WSFS FINANCIAL CORP – 10-Q – MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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WSFS Financial Corporationis parent to Wilmington Savings Fund Society, FSB (" WSFS Bank" or the "Bank"), one of the ten oldest banks continuously operating under the same name in the United States. A permanent fixture in the community, WSFS has been in operation for more than 180 years. In addition to its focus on stellar customer service, the Bank has continued to fuel growth and remain a leader in our community. We are a relationship-focused, locally-managed, community banking institution that has grown to become the largest thrift holding company in the State of Delaware, one of the top commercial lenders in the state, the third largest bank in terms of Delawaredeposits. We state our mission simply: We Stand for Service and Strengthening Our Communities. Our core banking business is commercial lending funded by customer-generated deposits. We have built a $2.2 billioncommercial loan portfolio by recruiting the best seasoned commercial lenders in our markets and offering a high level of service and flexibility typically associated with a community bank. We fund this business primarily with deposits generated through commercial relationships and retail deposits. We service our customers primarily from our 51 offices located in Delaware(42), Pennsylvania(7), Virginia(1) and Nevada(1). We also offer a broad variety of consumer loan products, retail securities and insurance brokerage through our retail branches.
We have two consolidated subsidiaries,
WSFS Bankhas two wholly owned subsidiaries, WSFS Investment Group, Inc.and Monarch Entity Services, LLC("Monarch"). WSFS Investment Group, Inc., markets various third-party investment and insurance products, such as single-premium annuities, whole life policies and securities primarily through the Bank's retail banking system and directly to the public. Monarch provides commercial domicile services which include employees, directors, sublease of office facilities and registered agent services in Delawareand Nevada. Our Cash Connect division is a premier provider of ATM Vault Cash and related services in the United States. Cash Connect manages nearly $437 millionin vault cash in nearly 13,000 ATMs nationwide and also provides online reporting and ATM cash management, predictive cash ordering, armored carrier management, ATM processing and equipment sales. Cash Connect also operates over 430 ATMs for WSFS Bank, which has, by far, the largest branded ATM network in Delaware. We offer trust and wealth management services through Christiana Trust, Cypress Capital Management, LLC(Cypress), WSFS Investment Groupbrokerage and our Private Banking group. The Christiana Trustdivision provides investment, fiduciary, agency and commercial domicile services from locations in Delawareand Nevadaand has over $15 billionin assets under administration. These services are provided to individuals and families as well as corporations and institutions. The Christiana Trustdivision of WSFS Bankprovides these services to customers locally, nationally and internationally making use of the advantages of its branch facilities in Delawareand Nevada. Cypress is an investment advisory firm that manages over $600 millionof portfolios for individuals, trusts, retirement plans and endowments. WSFS Investment Group, Inc.markets various third-party insurance products and securities through the Bank's retail banking system.
This Quarterly Report on Form 10-Q, and exhibits thereto, contains estimates, predictions, opinions, projections and other statements that may be interpreted as "forward-looking statements" as that phrase is defined in the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, references to our financial goals, management's plans and objectives for future operations, financial and business trends, business prospects, and management's outlook or expectations for earnings, revenues, expenses, capital levels, liquidity levels, asset quality or other future financial or business performance, strategies or expectations. Such forward-looking statements are based on various assumptions (some of which may be beyond the Company's control) and are subject to risks and uncertainties (which change over time) and other factors which could cause actual results to differ materially from those currently anticipated. Such risks and uncertainties include, but are not limited to, those related to the economic environment, particularly in the market areas in 32
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which we operate, including an increase in unemployment levels; the volatility of the financial and securities markets, including changes with respect to the market value of financial assets; changes in market interest rates may increase funding costs and reduce earning asset yields thus reducing margins, changes in government regulation affecting financial institutions, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules being issued in accordance with this statute and potential expenses and elevated capital levels associated therewith; possible additional loan losses, impairment of the collectability of loans; possible changes in trade, monetary and fiscal policies, laws and regulations and other activities of governments, agencies, and similar organizations, may have an adverse effect on business; possible regulations issued by the
Consumer Financial Protection Bureauor other regulators which might adversely impact our business model or products and services; possible stresses in the real estate markets, including possible continued deterioration in property values; our ability to expand into new markets and to maintain profit margins in the face of competitive pressures; our ability to effectively manage credit risk, interest rate risk market risk, operational risk, legal risk, liquidity risk, reputational risk, and regulatory and compliance risk; the effects of increased competition from both banks and non-banks; the effects of geopolitical instability and risks such as terrorist attacks; the effects of weather and natural disasters such as floods, droughts, wind, tornados and hurricanes, and the effects of man-made disasters; possible changes in the speed of loan prepayments by our customers and loan origination or sales volumes; possible acceleration of prepayments of mortgage-backed securities due to low interest rates, and the related acceleration of premium amortization on those securities; and the costs associated with resolving any problem loans, litigation and other risks and uncertainties, discussed in documents filed by us with the Securities and Exchange Commissionfrom time to time. Forward looking statements are as of the date they are made, and 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.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in conformity with U.S. generally accepted accounting principles. The preparation of these Consolidated Financial Statements requires us to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenue and expenses. We regularly evaluate these estimates and assumptions including those related to the allowance for loan losses, deferred taxes, fair value measurements, goodwill and other intangible assets. We base our estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Although our current estimates contemplate current economic conditions and how we expect them to change in the future, for the remainder of 2012, it is reasonably possible that actual conditions may be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Actual results may differ from these estimates under different assumptions or conditions. The following are critical accounting policies that involve more significant judgments and estimates. See further discussion of these critical accounting policies in our 2011 Annual Report on Form 10-K.
