WSFS Financial 10-Q 2010
WSFS FINANCIAL CORPORATION
PART I. Financial Information
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
The accompanying notes are an integral part of these consolidated Financial Statements.
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CONDITION
The accompanying notes are an integral part of these consolidated Financial Statements.
WSFS FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
The accompanying notes are an integral part of these consolidated Financial Statements.
WSFS FINANCIAL CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THREE MONTHS ENDED MARCH 31, 2010 AND 2009
1. BASIS OF PRESENTATION
Our consolidated Financial Statements include the accounts of WSFS Financial Corporation (“the Company”, “our Company”, “we”, “our” or “us”), Wilmington Savings Fund Society, FSB (“WSFS Bank” or the “Bank”) and Montchanin Capital Management, Inc. (“Montchanin”) and its wholly owned subsidiary, Cypress Capital Management, LLC (“Cypress”). We also have one unconsolidated affiliate, WSFS Capital Trust III (“the Trust”). WSFS Bank has a fully-owned subsidiary, WSFS Investment Group, Inc., which markets various third-party insurance products and securities products to Bank customers through WSFS’ retail banking system. Founded in 1832, the Bank is one of the ten oldest banks continuously operating under the same name in the United States.
We provide residential and commercial real estate, commercial and consumer lending services, as well as retail deposit and cash management services. In addition, we offer a variety of wealth management and trust services through WSFS Trust and Wealth Management. Lending activities are funded primarily with retail deposits and borrowings. The Federal Deposit Insurance Corporation (“FDIC”) insures our customers’ deposits to their legal maximum. We serve our customers primarily from our 41 banking offices located in Delaware (36), Pennsylvania (4) and Virginia (1) and through our website at www.wsfsbank.com.
Although our current estimates contemplate current economic conditions and how we expect them to change in the future, it is reasonably possible that in 2010, actual conditions may be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Amounts subject to significant estimates are items such as the allowance for loan losses and lending related commitments, goodwill and intangible assets, post-retirement obligations, the fair value of financial instruments and other-than-temporary impairments. Among other effects, such changes could result in future impairments of investment securities, goodwill and intangible assets and establishment of allowances for loan losses and lending related commitments as well as increased post-retirement expense.
Our accounting and reporting policies conform with U.S. generally accepted accounting principles and prevailing practices within the banking industry for interim financial information and Rule 10-01 of the SEC’s Regulation S-X. Rule 10-01 of Regulation S-X does not require us to include all information and notes for complete financial statements and prevailing practices within the banking industry. Operating results for the three month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for any future quarters or for the year ending December 31, 2010. For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission.
Accounting for Stock-Based Compensation
Stock-based compensation is accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718 (formerly SFAS No. 123R, Share-Based Payment). We have stock options outstanding under two plans (collectively, “Stock Incentive Plans”) for officers, directors and Associates of the Company and its subsidiaries. After shareholder approval in 2005, the 1997 Stock Option Plan (“1997 Plan”) was replaced by the 2005 Incentive Plan (“2005 Plan”). No future awards may be granted under the 1997 Plan. The 2005 Plan will terminate on the tenth anniversary of its effective date, after which no awards may be granted. The number of shares reserved for issuance under the 2005 Plan is 862,000. At March 31, 2010 there were 67,485 shares available for future grants under the 2005 Plan. At the April 2010 Annual Meeting of Shareholders a proposal was approved that increased the number of shares available for issuance by 335,000.
The Stock Incentive Plans provide for the granting of incentive stock options as defined in Section 422 of the Internal Revenue Code as well as non-incentive stock options (collectively, “Stock Options”). Additionally, the 2005 Plan provides for the granting of stock appreciation rights, performance awards, restricted stock and restricted stock unit awards, deferred stock units, dividend equivalents, other stock-based awards and cash awards. All Stock Options are to be granted at not less than the market price of our Corporation’s common stock on the date of the grant. All Stock Options granted during 2010 vest in 25% per annum increments, start to become exercisable one year from the grant date and expire five years from the grant date. Generally, all awards become immediately exercisable in the event of a change in control, as defined within the Stock Incentive Plans.
