income taxes. At September 30, 2009, the Companys securities available-for-sale had an amortized cost of $172.2 million and fair value of $166.1 million. The changes in fair value in our available-for-sale portfolio reflect normal market conditions and vary, either positively or negatively, based primarily on changes in general levels of market interest rates relative to the yields of the portfolio. Additionally, changes in the fair value of securities available-for-sale do not affect our loans-to-one borrower limit.
The Company conducts periodic reviews to identify and evaluate each investment that has an unrealized loss in accordance with U.S. generally accepted accounting principles. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded net of tax in Accumulated Other Comprehensive Income (AOCI) for available-for-sale securities while such losses related to held-to-maturity securities are not recorded as these investments are carried at their amortized cost.
Regardless of the classification of the securities as available-for-sale or held-to-maturity, the Company has assessed each position for credit impairment.
Factors considered in determining whether a loss is temporary include:
The Companys review for impairment generally entails:
For debt securities that are not deemed to be credit impaired, management performs additional analysis to assess whether it intends to sell or would more-likely-than-not be required to sell the investment before the expected recovery of the amortized cost basis. Management has asserted that is has no intent to sell and that it believes it is more-likely-than-not that it will not be required to sell the investment before recovery of its amortized cost basis.
Similarly, for equity securities, management considers the various factors described above including its intent and ability to hold the equity security for a period of time sufficient for recovery to amortized cost. Where management lacks that intent or ability, the securitys decline in fair value is deemed to be other-than-temporary and is recorded in earnings.
For debt securities, a critical component of the evaluation for other-than-temporary impairment is the identification of credit impaired securities where management does not receive cash flows sufficient to recover the entire amortized cost basis of the security. The extent of the Companys analysis regarding credit quality and the stress on assumptions used in the analysis had been refined for securities where the current fair value or other characteristics of the security warrant.
The Company recorded impairment charges on securities of $5.1 million during fiscal 2009 compared to $3.6 million in fiscal 2008. During the fiscal year ended September 30, 2009, $3.5 million of impairment charges were recorded on five investments in pooled trust preferred securities resulting from several factors, including a downgrade on their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. Management of the Company has deemed the impairment on these five trust preferred securities to be other-than-temporary based upon these factors and the duration and extent to which the market value has been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuers in the pooled security. There were no impairment charges taken on these securities during the fiscal period ending September 30, 2008. For the fiscal year ended September 30, 2009 and 2008, the Company recognized in earnings impairment charges of $1.3 million and $3.4 million, respectively, on equity securities. Impairment charges of $1.2 million and $2.0 million during the fiscal years ended September 30, 2009 and 2008, respectively, were related to the Companys holdings of the AMF Ultra Short Mortgage Fund. These impairment charges resulted from the continuing uncertainty in spreads in the bond market for mortgage related securities. This uncertainty has negatively impacted the market value of the securities in the fund and thus the net asset value of the fund itself. Management of the Company has deemed the impairment of the fund to be other-than-temporary based upon the duration and extent to which the market value has been less than cost, the limitations placed on fund redemptions, and the inability to forecast a recovery in the market value. Additional impairment charges of $75,000 and $1.3 million during the fiscal periods ended September 30, 2009 and 2008, respectively, related to the Companys holdings of Freddie Mac preferred stock resulting from the significant decline in the value of these securities following the announcement by the Federal Housing Finance Agency (FHFA) that both Freddie Mac and Fannie Mae have been placed under conservatorship. Additionally, the FHFA eliminated the payment of dividends on common stock and preferred stock and assumed the powers of the Board and management of both agencies. Management of the Company has deemed the impairment on the Freddie Mac stock to be other-than-temporary based upon the duration and extent to which the market value has been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuer. For the fiscal period ended September 30, 2009, the Company also recognized in earnings impairment charges of $279,000 on corporate obligations. There were no impairment charges on corporate obligations for the fiscal period ended September 30, 2008. The impairment charges for fiscal 2009 relate to the Companys holding of one corporate bond issued by a large commercial and consumer finance company who has filed a plan for reorganization under federal bankruptcy laws. Based on the factors concerning the issuer, management of the Company has deemed the impairment on this security to be other-than-temporary.
At September 30, 2009, the Banks investment portfolio policy allowed investments in instruments such as: (i) U.S. Treasury obligations; (ii) U.S. federal agency or federally sponsored agency obligations; (iii)
municipal obligations; (iv) mortgage-backed securities and collateralized mortgage obligations; (v) bankers acceptances; (vi) certificates of deposit; (vii) investment grade corporate bonds and commercial paper; (viii) real estate mortgage investment conduits; (ix) equity securities and mutual funds; and (x) trust preferred securities. The Board of Directors may authorize additional investments.
As a source of liquidity and to supplement its lending activities, the Bank has invested in residential mortgage-backed securities. Mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. Mortgage-backed securities represent a participation interest in a pool of single-family or other types of mortgages. Principal and interest payments are passed from the mortgage originators, through intermediaries (generally quasi-governmental agencies) that pool and repackage the participation interests in the form of securities, to investors, like us. The quasi-governmental agencies, which include GinnieMae, FreddieMac, and FannieMae, guarantee the payment of principal and interest to investors.
Mortgage-backed securities typically are issued with stated principal amounts. The securities are backed by pools of mortgages that have loans with interest rates that are within a set range and have varying maturities. The underlying pool of mortgages can be composed of either fixed-rate or adjustable-rate mortgage loans. Mortgage-backed securities are generally referred to as mortgage participation certificates or pass-through certificates. The interest rate risk characteristics of the underlying pool of mortgages (i.e., fixed-rate or adjustable-rate) and the prepayment risk are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgages. Expected maturities will differ from contractual maturities due to scheduled repayments and because borrowers may have the right to call or prepay obligations with or without prepayment penalties. Mortgage-backed securities issued by GinnieMae, FreddieMac, and FannieMae make up a majority of the pass-through certificates market.
The Bank also invests in mortgage-related securities, primarily collateralized mortgage obligations issued or sponsored by GinnieMae, FreddieMac, and FannieMae as well as private issuers. Investments in private issuer collateralized mortgage obligations are made because these issues generally are higher yielding than agency sponsored collateralized mortgage obligations with similar average life and payment characteristics. All such investments are rated AAA by a nationally recognized credit rating agency. Collateralized mortgage obligations are a type of debt security that aggregates pools of mortgages and mortgage-backed securities and creates different classes of collateralized mortgage obligations securities with varying maturities and amortization schedules as well as a residual interest with each class having different risk characteristics. The cash flows from the underlying collateral are usually divided into tranches or classes whereby tranches have descending priorities with respect to the distribution of principal and interest repayment of the underlying mortgages and mortgage backed securities as opposed to pass through mortgage backed securities where cash flows are distributed pro rata to all security holders. Unlike mortgage backed-securities from which cash flow is received and prepayment risk is shared pro rata by all securities holders, cash flows from the mortgages and mortgage-backed securities underlying collateralized mortgage obligations are paid in accordance with a predetermined priority to investors holding various tranches of such securities or obligations. A particular tranche or class may carry prepayment risk which may be different from that of the underlying collateral and other tranches. Collateralized mortgage obligations attempt to moderate reinvestment risk associated with conventional mortgage-backed securities resulting from unexpected prepayment activity.
As a Pennsylvania savings bank, the Bank has the authority to invest in the debt or equity securities of any corporation or similar entity existing under the laws of the United States, any state or the District of Columbia subject to the prudent man rule. Aggregate equity investments may not exceed the lesser of 7.5% of the book value of the Banks assets or 75% of its capital and surplus. The aggregate investment in the equity securities of any one issuer may not exceed 1% of the book value of the Banks assets or more than 5% of the total outstanding shares of the issuer. Under FDIC regulations, the Bank may only invest in listed equity securities or mutual funds.
Investment and Mortgage-Backed Securities Portfolio
The following tables set forth the composition and amortized cost of the Banks investment and mortgage-backed securities at the dates indicated.
At September 30, 2009, non-U.S. Government and U.S. Government agency or corporation securities that exceeded ten percent of stockholders equity are as follows. The AMF Ultra Short Mortgage Fund invests solely in mortgage-backed securities issued or guaranteed by U.S. government agencies or government-sponsored enterprises which are no longer rated. The AMF Ultra Short Mortgage Fund was rated Af by Standard & Poors until July 11, 2008. During fiscal 2009 the Company recognized a $1.2 million non-cash impairment charge on the AMF Ultra Short Mortgage Fund resulting from the continuing uncertainty in spreads in the bond market for mortgage related securities. This uncertainty has negatively impacted the market value of the securities in the fund and thus the net asset value of the fund itself. Management of the Company has deemed the impairment of the fund to be other-than-temporary based upon the duration and extent to which the market value has been less than cost, the limitations placed on fund redemptions, and the inability to forecast a recovery in the market value.
The following tables set forth the amortized cost of each category of investment securities of the Bank at September 30, 2009 which mature during each of the periods indicated and the weighted average yield for each range at maturities. The yields on the tax-exempt investments have been adjusted to their pre-tax equivalents, assuming a 34% tax rate.
Information regarding the contractual maturities and weighted average yield of the Banks mortgage-backed securities portfolio at September 30, 2009 is presented below.
Sources of Funds
General. Savings deposits obtained through the home office and branch offices have traditionally been the principal source of the Banks funds for use in lending and for other general business purposes. The Bank also derives funds from scheduled amortizations and prepayments of outstanding loans and mortgage-backed securities and sales of securities available-for-sale. The Bank also may borrow funds from the FHLB of Pittsburgh and other sources. Borrowings generally may be used on a short-term basis to compensate for seasonal or other reductions in savings deposits or other inflows at less than projected levels, as well as on a longer-term basis to support expanded lending activities.
Deposits. The Banks current deposit products include savings accounts, demand deposit accounts, NOW accounts, money market deposit accounts and certificates of deposit. Terms on interest-bearing deposit accounts range from three months to ten years. Included among these deposit products are Individual Retirement Account (IRA) certificates and Keogh Plan retirement certificates (collectively retirement accounts).