Allowance for Loan Losses
We maintain allowances for loan losses and charge losses to these allowances when realized. We consider the determination of the allowance for loan losses to be critical because it requires significant judgment reflecting our best estimate of impairment related to specifically evaluated impaired loans as well as the inherent risk of loss for those in the remaining loan portfolio. Our evaluation is based upon a continuing review of the portfolio, with consideration given to evaluations resulting from examinations performed by regulatory authorities.
We account for income taxes in accordance with
Financial Accounting Standards Board("FASB") Accounting Standards Codification ("ASC") 740, Income Taxes ("ASC 740"), which requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We consider our accounting policies on deferred taxes to be critical because we regularly assess the need for valuation allowances on deferred income tax assets that may result from, among other things, limitations imposed by Internal Revenue Code and uncertainties, including the timing of settlement and realization of these differences. No valuation allowance is required as of September 30, 2012. 33
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Fair Value Measurements
We adopted FASB ASC 820-10 Fair Value Measurements and Disclosures ("ASC 820"), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. We consider our accounting policies related to fair value measurements to be critical because they are important to the portrayal of our financial condition and results, and they require our subjective and complex judgment as a result of the need to make estimates about the effects of matters that are inherently uncertain. See Note 7, Fair Value Disclosures of Financial Assets to our Consolidated Financial Statements.
Goodwill and Other Intangible Assets
In accordance with FASB ASC 805, Business Combinations, and FASB ASC 350, Intangibles-Goodwill and Other, all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles and other intangibles are recorded at fair value. We consider our accounting policies related to goodwill and other intangible assets to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions or judgment could have a significant impact on our financial condition or results of operations.
For additional information regarding our goodwill and other intangible assets, see Note 11 to the Consolidated Financial Statements.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Our total assets decreased
$27.7 million, or less than 1%, to $4.3 billionduring the nine months ended September 30, 2012. Included in this decrease was a $46.4 million, or 2%, decrease in net loans resulting from our second quarter 2012 Asset Strategies efforts, and a $20.9 million, or 4%, decrease in cash and cash equivalents mainly due to the seasonal decrease in cash in non-owned ATMs and the use of cash from other institutions in Cash Connect's ATM Vault Cash business. Partially offsetting these decreases, investment securities increased $50.7 million, or 6%, and loans held-for-sale increased by $10.7 millionduring the nine months ended September 30, 2012. Total liabilities decreased $53.3 millionduring the nine months ended September 30, 2012to $3.8 billion. This decrease was primarily the result of decreased Federal Home Loan Bankadvances of $145.8 million, or 27%, as a result of net repayments. Partially offsetting these decreases was a $50.0 millionincrease in federal funds purchased and a $50.1 millionincrease in total customer deposits. Deposit growth included a $70.8 millionincrease in noninterest-bearing demand accounts, a $23.5 millionincrease in interest bearing demand accounts and a $20.5 millionincrease in savings accounts. These core deposit account increases were partially offset the purposeful decreases of $58.3 millionin high-cost, non-core customer time accounts and a $25.6 milliondecrease in brokered CDs. Capital Resources Stockholders' equity increased $25.7 millionbetween December 31, 2011and September 30, 2012. This increase was mainly due to net income of $23.8 millioncombined with an increase of $6.1 millionin the value of our available-for-sale securities portfolio. Partially offsetting these increases was the payment of common and preferred dividends of $5.1 millionduring the nine months ended September 30, 2012.
Book value per common share was
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Below is a table comparing the Bank's consolidated capital position to the minimum regulatory requirements as of
To be Well-Capitalized Consolidated For Capital Under Prompt Corrective Bank Capital Adequacy Purposes Action Provisions % of % of % of (Dollars in Thousands) Amount Assets Amount Assets Amount Assets
Total Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Risk-Weighted Assets) 418,043 13.02 128,386 4.00
192,578 6.00 Under guidelines issued by banking regulators, savings institutions such as the Bank must maintain certain capital levels in order to be considered adequately capitalized. The thresholds for being considered adequately capitalized are outlined in the table above. Failure to meet minimum capital requirements can initiate certain mandatory actions and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our bank's financial statements. At
September 30, 2012, the Bank was in compliance with regulatory capital requirements and was considered a "well-capitalized" institution. The Bank's core capital ratio of 9.91%, Tier 1 capital ratio of 13.02% and total risk based capital ratio of 14.28%, all remain substantially in excess of "well-capitalized" regulatory benchmarks, the highest regulatory capital rating. In addition, and not included in Bank capital, the holding company held $61.2 millionin cash to support dividends, acquisitions, strategic growth plans.