We announced on April 18, 2007, that our Executive Committee of the Board of Directors adopted an administrative policy related to the future award of stock options under the 2005 Plan. The Executive Committee’s policy provided that any change to the policy would only be made following the approval by our stockholders. At the 2010 Annual meeting of Shareholders, a proposal was approved to increase the maximum life of stock options and stock appreciation rights from five years to seven years.
A summary of the status of our Stock Incentive Plans at March 31, 2010 and March 31, 2009, respectively, and changes during the quarters then ended is presented below:
Beginning January 1, 2010, 541,910 stock options were exercisable with an intrinsic value of $1.5 million. In addition, at January 1, 2010, there were 191,558 non-vested options with a grant date fair value of $8.92. During the first quarter of 2010, 24,201 options vested with an intrinsic value of $328,000, and a grant date fair value of $6.65 per option. Also during the quarter, there were 16,861 options exercised with an intrinsic value of $351,000. In addition, 4,338 vested options and 1,782 non-vested options were forfeited with an intrinsic value of $3,000 and $10,000 and a grant date fair value of $12.65 and $9.69, respectively. There were 544,912 exercisable options remaining at March 31, 2010, with an intrinsic value of $3.7 million and a remaining contractual term of 2.4 years. At March 31, 2010, there were 736,576 stock options outstanding with an intrinsic value of $4.9 million and a remaining contractual term of 2.7 years. During the first quarter of 2009, no options were exercised and 3,624 options vested with a fair value of $13.88 per option.
The total amount of compensation cost related to non-vested stock options as of March 31, 2010 was $1.1 million. The weighted-average period over which they are expected to be recognized is 2.2 years. We issue new shares upon the exercise of options.
The Black-Scholes and other option-pricing models assume that options are freely tradable and immediately vested. Since options are not transferable, have vesting provisions, and are subject to trading blackout periods imposed by us, the value calculated by the Black-Scholes model may significantly overstate the true economic value of the options.
During the first quarter of 2010, we granted 26,089 options with a five-year life and a four-year vesting period. The Black-Scholes option-pricing model was used to determine the grant date fair value of options. Significant assumptions used in the model included a weighted-average risk-free rate of return of 1.8% for 2010; an expected option life of three and three-quarters years; and an expected stock price volatility of 43.3% in 2010. For the purposes of this option-pricing model, a dividend yield of 1.6% was assumed. The expected option life was determined based on the mid-point between the vesting date and the end of the contractual term.
We issued 5,703 restricted stock units and awards during the first quarter of 2010. These awards generally vest over a four to five year period. In addition, for these stock awards made to certain executive officers, there are additional vesting limitations. Under these additional limitations; 25% of the awards will become transferrable at the time of repayment of at least 25% of the aggregate financial assistance received by the Company under the Emergency Economic Stabilization Act of 2008 (“EESA”); an additional 25% of the shares granted (for an aggregate total of 50% of the shares transferrable) at the time of repayment of at least 50% of the aggregate financial assistance received by the Company under EESA; an additional 25% of the shares granted (for an aggregate total of 75% of the shares transferrable) at the time of repayment of at least 75% of the aggregate financial assistance received by the Company under EESA. The remainder of the shares will vest following the time of repayment of 100% of the aggregate financial assistance received by the Company under EESA. If the date specified has not occurred by the tenth anniversary of the grant date, the grantee shall forfeit all of the restricted shares.
Compensation costs related to these issuances are recognized over the lives of the restricted stock and restricted stock units. We amortize the expense related to the restricted stock grants into salaries, benefits and other compensation expense on a straight-line basis over the requisite service period for the entire award. When we award restricted stock to individuals from whom we may not receive services in the future, such as those who are eligible for retirement, we recognize the expense of restricted stock grants when we make the award, instead of amortizing the expense over the vesting period of the award.
The Long-Term Performance-Based Restricted Stock Unit program (“Long-Term Program”) will award up to an aggregate of 109,200 shares of WSFS stock to seventeen participants, only after the achievement of targeted levels of return on assets (“ROA”). Under the terms of the plan, if an annual ROA performance level of 1.20% is achieved, up to 54,900 shares will be awarded. If an annual ROA performance level of 1.35% is achieved, up to 76,100 shares will be awarded. If an annual ROA performance level of 1.50% or greater is achieved, up to 109,200 shares will be awarded. If these targets are achieved in any year up until 2011, the awarded stock will vest in 25% increments over four years. We did not recognize any compensation expense related to this program in the first quarter of 2010. Compensation expense for the Long-Term Program was based on the closing stock price as of May 28, 2009 and will begin to be recognized once the achievement of target performance is considered probable.