The Banks deposits are obtained primarily from residents of Allegheny and Butler Counties. The principal methods used by the Bank to attract deposit accounts include the offering of a wide variety of services and accounts, competitive interest rates and convenient office locations and service hours. Also, during fiscal 2008, the Bank joined the Certificate of Deposit Account Registry Service (CDARS). This service enables the Bank to provide customers with access to up to $50 million in FDIC insurance on CD investments. If a customer
places a deposit using the CDARS service the deposit is divided into amounts under $250,000 and spread out among other banks that use CDARS making the full amount eligible for FDIC insurance. For this service, CDARS charges a fee ranging from 6 to 24 basis points depending on the term of the certificate. It is a deposit-gathering tool that the Bank is using to build more profitable relationships without having to pledge collateral. As of September 30, 2009 the Bank had $7.0 million of CDARS deposits.
The following table shows the distribution of, and certain other information relating to the Banks deposits by type as for the periods indicated.
In recent years, the Bank has been required by market conditions to rely increasingly on short-term certificate accounts and other deposit alternatives that are more responsive to market interest rates than regulated fixed-rate, fixed-term certificates that were historically the Banks primary source of deposits. As a result of de-regulation and consumer preference for shorter term, market-rate sensitive accounts, the Bank has, like most financial institutions, experienced a significant shift in deposits towards relatively short-term, market-rate accounts. In recent years, the Bank has been successful in attracting retirement accounts which have provided the Bank with a relatively stable source of funds. As of September 30, 2009, the Banks total retirement funds were $47.1 million or 10.6% of its total deposits.
The Bank attempts to control the flow of deposits by pricing its accounts to remain generally competitive with other financial institutions in its market area, but does not necessarily seek to match the highest rates paid by competing institutions. In this regard, the senior officers of the Bank meet weekly to determine the interest rates which the Bank will offer to the general public.
Rates established by the Bank are also affected by the amount of funds needed by the Bank on both a short-term and long-term basis, alternative sources of funds and the projected level of interest rates in the future. The ability of the Bank to attract and maintain deposits and the Banks cost of funds have been, and will continue to be, significantly affected by economic and competitive conditions.
Certificates of Deposits. Maturities of certificates of deposit of $100,000 or more that were outstanding as of September 30, 2009 are summarized as follows:
Borrowings. The Bank is eligible to obtain advances from the FHLB of Pittsburgh upon the security of the common stock it owns in that bank, securities owned by the Bank and held in safekeeping by the FHLB, and certain of its residential mortgages, provided certain standards related to credit worthiness have been met. As of October 2, 2009, specific collateral is required to be pledged for borrowings with the FHLB of Pittsburgh. Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. FHLB advances are generally available to meet seasonal and other withdrawals of deposit accounts, to expand lending, and to aid the effort of members to establish better asset and liability management through the extension of maturities of liabilities. At September 30, 2009, the Bank had $118.5 million of long-term advances outstanding. Original maturities of long-term debt range from four to ten years.
The Bank also, from time to time, enters into sales of securities under agreements to repurchase (repurchase agreements). Such repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities in the statement of financial condition. At September 30, 2009, the Bank had $106.2 million in repurchase agreements outstanding, including $11.2 million in retail repurchase agreements and $95.0 million in wholesale structured repurchase agreements.
The Bank has eight separate repurchase agreements with PNC Bank, N.A. (PNC) and Citigroup Global Markets, Inc. (CGMI). Each agreement is structured as the sale of a specified amount of identified securities to the counterparty which the Bank has agreed to repurchase five to seven years after the initial sale. The underlying securities consist of various U.S. Government and agency obligations, municipal obligations, and mortgage-backed securities which continue to be carried as assets of the Bank and the Bank is entitled to receive interest and principal payments on the underlying securities. The Bank is required to post additional collateral if the market value of the securities subject to repurchase falls below 105% of principal amount. While the repurchase agreements are in effect, the Bank is required to pay interest quarterly at the rate specified in the agreement. Seven of the agreements provide an initial fixed or floating interest rate that converts to a floating or fixed rate at the end of six months to one year. The counterparty has the option of terminating the seven repurchase agreements at the conversion date and quarterly thereafter. The Bank also has one fixed rate agreement that does not convert. The counterparty may terminate this agreement at the end of six months. The counterparty may also terminate any of the repurchase agreements upon certain events of default including the Banks failure to maintain well capitalized status. Upon termination, the Bank would be required to repurchase the securities. At September 30, 2009, the Bank had $55.0 million outstanding with PNC and $40.0 million outstanding with CGMI.
At September 30, 2009, the Company had outstanding subordinated debt in the amount of $7.7 million. The debentures were issued on September 20, 2007 and initially bore an interest rate of 7.05% per annum through December 15, 2007. The rate adjusts quarterly thereafter to three-month LIBOR plus a margin of 136 basis points. The debentures mature on December 15, 2037 and are callable in whole or in part at par on or after December 15, 2012. The Company has the right to defer payments of interest on the debentures for up to five years. During any period of deferral, however, the Company will be prohibited from paying dividends on any class of its capital stock. The debt was issued to a Delaware statutory business trust, FB Capital Statutory Trust III, established by the Company for this purpose. The trust purchased the debentures using funds from the sale of trust preferred securities on substantially the same terms as the subordinated debt. During the second quarter of fiscal 2008, the Company entered into an interest rate swap to manage its exposure to interest rate risk. This interest rate swap transaction involved the exchange of the Companys floating rate interest rate payment on its $7.5 million in floating rate preferred securities for a fixed rate interest payment without the exchange of the underlying principal amount (see Note 20 Derivative Instrument).
The following table sets forth certain information regarding the short-term borrowings (due within one year or less) of the Bank at the dates or for the periods indicated.
At September 30, 2009, the Company had 131 full-time and 30 part-time employees. None of these employees are represented by a collective bargaining agreement, and the Company believes that it enjoys good relations with its personnel.
SUPERVISION AND REGULATION
Set forth below is a brief description of certain laws which relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.
Emergency Economic Stabilization Act of 2008
In response to unprecedented market turmoil, the Emergency Economic Stabilization Act (EESA) was enacted on October 3, 2008. EESA authorizes the Secretary of the Treasury to purchase up to $700 billion in troubled assets from financial institutions under the Troubled Asset Relief Program or TARP. Troubled assets include residential or commercial mortgages and related instruments originated prior to March 14, 2008 and any other financial instrument that the Secretary determines, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, the purchase of which is necessary to promote financial stability. If the Secretary exercises his authority under TARP, EESA directs the Secretary of Treasury to establish a program to guarantee troubled assets originated or issued prior to March 14, 2008. The Secretary is authorized to purchase up to $250 million in troubled assets immediately and up to $350 million upon certification by the President that such authority is needed. The Secretarys authority will be increased to $700 million if the President submits a written report to Congress detailing the Secretarys plans to use such authority unless Congress passes a joint resolution disapproving such amount within 15 days after receipt of the report. The Secretarys authority under TARP expires on December 31, 2009 unless the Secretary certifies to Congress that extension is necessary provided that his authority may not be extended beyond October 3, 2010.
Institutions selling assets under TARP will be required to issue warrants for common or preferred stock or senior debt to the Secretary. If the Secretary purchases troubled assets directly from an institution without a bidding process and acquires a meaningful equity or debt position in the institution as a result or acquires more than $300 million in troubled assets from an institution regardless of method, the institution will be required to meet certain standards for executive compensation and corporate governance, including a prohibition against incentives to take unnecessary and excessive risks, recovery of bonuses paid to senior executives based on materially inaccurate earnings or other statements and a prohibition against agreements for the payment of golden parachutes. Institutions that sell more than $300 million in assets under TARP auctions will not be entitled to a tax deduction for compensation in excess of $500,000 paid to its chief executive or chief financial official or any its other three most highly compensated officers. In addition, any severance paid to such officers for involuntary termination or termination in connection with a bankruptcy or receivership will be subject to the golden parachute rules under the Internal Revenue Code.
EESA increases the maximum deposit insurance amount up to $250,000 until December 31, 2013 and removes the statutory limits on the FDICs ability to borrow from the Treasury during this period. The FDIC may not take the temporary increase in deposit insurance coverage into account when setting assessments. EESA allows financial institutions to treat any loss on the preferred stock of the Federal National Mortgage Association or Federal Home Loan Mortgage Corporation as an ordinary loss for tax purposes.
Pursuant to his authority under EESA, the Secretary of the Treasury has created the TARP Capital Purchase Plan under which the Treasury Department will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies. Qualifying financial institutions may issue senior preferred stock with a value equal to not less than 1% of risk-weighted assets and not more than the lesser of $25 billion or 3% of risk-weighted assets. The senior preferred stock will pay dividends at the rate of 5% per annum until the fifth anniversary of the investment and thereafter at the rate of 9% per annum. No dividends may be paid on common stock unless dividends have been paid on the senior preferred stock. Until the third anniversary of the issuance of the senior preferred, the consent of the U.S. Treasury will be required for any increase in the dividends on the common stock or for any stock repurchases unless the senior preferred has been
redeemed in its entirety or the Treasury has transferred the senior preferred to third parties. The senior preferred will not have voting rights other than the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms, or any merger, exchange or similar transaction that would adversely affect its rights. The senior preferred will also have the right to elect two directors if dividends have not been paid for six periods. The senior preferred will be freely transferable and participating institutions will be required to file a shelf registration statement covering the senior preferred. The issuing institution must grant the Treasury piggyback registration rights. Prior to issuance, the financial institution and its senior executive officers must modify or terminate all benefit plans and arrangements to comply with EESA. Senior executives must also waive any claims against the Department of Treasury.
In connection with the issuance of the senior preferred, participating publicly traded institutions must issue to the Secretary immediately exercisable 10-year warrants to purchase common stock with an aggregate market price equal to 15% of the amount of senior preferred. The exercise price of the warrants will equal the market price of the common stock on the date of the investment. The Secretary may only exercise or transfer one-half of the warrants prior to the earlier of December 31, 2009 or the date the issuing financial institution has received proceeds equal to the senior preferred investment from one or more offerings of common or preferred stock qualifying as Tier 1 capital. The Secretary will not exercise voting rights with respect to any shares of common stock acquired through exercise of the warrants. The financial institution must file a shelf registration statement covering the warrants and underlying common stock as soon as practicable after issuance and grant piggyback registration rights. The number of warrants will be reduced by one-half if the financial institution raises capital equal to the amount of the senior preferred through one or more offerings of common stock or preferred stock qualifying as Tier 1 capital. If the financial institution does not have sufficient authorized shares of common stock available to satisfy the warrants or their issuance otherwise requires shareholder approval, the financial institution must call a meeting of shareholders for that purpose as soon as practicable after the date of investment. The exercise price of the warrants will be reduced by 15% for each six months that lapse before shareholder approval subject to a maximum reduction of 45%.
Under the recently enacted American Recovery and Reinvestment Act of 2009 (ARRA), the Secretary of Treasury, after consultation with the appropriate federal banking agency shall permit any recipient of funds under the TARP to repay such funds without regard to the source of the funds or any waiting period and when such assistance has been repaid, the Secretary shall liquidate any associated warrants at the current market value. ARRA has imposed additional compensation restrictions and corporate governance standards on companies participating in the TARP Capital Purchase Program. ARRA directs the Secretary of the Treasury to adopt standards for executive compensation that include limits on compensation that exclude incentives to take unnecessary and excessive risks that threaten the value of the participant while any assistance remains outstanding and provision for recovery by the participant of any bonus, retention award or incentive compensation paid to any senior executive office and up to the 20 next mostly highly compensated employees of the participant based on statements of earnings, revenues, gains or other criteria that are later found to be materially inaccurate. The board of directors of any TARP participant must adopt policies on excessive or luxury expenditures, as identified by the Secretary. TARP participants will be required to annually allow shareholders to have a separate non-binding vote on executive compensation while a TARP investment is outstanding.
On December 12, 2008, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the Purchase Agreement) with the United States Department of the Treasury (Treasury) under the TARP Capital Purchase Program, pursuant to which the Company sold (i) 7,000 shares of the Registrants Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the Series B Preferred Stock) and (ii) a warrant (the Warrant) to purchase 121,387 shares of the Companys common stock, par value $0.01 per share (the Common Stock), for an aggregate purchase price of $7.0 million in cash.
The Series B Preferred Stock will qualify as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter.
Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) will be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share declared on the Common Stock prior to December 12, 2008. The Company may redeem the series B Preferred Stock at a price of $1,000 per share plus
accrued and unpaid dividends, subject to the concurrence of the Treasury and its federal banking regulators. Prior to December 12, 2011, unless the Company has redeemed the Series B Preferred Stock or the Treasury has transferred the Series B Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its Common Stock dividend or repurchase its Common Stock or other equity or capital securities, other than in certain circumstances specified in the Agreement.
In addition, the ability of the Company to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its Junior Stock and Parity Stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series B Preferred Stock.
Junior Stock means the Common Stock and any other class or series of stock of the Company, the terms of which expressly provide that it ranks junior to the Series B Preferred Stock as to dividend rights and/or rights on liquidation, dissolution, or winding up of the Company. Parity Stock means any class or series of stock of the Company the terms of which do not expressly provide that such class or series will rank senior or junior to the Series B Preferred Stock as to dividend rights and/or rights on liquidation, dissolution, or winding up of the Company (in each case without regard to whether dividends accrue cumulatively or non-cumulatively).
The Warrant has a 10-year term and is immediately exercisable upon its issuance with an exercise price, subject to anti-dilution adjustments, equal to $8.65 per share of the Common Stock. Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.
The Series B Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. Upon the request of Treasury at any time, the Registrant has agreed to promptly enter into a deposit arrangement pursuant to which the Series B Preferred Stock may be deposited and depositary shares (Depositary Shares), representing fractional shares of Series B Preferred Stock, may be issued. The Registrant has agreed to register the Series B Preferred Stock, the Warrant, the shares of Common Stock underlying the Warrant (the Warrant Shares), and Depositary Shares, if any, as soon as practicable after the date of the issuance of the Series B Preferred Stock and the Warrant. Neither the Series B Preferred Stock nor the Warrant will be subject to any contractual restrictions on transfer, except that the Treasury may only transfer or exercise an aggregate of one-half of the Warrant Shares prior to the earlier of the redemption of 100% of the shares of Series B Preferred Stock and December 31, 2009.
The Purchase Agreement also subjects the Registrant to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the EESA). In this connection, as a condition to the closing of the transaction, each of Messrs. Richard G. Spencer, Anthony F. Rocco and Michael A. Mooney and Ms. Sandra L. Lee and Ms. Lisa L. Griffith, the Registrants Senior Executive Officers (as defined in the Purchase Agreement) (the Senior Executive Officers), (i) executed a waiver (the Waiver) voluntarily waiving any claim against the Treasury or the Registrant for any changes to such Senior Executive Officers compensation or benefits that are required to comply with the regulation issued by the Treasury under the TARP Capital Purchase Program as published in the Federal Register on October 20, 2008 and acknowledging that the regulation may require modification of the compensation, bonus, incentive, and other benefit plans, arrangements and policies and agreements (including so-called golden parachute agreements) (collectively, Benefit Plans) as they relate to the period the Treasury holds any equity or debt securities of the Registrant acquired through the TARP Capital Purchase Program; and (ii) entered into a letter agreement (the Letter Agreement) with the Registrant amending the Benefit Plans with respect to such Senior Executive Officer as may be necessary, during the period that the Treasury owns any debt or equity securities of the Registrant acquired pursuant to the Purchase Agreement or the Warrant, as necessary to comply with Section 111(b) of the EESA.
The fair value of the preferred stock and the common stock warrants was determined based on their relative fair values calculated as of their issuance date, December 12, 2008. Based on their relative fair values, the TARP proceeds (net of issuance costs) were allocated between preferred stock and additional paid in capital (for the warrant component). The market/discount rate used when deriving the fair value of the preferred stock was 10.00%. This rate was determined by calculating the average dividend rate of the five most recent preferred equity offerings completed by banks and thrifts. A Black-Scholes model was used to calculate the fair value of the common stock warrants. Key assumptions input into the model included: amount of common stock, $1,050,000 (based on 15% of the gross TARP proceeds); market price of the common stock on the warrant grant date, $6.75;
exercise price of the warrant, $8.65 (20 day trailing average of the common stock as of the Treasurys approval date); number of common stock warrants issued, 121,387; expected life of the warrants, 5 years; the risk free interest rate, 1.55%; the continuous annualized volatility of the change in the underlying common stocks price, 32.00%; and the simple annual expected cash dividend yield on common stock, 8.30%. Based on the calculations, the fair value of the preferred stock represented 95.65% of the total fair value of the preferred stock and common stock warrants, while the fair value of the common stock warrants represented 4.35% of the total. The discount on the preferred stock is being amortized on a straight-line basis over five years.
Regulation of the Company
General. The Company, as a bank holding company registered under the Bank Holding Company Act of 1956, as amended, is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System and by the Pennsylvania Department of Banking. The Company is also required to file annually a report of its operations with the Federal Reserve and the Pennsylvania Department of Banking. This regulation and oversight is generally intended to ensure that the Company limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of the Bank.
Under the Bank Holding Company Act, the Company must obtain the prior approval of the Federal Reserve before it may acquire control of another bank or bank holding company, merge or consolidate with another bank holding company, acquire all or substantially all of the assets of another bank or bank holding company, or acquire direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the Company would directly or indirectly own or control more than 5% of such shares. In addition, the Company must obtain the prior approval of the Pennsylvania Department of Banking in order to acquire control of another bank located in Pennsylvania.
Federal statutes impose restrictions on the ability of a bank holding company and its nonbank subsidiaries to obtain extensions of credit from its subsidiary bank, on the subsidiary banks investments in the stock or securities of the holding company, and on the subsidiary banks taking of the holding companys stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services by the subsidiary bank.
A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve policy that a bank holding company should stand ready to use available resources to provide adequate capital to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding companys failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve regulations, or both.
Non-Banking Activities. The business activities of the Company, as a bank holding company, are restricted by the Bank Holding Company Act. Under the Bank Holding Company Act and the Federal Reserves bank holding company regulations, the Company may only engage in, acquire, or control voting securities or assets of a company engaged in, (1) banking or managing or controlling banks and other subsidiaries authorized under the Bank Holding Company Act and (2) any non-banking activity the Federal Reserve has determined to be so closely related to banking or managing or controlling banks to be a proper incident thereto. These include any incidental activities necessary to carry on those activities as well as a lengthy list of activities that the Federal Reserve has determined to be so closely related to the business of banking as to be a proper incident thereto.
Financial Modernization. The Gramm-Leach-Bliley Act, which became effective in March 2000, permits greater affiliation among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a financial holding company. A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The Act also
permits the Federal Reserve and the Treasury Department to authorize additional activities for financial holding companies if they are financial in nature or incidental to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a satisfactory CRA rating. A financial holding company must provide notice to the Federal Reserve within 30 days after commencing activities previously determined by statute or by the Federal Reserve and Department of the Treasury to be permissible. The Company has not submitted notice to the Federal Reserve of our intent to be deemed a financial holding company.
Regulatory Capital Requirements. The Federal Reserve has adopted capital adequacy guidelines under which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the Bank Holding Company Act. The Federal Reserves capital adequacy guidelines are similar to those imposed on the Bank by the FDIC. See Regulation of the Bank - Regulatory Capital Requirements.
Restrictions on Dividends. The Pennsylvania Banking Code states, in part, that dividends may be declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital. The Bank has not declared or paid any dividends that have caused its retained earnings to be reduced below the amount required. Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due the Federal Deposit Insurance Corporation.
The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserves view that a bank holding company should pay cash dividends only to the extent that the holding companys net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding companys capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve may prohibit a bank holding company from paying any dividends if the holding companys bank subsidiary is classified as undercapitalized.
On November 17, 2009, the Company made informal commitments to the Federal Reserve Bank of Cleveland (Reserve Bank). The Company has agreed that, without the prior written approval of the Reserve Bank it will not declare or pay any dividends on outstanding shares and, also without prior written approval, that neither the Company nor its nonbank subsidiary will make any distributions of interest, principal or other sums on outstanding trust preferred securities. In addition, without the prior written approval of the Reserve Bank, the Company will not redeem or repurchase any shares of its stock and neither the Company nor any nonbank subsidiary will incur or guarantee any debt.
Prior to the commitments the Reserve Bank approved the Companys request to pay approximately $87,500 in dividends on its outstanding series of Fixed Rate Cumulative Perpetual Preferred Stock, Series B, held by the U.S. Department of Treasury payable November 16, 2009 and the payment of interest in the amount of $97,750 on its issue of trust preferred securities that was payable December 15, 2009.
Regulation of the Bank
General. As a Pennsylvania chartered savings bank with deposits insured by the FDIC, the Bank is subject to extensive regulation and examination by the Pennsylvania Department of Banking and by the FDIC, which insures its deposits to the maximum extent permitted by law. The federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds, and the nature and amount of and collateral for certain loans. The laws and regulations governing the Bank generally have been promulgated to protect depositors and not for the purpose of protecting stockholders. This regulatory structure also gives the federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Pennsylvania Department of Banking, the FDIC, or the United States Congress, could have a material impact on us and our operations.
Federal law provides the federal banking regulators, including the FDIC and the Federal Reserve, with substantial enforcement powers. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders, and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
Pennsylvania Savings Bank Law. The Pennsylvania Banking Code (Code) contains detailed provisions governing the organization, location of offices, rights and responsibilities of trustees, officers, and employees, as well as corporate powers, savings and investment operations, and other aspects of the Bank and its affairs. The Code delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking so that the supervision and regulation of state-chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.
The Code also provides state-chartered savings banks with all of the powers enjoyed by federal savings and loan associations, subject to regulation by the Pennsylvania Department of Banking. The Federal Deposit Insurance Act, however, prohibits a state-chartered bank from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to us by the Code is significantly restricted by the Federal Deposit Insurance Act.
Federal Deposit Insurance. The Banks deposits are insured to applicable limits by the FDIC. The maximum deposit insurance amount has been increased from $100,000 to $250,000 until December 31, 2013. On October 13, 2008, the FDIC established a Temporary Liquidity Guarantee Program under which the FDIC fully guarantees all non-interest-bearing transaction accounts until December 31, 2009 (the Transaction Account Guarantee Program) and all senior unsecured debt of insured depository institutions or their qualified holding companies issued between October 14, 2008 and October 31, 2009 that matures prior to December 31, 2012 (the Debt Guarantee Program). Senior unsecured debt would include federal funds purchased and certificates of deposit standing to the credit of the bank. After November 12, 2008, institutions that did not opt out of the Programs by December 5, 2008 were assessed at the rate of ten basis points for transaction account balances in excess of $250,000 and at a rate between 50 and 100 basis points of the amount of debt issued. Participating holding companies that have not issued FDIC-guaranteed debt prior to April 1, 2009 must apply to remain in the Debt Guarantee Program. Participating institutions will be subject to surcharges for debt issued after that date. Effective October 1, 2009, the Transaction Account Guarantee Program was extended until June 30, 2010, with an increased assessment after January 1, 2010. The Company and the Bank opted out of the Debt Guarantee Program. The Bank did not opt out of the Transaction Account Guarantee Program or its extension.
The FDIC has adopted a risk-based premium system that provides for quarterly assessments based on an insured institutions ranking in one of four risk categories based on their examination ratings and capital ratios. Well-capitalized institutions with the CAMELS ratings of 1 or 2 are grouped in Risk Category I and, until 2009, were assessed for deposit insurance at an annual rate of between five and seven basis points with the assessment rate for an individual institution determined according to a formula based on a weighted average of the institutions individual CAMELS component ratings plus either five financial ratios or the average ratings of its long-term debt. Institutions in Risk Categories II, III and IV were assessed at annual rates of 10, 28, and 43 basis points, respectively. Insured depository institutions that were in existence on December 31, 1996 and paid assessments prior to that date (or their successors) were entitled to a one-time credit against future assessments based on their past contributions to the predecessor to the Deposit Insurance Fund. The Bank used its special assessment credit to offset the cost of its deposit insurance premium until the fourth calendar quarter of 2008 when the credit was exhausted.
Pursuant to the Federal Deposit Insurance Reform Act of 2005 (the Reform Act), the FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund annually at between 1.15% and 1.5% of estimated insured deposits. Due to recent bank failures, the FDIC determined that the reserve ratio was 1.01% as of June 30, 2008. In accordance with the Reform Act, as amended by the Helping Families Save Their Home Act of 2009, the FDIC has established and implemented a plan to restore the reserve ratio to 1.15% within eight years.
For the quarter beginning January 1, 2009, the FDIC raised the base annual assessment rate for institutions in Risk Category I to between 12 and 14 basis points while the base annual assessment rates for institutions in Risk Categories II, III and IV were increased to 17, 35, and 50 basis points, respectively. For the quarter beginning April 1, 2009 the FDIC set the base annual assessment rate for institutions in Risk Category I to between 12 and 16 basis points and the base annual assessment rates for institutions in Risk Categories II, III and IV at 22, 32, and 45 basis points, respectively. An institutions assessment rate could be lowered by as much as five basis points based on the ratio of its long-term unsecured debt to deposits or, for smaller institutions based on the ratio of certain amounts of Tier 1 capital to deposits. The assessment rate may be adjusted for Risk Category I institutions that have a high level of brokered deposits and have experienced higher levels of asset growth (other than through acquisitions) and could be increased by as much as ten basis points for institutions in Risk Categories II, III, and IV whose ratio of brokered deposits to deposits exceeds 10% of assets. Reciprocal deposit arrangements like CDARS were treated as brokered deposits for Risk Category II, III, and IV institutions but not for institutions in Risk Category I. An institutions base assessment rate would also be increased if an institutions ratio of secured liabilities (including FHLB advances and repurchase agreements) to deposits exceeds 25%. The maximum adjustment for secured liabilities for institutions in Risk Categories I, II, III and IV would be 8, 11, 16, and 22.5 basis points, respectively, provided that the adjustment may not increase an institutions base assessment rate by more than 50%.
The FDIC imposed a special assessment equal to five basis points of assets less Tier 1 capital as of June 30, 2009 payable on September 30, 2009 and reserved the right to impose additional special assessments. In lieu of further special assessments, on November 12, 2009 the FDIC approved a final rule to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012 on December 30, 2009. For purposes of estimating future assessments, an institution would assume 5% annual growth in the assessment base and a three basis point increase in the current assessment rate for 2011 and 2012. The prepaid assessment would be applied against the actual assessment until exhausted. Any funds remaining after June 30, 2013 would be returned to the institution. If the prepayment would impair an institutions liquidity or otherwise create significant hardship, it could apply for an exemption.
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (FICO), an agency of the Federal government established to recapitalize the Federal Savings and Loan Insurance Corporation. The FICO assessment rates, which are determined quarterly, averaged .0102 % of insured deposits on an annualized basis in fiscal year 2009. These assessments will continue until the FICO bonds mature in 2017.
Regulatory Capital Requirements. The FDIC has promulgated capital adequacy requirements for state-chartered banks that, like us, are not members of the Federal Reserve System. At September 30, 2009, the Bank exceeded all regulatory capital requirements and was classified as well capitalized.
The FDICs capital regulations establish a minimum 3% Tier 1 leverage capital requirement for the most highly rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively increases the minimum Tier 1 leverage ratio for such other banks to 4% to 5% or more. Under the FDICs regulation, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System. Tier 1 or core capital is defined as the sum of common stockholders equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain mortgage and non-mortgage servicing assets and purchased credit card relationships.
The FDICs regulations also require that state-chartered, non-member banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital for the risk-based standards are the same as those for the leverage capital requirement. The components of supplementary (Tier 2) capital include cumulative perpetual preferred stock, mandatory subordinated debt,
perpetual subordinated debt, intermediate-term preferred stock, up to 45% of unrealized gains on equity securities, and a banks allowance for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital that may be included in total capital is limited to 100% of Tier 1 capital.
A bank that has less than the minimum leverage capital requirement is subject to various capital plan and activities restriction requirements. The FDICs regulations also provide that any insured depository institution with a ratio of Tier 1 capital to total assets that is less than 2.0% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and could be subject to termination of deposit insurance.
The Bank is also subject to minimum capital requirements imposed by the Pennsylvania Department of Banking on Pennsylvania-chartered depository institutions. Under the Pennsylvania Department of Bankings capital regulations, a Pennsylvania bank or savings bank must maintain a minimum leverage ratio of Tier 1 capital (as defined under the Federal Deposit Insurance Corporations capital regulations) to total assets of 4%. In addition, the Pennsylvania Department of Banking has the supervisory discretion to require a higher leverage ratio for any institutions based on the institutions substandard performance in any of a number of areas. The Bank was in compliance with both the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking capital requirements as of September 30, 2009.
Affiliate Transaction Restrictions. Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Such transactions between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are limited to 10% of a bank subsidiarys capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiarys capital and surplus. Further, loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that all transactions between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Pittsburgh, which is one of 12 regional Federal Home Loan Banks. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e. advances) in accordance with policies and procedures established by the board of trustees of the FHLB.
As a member, it is required to purchase and maintain stock in the FHLB of Pittsburgh in an amount not less than 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 4.75% of its outstanding advances from the FHLB, if any, plus 0.75% of its unused borrowing capacity, whichever is greater. At September 30, 2009, the Bank was in compliance with this requirement.
Federal Reserve System. The Federal Reserve requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking and NOW accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy the liquidity requirements that are imposed by the Department. At September 30, 2009, the Bank met its reserve requirements.
Loans-to-One Borrower. Under Pennsylvania and federal law, Pennsylvania savings banks have, subject to certain exemptions, lending limits to one borrower in an amount equal to 15% of the institutions capital accounts. An institutions capital account includes the aggregate of all capital, surplus, undivided profits, capital securities, and general reserves for loan losses. Pursuant to the national bank parity provisions of the Pennsylvania Banking Code, the Bank may also lend up to the maximum amounts permissible for national banks, which are allowed to make loans-to-one borrower of up to 25% of capital and surplus in certain circumstances. As of September 30, 2009, the Banks loans-to-one borrower limitations were $8.4 million and $14.0 million, pursuant to the 15% and 25% limits, respectively, and it was in compliance with such limitations.
Item 2. Properties.
At September 30, 2009, the Bank conducted its business from its main office in Pittsburgh, Pennsylvania and thirteen full-service branch offices located in Allegheny and Butler counties. The following table sets forth certain information with respect to the offices of the Bank as of September 30, 2009.
Item 3. Legal Proceedings.
The Company is not involved in any legal proceedings other than legal proceedings occurring in the ordinary course of business, of which none are expected to have a material adverse effect on the Company. In the opinion of management, the aggregate amount involved in such proceedings is not material to the financial condition or results of operations of the Bank.
Item 5. Market for the Registrants Common Equity, and Related Stockholder Matters and Issuer Purchases of Equity Securities.
As of September 30, 2009 Fidelity Bancorp, Inc. had 3,045,818 shares of stock outstanding and approximately 1,200 stockholders, including beneficial owners whose stock is held in nominee name.
There were no unregistered sales of equity securities during the quarter ended September 30, 2009.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The Company reported a net loss of $1.7 million and a net loss available to common stockholders of $2.0 million or ($0.66) per diluted common share compared to net income of $841,000 or $0.28 per diluted common share for fiscal 2008. The $2.6 million decrease in earnings for fiscal 2009 primarily reflects an increase in the provision for loan losses of $4.6 million, an increase of $1.5 million in other-than-temporary impairment (OTTI) charges on certain investment securities, as well as an increase in FDIC deposit insurance expense of $1.1 million.
Return on average equity was (3.65%) and 1.83% for fiscal years 2009 and 2008, respectively. Return on average assets was (0.23%) and 0.12% for fiscal 2009 and 2008, respectively. The ratio of other expenses to average assets for fiscal 2009 was 1.96% compared to 1.77% in fiscal 2008.
Total assets of the Company totaled $730.0 million at September 30, 2009, compared to $727.2 million at September 30, 2008. Increases were noted in cash and cash equivalents, available-for-sale securities, Federal Home Loan Bank stock, office premises and equipment, and other assets, partially offset by decreases in held-to-maturity securities, loans receivable, and cash surrender value of life insurance.
The operating results of the Company depend primarily upon its net interest income, which is the difference between the yield earned on its interest earning assets and the rates paid on its interest bearing liabilities (interest-rate spread) and also the relative amounts of its interest earning assets and interest bearing liabilities. For the fiscal year ended September 30, 2009, the tax-equivalent interest-rate spread increased to 2.25%, as compared to 2.14% in fiscal 2008. The ratio of average interest earning assets to average interest bearing liabilities increased to 109.64% in fiscal 2009, from 108.91% in fiscal 2008. The increase in the spread for fiscal 2009 is attributed to the average rate paid on interest-bearing liabilities decreasing more than the average yield on interest-earning assets. The Companys operating results are also affected to varying degrees by, among other things, service charges and fees, gains and losses on sales of securities and loans, impairment charges on securities, provision for loan losses, other operating income, operating expenses, and income taxes.
Critical Accounting Policies, Judgments and Estimates
Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. These policies are contained in Note 1 to the consolidated financial statements.
Our accounting and reporting policies conform with U.S. generally accepted accounting principles and general practices within the financial services industry. Recent accounting pronouncements are contained in Note 1 to the consolidated financial statements. The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurances that actual results will not differ from those estimates. If actual results are different than managements judgments and estimates, the Companys financial results could change, and such change could be material.
Allowance for Loan Losses. The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on managements review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including managements assumptions as to future delinquencies, recoveries, and losses. All of these factors may be susceptible to significant change. To the extent actual
outcomes differ from managements estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods.
Valuation of Goodwill. The Company assesses the impairment of goodwill at least annually and whenever events or significant changes in circumstances indicate that the carrying value may not be recoverable. Factors that the Company considers important in determining whether to perform an impairment review include significant underperformance relative to forecasted operating results and significant negative industry or economic trends. If the Company determines that the carrying value of goodwill may not be recoverable, then the Company will assess impairment based on a projection of discounted future cash flows and measure the amount of impairment based on fair value.
Accounting for Stock Options. Stock based compensation expense is reported in net income utilizing the fair-value-based method in accordance with U.S. generally accepted accounting principles. The fair value of each option award is estimated at the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in Note 13. Expected volatilities are based on the historical volatility of the Companys stock. The Company uses historical data to estimate option exercise and employee and director terminations within the model, as well as the expected term of options granted, which represents the period of time that options granted are expected to be outstanding. Separate groups of employees and directors that have similar historical exercise behavior are considered separately for valuation purposes. Ranges result from certain groups of employees and directors exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. All of these assumptions may be susceptible to change and would impact earnings in future periods.
Securities. Securities for which the Company has the positive intent and ability to hold to maturity are reported at cost adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Declines in the fair value of individual securities below their amortized cost that are other-than-temporary result in writedowns of the individual securities to their estimated fair value. For a discussion on the determination of an other-than-temporary decline, please refer to Note 1 of the consolidated financial statements. The Company recognized other-than-temporary writedowns of $5.1 million and $3.6 million in fiscal 2009 and 2008, respectively.
Impaired Loans. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market price or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Income Taxes. Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the date of enactment. The Company establishes a valuation allowance for deferred tax assets in accordance with U.S. generally accepted accounting principles when it is more-likely-than-not that the deferred tax asset will not be realized through carry-back to taxable income in prior years, future reversals of existing taxable temporary differences and, to a lesser extent, future taxable income.
The Company did not record any unrecognized tax benefits as of September 30, 2009 and 2008. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. During the years ended September 30, 2009 and 2008, the Company recognized neither interest nor penalties. The Company has not recorded an accrual for the payment of interest and penalties at September 30, 2009 and 2008.
Liquidity and Capital Resources
The Company has no operating business other than that of the Bank. The Companys principal liquidity needs are for the payment of dividends and the payment of interest on its outstanding subordinated debt. The Companys principal sources of liquidity are earnings on its investment securities portfolio and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends. Furthermore, on November 17, 2009, the Company made informal commitments to the Federal Reserve Bank of Cleveland (Reserve Bank). The Company has agreed that, without the prior written approval of the Reserve Bank it will not declare or pay any dividends on outstanding shares and, also without prior written approval, that neither the Company nor its nonbank subsidiary will make any distributions of interest, principal or other sums on outstanding trust preferred securities. In addition, without the prior written approval of the Reserve Bank, the Company will not redeem or repurchase any shares of its stock and neither the Company nor any nonbank subsidiary will incur or guarantee any debt.
Prior to the commitments the Reserve Bank approved the Companys request to pay approximately $87,500 in dividends on its outstanding series of Fixed Rate Cumulative Perpetual Preferred Stock, Series B, held by the U.S. Department of Treasury payable November 16, 2009 and the payment of interest in the amount of $97,750 on its issue of trust preferred securities that was payable December 15, 2009.
The Banks primary sources of funds have historically consisted of deposits, amortization and prepayments of outstanding loans and mortgage-backed securities, borrowings from the FHLB of Pittsburgh, and other sources, including repurchase agreements and sales of investments. During fiscal 2009, the Bank used its capital resources primarily to meet its ongoing commitments to fund maturing savings certificates and savings withdrawals, fund existing and continuing loan commitments, and to maintain its liquidity. At September 30, 2009 the total of approved loan commitments amounted to $12.5 million and the Company had $13.8 million of undisbursed loan funds. Unfunded commitments under lines and letters of credit amounted to $74.1 million at September 30, 2009. The amount of savings certificates which are scheduled to mature in the twelve-month period ended September 30, 2010 is $102.5 million. Management believes that, by evaluation of competitive instruments and pricing in its market area, it can, in most circumstances, manage and control maturing deposits so that a substantial amount of such deposits are redeposited in the Company.
In order to increase the funds available to the Deposit Insurance Fund, the FDIC is requiring all insured depository institutions to prepay their federal deposit insurance assessments through 2012. The prepayment is due December 30, 2009 and is based on the institutions assessment base and assessment rate as of September 30, 2009 assuming 5% annual growth in deposits and a three basis point increase in the assessment rate during years 2011 and 2012. The prepayment would be recorded on the balance sheet as a prepaid expense against which future quarterly assessments would be charged. We expect to make the prepayment from available cash on hand.
Off-Balance Sheet Arrangements
The Company is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. The Company is not party to any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on the Companys financial condition, revenues or expenses, results of operations, liquidity or capital expenditures, or resources.
At September 30, 2009, the Company had capital in excess of all applicable regulatory capital requirements. At September 30, 2009, the ratio of the Companys Tier 1 capital to average assets was 7.64%. The Companys ratio of Tier 1 capital to risk-weighted assets was 11.52% and its ratio of total capital to risk-weighted assets was 12.70%.
The Bank currently exceeds all regulatory capital requirements, having a leverage ratio of Tier 1 capital to total average assets of 6.90%, a ratio of Tier 1 capital to risk-weighted assets of 10.46%, and a ratio of qualifying total capital to risk-weighted assets and off-balance sheet items of 11.67% at September 30, 2009.
The Companys assets were $730.0 million at September 30, 2009, an increase of $2.8 million or 0.4% from assets at September 30, 2008. Increases were noted in cash and cash equivalents, available-for-sale securities, Federal Home Loan Banks stock, office premises and equipment, and other assets, partially offset by decreases in held-to-maturity securities, loans receivable, and cash surrender value of life insurance.
Net loans receivable decreased $51.0 million or 11.1% to $409.8 million at September 30, 2009 from $460.8 million at September 30, 2008. Loans originated totaled $110.0 million in fiscal 2009, including amounts disbursed under lines of credit, versus $163.0 million in fiscal 2008. Mortgage loans originated amounted to $72.8 million, including $38.8 million originated for sale, compared to $68.2 million, including $12.5 million originated for sale, in fiscal 2009 and 2008, respectively. The Bank did not purchase any mortgage loans in fiscal 2009 or fiscal 2008. The increase in the level of mortgage loan originations in fiscal 2009 reflected the low interest rate environment that existed during fiscal 2009. The origination of adjustable rate mortgages (ARMs) decreased to $12.8 million in fiscal 2009 from $15.6 million in fiscal 2008. Due to the low interest rate environment during fiscal 2009, most of our customers preferred fixed rate loans, which contributed to the decrease in ARM originations. Due to the low interest rate environment during fiscal 2009, for asset/liability purposes, the Bank decided to sell most of the fixed rate, single-family mortgage loans that were originated, rather than retaining them in the Banks portfolio. Gains of $525,000 were realized on these sales in fiscal 2009. Principal repayments on outstanding mortgage loans increased to $78.7 million in fiscal 2009 as compared to $58.7 million in fiscal 2008. The combination of the above factors resulted in an overall decrease in mortgage loans receivable to $290.5 million at September 30, 2009 from $335.3 million at September 30, 2008.
Other loan originations, including installment loans, commercial business loans, and disbursements under lines of credit totaled $37.3 million in fiscal 2009 versus $94.8 million in fiscal 2008. During fiscal 2009, the Bank continued to emphasize other loans, particularly home equity loans, home equity lines of credit, and commercial business loans, since they generally have shorter terms than mortgage loans and would perform better in a rising rate environment. The decrease in originations was due to competitive market pressures. Customers seek the lowest rates available for these products. Installment loan originations and consumer lines of credit disbursements were $14.5 million in fiscal 2009 compared to $22.8 million in fiscal 2008. Commercial business loan originations and business line of credit disbursements were $22.8 million in fiscal 2009 compared to $14.3 million in fiscal 2008. Principal repayments on other loans were $38.5 million in fiscal 2009 compared to $33.8 million in 2008. The net result of the above factors caused the balance of installment loans to decrease to $84.4 million at September 30, 2009, as compared to $94.7 million at September 30, 2008. Commercial business loans and leases were $54.5 million at September 30, 2009 versus $45.5 million at September 30, 2008.
The following table sets forth information regarding non-accrual loans and foreclosed real estate at the dates indicated. The table does not include $2.4 million and $653,000 in loans at September 30, 2009 and 2008, respectively, that were more than 90 days past maturity but were otherwise performing in accordance with their terms. These loans represent commercial business lines of credit, which have reached their maturity dates and are in the process of renewing. The Bank did not have any loans classified as troubled debt restructurings at the dates presented.
Nonperforming loans increased to $14.9 million (3.64% of net loans receivable) at September 30, 2009 compared to $5.7 million (1.24% of net loans receivable) at September 30, 2008. At September 30, 2009, non-accrual loans consisted of thirteen 1-4 family residential real estate loans totaling $1.4 million, seven commercial real estate loans totaling $11.8 million, thirteen installment loans totaling $350,000, and eleven commercial business loans totaling $1.4 million. Significant additions to non-performing loans included:
Management has evaluated these loans and is satisfied that the allowance for loan losses at September 30,
2009 is adequate. The allowance for loan losses was $5.7 million at September 30, 2009 and $3.4 million at September 30, 2008. The balance at September 30, 2009, at 1.4% of net loans receivable and 38.3% of non-performing loans, is considered reasonable by management.
Foreclosed real estate at September 30, 2009 consists of one single-family residential property and one non-farm non-residential property, which are located in the Banks market area. Management believes that the carrying values of the properties at September 30, 2009 approximate their fair values less costs to sell. However, while management uses the best information available to make such determinations, future adjustments may become necessary.
Cash and Cash Equivalents
Cash and cash equivalents increased $31.7 million, or 294.4%, to $42.5 million at September 30, 2009 from $10.8 million at September 30, 2008. The increase in cash and cash equivalents reflects increases in both cash and due from banks, which increased $13.9 million, and interest-bearing deposits in other banks, which increased $17.8 million. The increase in cash and cash equivalents was driven primarily by cash flows from loan repayments and increased deposits.
Securities available-for-sale increased $19.4 million or 13.2% to $166.1 million at September 30, 2009 from $146.7 million at September 30, 2008. These securities may be held for indefinite periods of time and are generally used as part of the Banks asset/liability management strategy. These securities may be sold in response to changes in interest rates, prepayment rates, or to meet liquidity needs. These securities consist of mortgage-backed securities, collateralized mortgage obligations, U.S. Government and Agency securities, tax-exempt municipal obligations, mutual funds, Federal Home Loan Mortgage Corporation stock, corporate obligations, trust preferred securities, and other equity securities. During fiscal 2009, the Company purchased $51.8 million of these securities. During fiscal 2009, the Company did not sell any of these securities.
Securities held-to-maturity decreased $3.0 million or 3.9% to $72.4 million at September 30, 2009, compared to $75.4 million at September 30, 2008. These investments are comprised of mortgage-backed securities, collateralized mortgage obligations, U.S. Government and Agency securities, tax-exempt municipal securities, and corporate obligations. During fiscal 2009, the Bank purchased $29.9 million of these securities.
Deposits increased $27.5 million during fiscal 2009 to $443.9 million at September 30, 2009 compared to $416.4 million at September 30, 2008. Deposit growth was generated in each category including money market accounts, time deposits, checking accounts, and savings accounts, with the largest increase noted in low cost checking accounts. Management continues to try to attract and retain deposit accounts.
Securities Sold Under Agreements To Repurchase
Securities sold under agreements to repurchase represents retail agreements and wholesale structured borrowings. Securities sold under agreement to repurchase increased $2.2 million or 2.2% to $106.2 million at September 30, 2009, from $104.0 million at September 30, 2008. The increase is the result of an increase in retail agreements. During fiscal 2009 and 2008 the Company had $11.2 million and $9.0 million of retail agreements outstanding, respectively. During fiscal 2009 and 2008 the Company had $95.0 million of wholesale structured borrowings outstanding.
Short-term borrowings include Federal Home Loan Bank RepoPlus advances, a Federal Home Loan Bank revolving line of credit, federal funds purchased, and to a much lesser extent, treasury, tax, and loan notes. These borrowings decreased $32.2 million to $104,000 at September 30, 2009, from $32.3 million at September
30, 2008. The decrease was a result of the increase in deposits and the decreases in securities held-to-maturity and net loans, partially offset by an increase in securities available-for-sale.
Long-term debt represents FHLB advances including fixed-rate advances and Convertible Select advances. Long-term debt decreased $259,000 or 0.2% to $118.5 million at September 30, 2009, from $118.8 million at September 30, 2008. As noted above, the decrease was a result of the increase in deposits and the decreases in securities held-to-maturity and net loans, partially offset by an increase in securities available-for-sale.
Subordinated debt represents debt issued by the Company to FB Capital Statutory Trust III in conjunction with the issuance of trust preferred securities by the Trust. The debt is unsecured and ranks subordinated and junior in right of payment to all indebtedness, liabilities, and obligations of the Company. The debt is due concurrently with the trust preferred securities. Subordinated debt was $7.7 million at September 30, 2009 and 2008.
Stockholders equity increased $5.0 million or 11.8% to $47.1 million at September 30, 2009 compared to September 30, 2008. This result reflects stock options exercised of $1,000; stock issued under the Dividend Reinvestment Plan of $75,000; stock-based compensation of $97,000; a decrease in the accumulated other comprehensive loss of $1.3 million, which is a result of changes in the net unrealized losses on the available-for-sale securities, and by the unrealized loss recognized on the cash flow hedge as discussed in Note 20, Derivative Instrument; common stock warrants issued of $302,000; and the issuance of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the Series B Preferred Stock) of $6.7 million. On December 12, 2008, the Company sold $7.0 million in preferred stock to the U.S. Department of Treasury as a participant in the federal governments TARP Capital Purchase Program. In connection with the investment, the Company also issued a ten-year warrant to the Treasury which permits the Treasury to purchase up to 121,387 shares of its common stock at an exercise price of $8.65 per share. The Series B Preferred Stock will pay dividends at the rate of 5% per annum until the fifth anniversary of issuance and, unless earlier redeemed, at the rate of 9% thereafter. Until the third anniversary of the issuance of the Series B Preferred Stock or its earlier redemption or transfer by the Treasury Department to an unaffiliated holder, the Company may not increase the dividend on the common stock or repurchase any shares of common stock. Offsetting these increases was the net loss of $1.7 million; and common and preferred stock cash dividends paid of $1.4 million.
Results of Operations
Comparison of Fiscal Years Ended September 30, 2009 and 2008
The Company recorded a net loss of $1.7 million and a net loss available to common stockholders of $2.0 million or ($0.66) per diluted common share for the year ended September 30, 2009 compared to net income of $841,000 or $0.28 per diluted common share for fiscal 2008. The $2.6 million decrease in earnings for fiscal 2009 primarily reflects an increase in the provision for loan losses of $4.6 million, an increase of $1.5 million in other-than-temporary impairment (OTTI) charges on certain investment securities, as well as an increase in FDIC deposit insurance expense of $1.1 million. Other factors contributing to the decrease in net income from fiscal 2008 include an increase in operating expenses (excluding FDIC deposit insurance expense) of $441,000, or 3.4%, partially offset by an increase in net interest income of $590,000 or 3.6%, an increase in other income (excluding OTTI charges) of $758,000, or 20.8%, and a tax benefit of $2.3 million. The net loss available to common stockholders and diluted loss per common share also reflects $265,000 in preferred stock dividends and discount accretion during the 2009 fiscal year compared to none during the prior fiscal year.
Average Balance Sheet and Analysis of Net Interest Income
The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars, rates, and the net interest margin. The average balance of loans receivable includes non-accrual loans. Average balances are based on month-end balances. The Company does not believe that the use of month-end balances has a material impact on the information presented. Interest income on tax exempt investments has been adjusted for federal income tax purposes using an assumed rate of 34%.
The following table presents certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in volume (change in volume multiplied by old rate), and (2) changes in rate (change in rate multiplied by old volume). Changes in rate/volume (change in rate multiplied by change in volume) have been allocated between changes in rate and changes in volume based on the absolute values of each. Interest income on tax exempt investments has been adjusted for federal income tax purposes using a rate of 34%.
Interest Income on Loans
Interest income on loans decreased by $2.0 million or 7.0% to $26.3 million in fiscal 2009 from $28.2 million in fiscal 2008. The decrease reflects both a decrease in the average size of the loan portfolio and a decrease in the average yield earned on the loan portfolio. The average size of the loan portfolio decreased from an average balance of $462.6 million in fiscal 2008 to $456.5 million in fiscal 2009.
Interest Income on Mortgage-Backed Securities
Interest income on mortgage-backed securities decreased by $216,000 or 5.3% in fiscal 2009 as compared to fiscal 2008. The decrease reflects both a decrease in the average balance of mortgage-backed securities held and a decrease in the yield earned on these securities in fiscal 2009. The average balance of mortgage-backed securities held, including mortgage-backed securities available-for-sale, decreased from $90.8 million in fiscal 2008 to $89.0 million in fiscal 2009. The yield earned on mortgage-backed securities is affected, to some degree, by the repayment rate of loans underlying the securities. Premiums or discounts on the securities, if any, are amortized to interest income over the life of the securities using the level yield method. During periods of falling interest rates, repayments of the loans underlying the securities generally increase, which shortens the average life of the securities and accelerates the amortization of the premium or discount. Falling rates, however, also tend to increase the market value of the securities. A rising rate environment generally causes a reduced level of loan repayments and a corresponding decrease in premium/discount amortization rates. Rising rates generally decrease the market value of the securities.
Interest Income on Investments
Interest income on investments (including those available-for-sale), which includes interest earning deposits with other institutions and FHLB stock, was $5.8 million in fiscal 2009, compared to $7.1 million in fiscal 2008. The fiscal 2009 results reflect a decrease in the average tax-equivalent yield earned on these investments, partially offset by an increase in the average balance of such investments to $158.0 million in fiscal 2009 as compared to $147.1 million in fiscal 2008. Also, the decrease was attributed to the FHLB announcing in December 2008 that it was suspending dividend payments beginning with the dividend payment that would have been payable in the March 2009 quarter in an effort to retain capital. The FHLB of Pittsburgh historically paid quarterly cash dividends, which were last paid on November 17, 2008 at an annualized rate of 2.35%.
Interest Expense on Deposits
Interest on deposits decreased $3.3 million or 28.3% to $8.4 million in fiscal 2009 from $11.8 million in fiscal 2008. The decrease reflects a decrease in the average rate paid on deposits, partially offset by an increase in the average balance of deposits.
Interest Expense on Securities Sold Under Agreement to Repurchase
Interest expense on securities sold under agreement to repurchase (including retail and structured borrowings) increased $305,000 or 6.3% to $5.1 million in fiscal 2009 compared to $4.8 million in fiscal 2008. The increase reflects both a higher level of average securities sold under agreement to repurchase in fiscal 2009 and an increase in the cost of these funds.
Interest Expense on Short-Term Borrowings
Interest expense on short-term borrowings (including FHLB RepoPlus advances, FHLB revolving line of credit, federal funds purchased, and treasury, tax and loan notes) decreased $616,000 or 83.2% to $124,000 in fiscal 2009 compared to $740,000 in fiscal 2008. The decrease reflects both a lower level of average short-term borrowing in fiscal 2009 and a decrease in the cost of these funds.
Interest Expense on Long-Term Debt
Interest expense on long-term debt (including FHLB fixed rate advances, and Convertible Select advances) decreased $413,000 or 7.8% to $4.9 million in fiscal 2009, compared to $5.3 million in fiscal 2008. The decrease reflects both a decrease in the average balance of long-term debt and a decrease in the cost of these borrowings.
Interest Expense on Subordinated Debt
Interest on subordinated debt declined $40,000 or 8.9% to $411,000 in fiscal 2009 compared to $451,000 in fiscal 2008. The decrease reflects a decrease in the average cost of these floating-rate debentures while the average balance remained unchanged. The decrease in interest expense on subordinated debt was partially offset by $181,000 in interest expense on an interest rate swap contract to hedge its interest rate exposure from the subordinated debt.
Provision for Loan Losses
The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents managements best estimates of the losses inherent in the portfolio, based on a quarterly review by management of the following factors:
Large groups of smaller balance homogenous loans, such as residential real estate, small commercial real estate, and home equity and consumer loans, are evaluated in the aggregate using historical loss factors and other data. Large balance and/or more complex loans, such as multi-family and commercial real estate loans may be evaluated on an individual basis and are also evaluated in the aggregate to determine adequate reserves. As individually significant loans become impaired, specific reserves are assigned to the extent of the impairment.
The provision for loan losses was $5.9 million for the fiscal year ended September 30, 2009. The provision for loan losses was $1.3 million for the fiscal year ended September 30, 2008. The provisions reflect managements evaluation of the loan portfolio, current economic conditions, and other factors as described below. The allowance increased from $3.4 million at September 30, 2008 to $5.7 million at September 30, 2009. Loan charge-offs, net of recoveries, were $3.6 million in fiscal 2009 compared to $863,000 in fiscal 2008. The balance of non-performing loans has increased to $14.9 million at September 30, 2009 compared to $5.7 million at September 30, 2008. Please refer to discussion of non-performing assets on pages 38 though 39.
The allowance for loan losses is maintained at a level that represents managements best estimate of losses in the loan portfolio at the balance sheet date. However, there can be no assurance that the allowance for losses will be adequate to cover losses, which may be realized in the future, and that additional provisions for losses will not be required.
Excluding OTTI charges of $5.1 million and $3.6 million for the fiscal periods ended September 30, 2009 and 2008, respectively, non-interest or total other income increased $758,000 or 20.8% to $4.4 million for the year ended September 30, 2009 compared to $3.7 million for the prior year. The increase is primarily due to an increase in loan service charges and fees, an increase in the gains on sales of loans, an increase in ATM fees, and an increase in earnings on cash surrender value of life insurance, partially offset by a decrease in gains on the sales of investment securities, a decrease in non-insured investment product income, and a decrease in other operating income.
Included in non-interest income is service fee income on loans and late charges of $618,000, which increased by $107,000 in fiscal 2009. These fees were $511,000 in fiscal 2008. Fiscal 2009 results include an increase in late charges collected on commercial loans, an increase in loan satisfaction fee income, an increase in miscellaneous fees collected on commercial loans, and an increase in title insurance fees, partially offset by a decrease in miscellaneous fees collected on residential mortgage loans and home equity loans.
The Company recorded net gains on sales of securities of $26,000 in fiscal 2008. The Company did not sell any securities during fiscal 2009. Sales during fiscal 2008 were made from the available-for-sale category. The sales reflected normal efforts to reposition portions of the portfolio at various times during the year to reflect changing economic conditions, changing market conditions, and to carry out asset/liability management strategies.
The Company recorded impairment charges on securities of $5.1 million during fiscal 2009 compared to $3.6 million in fiscal 2008. During the fiscal year ended September 30, 2009, $3.5 million of impairment charges were recorded on five investments in pooled trust preferred securities resulting from several factors, including a downgrade on their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. Management of the Company has deemed the impairment on these five trust preferred securities to be other-than-temporary based upon these factors and the duration and extent to which the market value has been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuers in the pooled security. There were no impairment charges taken on these securities during the fiscal year ending September 30, 2008. For the fiscal period ended September 30, 2009 and 2008, the Company recognized in earnings impairment charges of $1.3 million and $3.4 million, respectively, on equity securities. Impairment charges of $1.2 million and $2.0 million during the fiscal periods ended September 30, 2009 and 2008, respectively, were related to the Companys holdings of the AMF Ultra Short Mortgage Fund. These impairment charges resulted from the continuing uncertainty in spreads in the bond
market for mortgage related securities. This uncertainty has negatively impacted the market value of the securities in the fund and thus the net asset value of the fund itself. Management of the Company has deemed the impairment of the fund to be other-than-temporary based upon the duration and extent to which the market value has been less than cost, the limitations placed on fund redemptions, and the inability to forecast a recovery in the market value. Additional impairment charges of $75,000 and $1.3 million during the fiscal years ended September 30, 2009 and 2008, respectively, related to the Companys holdings of Freddie Mac preferred stock resulting from the significant decline in the value of these securities following the announcement by the Federal Housing Finance Agency (FHFA) that both Freddie Mac and Fannie Mae have been placed under conservatorship. Additionally, the FHFA eliminated the payment of dividends on common stock and preferred stock and assumed the powers of the Board and management of both agencies. Management of the Company has deemed the impairment on the Freddie Mac stock to be other-than-temporary based upon the duration and extent to which the market value has been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuer. For the fiscal period ended September 30, 2009, the Company also recognized in earnings impairment charges of $279,000 on corporate obligations. There were no impairment charges on corporate obligations for the fiscal period ended September 30, 2008. The impairment charges for fiscal 2009 relate to the Companys holding of one corporate bond issued by a large commercial and consumer finance company who has filed a plan for reorganization under federal bankruptcy laws. Based on the factors concerning the issuer, management of the Company has deemed the impairment on this security to be other-than-temporary.
Gain on sale of loans was $525,000 and $143,000 in fiscal years 2009 and 2008, respectively. The Company sells, servicing released, a portion of the fixed-rate, first mortgage residential loans it originates. This strategy allows the Company to offer competitive market rates on loans, while not retaining in its portfolio some loans that may not fit the current asset/liability strategy. In addition, such loans can generally be sold at a profit when a commitment to sell is locked in when the application is taken. Due to the low interest rate environment during fiscal 2009, the Bank decided to sell most of the fixed rate, single-family mortgage loans that were originated.
Automated teller machine (ATM) fees were $737,000 and $714,000 in fiscal years 2009 and 2008, respectively. The increase in fiscal 2009 is primarily attributed to an increase in the interchange fees earned on debit card transactions.
Non-insured investment product income was $126,000 and $232,000 in fiscal years 2009 and 2008, respectively. The decrease in fiscal 2009 is primarily attributed to a decrease in the commissions earned on the sales of these products due to lower volumes of sales.
Cash surrender value of life insurance income was $742,000 and $270,000 in fiscal years 2009 and 2008, respectively. The increase in fiscal 2009 is primarily attributed to $463,000 of bank owned life insurance earnings recognized during the current fiscal period attributed to the death of the Companys former Chairman of the Board.
Other operating income includes miscellaneous sources of income, which consist primarily of rental income, wire fees, fees from the sale of cashiers checks and money orders, and safe deposit box rental income. Such income amounted to $182,000 and $272,000 in fiscal 2009 and 2008, respectively. The decrease for fiscal 2009 is primarily attributed to a reduction in the recoveries collected on a loss related to a check kiting fraud discovered in March 2005 attributable to one business customer. The recoveries collected for fiscal 2009 were $17,000, as compared to $51,000 for fiscal 2008. The decrease is also attributed to a reduction in fees earned on the Companys official check account held with a third party. In April of 2008 the third party changed their earnings rate from Fed Funds minus zero basis points to Fed Funds minus 110 basis points, essentially putting the Bank at a service fee expense position compared to income in the prior year period.
Other expenses increased $1.5 million or 12.0% to $14.4 million in fiscal 2009 compared to $12.9 million in fiscal 2008 primarily due to an increase in compensation and benefits expense, an increase in the losses on foreclosed real estate, an increase in professional fees, an increase in service bureau expense, an increase in FDIC deposit insurance premiums, and an increase in other operating expenses, partially offset by a decrease in office occupancy and equipment expense, a decrease in depreciation and amortization, and a decrease in foreclosed real estate expense.
Compensation, payroll taxes, and fringe benefits, the largest component of operating expenses, increased $133,000 or 1.7% to $8.1 million in fiscal 2009 compared to $8.0 million in fiscal 2008. Factors contributing to the increase in fiscal 2009 were normal salary increases, an increase in health insurance expense, and increased payroll taxes, partially offset by lower bonus expense, lower retirement expenses, and lower life insurance expenses due to the death of the Companys former Chairman of the Board.
Office occupancy and equipment expense decreased $17,000 or 1.6% in fiscal 2009 compared to fiscal 2008. The decrease in fiscal 2009 reflects decreases in rent expense and furniture, fixtures, and equipment expense, partially offset by increases in real estate taxes paid on office buildings and office repairs and maintenance expense.
Depreciation and amortization decreased $19,000 or 3.7% to $488,000 in fiscal 2009 compared to $507,000 in fiscal 2008. The decrease in depreciation reflects equipment becoming fully depreciated, partially offset by depreciation on additions in those years.
The Bank recorded net losses on the sales of foreclosed real estate of $17,000 in fiscal year 2009 versus net gains of $10,000 in fiscal year 2008. Foreclosed real estate expense was $3,000 and $34,000 in fiscal years 2009 and 2008, respectively. The results reflect the costs associated with the holding and disposition of properties including writedowns during the periods. At September 30, 2009, the Bank had one single-family residential property and one non-farm non-residential property classified as foreclosed real estate. At September 30, 2009 and 2008, the Bank had $103,000 and $170,000 in foreclosed real estate, respectively.
Intangible amortization was $22,000 and $28,000 in fiscal years 2009 and 2008, respectively. The results reflect the amortization of the intangibles generated by the acquisitions of Carnegie Financial Corporation in February 2002 and First Pennsylvania Savings Association in December 2002, on an accelerated basis over ten years.
Advertising expense was $390,000 and $400,000 in fiscal years 2009 and 2008, respectively. The Company strives to market its products and services in a cost effective manner and incorporates a market segmentation strategy in its business plan to effectively manage its advertising dollars.
Professional fees were $462,000 and $389,000 in fiscal years 2009 and 2008, respectively. Professional fees include legal fees, audit fees, and supervisory examination and assessment fees. The increase in fiscal 2009 is primarily attributed to an increase in legal fees. The increase in legal fees is primarily related to the collection efforts on delinquent loans.
Service bureau expense amounted to $450,000 and $336,000 for fiscal years ended 2009 and 2008, respectively. The increase in fiscal 2009 is a result of the Bank continually adding technology and new products and services.
Federal deposit insurance premiums were $1.2 million and $56,000 for fiscal years ended 2009 and 2008, respectively. The increase in fiscal 2009 is primarily related to the FDIC imposing a 5 basis point special assessment on each insured depository institutions assets minus Tier 1 capital as of June 30, 2009. For the Bank the special assessment was $340,000. The increase was also due to recent increases in the assessment rate for deposit insurance from the previous 5 to 7 basis points to 12 to 14 basis points. In addition, the Bank has elected to participate in the Transaction Account Guarantee Program under the FDICs Temporary Liquidity Guarantee Program which provides unlimited insurance coverage for non-interest bearing transaction accounts. Under this program, the Bank has been assessed at the rate of 10 basis points for transaction account balances in excess of
the $250,000 insurance limit. After December 31, 2009, the Bank will be assessed at a rate of between 15 and 25 basis points on such balances.
Other operating expenses, which consist primarily of check processing costs, software costs, bank service charges, directors fees, and other administrative expenses, amounted to $2.3 million in fiscal 2009 and $2.1 million in fiscal 2008. Significant variations in fiscal 2009, compared to fiscal 2008, include increases in software and ScoreCard Reward expenses. In October of 2008 the Bank started a ScoreCard Reward program where customers can earn points for using their check card for normal routine purchases. For every $2.00 a customer spends, one point is earned. Points can be redeemed for electronics, air travel, hotel stays and other rewards. The Bank accrues expense based on its estimated redemption rate and also pays administrative fees for the program.
Total income tax benefit for the year ended September 30, 2009 was $2.3 million, as compared to tax expense of $1.4 million for the year ended September 30, 2008 period. The tax provision for the year ended September 30, 2009 was significantly impacted by the OTTI charges during the period and also by the $463,000 in bank owned life insurance income that was recorded during the period. The amount of tax benefit recognized on the OTTI charges was based on the tax characteristics of each security (capital or ordinary). Those securities that are treated as capital for tax purposes have limited tax benefits recorded. The Company recognized the AMF Ultra Short Mortgage Fund impairment loss of $1.2 million as a capital loss and recorded a tax valuation allowance of $419,000 relating to this investment. The tax provision was also impacted by the impairment charges recorded for the fiscal year ended September 30, 2008. On October 3, 2008, the Emergency Economic Stabilization Act was enacted which included a provision permitting banks to recognize losses relating to FNMA and FHLMC preferred stock as an ordinary loss, thereby allowing the Company to recognize a tax benefit on the losses. Consequently, the Company recognized this additional tax benefit in the quarter ending December 31, 2008 for the OTTI charges related to its holdings of FHLMC preferred stock recorded in fiscal 2008. Also, the Company has a tax benefit recorded for the year ended September 30, 2009 due to tax-exempt income that is currently higher than pre-tax income due to the OTTI charges and increase in loan loss provision charges taken during the current fiscal year period as well as the $463,000 in bank owned life insurance income that was recorded during the period. Tax-exempt income includes income earned on certain municipal investments that qualify for state and/or federal income tax exemption; income earned by the Banks Delaware subsidiary, which is not subject to state income tax; and earnings on Bank-owned life insurance policies, which are exempt from federal taxation. State and federal tax-exempt income for fiscal 2009 was $7.0 million and $2.3 million, respectively, compared to $7.7 million and $1.6 million, respectively, for fiscal 2008.
The Company may from time to time make written or oral forward-looking statements, including statements contained in the Companys filings with the Securities and Exchange Commission, in its reports to stockholders, and in other communications by the Company, which are made in good faith by the Company pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to the Companys beliefs, plans, objectives, goals, expectations, anticipations, estimates, and intentions, that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond the Companys control). The words may, could, should, would, believe, anticipate, estimate, expect, intend, plan, and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Companys financial performance to differ materially from that expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies, including interest rate policies of the Board of Governors of the Federal Reserve System (the FRB); inflation; interest rate, market and monetary fluctuations; the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; the willingness of customers to substitute competitors products and services for the Companys products and services and vice versa; laws concerning taxes, banking, securities, and insurance; technological changes; future acquisitions; the expense savings and revenue enhancements from acquisitions being less than expected; the growth and profitability of the Companys noninterest or fee income being less than expected; unanticipated regulatory or
judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of the Company.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and related notes presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a more significant impact on the Banks performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Companys assets and liabilities are critical to the maintenance of acceptable performance levels.
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
Fidelity Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition of Fidelity Bancorp, Inc. and its subsidiaries as of September 30, 2009 and 2008, and the related consolidated statements of income, stockholders equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fidelity Bancorp, Inc. and subsidiaries as of September 30, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 16 to the financial statements, effective October 1, 2008, the Company adopted FASB ASC Topic 820 Fair Value Measurement and Disclosures.
We are not engaged to examine managements assessment of the effectiveness of Fidelity Bancorp, Inc.s internal control over financial reporting as of September 30, 2009, which is included in Item 9A(T) of Form 10-K and, accordingly, we do not express an opinion thereon.
/s / S.R. Snodgrass A.C.
December 21, 2009
Consolidated Statements of Financial Condition
See notes to consolidated financial statements.
Consolidated Statements of Income (Loss)
See notes to consolidated financial statements.
Consolidated Statements of Income (Loss) (Continued)
See notes to consolidated financial statements.
Consolidated Statements of Stockholders Equity
See notes to consolidated financial statements.
Consolidated Statements of Cash Flows
See notes to consolidated financial statements.
Consolidated Statements of Cash Flows (Continued)