We manage our liquidity and funding needs through our treasury function and our Asset/Liability Committee. We have a policy that separately addresses liquidity, and management monitors our adherence to policy limits. Also, liquidity risk management is a primary area of examination by the banking regulators. As a financial institution, the Bank has ready access to several sources to fund growth and meet its liquidity needs. Among these are: net income, retail deposit generation, loan repayments, borrowing from the FHLB, repurchase agreements, access to the Federal Reserve Discount Window, and access to the brokered deposit market as well as other wholesale funding avenues. In addition, we have a large portfolio of high-quality, liquid investments, primarily short-duration mortgage-backed securities and government sponsored enterprises ("GSE") notes that provide a near-continuous source of cash flow to meet current cash needs, or can be sold to meet larger discrete needs for cash. Management believes these sources are sufficient to maintain required and prudent levels of liquidity. During the nine months ended
September 30, 2012, cash and cash equivalents decreased $20.9 millionto $447.1 million. This decrease was primarily a result of the following: cash used for $145.8 millionfor net repayments of FHLB advances; $38.2 millionincrease in net loans; $28.3 millionnet increase in investment securities available for sale and a $30.0 millionrepayment of unsecured bank debt. Offsetting these decreases in cash were: $63.3 millionincrease in cash provided by operating activities; $53.1 millionincrease from the issuance of senior notes during the third quarter of 2012; $50.0 millionincrease in cash provided through an increase in federal funds purchased; $42.1 millionnet increase in deposits and $11.8 millionincrease from the sales of assets acquired through foreclosure. 35
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The following table shows our nonperforming assets and past due loans at the dates indicated. Nonperforming assets include nonaccruing loans, nonperforming real estate, assets acquired through foreclosure and restructured mortgage and home equity consumer debt. Nonaccruing loans are those on which the accrual of interest has ceased. Loans are placed on nonaccrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and the value of the collateral is insufficient to cover principal and interest. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the amortization of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on management's assessment of the ultimate collectability of principal and interest. Past due loans are loans contractually past due 90 days or more as to principal or interest payments but which remain on accrual status because they are considered well secured and in the process of collection. September 30, December 31, 2012 2011 (In Thousands) Nonaccruing loans: Commercial $ 3,579 $ 23,080 Owner-occupied commercial (1) 13,324 - Consumer 5,188 1,018 Commercial mortgage 5,875 15,814 Residential mortgage 9,354 9,057 Construction 2,620 22,124 Total nonaccruing loans 39,940 71,093 Assets acquired through foreclosure 6,996 11,695 Troubled debt restructuring (accruing) 10,189 8,887 Total nonperforming assets $ 57,125 $ 91,675 Past due loans (2): Residential mortgages - 887 Commercial and commercial mortgage 1,869 78 Total past due loans $ 1,869 $ 965 Ratios: Allowance for loan losses to total loans (3) 1.69 % 1.92 % Nonperforming assets to total assets 1.34 % 2.14 % Nonaccruing loans to total loans (3) 1.48 % 2.58 % Loan loss allowance to nonaccruing loans 114.17 % 74.66 % Loan loss allowance to total nonperforming assets 79.82 % 57.9 %
(1) Prior to 2012, owner-occupied loans were included in commercial loan
(2) Past due loans are accruing loans which are contractually past due 90 days or
more as to principal or interest. These loans are well secured and in the
process of collection.
(3) Total loans exclude loans held for sale.
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Nonperforming assets decreased
$34.6 millionbetween December 31, 2011and September 30, 2012. As a result, non-performing assets as a percentage of total assets decreased from 2.14% at December 31, 2011to 1.34% at September 30, 2012. This significant reduction was mainly due to the successful efforts of our "Asset Strategies" during the second quarter of 2012. In addition, during the third quarter a total of $8.0 millionwas collected or paid down through additional note sales and ongoing asset management activities. Lastly, as the result of recent OCC guidance, during the third quarter of 2012, $4.7 millionof loans were reclassified from performing loans to nonaccrual status (consisting of $2.5 millionof residential mortgages and $2.2 millionof consumer loans). For additional information on this reclass, see the "Allowance for Loan Losses" section of this Management Discussion and Analysis. The following table summarizes the changes in nonperforming assets during the period indicated: For the nine For the year months ended ended September 30, 2012 December 31, 2011 (In Thousands) Beginning balance $ 91,675 $ 92,898 Additions 55,321 89,842 Collections (40,559 ) (40,695 ) Collections from loan dispositions (14,305 )
Transfers to accrual (552 )
Charge-offs / write-downs, net (34,455 ) (41,896 ) Ending balance $ 57,125 $ 91,675 The timely identification of problem loans is a key element in our strategy to manage our loan portfolio. Timely identification enables us to take appropriate action and, accordingly, minimize losses. An asset review system established to monitor the asset quality of our loans and investments in real estate portfolios facilitates the identification of problem assets. In general, this system utilizes guidelines established by federal regulation.