At March 31, 2010 we had 67,485 remaining shares available for issuance under the 2005 Plan. Full share awards, such as restricted stock, have the equivalence of four option grants for the purpose of calculating shares available for issuance. Under the provisions of the Long-Term Program, if a performance level is achieved and there are insufficient shares available for grant, then we would have the option of granting the available shares with the remainder being paid in cash.
The impact of stock-based compensation for the three months ended March 31, 2010 was $370,000 pre-tax ($288,000 after tax) or $0.04 per share, to salaries, benefits and other compensation. This compares to $445,000 pre-tax ($359,000 after tax) or $0.06 per share for the three months ended March 31, 2009.
2. EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per share:
For the three months ended March 31, 2010, 795,000 employee stock options were excluded from the computation of diluted net loss per common share of which 78,000 were because the effect would have been antidilutive due to the net loss reported in this period.
3. INVESTMENT SECURITIES
The following tables detail the amortized cost and the estimated fair value of the Company’s investment securities held-to-maturity and securities available-for-sale (which includes reverse mortgages):
Securities with market values aggregating $40.3 million at March 31, 2010 were specifically pledged as collateral for WSFS’ Treasury Tax and Loan account with the Federal Reserve Bank, securities sold under agreement to repurchase, and certain letters of credit and municipal deposits which require collateral. Accrued interest receivable relating to investment securities was $379,000 and $352,000 at March 31, 2010 and December 31, 2009, respectively.
The scheduled maturities of investment securities held-to-maturity and securities available-for-sale at March 31, 2010 and December 31, 2009 were as follows:
(1) Reverse mortgages do not have contractual maturities. We have included reverse mortgages in maturities within one year.
There were no sales of investment securities classified as available-for-sale during 2010 or 2009. As a result, there were no net gains/losses realized during 2010 or 2009. The cost basis for investment security sales was based on the specific identification method. Investment securities totaling $240,000 and $18.6 million were called by their issuers during 2010 and 2009, respectively.
At March 31, 2010, we owned investment securities totaling $3.1 million where the amortized cost basis exceeded fair value. Total unrealized losses on those securities were $25,000 at March 31, 2010. This temporary impairment is the result of changes in market interest rates subsequent to the purchase of the securities. Securities amounting to $109,000 have been impaired for 12 months or longer. We have determined that these securities are not other than temporarily impaired. The investment portfolio is reviewed on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and new-term prospects of the issuer, including any specific events which may influence the operations of the issuer and the intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market. We evaluate our intent and ability to hold debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy and interest rate risk position. In addition, we do not have the intent to sell, nor is it more likely-than not we will be required to sell these securities before we are able to recover the amortized cost basis.
The table below shows our investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at March, 31, 2010.
The table below shows our investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities were in a continuous unrealized loss position at December 31, 2009.
4. MORTGAGE-BACKED SECURITIES
The following tables detail the amortized cost and the estimated fair value of the Company’s mortgage-backed securities:
(1) Includes Agency CMO’s classified as available-for-sale.
The portfolio of available-for-sale mortgage-backed securities consists of $742.5 million of both Agency and non-Agency bonds. All bonds were AAA-rated at the time of purchase; $90.8 million are now rated below AAA. Downgraded bonds were evaluated at March 31, 2010. The result of this evaluation shows no other-than-temporary impairment as of March 31, 2010. An evaluation of downgraded bonds at December 31, 2009 showed one bond ($2.6 million) had other-than-temporary impairment which resulted in an earnings charge of $86,000 or 9 basis points of downgraded bonds and only 1 basis point of the total mortgage-backed security portfolio. The $86,000 of other-than-temporary impairment loss recognized during the fourth quarter of 2009 represents our only other-than-temporary impairment charge since the start of the credit cycle in 2008. The weighted average duration of the mortgage-backed securities was 2.5 years at March 31, 2010.