The matching of maturities or repricing periods of interest rate-sensitive assets and liabilities to promote a favorable interest rate spread and mitigate exposure to fluctuations in interest rates is our primary tool for achieving our asset/liability management strategies. We regularly review our interest-rate sensitivity and adjust the sensitivity within acceptable tolerance ranges established by the Board of Directors. At
September 30, 2012, interest-earning assets exceeded interest-bearing liabilities that mature or reprice within one year (interest-sensitive gap) by $133.3 million. Our interest-sensitive assets as a percentage of interest-sensitive liabilities within the one-year window increased from 102.8% at December 31, 2011, to 106.2% at September 30, 2012. Likewise, the one-year interest-sensitive gap as a percentage of total assets changed to 3.13% at September 30, 2012from 1.54% at June 30, 2012. The change in sensitivity since December 31, 2011reflects our continuing effort to effectively manage interest rate risk and positions us to improve our net interest margin in a rising rate environment. Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in our lending, investing, and funding activities. To that end, we actively monitor and manage our interest rate risk exposure. One measure, required to be performed by Federal regulation, measures the impact of an immediate change in interest rates in 100 basis point increments on the net portfolio value ratio. The economic value of equity ratio is defined as the economic value of the estimated cash flows from assets and liabilities as a percentage of economic value of cash flows from total assets. 37
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The table below shows the estimated impact of immediate changes in interest rates on our net interest margin and net portfolio value ratio at the specified levels at
September 30, 2012 December 31, 2011 % Change in % Change in Economic % Change in Economic Interest Rate Net Interest Value of Net Interest Value of (Basis Points) Margin (1) Equity (2) Margin (1) Equity (2) +300 8% 12.38% 6% 11.17% +200 3% 12.52% 3% 11.30% +100 -2% 12.34% -2% 11.21% - 0% 12.03% 0% 10.97% -100 0% 11.23% 1% 10.19% -200(3) NMF NMF NMF NMF -300(3) NMF NMF NMF NMF
(1) The percentage difference between net interest margin in a stable interest
rate environment and net interest margin as projected under the various rate
(2) The economic value of equity ratio in a stable interest rate environment and
the economic value of equity ratio as projected under the various rate change
(3) Sensitivity indicated by a decrease of 200 or 300 basis points is not deemed
rates at that time.
We also engage in other business activities that are sensitive to changes in interest rates. For example, mortgage banking revenues and expenses can fluctuate with changing interest rates. In addition, our Cash Connect's ATM Vault Cash program generates bailment income that can also fluctuate with changes in interest rates. These fluctuations are difficult to model and estimate.
COMPARISON OF THE THREE AND NINE MONTHS ENDED
Results of Operations
During the third quarter of 2012, we recorded net income of
$10.0 million, or $1.06per diluted common share which was an increase of $3.2 millioncompared to the third quarter 2011. Results for the quarter were positively impacted by lower credit costs of $2.5 millionfrom the third quarter 2011, reflecting the improved credit quality of our loan portfolio. Additionally, noninterest income increased $2.8 milliondue to franchise growth across all segments when compared to the third quarter 2011. Also impacting net income was lower noninterest expenses of $259,000from the same period a year ago. Partially offsetting these gains, net interest margin decreased 22 basis points from 3.63% in the third quarter 2011 to 3.41% in the third quarter 2012 due to our second quarter 2012 Asset Strategies initiatives, our issuance of senior notes from the third quarter of 2012, and the continued low, flat interest rate environment. Net income for the first nine months of 2012 was $23.8 million, or $2.47per diluted common share; an increase of $7.3 millionfrom the same period in 2011. Earnings for the first nine months of 2012 were impacted by growth in noninterest income of $18.9 million, which included $13.3 millionof securities gains from the second quarter Asset Strategies. The remaining increase in noninterest income reflects continued growth across all segments of the franchise. In addition, interest income increased by $1.9 millionto $95.5 millionduring 2012, also reflecting the growth of the franchise and our proactive interest rate management efforts. Offsetting these increases was a $6.2 millionincrease in credit costs, which also included the impact of our second quarter Assets Strategies. In addition, noninterest expenses increased by $1.8 millionduring the year, mainly due to the final stages of our retail branch expansion plan and the relocation of our operations center over the past twelve months. 38
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Net Interest Income
The following tables provide information concerning the balances, yields and rates on interest-earning assets and interest-bearing liabilities during the periods indicated.