Accrued interest receivable relating to mortgage-backed securities was $3.1 million at March 31, 2010 and $2.8 million at December 31, 2009. At March 31, 2010, mortgage-backed securities with market values aggregating $343.6 million were pledged as collateral for retail customer repurchase agreements and municipal deposits. From time to time, mortgage-backed securities are also
pledged as collateral for Federal Home Loan Bank (FHLB) borrowings and other obligations. The fair value of these pledged mortgage-backed securities at March 31, 2010 was $114.4 million.
During the first three months of 2010, there were no sales of mortgage-backed securities available-for-sale. The cost basis of all mortgage-backed securities sales is based on the specific identification method. During the first three months of 2009, proceeds from the sale of mortgage-backed securities available-for-sale were $20.8 million, resulting in a gain of $547,000.
We own $12.4 million par value of SASCO RM-1 2002 securities which are classified as trading, of which, $1.4 million is accrued interest paid in kind. Because of seasoning and being well over-collateralized, we expect to recover all principal and interest. Based on FASB ASC 320, Investments – Debt and Equity Securities (“ASC 320”) (Formerly SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities) when these securities were acquired they were classified as trading. It was our intent to sell them in the near term. We have used the guidance under ASC 320 to provide a reasonable estimate of fair value in 2009. We estimated the value of these securities as of March 31, 2010 based on the pricing of BBB+ securities that have an active market through a technique which estimates the fair value of this asset using the income approach.
At March 31, 2010, we owned mortgage-backed securities totaling $184.7 million where the amortized cost basis exceeded fair value. Total unrealized losses on these securities were $6.1 million at March 31, 2010. This temporary impairment is the result of changes in market interest rates, a lack of liquidity in the mortgage-backed securities market and the reduction in credit ratings of 28 bonds out of 216 bonds. Most of these securities have been impaired for twelve months or longer. We have determined that these securities are not other-than-temporarily impaired. Quarterly, we evaluate the current characteristics of each of our mortgage-backed securities such as delinquency and foreclosure levels, credit enhancement, projected losses and coverage. In addition, we do not have the intent to sell, nor is it more likely-than not we will be required to sell these securities before we are able to recover the amortized cost basis.
The table below shows our mortgage-backed securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at March, 31, 2010.
The table below shows our mortgage-backed securities’ gross unrealized losses and fair value by investment category and length of time that individual securities were in a continuous unrealized loss position at December 31, 2009.
5. IMPAIRED LOANS
Loans from which it is probable we will not collect all principal and interest due according to contractual terms are measured for impairment in accordance with the provisions of FASB ASC 310, Receivables (Formerly SFAS No. 114, Accounting for Creditors for Impairment of a Loan). The amount of impairment is required to be measured using one of three methods; (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, a specific allowance is allocated for the impairment.
We had impaired loans (for which ASC 310 applied) of approximately $71.4 million at March 31, 2010 compared to $73.2 million at December 31, 2009. The average recorded balance of aggregate impaired loans was $72.3 million for the three months ended March 31, 2010 and $62.2 million for the year-ended December 31, 2009. The specific allowance for losses on these impaired loans was $11.0 million at March 31, 2010 compared to $11.8 million at December 31, 2009. The specific reserve at March 31, 2010 was associated with $41.9 million of total impaired loans. The remaining $29.5 million of impaired loans had no related specific reserve.
When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for loan losses. Losses are recognized in the period an obligation becomes uncollectible.
6. COMPREHENSIVE INCOME
The following schedule reconciles net income to total comprehensive income:
7. TAXES ON INCOME
We account for income taxes in accordance with FASB ASC 740, Income Taxes (“ASC 740”) (Formerly SFAS No. 109, Accounting for Income Taxes and FASB Interpretation No. 48, Accounting for Uncertainty In Income Taxes, an Interpretation of FASB Statement 109). ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We have assessed valuation allowances on the deferred income taxes due to, among other things, limitations imposed by Internal Revenue Code and uncertainties, including the timing of settlement and realization of these differences. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. ASC 740 prescribes a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. We recognize, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the financial statements. Assessment of uncertain tax positions under ASC 740 requires careful consideration of the technical merits of a position based on our analysis of tax regulations and interpretations. Significant judgment may be involved in applying the requirements of ASC 740.