Three Months Ended September 30,
2012 2011 Average Yield/ Average Yield/ (Dollars In Thousands) Balance Interest Rate (1) Balance Interest Rate (1) Assets: Interest-earning assets: Loans (2) (3): Commercial real estate loans $ 718,046 $ 8,803 4.90 % $ 731,527 $ 8,556 4.68 % Residential real estate loans (6) 276,681 2,980 4.31 293,800 3,454 4.70 Commercial loans 1,435,514 16,848 4.61 1,368,703 17,193 4.99 Consumer loans 283,704 3,372 4.73 296,709 3,737 5.00 Total loans 2,713,945 32,003 4.73 2,690,739 32,940 4.94 Mortgage-backed securities (4) 829,930 4,344 2.09 801,446 7,052 3.52 Investment securities (4) (5) 53,392 158 1.27 43,959 99 0.90 Other interest-earning assets 31,187 9 0.11 37,830 - - Total interest-earning assets 3,628,454 36,514 4.03 3,573,974 40,091 4.52 Allowance for loan losses (46,808 ) (57,125 ) Cash and due from banks 70,366 65,997 Cash in non-owned ATMs 362,332 378,651 Bank-owned life insurance 63,315 63,463 Other noninterest-earning assets 118,330 119,888 Total assets $ 4,195,989 $ 4,144,848 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Interest-bearing deposits: Interest-bearing demand $ 404,185 $ 53 0.05 % $ 324,367 $ 75 0.09 % Money market 759,944 431 0.23 731,979 720 0.39 Savings 390,275 83 0.08 375,243 386 0.41 Customer time deposits 716,676 2,365 1.31 757,975 3,237 1.69
Total interest-bearing customer deposits 2,271,080 2,932
0.51 2,189,564 4,418 0.80 Brokered certificates of deposit 283,345 305 0.43 209,629 201 0.38 Total interest-bearing deposits 2,554,425 3,237 0.50 2,399,193 4,619 0.76 FHLB of Pittsburgh advances 389,745 1,403 1.41 610,253 2,484 1.59 Trust preferred borrowings 67,011 369 2.15 67,011 340 1.99 Senior debt 20,924 353 6.60 - - - Other borrowed funds 129,293 259 0.80 142,725 468 1.31 Total interest-bearing liabilities 3,161,398 5,621 0.71 3,219,182 7,911 0.98 Noninterest-bearing demand deposits 590,133 516,257 Other noninterest-bearing liabilities 33,757 26,001 Stockholders' equity 410,701 383,408 Total liabilities and stockholders' equity $ 4,195,989 $ 4,144,848 Excess of interest-earning assets over interest-bearing liabilities $ 467,056 $ 354,792 Net interest and dividend income $ 30,893 $ 32,180 Interest rate spread 3.32 % 3.54 % Net interest margin 3.41 % 3.63 %
(1) Weighted average yields have been computed on a tax-equivalent basis using a
35% effective tax rate.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale.
(5) Includes reverse mortgages.
(6) Includes loans held for sale arising during the normal course of business.
Table of Contents Nine Months Ended September 30, 2012 2011 Average Yield/ Average Yield/ (Dollars In Thousands) Balance Interest Rate (1) Balance Interest Rate (1) Assets: Interest-earning assets: Loans (2) (3): Commercial real estate loans $ 729,599 $ 26,717 4.88 % $ 749,318 $ 26,434 4.70 % Residential real estate loans (6) 276,400 9,211 4.44 303,371 11,009 4.84 Commercial loans 1,459,698 51,891 4.73 1,311,390 48,855 4.99 Consumer loans 285,701 10,244 4.79 302,732 11,401 5.04 Loans held for sale (7) 7,113 122 2.29 - - - Total loans 2,758,511 98,185 4.76 2,666,811 97,699 4.93 Mortgage-backed securities (4) 817,253 14,953 2.44 749,961 20,962 3.73 Investment securities (4) (5) 50,152 335 0.99 43,164 396 1.22 Other interest-earning assets 33,208 27 0.11 36,990 - - Total interest-earning assets 3,659,124 113,500 4.16 3,496,926 119,057 4.57 Allowance for loan losses (49,140 ) (58,435 ) Cash and due from banks 90,969 62,869 Cash in non-owned ATMs 363,497 342,345 Bank-owned life insurance 63,465 64,221 Other noninterest-earning assets 123,228 120,583 Total assets $ 4,251,143 $ 4,028,509 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Interest-bearing deposits: Interest-bearing demand $ 395,081 $ 157 0.05 % $ 316,712 $ 301 0.13 % Money market 754,942 1,357 0.24 712,404 2,293 0.43 Savings 388,894 361 0.12 348,967 1,215 0.47 Retail time deposits 739,073 7,886 1.43 769,528 10,491 1.82
Total interest-bearing retail deposits 2,277,990 9,761
0.57 2,147,611 14,300 0.89 Brokered certificates of deposit 283,169 891 0.42 190,395 576 0.40 Total interest-bearing deposits 2,561,159 10,652 0.56 2,338,006 14,876 0.85 FHLB of Pittsburgh advances 466,266 4,985 1.40 558,807 7,866 1.86 Trust preferred borrowings 67,011 1,114 2.18 67,011 1,015 2.00 Senior debt 7,026 353 6.60 - - - Other borrowed funds 136,282 895 0.88 158,822 1,679 1.41
Total interest-bearing liabilities 3,237,744 17,999
0.74 3,122,646 25,436 1.09 Noninterest-bearing demand deposits 574,708 506,316 Other noninterest-bearing liabilities 33,922 22,744 Stockholders' equity 404,769 376,803 Total liabilities and stockholders' equity $ 4,251,143 $ 4,028,509 Excess of interest-earning assets over interest-bearing liabilities $ 421,380 $ 374,280 Net interest income $ 95,501 $ 93,621 Interest rate spread 3.42 % 3.48 % Net interest margin 3.49 % 3.60 %
(1) Weighted average yields have been computed on a tax-equivalent basis using a
35% effective tax rate.
(2) Nonperforming loans are included in average balance computations.
(3) Balances are reflected net of unearned income.
(4) Includes securities available-for-sale.
(5) Includes reverse mortgages.
(6) Includes loans held for sale arising from the normal course of business.
(7) Includes loans held for sale in conjunction with asset disposition
Net interest income for the third quarter 2012 declined
$1.3 million, or 4%, when compared to the third quarter 2011. The decrease in net interest income reflects a decline in yields in our mortgage-backed securities portfolio due to the impact of our second quarter 2012 Assets Strategies efforts, and the ongoing impact of the historically low interest rate environment. In addition, the increase in borrowing costs was mainly due to the issuance of $55.0 millionof 6.25% senior notes during the third quarter of 2012. Offsetting these decreases was our continued proactive rate management as evidenced by our 29 basis point decrease in retail funding costs, while we had only a 21 basis point decrease in overall loan yield during the same period. 40
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The net interest margin for the third quarter 2012 was 3.41%, a 22 basis point decrease when compared to 3.63% for the third quarter 2011. The decrease reflects the impact of our Assets Strategies efforts during the second quarter 2012, the issuance of
$55 millionof 6.25% senior notes during the third quarter 2012 and the impact of the historically low, flat interest rate environment, particularly on our securities yields and loan pricing. Net interest income for the nine months ended September 30, 2012was $95.5 millioncompared to $93.6 millionfor the same period in 2011. This increase reflects the favorable impact of the growth in our franchise and proactive interest rate management in both customer and wholesale funding costs. However, the net interest margin for the nine months ended September 30, 2012was 3.49%, down 11 basis points from the same period in 2011. Similar to the quarterly discussion above this decrease was mainly due to: decreased MBS portfolio yields over the prior year as a result of our Asset Strategies efforts, our $55.0 millionsenior note issuance; and the continued historically low interest rate environment. Allowance for Loan Losses We maintain allowances for loan losses and charge losses to these allowances when such losses are identified. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of probable loan losses related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios. We established our loan loss allowance in accordance with guidance provided in the Securities and Exchange Commission'sStaff Accounting Bulletin 102 ("SAB 102"). Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula allowances for commercial and commercial real estate loans; and allowances for pooled homogenous loans. Specific reserves are established for certain impaired loans in cases where we have identified significant conditions or circumstances related to a specific credit that indicates that a loss is probable to occur. The formula allowances for commercial, commercial real estate and construction loans are calculated by applying estimates of default and loss severity to outstanding loans based on the risk grade of loans. Default rates are determined through a past twelve quarter migration analysis. Loss severity is based on a three year historical analysis. As a result, changes in risk grades affect the amount of the formula allowance. Pooled loans are usually smaller, not-individually-graded and homogenous in nature, such as consumer installment loans and residential mortgages. Loan loss allowances for pooled loans are first based on a five-year net charge-off history. The average loss allowance per homogenous pool is based on the product of average annual historical loss rate and the homogeneous pool balances. These separate risk pools are then assigned a reserve for losses based upon this historical loss information. Qualitative and environmental adjustment factors are taken into consideration when determining above reserve estimates. These adjustment factors are based upon our evaluation of various current conditions, including those listed below.
• General economic and business conditions affecting the Bank's key lending
areas, • Credit quality trends, • Recent loss experience in particular segments of the portfolio, • Collateral values and loan-to-value ratios, • Loan volumes and concentrations, including changes in mix, • Seasoning of the loan portfolio, • Specific industry conditions within portfolio segments, • Bank regulatory examination results, and
<p> • Other factors, including changes in quality of the loan origination,
servicing and risk management processes. 41
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Our loan officers and risk managers meet at least quarterly to discuss and review these conditions and risks associated with individual problem loans. In addition, various regulatory agencies and loan review consultants periodically review our loan ratings and allowance for loan losses.
During the first quarter of 2012, we made certain improvements to the method in which we determine the allowance for loan loss. These improvements include:
• Used a three year loss migration analysis to determine the probability of
• Segregated the commercial loan segment to more specifically analyze the risks
associated with business, owner-occupied CRE, investor CRE and Construction
loan portfolios • Improved the data used to determine qualitative adjustment factors
• Established a portion of the allowance for loan losses related to model and
• Revised our loan risk rating system based on recommendations from industry
As a result of recent guidance provided by the OCC, during the third quarter of 2012
$4.7 millionof loans were identified as troubled debt restructurings because the borrower's obligation to us has been discharged in bankruptcy and the borrower has not reaffirmed the debt. These loans were reclassified from performing loans to nonaccrual status and consisted of $2.5 millionof residential mortgages and $2.2 millionof consumer loans. Net loan charge-offs of $1.3 millionwere recognized. As of September 30, 2012, less than 4% of the loans within this category were 30 days or more past due and 88% of these loans have been making payments for at least the past 12 consecutive months. Based on this performance, we expect to recover a significant amount of these losses over time as principal payments are received. During the third quarter of 2012, the provision for loan losses was also impacted by a higher level of estimated losses related to consumer loans [using updated historical data as adjusted for the current periods charge-offs and trends]. The third quarter adjustment was consistent with adjustments made in the prior year and resulted in an increase from the estimate previously used. The provision for loan losses was $3.8 millionin the quarter ending September 30, 2012compared to $6.6 millionin the same quarter of 2011. Total credit costs (including the provision for loan losses, loan workout expense, OREO expense and other credit reserves) decreased to $5.9 millionfrom $8.4in the third quarter of 2011, reflecting the improved credit quality of our loan portfolio. 42
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The table below represents a summary of the changes in the allowance for loan losses during the periods indicated.
For the Nine Months Ended September 30, 2012 2011 (Dollars in Thousands) Beginning balance $ 53,080 $ 60,339 Provision for loan losses 28,379 21,048 Charge-offs: Residential real estate (1) 3,343 2,183 Commercial real estate 5,600 6,609 Construction 10,680 8,179 Commercial 11,920 7,641 Owner-occupied commercial (2) 3,012 - Overdrafts 813 613 Consumer (1) 4,680 4,859 Total charge-offs 40,048 30,084 Recoveries: Residential real estate 171 116 Commercial real estate 382 381 Construction 1,642 557 Commercial 1,482 409 Owner-occupied commercial (2) 13 - Overdrafts 297 267 Consumer 200 155 Total recoveries 4,187 1,885 Net charge-offs 35,861 28,199 Ending balance $ 45,598 $ 53,188 Net charge-offs to average gross loans outstanding, net of unearned income (3) 1.75 % 1.41 %
(1) Recent regulatory guidance regarding loans discharged in Chapter 7 bankruptcy
resulted in charge-offs of
residential real estate for the nine months ending
(2) Prior to 2012, owner-occupied loans were included in commercial loan
(3) Ratios for the nine months ended
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Noninterest income increased
$2.8 millionto $19.7 millionfor the quarter ended September 30, 2012from $16.9 millionin the third quarter of 2011. Excluding the effect of net securities gains in both periods and the unanticipated BOLI income during the third quarter of 2012, noninterest income increased by $1.3 million, or 9%. Mortgage banking and loan fee income increased $753,000, or 87%. Fiduciary and investment management income increased $271,000, or 9%, reflecting growth in the trust and wealth management segment, and credit/ debit card and ATM fees increased by $215,000, or 4%, reflecting growth in Cash Connect (our ATM division). For the nine months ended September 30, 2012noninterest income increased $18.9 millionto $65.5 millioncompared to the same period in 2011. Excluding the effect of net securities gains in both periods and the unanticipated BOLI income in both years, noninterest income increased by $4.2 million, or 10%. Similar to the quarterly comparison, the increase in fee income was largely due to continued growth across all of our segments. The increase includes $1.5 million, or 10%, in credit/ debit card and ATM fees, $825,000, or 9%, increase in fiduciary and investment management income and $779,000or 27%, increase in mortgage banking and loan fee income.
Noninterest expenses decreased
$260,000, or 1%, to $32.2 millionin the third quarter of 2012 compared to the same period in 2011. Excluding our "Right Here" advertising campaign ($961,000)in the third quarter of 2011, expenses increased $701,000or only 2% over the same period in 2011. This increase reflects the higher expenses associated with the prior years' retail branch expansion plan, including the opening and renovation of four branches and the relocation of our operations center in the second half of 2011 and increased compensation related costs related to our improved performance in 2012 and changes in the timing of the awards. These increases were largely mitigated by our expense management efforts over the last year. For the nine months ended September 30, 2012, noninterest expense increased $1.7 million, or 2%, to $96.2 millioncompared to the same period in 2011. Similar to the quarterly comparison, contributing to the increase were expenses associated with strategic investments, including the opening and renovation of four branches and the relocation of our operations center in the second half of 2011 and completed in early 2012 and added compensation costs related to our improved performance in 2012. Income Taxes We and our subsidiaries file a consolidated Federal income tax return and separate state income tax returns. Income taxes are accounted for in accordance with ASC 740, which requires the recording of deferred income taxes for tax consequences of temporary differences. We recorded an income tax expense of $4.8 millionand $12.7 millionduring the three months and nine months ended September 30, 2012, respectively, compared to an income tax expense of $3.3 millionand $8.2 millionfor the same periods in 2011. The third quarter 2012 included the recognition of tax benefits related to $1.0 millionof tax-free income from life insurance proceeds received from our BOLI investment. The second quarter 2011 included $1.2 millionof similar tax-free BOLI income. The third quarter 2011 included tax benefits of $376,000resulting primarily from a decrease in our income tax reserve due to the expiration of the statute of limitations on certain items. Our effective tax rate was 32.3% and 34.9% for the three and nine months ended September 30, 2012, respectively, compared to 33.0% and 33.2% during the same periods in 2011. Excluding the tax-free BOLI proceeds and statute of limitations related benefit, our effective tax rates were 34.7% and 35.8% for the three and nine months ended September 30, 2012compared to 36.7% and 36.3% during the same periods in 2011. The effective tax rate reflects the recognition of certain tax benefits in the financial statements including those benefits from tax-exempt interest income (including a 50% interest income exclusion on a loan to an Employee Stock Ownership Plan), federal low-income housing tax credits, and BOLI income. These tax benefits are offset by the tax effect of stock-based compensation expense related to incentive stock options and a provision for state income tax expense.
We frequently analyze our projections of taxable income and make adjustments to our provision for income taxes accordingly.
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RECENT ACCOUNTING PRONOUNCEMENTS
April 2011, the FASB issued an update ("ASU" No. 2011-02, A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring) which clarifies when creditors should classify loan modifications as troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. A provision in Update 2011-02 also ends the FASB's deferral of the additional disclosures about troubled debt restructurings as required by Update 2010-20. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements. In April 2011, the FASB issued an update ("ASU" No. 2011-03, Reconsideration of Effective Control in Repurchase Agreements) which removes from the assessment of effective control the criterion related to the transferor's ability to repurchase or redeem financial assets on substantially agreed terms, even in the event of default by the transferee. In addition, this guidance also eliminates the requirement to demonstrate that a transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The new guidance is effective for interim and annual periods beginning on or after December 15, 2011, and applies prospectively to transactions or modifications of existing transactions occurring on or after the effective date. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements. In May 2011, the FASB issued an update ("ASU" No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS) to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. While the overall guidance is consistent with U.S. GAAP, the amendment includes additional fair value disclosure requirements. The amendments in the guidance are effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements; however, the adoption did have an impact on our fair value disclosures. In June 2011, the FASB issued an update ("ASU" No. 2011-05, Presentation of Comprehensive Income) to eliminate the option to present the components of other comprehensive income as part of the statement of changes in shareholder's equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements; however, the adoption did have an impact on our presentation of comprehensive income. In September 2011, the FASB issued an update ("ASU" No. 2011-08, Intangibles-Goodwill and Other (Topic 350)-Testing Goodwill for Impairment) to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements. In December 2011, the FASB issued an update ("ASU" No. 2011-11, Balance Sheet (Topic 350)-Offsetting) to address balance sheet offsetting. An entity is required to disclose information about offsetting and related arrangements so that users of the financial statements can understand the effect of those arrangements on its financial position. Entities are required to disclose both gross information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. The instruments and transactions include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This amendment is effective for interim and annual reporting periods beginning on or after January 1, 2013. We do not expect the adoption of this guidance to have a material impact on our financial statements. 45
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December 2011, the FASB issued an update ("ASU" No. 2011-12, Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05) which under ASU 2011-05 defers the effective date pertaining to reclassification adjustments out of other accumulated other comprehensive income (AOCI). Concerns were raised that reclassifications of items out of AOCI would be costly for preparers and may add unnecessary complexity to financial statements. All other requirements in ASU 2011-05 are not affected by this Update. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements. In July 2012, the FASB issued an update ("ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment) which permits entities to perform an optional qualitative assessment for determining whether it is more likely than not that an indefinite-lived intangible asset is impaired. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We are evaluating the impact of ASU 2012-02; however, we do not expect the adoption of this guidance to have a material impact on our financial statements.
July 21, 2010, the President signed the Dodd-Frank Act into law. This legislation makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. While the full effects of the legislation on us cannot yet be determined, this legislation was opposed by the American Bankers Associationand is generally perceived as negatively impacting the banking industry. This legislation may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect our business. There are many parts of the Dodd-Frank Act that have yet to be determined and implemented however, as a direct result of the Act, the following rulings have been adopted or will be adopted in the coming years: • On August 10, 2010the Board of Directors of the FDICadopted a final
ruling permanently increasing the standard maximum deposit insurance
$100,000 to $250,000, which became effective on July 22, 2010. • During January of 2011, an implementation plan for the phase out of the Office of Thrift Supervision("the OTS"), was announced by the joint agencies, and it merged into the Office of the Comptroller of the Currency. The provisions of the plan included a transition from the quarterly Thrift Financial Report, to the Call Report, which began with the March 2012reporting period.
deposits to average assets minus tangible equity. The changes went into effect during the second quarter of 2011. It is the intent of the
FDICthat banks with over $10 billionin assets pay a larger share of the assessments into the DIF.
debit interchange fees would be capped at
the transaction, with the possibility of an additional cent if the issuer
implements certain fraud-prevention standards. This rule directly affects
$10 billionor more in assets.
payment of interest on demand deposits.
created to centralize responsibility for consumer financial protection.
The bureau has been given the responsibility for implementing, examining
and enforcing compliance with Federal consumer protection laws. In
June 2012, the Federal Reserve Board, the Office of the Comptroller of the Currencyand the Federal Deposit Insurance Corporationapproved three proposals that would amend the existing capital adequacy requirements of banks and bank holding companies. The three proposals would, among other things, implement the Basel III capital standards, as well as the Basel II standardized approach for almost all banking organizations in the United Statesincluding us. The BaselIII proposal would increase the minimum levels of required capital, narrow the definition of capital, and places greater emphasis on common equity. The BaselII standardized proposal would modify the risk weights for various asset classes. We are still in the process of assessing the impacts of these complex proposals. 46
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