The total amount of unrecognized tax benefits as of March 31, 2010 and December 31, 2009 were $1.0 million and $1.9 million, respectively, of which $500,000 would have affected our March 31, 2010 effective tax rate if recognized. As of March 31, 2010 and December 31, 2009, the total amount of accrued interest included in such unrecognized tax benefits was $39,000 and $372,000, respectively. No penalties are included in such unrecognized tax benefits. We record interest and penalties on potential income tax deficiencies as income tax expense. The decrease in the unrecognized tax benefits was primarily due to the expiration of a statute of limitations.
While our Federal and State tax years 2006 through 2009 remain subject to examination as of March 31, 2010, the Internal Revenue Service (“IRS”) completed its examination of our 2004 through 2006 Federal tax returns during the quarter ended June 30, 2008. During 2008 we successfully completed the IRS appeal process and during the quarter ended March 31, 2009 we recovered $863,000 of taxes plus $275,000 of interest that were previously assessed during the audit phase.
During 2007, we donated a N.C. Wyeth mural which was previously displayed in our former headquarters. The estimated fair value of the mural was $6.0 million, which was recorded as a charitable contribution expense. We recognized a related offsetting gain on the transfer of the asset during 2007. The expense and offsetting gain was shown net in our Consolidated Financial Statements during 2007. As the gain on the transfer of the asset is permanently excludible from taxation, the charitable contribution transaction results in a permanent deduction for income tax purposes. The amount of the deduction represents an income tax uncertainty because it is subject to evaluation by the IRS. The IRS is still in the process of evaluating this tax deduction and we anticipate this evaluation to be completed during 2010.
8. SEGMENT INFORMATION>
Under the definition of FASB ASC 280, Segment Reporting (“ASC 280”) (Formerly SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information) we discuss our business in three segments. There is one segment for WSFS Bank (including WSFS Investment Group, Inc.), Cash Connect, (the ATM division of WSFS), and Trust and Wealth Management. Trust and Wealth Management combines Montchanin and the WSFS Trust and Wealth Management Division into a single reportable segment because each has similar economic characteristics, products, customers and distribution methods. During 2009 we reported the results of 1st Reverse (the national reverse mortgage subsidiary of WSFS) as a separate segment, consistent with the guidance promulgated in ASC 280, however we completed a wind-down of 1st Reverse’s operation during the latter part of 2009 and have no results to report as an operating segment in 2010.
The WSFS Bank segment provides financial products to commercial and retail customers through its 41 banking offices located in Delaware (36), Pennsylvania (4) and Virginia (1). Retail and Commercial Banking, Commercial Real Estate Lending, Private Banking and other banking business units (including the reorganization of WSFS Investment Group, Inc.) are operating departments of WSFS. These departments share the same regulator, the same market, many of the same customers and provide similar products and services through the general infrastructure of the Bank. Because of these and other reasons, these departments are not considered discrete segments and are appropriately aggregated within the WSFS Bank segment of the Company in accordance with ASC 280.
Cash Connect provides turnkey ATM services through strategic partnerships with several of the largest networks, manufacturers and service providers in the ATM industry. The balance sheet category “Cash in non-owned ATMs” includes cash from which fees income is earned through bailment arrangements with customers of Cash Connect.
The Wealth Management column is comprised of the WSFS Trust & Wealth Management division and Montchanin. In 2005, the WSFS Trust and Wealth Management division was established in response to our commercial customers’ demand for the same high level service in their investment relationships that they enjoy as banking customers of WSFS Bank. Montchanin provides asset management products and services to customers in the Bank’s primary market area. Montchanin has one consolidated wholly owned subsidiary, Cypress Capital Management, LLC (Cypress). Cypress is a Wilmington-based investment advisory firm serving high net-worth individuals and institutions.
An operating segment is a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision makers to make decisions about resources to the allocated to the segment and assess its performance, and for which discrete financial information is available. We evaluate performance based on pretax ordinary income relative to resources used, and allocate resources based on these results. The accounting policies applicable to our segments are those that apply to our preparation of the accompanying Consolidated Financial Statements. Segment information for the three months ended March 31, 2010 and 2009 follows: