ITEM 1. BUSINESS
General
Northwest Bancorp, Inc.
Northwest Bancorp, Inc. is a Federal corporation formed on June 29, 2001, as the successor to a Pennsylvania corporation of the same name. Both the Federal corporation and its Pennsylvania predecessor are referred to as the “Company.” The Company became the stock holding company of Northwest Savings Bank (the “Bank”) in a transaction (the “Two-Tier Reorganization”) that was approved by the Bank’s stockholders in December of 1997, and completed in February of 1998. In the Two-Tier Reorganization, each share of the Bank’s common stock was converted into and became a share of common stock of the Company, par value $0.10 per share (the “Common Stock”), and the Bank became a wholly-owned subsidiary of the Company. Northwest Bancorp, MHC (the “Mutual Holding Company”), which owned a majority of the Bank’s outstanding shares of common stock immediately prior to completion of the Two-Tier Reorganization, became the owner of the same percentage of the outstanding shares of Common Stock of the Company immediately following the completion of the Two-Tier Reorganization. On August 25, 2003, the Company completed an incremental stock offering whereby the Company cancelled 7,255,520 shares of the Company’s stock owned by the Mutual Holding Company and the Company sold the same number of shares in a subscription offering. The Mutual Holding Company owns approximately 63% of the Company’s outstanding shares. The Mutual Holding Company received approval from the Office of Thrift Supervision (“OTS”) to waive its right to receive cash dividends from the Company during 2007. As of December 31, 2007, the primary activity of the Company was the ownership of all of the issued and outstanding common stock of the Bank.
As of December 31, 2007, through the Bank, the Company operated 166 community-banking offices throughout its market area in northwest, southwest and central Pennsylvania, western New York, eastern Ohio, Maryland and Florida. The Company, through the Bank and its wholly owned subsidiaries, also operates 49 consumer finance offices throughout Pennsylvania and two consumer finance offices in New York. Historically, the Company has focused its lending activities primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four- family residences. In an effort to reduce interest rate risk and improve profit margins, the Company has made a strategic decision to focus its lending efforts on shorter term consumer and commercial loans, while continuing to provide one- to four- family first mortgage loans to customers in its market area. With the change in lending emphasis, the Company regularly sells a portion of the one- to four-family mortgage loans originated by its retail offices.
The Company’s principal sources of funds are deposits, borrowed funds and the principal and interest payments on loans and marketable securities. The principal source of income is interest received from loans and marketable securities. The Company’s principal expenses are the interest paid on deposits and the cost of employee compensation and benefits.
The Company’s principal executive office is located at 100 Liberty Street, Warren, Pennsylvania, and its telephone number at that address is (814) 726-2140.
The Company’s website (www.northwestsavingsbank.com) contains a direct link to the Company’s filings with the Securities and Exchange Commission, including copies of annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these filings, if any. Copies may also be obtained, without charge, by written request to Shareholder Relations, P.O. Box 128, 100 Liberty Street, Warren, Pennsylvania 16365.
Northwest Savings Bank
The Bank is a Pennsylvania-chartered stock savings bank headquartered in Warren, which is located in northwestern Pennsylvania. The Bank is a community-oriented financial institution offering traditional deposit and loan products, and through a wholly-owned subsidiary, consumer finance services. The Bank’s mutual savings bank predecessor was founded in 1896. The Bank in its current stock form was established on November 2, 1994, as a result of the reorganization (the “Reorganization”) of the Bank’s mutual predecessor into a mutual holding company structure. At the time of the Reorganization, the Bank issued a majority of its to-be outstanding shares of common stock to the Mutual Holding Company (which was formed in connection with the Reorganization) and sold a minority of its to-be outstanding shares to stockholders other than the Mutual Holding Company in a stock offering conducted as part of the Reorganization.
The Bank’s principal executive office is located at 100 Liberty Street, Warren, Pennsylvania, and its telephone number at that address is (814) 726-2140.
Market Area
The Company has been, and intends to continue to be, an independent community-oriented financial institution offering a wide variety of financial services to meet the needs of the communities it serves. The Company is headquartered in Warren, Pennsylvania, which is located in the northwestern region of Pennsylvania, and has its highest concentration of deposits and loans in the portion of its office network located in northwestern Pennsylvania. Since the early 1990s, the Company has expanded, primarily through acquisitions, into the southwestern and central regions of Pennsylvania. As of December 31, 2007, the Company operated 140 community banking offices and 49 consumer finance offices located in the Pennsylvania counties of Allegheny, Armstrong, Bedford, Berks, Blair, Butler, Cambria, Cameron, Centre, Chester, Clarion, Clearfield, Clinton, Columbia, Crawford, Cumberland, Dauphin, Elk, Erie, Fayette, Forest, Huntingdon, Indiana, Jefferson, Lancaster, Lawrence, Lebanon, Luzerne, Lycoming, McKean, Mercer, Mifflin, Northumberland, Potter, Schuylkill, Tioga, Venango, Warren, Washington, Westmoreland and York. In addition, the Company operated five community banking offices located in the Ohio counties of Ashtabula, Geauga and Lake, 14 community banking offices located in the New York counties of Chautauqua, Erie, Monroe and Cattaraugus, five community banking offices in the Maryland counties of Baltimore, Anne Arundel and Howard and two community banking offices in Broward County, Florida. The Company, through the Bank and its subsidiaries, also operates two consumer finance offices in southwestern New York.
Lending Activities
General. Historically, the principal lending activity of the Company has been the origination, for retention in its portfolio, of fixed-rate and, to a lesser extent, adjustable-rate mortgage loans collateralized by one- to four-family residential real estate located in its market area. The Company also originates loans collateralized by multifamily residential and commercial real estate, commercial business loans and consumer loans.
In an effort to manage interest rate risk, the Company has sought to make its interest-earning assets more interest rate sensitive by originating adjustable-rate loans, such as adjustable-rate mortgage loans and home equity loans, and by originating short-term and medium-term fixed-rate consumer loans. Another emphasis of the Company in recent years has been the origination of commercial real estate and commercial business loans which generally have either relatively short maturities or variable rates of interest. The Company also purchases mortgage-backed securities and other types of investment securities that generally have short average lives or adjustable interest rates. Because the Company also originates a substantial amount of long-term fixed-rate mortgage loans collateralized by one- to four-family residential real estate, when possible, such loans are originated and underwritten according to standards that allow the Company to sell them in the secondary mortgage market for purposes of managing interest-rate risk and liquidity. The Company currently sells in the secondary market a limited amount of fixed-rate residential mortgage loans with maturities of more than 15 years, and generally retains all adjustable-rate mortgage loans and fixed-rate residential mortgage loans with maturities of 15 years or less. Although the Company is selling an increasing amount of the mortgage loans that it originates, it continues to be a portfolio lender and at any one time the Company holds only a nominal amount of loans identified as available-for-sale. The Company retains servicing on the mortgage loans it sells and realizes monthly service fee income. The Company generally retains in its portfolio all consumer loans that it originates while it periodically sells participations in the multifamily residential, commercial real estate or commercial business loans that it originates in a effort to reduce the risk to certain individual credits and the risk to certain businesses or industries. The Company has not changed its underwriting standards, nor has it introduced the sub-prime products that are causing many of the foreclosure issues in the marketplace today.
Analysis of Loan Portfolio. Set forth below are selected data relating to the composition of the Company’s loan portfolio by type of loan as of the dates indicated.
(1)
Consists primarily of secured and unsecured personal loans.
Loan Maturity and Repricing Schedule. The following table sets forth the maturity or period of repricing of the Company’s loan portfolio at December 31, 2007. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Adjustable and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature, and fixed-rate loans are included in the period in which the final contractual repayment is due.
Fixed- and Adjustable-Rate Loan Schedule. The following table sets forth at December 31, 2007, the dollar amount of all fixed-rate and adjustable-rate loans due after December 31, 2008. Adjustable- and floating-rate loans are included in the table based on the contractual due date of the loan.
One- to Four-Family Residential Real Estate Loans. The Company currently offers one- to four-family residential mortgage loans with terms typically ranging from 15 to 30 years, with either adjustable or fixed interest rates. Originations of fixed-rate mortgage loans versus adjustable-rate mortgage loans are monitored on an ongoing basis and are affected significantly by such factors as the level of market interest rates, customer preference, the Company’s interest rate sensitivity position and loan products offered by the Company’s competitors. Therefore, even when management’s strategy is to increase the origination of adjustable-rate mortgage loans, market conditions may be such that there is greater demand for fixed-rate mortgage loans.
The Company’s fixed-rate loans, whenever possible, are originated and underwritten according to standards that permit sale into the secondary mortgage market. Whether the Company can or will sell fixed-rate loans into the secondary market, however, depends on a number of factors including the yield and the term of the loan, market conditions, and the Company’s current liquidity and interest rate sensitivity position. The Company historically has been primarily a portfolio lender, and at any one time the Company has held only a nominal amount of loans that may be sold. The Company’s current strategy is to grow the consumer and commercial loan portfolios by more than it grows its portfolio of long-term fixed-rate mortgages. With this in mind, it currently retains in its portfolio fixed-rate loans with terms of 15 years or less, and sells a portion of fixed-rate loans (servicing retained) with terms of more than 15 years. The Company’s mortgage loans are amortized on a monthly basis with principal and interest due each month. One- to four-family residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option, usually without a prepayment penalty.
The Company currently offers adjustable-rate mortgage loans with initial interest rate adjustment periods of one, three and five years, based on changes in a designated market index. The Company determines whether a borrower qualifies for an adjustable-rate mortgage loan based on the fully indexed rate of the adjustable-rate mortgage loan at the time the loan is originated. One- to four-family residential adjustable-rate mortgage loans totaled $67.1 million, or 1.4% of the Company’s gross loan portfolio at December 31, 2007.
The Company’s one- to four-family residential first mortgage loans customarily include due-on-sale clauses, which are provisions giving the Company the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as collateral for the loan. Due-on-sale clauses are an important means of adjusting the rates on the Company’s fixed-rate mortgage loan portfolio, and the Company has generally exercised its rights under these clauses.
Regulations limit the amount that a savings bank may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Appraisals are either performed by the Company’s in-house appraisal staff or by an appraiser who has been deemed qualified by the Company’s chief appraiser. Such regulations permit a maximum loan-to-value ratio of 95% for residential property and 80% for all other real estate loans. The Company’s lending policies generally limit the maximum loan-to-value ratio on both fixed-rate and adjustable-rate mortgage loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the real estate that serves as collateral for the loan. The Company makes a limited amount of one- to four-family real estate loans with loan-to-value ratios in excess of 80%. For one- to four-family real estate loans with loan-to-value ratios in excess of 80%, the Company generally requires the borrower to obtain private mortgage insurance on the entire amount of the loan. The Company requires fire and casualty insurance, as well as a title guaranty regarding good title, on all properties securing real estate loans made by the Company.
Some financial institutions acquired by the Company held loans that are serviced by others and secured by one- to four-family residences. At December 31, 2007, the Company’s portfolio of loans serviced by others totaled $13.9 million. The Company currently has no formal plans to enter into new loan participations.
Included in the Company’s $2.4 billion portfolio of one- to four-family residential real estate loans are construction loans of $25.0 million, or 1.0% of the Company’s total loan portfolio. The Company offers fixed-rate and adjustable-rate residential construction loans primarily for the construction of owner-occupied one- to four-family residences in the Company’s market area to builders or to owners who have a contract for construction. Construction loans are generally structured to become permanent loans, and are originated with terms of up to 30 years with an allowance of up to one year for construction. During the construction phase the loans have a fixed interest rate and convert into either a fixed-rate or an adjustable-rate mortgage loan at the end of the construction period. Advances are made as construction is completed. In addition, the Company originates loans within its market area that are secured by individual unimproved or improved lots. Land loans are currently offered with fixed-rates for terms of up to 10 years. The maximum loan-to-value ratio for the Company’s land loans is 75% of the appraised value, and the maximum loan-to-value ratio for the Company’s construction loans is 95% of the lower of cost or appraised value.
Construction lending generally involves a greater degree of credit risk than other one- to four-family residential mortgage lending. The repayment of the construction loan is often dependent upon the successful completion of the construction project. Construction delays or the inability of the borrower to sell the property once construction is completed may impair the borrower’s ability to repay the loan.
Multifamily Residential and Commercial Real Estate Loans. The Company’s multifamily residential real estate loans are secured by multifamily residences, such as rental properties. The Company’s commercial real estate loans are secured by nonresidential properties such as hotels, church property, manufacturing facilities and retail establishments. At December 31, 2007, a significant portion of the Company’s multifamily residential and commercial real estate loans were secured by properties located within the Company’s market area. The Company’s largest multifamily residential real estate loan relationship at December 31, 2007, had a principal balance of $13.7 million, and was collateralized by multiple residential real estate rental properties. These loans were performing in accordance with their terms as of December 31, 2007. The Company’s largest commercial real estate loan relationship at December 31, 2007, had a principal balance of $42.9 million and was collateralized by several hotels and retail stores. These loans were performing in accordance with their terms as of December 31, 2007. Multifamily residential and commercial real estate loans are offered with both adjustable interest rates and fixed interest rates. The terms of each multifamily residential and commercial real estate loan are negotiated on a case-by-case basis. The Company generally makes multifamily residential and commercial real estate loans up to 80% of the appraised value of the property collateralizing the loan.
Loans secured by multifamily residential and commercial real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multifamily residential and commercial real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
Consumer Loans. The principal types of consumer loans offered by the Company are adjustable-rate home equity lines of credit and fixed-rate consumer loans such as second mortgage loans, home equity loans, automobile loans, sales finance loans, unsecured personal loans, credit card loans, and loans secured by deposit accounts. Consumer loans are offered with maturities generally of ten years or less. Generally, the Company’s home equity lines of credit are secured by the borrower’s principal residence with a maximum loan-to-value ratio, including the principal balances of both the first and second mortgage loans, of 90% or less. Such loans are offered on an adjustable-rate basis with terms of up to twenty years. At December 31, 2007, the disbursed portion of home equity lines of credit totaled $120.1 million, or 9.5% of consumer loans, with $211.3 million remaining undisbursed.
The underwriting standards employed by the Company for consumer loans include a determination of the applicant’s credit history and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Creditworthiness of the applicant is of primary consideration; however, the underwriting process also includes a comparison of the value of the collateral in relation to the proposed loan amount.
Consumer loans entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, recreation vehicles, appliances, and furniture. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the lack of demand for used automobiles.
Commercial Business Loans. The Company currently offers commercial business loans to finance various activities in the Company’s market area, some of which are secured in part by additional real estate collateral. At December 31, 2007 the largest commercial business loan relationship had a principal balance of $15.5 million, and was secured by all fixed assets, all accounts and assignment of trust of a community hospital.
Commercial business loans are offered with both fixed and adjustable interest rates. Underwriting standards employed by the Company for commercial business loans include a determination of the applicant’s ability to meet existing obligations and payments on the proposed loan from normal cash flows generated by the applicant’s business. The financial strength of each applicant also is assessed through a review of financial statements provided by the applicant.
Commercial business loans generally bear higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower’s business. The Company generally obtains personal guarantees from the borrower or a third party as a condition to originating its commercial business loans.
Loan Originations, Solicitation, Processing, and Commitments. Loan originations are derived from a number of sources such as real estate broker referrals, existing customers, borrowers, builders, attorneys, brokers and walk-in customers. Historically all of the Company’s loan originators were salaried employees, and the Company did not pay commissions in connection with loan originations. Beginning in 2007, the Company implemented a program whereby certain commercial lenders are paid commissions based on predetermined goals. Upon receiving a loan application, the Company obtains a credit report and employment verification to verify specific information relating to the applicant’s employment, income, and credit standing. In the case of a real estate loan, an in-house appraiser or an appraiser approved by the Company, appraises the real estate intended to secure the proposed loan. A loan processor in the Company’s loan department checks the loan application file for accuracy and completeness, and verifies the information provided. The Company has a formal loan policy, which assigns lending limits to the Company’s various loan officers. Also, the Company has a Credit Committee that meets quarterly to review the assigned lending limits and to monitor the Company’s lending policies, loan activity, economic conditions and concentrations of credit. The Company has a Senior Loan Committee, which has lending authority as designated in the Company’s loan policy that is approved by the Board of Directors. Loans exceeding the limits established for the Senior Loan Committee must be approved by the Executive Committee of the Board of Directors or by the entire Board of Directors. The Company’s policy is to make no loans either individually or in the aggregate to one entity in excess of $15.0 million. Exceptions to this policy are permitted with the prior approval from the Board of Directors. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan, and at the discretion of the Company, flood insurance may be required. After the loan is approved, a loan commitment letter is promptly issued to the borrower. At December 31, 2007, the Company had commitments to originate $69.9 million of loans.
If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral and required insurance coverage. The borrower must provide proof of fire and casualty insurance on the property (and, as required, flood insurance) serving as collateral, which insurance must be maintained during the full term of the loan. A title guaranty, based on a title search of the property, is required on all loans secured by real property.
Loan Origination Fees and Other Income. In addition to interest earned on loans, the Company generally receives loan origination fees. To the extent that loans are originated or acquired for the Company’s portfolio, Statement of Financial Accounting Standards No. 91 (“SFAS 91”) requires that the Company defer loan origination fees and costs and amortize such amounts as an adjustment of yield over the life of the loan by use of the level yield method. Fees deferred under SFAS 91 are recognized into income immediately upon prepayment or the sale of the related loan. At December 31, 2007 the Company had $4.2 million of net deferred loan origination fees. Loan origination fees are volatile sources of income. Such fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the marketplace.
In addition to loan origination fees, the Company also receives other fees, service charges, and other income that consist primarily of deposit transaction account service charges, late charges, credit card fees, and income from operations of real estate owned (“REO”). The Company recognized fees and service charges of $27.8 million, $24.5 million, $11.9 million, and $16.8 million, for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and for the fiscal year ended June 30, 2005, respectively.
Loans-to-One Borrower. Savings banks are subject to the same loans-to-one borrower limits as those applicable to national banks, which restrict loans to one borrower to an amount equal to 15% of unimpaired capital and unimpaired surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured by readily marketable collateral (generally, financial instruments and bullion, but not real estate). At December 31, 2007, the largest aggregate amount loaned by the Company to one borrower totaled $42.9 million and was secured by several hotels and retail stores. The Company’s second largest lending relationship totaled $16.0 million and was secured by a hotel. The Company’s third largest lending relationship totaled $15.5 million and was secured by commercial real estate, fixed assets, accounts and assignment of trust. The Company’s fourth largest lending relationship totaled $15.0 million and was secured by commercial real estate. The Company’s fifth largest lending relationship totaled $13.7 million and was secured by multiple residential real estate properties.
Delinquencies and Classified Assets
Collection Procedures. The Company’s collection procedures provide that when a loan is five days past due, a computer-generated late notice is sent to the borrower requesting payment. If delinquency continues, at 15 days a delinquent notice, plus a notice of a late charge, is sent and personal contact efforts are attempted, either in person or by telephone, to strengthen the collection process and obtain reasons for the delinquency. Also, plans to arrange a repayment plan are made. If a loan becomes 60 days past due, a collection letter is sent, personal contact is attempted, and the loan becomes subject to possible legal action if suitable arrangements to repay have not been made. In addition, the borrower is given information, which provides access to consumer counseling services, to the extent required by regulations of the Department of Housing and Urban Development. When a loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been made or kept by the borrower, generally a notice of intent to foreclose is sent to the borrower, giving 30 days to cure the delinquency. If not cured, foreclosure proceedings are initiated.
Nonperforming Assets. Loans are reviewed on a regular basis and are placed on a nonaccrual status when, in the opinion of management, the collection of additional interest is doubtful. Loans are automatically placed on nonaccrual status when either principal or interest is 90 days or more past due. Interest accrued and unpaid at the time a loan is placed on a nonaccrual status is charged against interest income.
Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is classified as REO until such time as it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at the lower of the related loan balance or its fair value as determined by an appraisal, less estimated costs of disposal. If the value of the property is less than the loan, less any related specific loan loss reserve allocations, the difference is charged against the allowance for loan losses. Any subsequent write-down of REO is charged against earnings.
Loans Past Due and Nonperforming Assets. The following table sets forth information regarding the Company’s loans 30 days or more past due, nonaccrual loans 90 days or more past due, and real estate acquired or deemed acquired by foreclosure at the dates indicated. When a loan is delinquent 90 days or more, the Company fully reserves all accrued interest thereon and ceases to accrue interest thereafter. For all the dates indicated, the Company did not have any material restructured loans within the meaning of SFAS 15. A large number of one- to four- family mortgage loans are due on the first day of the month. Effective December 31, 2005, the Company changed its fiscal year-end from June 30 (a 30-day month) to December 31 (a 31-day month) causing the loans that are 30 to 59 days delinquent to increase dramatically compared to prior fiscal year ends because of the additional day.
(1)
The Company classifies as nonperforming all loans 90 days or more delinquent.
During the year ended December 31, 2007, gross interest income of approximately $3.9 million would have been recorded on loans accounted for on a nonaccrual basis if the loans had been current during the year. No interest income on nonaccrual loans was included in income during the year.
Classification of Assets. The Company’s policies, consistent with regulatory guidelines, provide for the classification of loans and other assets such as debt and equity securities, considered to be of lesser quality as “substandard,” “doubtful,” or “loss” assets. 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 savings institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” so that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient
to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated “special mention” by management. At December 31, 2007, the Company had 269 loans, with an aggregate principal balance of $40.6 million, designated as special mention.
The Company regularly reviews its asset portfolio to determine whether any assets require classification in accordance with applicable regulations. The Company’s largest classified assets are generally also the Company’s largest nonperforming assets.
The following table sets forth the aggregate amount of the Company’s classified assets at the dates indicated.
Allowance for Loan Losses. Loans that have been classified as substandard or doubtful are reviewed by the Credit Review (“Credit Review”) department for possible impairment under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan.” A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement including both contractual principal and interest payments.
If an individual loan is deemed to be impaired the Credit Review department determines the proper measurement of impairment for each loan based on one of three methods as prescribed by SFAS No. 114: (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 the collateral if the loan is collateral dependent. If the measure of the impaired loan is more or less than the recorded investment in the loan, the Credit Review department adjusts the specific allowance associated with that individual loan accordingly.
If a substandard or doubtful loan is not considered to be individually impaired, it is grouped with other loans that possess common characteristics for impairment evaluation and analysis under the provisions of SFAS No. 5, “Accounting for Contingencies.” This segmentation is accomplished by grouping loans of similar product types, risk characteristics and industry concentration into homogeneous pools. Each pool is then analyzed based on the historical delinquency, charge-off and recovery trends over the past three years which are then extended to include the loss realization period during which the event of default occurs, additional consideration is also given to the current economic, political, regulatory and interest rate environment. This adjusted historical net charge-off amount as a percentage of loans outstanding for each group is used to estimate the measure of impairment.
The individual impairment measures along with the estimated losses for each homogeneous pool are consolidated into one summary document. This summary schedule along with the supporting documentation used to establish this schedule is presented to the Credit Committee on a quarterly basis by the Credit Review department. The Credit Committee is comprised of members of Senior Management from various departments within the Company including mortgage, consumer and commercial lending, appraising, administration and finance as well as the President of the Company. The Credit Committee reviews the processes and documentation presented, reviews the concentration of credit by industry and customer, discusses lending products, activity, competition and collateral values, as well as economic conditions in general and in each market area of the Company. Based on this review and discussion, the appropriate range of the allowance for loan losses is estimated and any adjustments necessary to reconcile the actual allowance for loan losses with this estimate is determined. In addition, the Credit Committee considers whether any changes to the methodology are needed. The Credit Committee also compares the Company’s delinquency trends, nonperforming asset amounts and allowance for loan loss levels to its peer group and to state and national statistics. A similar review is also performed by the Board of Directors’ Risk Management Committee.
In addition to the reviews by the Credit Committee and the Risk Management Committee, regulators from either the FDIC or Pennsylvania State Department of Banking perform an extensive review on an annual basis for the adequacy of the allowance for loan losses and its conformity with regulatory guidelines and pronouncements. The internal audit department also performs a regular review of the detailed supporting schedules for accuracy and reports their findings to the Audit Committee of the Board of Directors. Any recommendations or enhancements from these independent parties are considered by management and the Credit Committee and implemented accordingly.
Management acknowledges that this is a dynamic process and consists of factors, many of which are external and out of management’s control, that can change. The adequacy of the allowance for loan losses is based upon estimates using all the information previously discussed as well as current and known circumstances and events. There is no assurance that actual portfolio losses will not be substantially different than those that were estimated. Management believes that all known losses as of the balance sheet dates have been recorded.
Analysis of the Allowance For Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated. Ratios for the six months ended December 31, 2005 have been annualized.
Allocation of Allowance for Loan Losses. The following table sets forth the allocation of allowance for loan losses by loan category at the dates indicated.
(1)
Represents percentage of loans in each category to total loans.
(1)
Represents percentage of loans in each category to total loans.
Investment Activities
The Company’s investment portfolio is comprised of mortgage-backed securities, investment securities, and cash and cash equivalents. Decreases in investment securities and mortgage-backed securities resulted from the Company’s efforts to minimize credit risk in its investment portfolio by divesting of a significant portion of its non-agency corporate debt securities and mutual funds. Included in the sale of investments were securities previously classified as held-to-maturity, and as a result of this sale all remaining held-to-maturity investments were required to be reclassified as available-for-sale.
The Company is required under federal regulations to maintain a minimum amount of liquid assets that may be invested in specified short-term securities and certain other investments. The Company generally has maintained a portfolio of liquid assets that exceeds regulatory guidelines. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management’s judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management’s projections as to the short-term demand for funds to be used in the Company’s loan origination and other activities.
Amortized Cost and Market Value of Investment and Mortgage-Backed Securities. The following table sets forth certain information regarding the amortized cost and market values of the Company’s investment securities portfolio and mortgage-backed securities portfolio at the dates indicated.
Issuers of Mortgage-Backed Securities. The following table sets forth information regarding the issuers and the carrying value of the Company’s mortgage-backed securities.
Investment Portfolio Maturities. The following table sets forth the scheduled maturities, carrying values, amortized cost, market values and weighted average yields for the Company’s investment securities and mortgage-backed securities portfolios at December 31, 2007. Adjustable-rate mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust.
Sources of Funds
General. Deposits are the major source of the Company’s funds for lending and other investment purposes. In addition to deposits, the Company derives funds from the amortization and prepayment of loans and mortgage-backed securities, the maturity of investment securities, operations and, if needed, borrowings from the FHLB. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes.
Deposits. Consumer and commercial deposits are attracted principally from within the Company’s market area through the offering of a broad selection of deposit instruments including checking accounts, savings accounts, money market deposit accounts, term certificate accounts and individual retirement accounts. While the Company accepts deposits of $100,000 or more, it does not offer substantial premium rates for such deposits. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The Company regularly executes changes in its deposit rates based upon cash flow requirements, general market interest rates, competition, and liquidity requirements. Other than those obtained through bank acquisitions, the Company does not obtain funds through brokers, nor does it solicit funds outside its market area.
The following table sets forth the dollar amount of deposits in the various types of savings accounts offered by the Company between the dates indicated.
(1)
Represents percentage of total deposits.
(2)
Represents weighted average nominal rate at fiscal year end.
(1)
Represents percentage of total deposits.
(2)
Represents weighted average nominal rate at fiscal year end.
Large Certificates of Deposit Maturities. The following table indicates the amount of the Company’s certificates of deposit of $100,000 or more by time remaining until maturity at December 31, 2007.
Borrowings
Deposits are the primary source of funds for the Company’s lending and investment activities and for its general business purposes. The Company also relies upon borrowings from the FHLB to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Borrowings from the FHLB typically are collateralized by the Bank’s stock in the FHLB and a portion of the Bank’s real estate loans.
The FHLB functions as a central reserve bank providing credit for the Bank and other member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings on the security of such stock and certain of its real estate loans and other assets (principally, securities that are direct obligations of the United States or its sponsored entities) provided certain standards related to creditworthiness have been met. Borrowings are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of borrowings are based either on a fixed percentage of a member institution’s net worth or on the FHLB’s assessment of the institution’s creditworthiness. All of the Company’s FHLB borrowings currently have fixed interest rates and original maturities of between one day and ten years.
Competition
The Company’s market area in Pennsylvania, western New York, eastern Ohio, Maryland and Florida has a large concentration of financial institutions. As a result, the Company encounters strong competition both in attracting deposits and in originating retail and commercial loans. Its most direct competition for deposits has come historically from commercial banks, brokerage houses, other savings associations, and credit unions in its market area, and the Company expects continued strong competition from such financial institutions in the foreseeable future with the continued acceptance by customers of internet banking, competition for deposits has increased from out of market institutions as well as insurance companies. The Company competes for deposits by offering depositors a high level of personal service and expertise together with a wide range of financial services.
The competition for retail and commercial loans comes principally from commercial banks, mortgage banking companies, and other savings institutions. This competition for loans has increased substantially in recent years as a result of the large number of institutions competing in the Company’s market area as well as the increased efforts by commercial banks to expand small business lending. The Company competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers, real estate brokers, and builders. Factors that affect competition include general and local economic conditions, current interest rate levels, and volatility of the mortgage markets.
Subsidiary Activities
The Company’s sole consolidated subsidiary is the Bank. The Bank has seven wholly owned subsidiaries, Northwest Settlement Agency, LLC, Great Northwest Corporation, Northwest Financial Services, Inc., Northwest Consumer Discount Company, Inc., Allegheny Services, Inc., Boetger and Associates, Inc., and Northwest Capital Group, Inc. For financial reporting purposes all of these companies are included in the consolidated financial statements of the Company.
Northwest Settlement Agency, LLC was created in 2006 to provide title insurance to borrowers of Northwest Savings Bank and others. At December 31, 2007, the Bank had an equity investment in Northwest Settlement Agency, LLC of $547,000. For the period ended December 31, 2007, Northwest Settlement Agency, LLC had net income of $310,000.
Great Northwest’s sole activity is holding equity investments in government-assisted low-income housing projects in various locations in the Company’s market area. At December 31, 2007, the Bank had an equity investment in Great Northwest of $5.8 million. For the year ended December 31, 2007, Great Northwest had net income of $157,000 generated primarily from federal low-income housing tax credits.
Northwest Financial Services’ principal activity is the operation of retail brokerage activities for the Company. It also maintains ownership of the common stock of several financial institutions. In addition, Northwest Financial Services holds an equity investment in one government assisted low-income housing project. At December 31, 2007, the Bank had an equity investment in Northwest Financial Services of $7.1 million, and for the year ended December 31, 2007, Northwest Financial Services had net income of $121,000.
Northwest Consumer Discount Company operates 49 consumer finance offices throughout Pennsylvania and two consumer finance offices in New York as a separate company doing business therein as Northwest Finance Company. At December 31, 2007, the Bank had an equity investment in Northwest Consumer Discount Company of $25.0 million and the net income of Northwest Consumer Discount Company for the year ended December 31, 2007 was $2.1 million. Consumer loans entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, and recreation vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the lack of demand for used automobiles.
Allegheny Services, Inc. is a Delaware investment company that holds mortgage loans originated through the Bank’s wholesale lending operation as well as municipal bonds. In addition, Allegheny Services, Inc has loans to both the Bank and Northwest Consumer Discount Company. At December 31, 2007 the Bank had an equity investment in Allegheny Services, Inc. of $612.6 million, and for the year ended December 31, 2007, Allegheny Services, Inc. had net income of $25.5 million.
Boetger and Associates, Inc. is an actuarial and employee benefits consulting firm that specializes in the design, implementation and administration of qualified retirement plan programs. At December 31, 2007 the Bank had an equity
investment of $1.4 million in Boetger and Associates and for the year ended December 31, 2007 Boetger and Associates had net income of $113,000.
Northwest Capital Group’s principal activity is to own, operate and ultimately divest of properties that were acquired in foreclosure. At December 31, 2007 the Bank had an equity investment of $703,000 in Northwest Capital Group and reported no net income for the year ended December 31, 2007.
Northwest Finance Company, Inc. operates two consumer finance offices in Jamestown and Fredonia, New York. As of December 31, 2007, Northwest Consumer Discount Company’s equity investment in Northwest Finance Company was $(65,000). For the year ended December 31, 2007, Northwest Finance Company had net income of $82,000.
Federal regulations require insured institutions to provide 30 days advance notice to the FDIC before establishing or acquiring a subsidiary or conducting a new activity in a subsidiary. The insured institution must also provide the FDIC such information as may be required by applicable regulations and must conduct the activity in accordance with the rules and orders of the FDIC. In addition to other enforcement and supervision powers, the FDIC may determine after notice and opportunity for a hearing that the continuation of a savings association’s ownership of or relation to a subsidiary constitutes a serious risk to the safety, soundness or stability of the savings association, or is inconsistent with the purposes of federal banking law. Upon the making of such a determination, the FDIC may order the savings association to divest the subsidiary or take other actions.
Personnel
As of December 31, 2007, the Company and its wholly owned subsidiaries had 1,644 full-time and 320 part-time employees. None of the Company’s employees is represented by a collective bargaining group. The Company believes its relationship with its employees to be good.
REGULATION
General
The Company is a Federal corporation, and the Mutual Holding Company is a Federal mutual holding company. The Company and the Mutual Holding Company are required to file certain reports with, and otherwise comply with the rules and regulations of the OTS.
The Bank is a Pennsylvania-chartered savings bank whereby deposit accounts are insured up to applicable limits by the FDIC under the Deposit Insurance Fund (“DIF”). The Bank is subject to extensive regulation by the Department of Banking of the Commonwealth of Pennsylvania (the “Department”), as its chartering agency, and by the FDIC, as the deposit insurer. The Bank must file reports with the Department and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions including, but not limited to, mergers with or acquisitions of other financial institutions. There are periodic examinations by the Department and the FDIC to test the Bank’s compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the FDIC insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and with their 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 Department or the FDIC could have a material adverse impact on the Company, the Mutual Holding Company, the Bank and their operations.
Pennsylvania Savings Bank Law
The Pennsylvania Banking Code of 1965, as amended (the “Banking Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, employees, and depositors, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Banking Code delegates extensive rulemaking power and administrative discretion to the Department 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.
One of the purposes of the Banking Code is to provide savings banks with the opportunity to be competitive with each other and with other financial institutions existing under other Pennsylvania laws as well as other state, federal and foreign laws.
A Pennsylvania savings bank may locate or change the location of its principal place of business and establish an office anywhere in Pennsylvania, with the prior approval of the Department.
The Department generally examines each savings bank not less frequently than once every two years. Although the Department may accept the examinations and reports of the FDIC in lieu of the Department’s examination, the current practice is for the Department to conduct individual examinations. The Department may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any trustee, officer, attorney, or employee of a savings bank engaged in an objectionable activity, after the Department has ordered the activity to be terminated, to show cause at a hearing before the Department why such person should not be removed.
Insurance of Deposit Accounts.
Deposit accounts at Northwest Savings Bank are insured by the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. Northwest Savings Bank’s deposits, therefore, are subject to Federal Deposit Insurance Corporation deposit insurance assessments.
On February 15, 2007, federal legislation to reform federal deposit insurance was enacted. This new legislation, among other things, increased the amount of federal deposit insurance coverage per separately insured depositor (with a cost of living adjustment to become effective in five years). The legislation also requires that the deposit reserve ratio be modified to provide for a range between 1.15% and 1.50% of estimated insured deposits.
On November 2, 2007, the Federal Deposit Insurance Corporation adopted final regulations that assess insurance premiums based on risk. As a result, the new regulation will enable the Federal Deposit Insurance Corporation to more closely tie each financial institution’s deposit insurance premiums to the risk it poses to the deposit insurance fund. Under the new risk-based assessment system, the Federal Deposit Insurance Corporations will evaluate the risk of each financial institution based on its supervisory rating, its financial ratios, and its long-term debt issuer rating. The new rates for nearly all of the financial institution industry vary between five and seven cents for every $100 of domestic deposits. The assessment to be paid during the year ending December 31, 2007 by the Bank was offset by a $3.6 million credit from the Federal Deposit Insurance Corporation for prior premiums paid by the Bank. This credit will be exhausted during the March 31, 2008 quarter and the Bank will begin paying premiums at that time. At the same time, the Federal Deposit Insurance Corporation also adopted final regulations designating the reserve ratio for the deposit insurance fund during 2007 at 1.25% of estimated insured deposits.
Effective March 31, 2007, the Federal Deposit Insurance Corporation merged the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”) into a single fund called the Deposit Insurance Fund. As a result of this merger, the BIF and the SAIF were abolished. The merger of the BIF and the SAIF into the Deposit Insurance Fund does not affect the authority of the Financing Corporation (“FICO”) to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance cost and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2007, the annualized FICO assessment was equal to 1.14% for each $100 in domestic deposits maintained at an institution.
Capital Requirements
Any savings institution that fails any of the FDIC capital requirements is subject to possible enforcement actions by the FDIC. Such actions could include a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on an institution’s operations, termination of federal deposit insurance, and the appointment of a conservator or receiver. Certain actions are required by law. The FDIC’s capital regulation provides that such actions, through enforcement proceedings or otherwise, could require one or more of a variety of corrective actions.
The Bank is also subject to more stringent capital guidelines of the Department. Although not adopted in regulation form, the Department utilizes capital standards of 6% leverage capital and 10% risk-based capital. The components of leverage and risk-based capital are substantially the same as those defined by the FDIC.
Loans-to-One Borrower Limitation
Under federal regulations, with certain limited exceptions, a Pennsylvania chartered savings bank may lend to a single or related group of borrowers on an “unsecured” basis an amount equal to 15% of its unimpaired capital and surplus. An
additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. The Company’s internal policy, however, is to make no loans either individually or in the aggregate to one entity in excess of $15.0 million. However, in special circumstances this limit may be exceeded subject to the approval of the Board of Directors.
Prompt Corrective Action
Under federal regulations, a bank shall be deemed to be (i) “well capitalized” if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized”; (iii) “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Federal regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). As of December 31, 2007, the Bank was a “well-capitalized institution” for this purpose.
Activities and Investments of Insured State-Chartered Banks
Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not, directly or indirectly, acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary; (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation, or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets; (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’, and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions; and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
The USA PATRIOT Act
The USA Patriot Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA Patriot Act also requires the federal banking agencies to take into consideration the effectiveness of controls designed to combat money-laundering activities in determining whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations.
Holding Company Regulation
Generally. Federal law allows a state savings bank, such as the Bank, that qualifies as a “Qualified Thrift Lender,” as discussed below, to elect to be treated as a savings association for purposes of the savings and loan company provisions of the HOLA. Such election results in its holding company being regulated as a savings and loan holding company by the OTS rather than as a bank holding company by the Federal Reserve Board. In 2001 the Company and the Mutual Holding Company made such election by converting from a Pennsylvania corporation and a Pennsylvania mutual holding company to a Federal corporation and Federal mutual holding company, respectively. The Company and the Mutual Holding Company are savings and loan holding companies within the meaning of the HOLA. As such, the Company and the Mutual Holding Company are registered with the OTS and are subject to OTS regulations, examinations, supervision and reporting requirements. In addition, the OTS has enforcement authority over the Company and the Mutual Holding Company and any nonsavings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. As federal corporations, the Company and the Mutual Holding Company are generally not subject to state business organizations laws.
Permitted Activities. Pursuant to Section 10(o) of the HOLA and OTS regulations and policy, a mutual holding company and a federally chartered mid-tier holding company, such as the Company, may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act, unless the Director of the OTS, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987; and (x) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Director. In addition, a Federal mutual holding company may engage in any activities permissible for a financial holding company under Section 4(k) of the Bank Holding Company Act and regulations of the Federal Reserve Board thereunder, including underwriting debt and equity securities, insurance agency and underwriting, and merchant banking. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed above, and has a period of two years to cease any nonconforming activities and divest of any nonconforming investments.
The HOLA prohibits a savings and loan holding company, including the Company and the Mutual Holding Company, directly or indirectly, or through one or more subsidiaries, from acquiring another savings institution or holding company thereof, without prior written approval of the OTS. It also prohibits the acquisition or retention of more than 5% of the voting stock of another savings institution or savings and loan holding company without the prior approval of the OTS, and from acquiring or retaining control of any depository institution that is not FDIC-insured. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
Qualified Thrift Lender Test. To be regulated as a savings and loan holding company by the OTS (rather than as a bank holding company by the Federal Reserve Board), the Bank must qualify as a Qualified Thrift Lender. To qualify as a Qualified Thrift Lender, the Bank must maintain compliance with the test for a “domestic building and loan association,” as defined in the Internal Revenue Code, or with the Qualified Thrift Lender test. Under the Qualified Thrift Lender test, a savings institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least nine months out of each 12-month period. As of December 31, 2007 the Bank met the Qualified Thrift Lender test.
Waivers of Dividends by the Mutual Holding Company. OTS regulations require the Mutual Holding Company to notify the OTS of any proposed waiver of its right to receive dividends. The OTS reviews dividend waiver notices on a case-by-case basis. During 2007 the Mutual Holding Company requested and received permission from the OTS to waive dividends.
Conversion of the Mutual Holding Company to Stock Form. OTS regulations permit the Mutual Holding Company to convert from the mutual to the stock form of ownership (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new holding company would be formed as the successor to the Company (the “New Holding Company”), the Mutual Holding Company’s corporate existence would end, and certain depositors of the Bank would receive the right to subscribe for additional shares of the New Holding Company. Based upon current OTS policy, in a Conversion Transaction, each share of Common Stock held by the Company’s public stockholders (“Minority Stockholders”) would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant an exchange ratio that ensures that after the Conversion Transaction, subject to any adjustment to reflect the receipt of cash in lieu of fractional shares, the percentage of the to-be outstanding shares of the New Holding Company issued to Minority Stockholders in exchange for their Common Stock would be equal to the percentage of the outstanding shares of Common Stock held by Minority Stockholders immediately prior to the Conversion Transaction. The total number of shares held by Minority
Stockholders after the Conversion Transaction would also be affected by any purchases by such persons in the offering that would be conducted as part of the Conversion Transaction.
Federal Securities Laws
Shares of the Company’s common stock are registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company is also subject to the proxy rules, tender offer rules, insider trading restrictions, annual and periodic reporting, and other requirements of the Exchange Act.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the Securities and Exchange Commission, under the Securities Exchange Act of 1934.
The Sarbanes-Oxley Act includes specific additional disclosure requirements, requires the Securities and Exchange Commission and national securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the Securities and Exchange Commission. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
Although the Company has incurred additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, such compliance has not had a material impact on the Company’s results of operations or financial condition.
Regulatory Enforcement Authority
Federal law provides federal banking regulators 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.
Dividends
The Company’s ability to pay dividends depends, to a large extent, upon the Bank’s ability to pay dividends to the Company. The Banking Code of the Commonwealth of Pennsylvania states, in part, that dividends may be declared and paid by the Bank only out of accumulated net earnings. A dividend may not be declared or paid unless the surplus, prior to the transfer of net earnings, would not be reduced by the payment of the dividend. Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due to the FDIC. The Bank has not declared or paid any dividends which caused the Bank’s surplus to be reduced as described above and the Bank was not in default of any assessment due the FDIC.
In addition, the Bank is required to notify the OTS prior to paying a dividend to the Company, and receive the nonobjection of the OTS to any such dividend.
FEDERAL AND STATE TAXATION
Federal Taxation. For federal income tax purposes, the Company files a consolidated federal income tax return with its wholly owned subsidiaries on a calendar year basis. The applicable federal income tax expense or benefit is properly allocated to each subsidiary based upon taxable income or loss calculated on a separate company basis. The Mutual Holding Company is not permitted to file a consolidated federal income tax return with the Company, and must pay Federal income tax on 20% of the dividends received from the Company. Because the Mutual Holding Company has nominal assets other than the stock of the Company, it does not have a material federal income tax liability other than the tax due on the dividends received from the Company, if any are received.
The Company accounts for income taxes in accordance with SFAS 109. The asset and liability method accounts for deferred income taxes by applying the enacted statutory rates in effect at the balance sheet date to differences between the book cost and the tax cost of assets and liabilities. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax laws.
The Company is currently under examination by the Internal Revenue Service for the tax periods ended June 30, 2005, December 31, 2005 and December 31, 2006. The statute of limitations is open for examinations by the Internal Revenue Service for the tax years ended June 30, 2004 through December 31, 2007.
State Taxation. The Company is subject to the Corporate Net Income Tax and the Capital Stock Tax of the Commonwealth of Pennsylvania. Dividends received from the Bank qualify for a 100% dividends received deduction and are not subject to Corporate Net Income Tax. In addition, the Company’s investments in its subsidiaries qualify as exempt intangible assets and greatly reduce the amount of Capital Stock Tax assessed.
The Bank is subject to the Mutual Thrift Institutions Tax of the Commonwealth of Pennsylvania based on the Bank’s financial net income determined in accordance with generally accepted accounting principles with certain adjustments. The tax rate under the Mutual Thrift Institutions Tax is 11.5%. Interest on Pennsylvania and federal obligations is excluded from net income. An allocable portion of interest expense incurred to carry the obligations is disallowed as a deduction. The Bank is also subject to taxes in the other states in which it conducts business. These taxes are apportioned based upon the volume of business conducted in those states as a percentage of the whole. Because a majority of the Bank’s affairs are conducted in Pennsylvania, taxes paid to other states are not material.
The subsidiaries of the Bank are subject to the Corporate Net Income Tax and the Capital Stock Tax of the Commonwealth of Pennsylvania and other applicable taxes in the states where they conduct business.
ITEM 1A.
ITEM 1A. RISK FACTORS
In addition to factors discussed in the description of the business of the Company and Bank and elsewhere in this report, the following are factors that could adversely affect future results of operations and financial condition of the Company.
Our Stock Value May be Negatively Affected by our Mutual Holding Company Structure, which May Impede Takeovers. The Mutual Holding Company, as the majority stockholder of the Company, is able to control the outcome of virtually all matters presented to stockholders for their approval, including a proposal to acquire the Company. Accordingly, the Mutual Holding Company may prevent the sale of control or merger of the Company or its subsidiaries even if such a transaction were favored by a majority of the public stockholders of the Company.
Changes in Interest Rates Could Adversely Affect the Company’s Results of Operations and Financial Condition. The Company’s results of operations and financial condition are significantly affected by changes in interest rates. Results of operations depend substantially on net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Because the Company’s interest-bearing liabilities generally reprice or mature more quickly than its interest-earning assets, an increase in interest rates generally would tend to result in a decrease in net interest income. The Company has taken steps to mitigate this risk such as investing excess funds in variable rate and short-term investments.
Changes in interest rates may also affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, the Company is subject to reinvestment risk to the extent that it is unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases
in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. Also, increases in interest rates may extend the life of fixed rate assets, whereby, the Company would not have the opportunity to reinvest in higher yielding alternatives.
If the Allowance for Credit Losses is Not Sufficient to Cover Actual Loan Losses, the Company’s Earnings Could Decrease. The Company’s customers may not repay their loans according to the original terms, and the collateral, if any, securing the payment of those loans may be insufficient to pay any remaining loan balance. The Company may experience significant loan losses, which could have a material adverse effect on operating results. The Company makes various assumptions and judgments about the collectibility of the loan portfolio, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. If the assumptions prove to be incorrect, the allowance for credit losses may not be sufficient to cover losses inherent in the loan portfolio, resulting in additions to the allowance. Material additions to the allowance would materially decrease net income.
The Company’s emphasis on the origination of commercial real estate and business loans is one of the more significant factors in evaluating the allowance for loan losses. As the Company continues to increase the amount of such loans, additional or increased provisions for loan losses may be necessary and would decrease earnings.
Bank regulators periodically review the Company’s allowance for loan losses and may require an increase to the provision for loan losses or further loan charge-offs. Any increase in the Company’s allowance for loan losses or loan charge-offs as required by these regulatory authorities could have a material adverse effect on the Company’s results of operations and/ or financial condition.
The Concentration of Loans in the Company’s Primary Market Area May Increase Risk. The Company’s success depends primarily on the general economic conditions in northwest, southwest and central Pennsylvania, western New York, eastern Ohio, Maryland and Florida. Accordingly, the local economic conditions in these areas have a significant impact on the ability of borrowers to repay loans and the value of the collateral securing those loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control would impact these local economic conditions and could negatively affect financial results.
Strong Competition May Limit Growth and Profitability. Competition in the banking and financial services industry is intense. The Company competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors (whether regional or national institutions) have substantially greater resources and lending limits than the Company and may offer certain services that the Company does not or cannot provide. The Company’s profitability depends upon its ability to successfully compete in its market area.
The Company Operates in a Highly Regulated Environment and May Be Adversely Affected by Changes in Laws and Regulations. The Company is subject to extensive regulation, supervision and examination by the OTS, the FDIC and the Commonwealth of Pennsylvania. Such regulators govern the activities in which the Company may engage, primarily for the protection of depositors. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a bank, the classification of assets by a bank and the adequacy of a bank’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on the Company and its operations. The Company believes that it is in substantial compliance with applicable federal, state and local laws, rules and regulations. Because the Company’s business is highly regulated, the laws, rules and applicable regulations are subject to regular modification and change. There can be no assurance that proposed laws, rules and regulations, or any other law, rule or regulation will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect the Company’s business, financial condition or prospects.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2007, the Company conducted its business through its main office located in Warren, Pennsylvania, 131 other full-service offices and eight free-standing drive-up locations throughout its market area in northwest, southwest and central Pennsylvania, fourteen offices in western New York, five offices in eastern Ohio, five offices in Maryland and two offices in south Florida. The Company and its wholly owned subsidiaries also operated 49 consumer finance offices located throughout Pennsylvania and two consumer lending offices in New York. At December 31, 2007, the Company’s premises and equipment had an aggregate net book value of approximately $110.9 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year covered by this report, the Company did not submit any matters to the vote of security holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is listed on the Nasdaq Global Select Market under the symbol “NWSB.” As of December 31, 2007, the Company had 20 registered market makers, 7,361 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 48,580,309 shares outstanding, net of 2,610,800 treasury shares repurchased. As of such date, the Mutual Holding Company held 30,536,457 shares of common stock and stockholders other than the Mutual Holding Company held 18,043,852 shares. The following table sets forth market price and dividend information for the Company’s common stock.
Payment of dividends on the Common Stock is subject to determination and declaration by the Board of Directors and will depend upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, the Company’s results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends, once declared, will continue.
There were no sales of unregistered securities during the quarter ended December 31, 2007.
During the year the Company repurchased 1,502,900 shares of common stock, at an average cost of $27.16, as part of previously announced repurchase programs. The maximum number of shares available for repurchase at December 31, 2007 is 405,600. Subsequent to December 31, 2007, the Company repurchased an additional 132,000 shares of common stock.
The following table reports information regarding purchases of the Company’s common stock during the fourth quarter of 2007 and the stock repurchase plan approved by the Company’s Board of Directors:
ISSUER PURCHASES OF EQUITY SECURITES
Stock Performance Graph
Set forth hereunder is a stock performance graph comparing (a) the cumulative total return on the Common Stock between June 30, 2002 and December 31, 2007, (b) the cumulative total return on stocks included in the Total Return Index for the Nasdaq Stock Market (US) over such period, and (c) the cumulative total return on stocks included in the Nasdaq Bank Index over such period. Cumulative return assumes the reinvestment of dividends, and is expressed in dollars based on an assumed investment of $100.
There can be no assurance that the Company’s stock performance will continue in the future with the same or similar trend depicted in the graph. The Company will not make or endorse any predictions as to future stock performance.
COMPARISON OF 66 MONTH CUMULATIVE TOTAL RETURN*
Among Northwest Bancorp, The NASDAQ Composite Index
And The NASDAQ Bank Index
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial and Other Data
Set forth below are selected consolidated financial and other data of the Company. For additional information about the Company, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company and related notes included elsewhere herein.
*
Ratios are annualized where appropriate
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
In addition to historical information, this document contains forward-looking statements. The forward-looking statements contained in the following sections are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed. Readers should not place undue reliance on these forward-looking statements, as they reflect management’s analysis as of the date of this report. The Company has no obligation to update or revise these forward-looking statements to reflect events or circumstances that occur after the date of this report. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including quarterly reports on Form 10-Q and current reports filed on Form 8-K.
Executive Summary
Effective December 31, 2005, the Company changed its fiscal year end from June 30 to December 31. As such, this report contains certain information for comparative purposes that may not have been previously reported.
Total assets increased by $135.7 million, or 2.1%, to $6.664 billion at December 31, 2007 from $6.528 billion at December 31, 2006. This increase is primarily related to the June 2007 acquisition of Penn Laurel Financial Corporation and its subsidiary CSB Bank (“CSB Bank”). The Company converted CSB Bank’s five Clearfield and Elk County Pennsylvania offices into offices of the Bank. CSB Bank had assets of approximately $230.0 million, including loans of $144.4 million and deposits of $165.8 million.
The earnings of the Company depend primarily on its level of net interest income, which is the difference between interest earned on the Company’s interest-earning assets, consisting primarily of loans, mortgage-backed securities and other investment securities, and the interest paid on interest-bearing liabilities, consisting primarily of deposits, borrowed funds, and trust-preferred securities. Net interest income is a function of the Company’s interest rate spread, which is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to interest-bearing liabilities. Also contributing to the Company’s earnings is noninterest income, which consists primarily of service charges and fees on loan and deposit products and services, fees related to insurance and investment management and trust services, and gains and losses on sale of assets. Interest income and noninterest income are offset by a provision for loan losses, general administrative and other expenses, including employee compensation and benefits and occupancy and equipment costs, as well as by state and federal income tax expense.
Net income for the year ended December 31, 2007 was $49.1 million, or $0.99 per diluted share, a decrease of $2.4 million, or 4.7%, from $51.5 million, or $1.03 per diluted share, for the year ended December 31, 2006. This decrease was a result of a decrease in noninterest income and an increase in noninterest expense, partially offset by an increase in net interest income, all of which are discussed in detail in the following sections.
Critical Accounting Policies
The Company’s critical accounting policies involve accounting estimates that: a) require assumptions about highly uncertain matters, and b) could vary sufficiently to cause a material effect on the Company’s financial condition or results of operations.
Allowance for Loan Losses. In originating loans, the Company recognizes that losses will be experienced on loans and that the risk of loss will vary with, among other things, the type of loan, the creditworthiness of the borrower, general economic conditions and the quality of the collateral for the loan. The Company maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance for loan losses represents management’s estimate of probable losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent losses, information about specific borrower situations and estimated collateral values, and current economic conditions. The loan portfolio and other credit exposures are regularly reviewed by management in its determination of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes a review of historical losses, peer group comparisons, industry data and economic conditions. As an integral part of their examination process, regulatory agencies periodically review the Company’s allowance for loan losses and may require the Company to make additional provisions for estimated losses based upon judgments different from those of management. In establishing the allowance for loan losses, loss factors are applied to various pools of outstanding loans. Loss factors are derived using the Company’s historical loss experience and may be adjusted for factors that affect the collectibility of the portfolio as of the evaluation date. Commercial loans over a certain dollar amount are evaluated individually to determine the required allowance for loan losses and to evaluate the potential impairment of such loans under SFAS 114, “Accounting by Creditors for Impairment of a Loan”. Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Company’s financial condition and results of operations. The allowance review methodology is based on information known at the time of the review. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. Such changes could impact future results. Management believes, to the best of their knowledge, that all known losses as of December 31, 2007 have been recorded.
Goodwill. Goodwill is not subject to amortization but must be tested for impairment at least annually, and possibly more frequently if certain events or changes in circumstances arise. Impairment testing requires that the fair value of each reporting unit be compared to its carrying amount, including goodwill. Reporting units are identified based upon analyzing each of the Company’s individual operating segments. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. Goodwill is allocated to the carrying value of each reporting unit based on its relative fair value at the time it is acquired. Determining the fair value of a reporting unit requires a high degree of subjective management judgment. A discounted cash flow valuation model is used to determine the fair value of each reporting unit. The discounted cash flow model incorporates
such variables as growth of net income, interest rates and terminal values. Based upon an evaluation of key data and market factors, management selects the specific variables to be incorporated into the valuation model. Future changes in the economic environment or the operations of the reporting units could cause changes to these variables, which could give rise to declines in the estimated fair value of the reporting unit. Declines in fair value could result in impairment being identified. The Company has established June 30 of each year as the date for conducting its annual goodwill impairment assessment. The variables are selected as of that date and the valuation model is run to determine the fair value of each reporting unit. At June 30, 2007, the Company did not identify any individual reporting unit where the fair value was less than the carrying value.
Deferred Income Taxes. The Company uses the asset and liability method of accounting for income taxes as prescribed in Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Using this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates the Company makes in determining our deferred tax assets, which are inherently subjective, are reviewed on an ongoing basis as regulatory and business factors change. A reduction in estimated future taxable income could require the Company to record a valuation allowance. Changes in levels of valuation allowances could result in increased income tax expense, and could negatively affect earnings.
Other Intangible Assets. Using the purchase method of accounting for acquisitions, the Company is required to record the assets acquired, including identified intangible assets, and liabilities assumed at their fair values. These fair values often involve estimates based on third party valuations, including appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. Core deposit and other intangible assets are recorded in purchase accounting when a premium is paid to acquire other entities or deposits. Other intangible assets, which are determined to have finite lives, are amortized based on the period of estimated economic benefits received, primarily on an accelerated basis.
Pension Benefits. Pension costs and liabilities are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, benefits earned, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with U.S. generally accepted accounting principles, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation of future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Company’s pension obligations and future expense.
In determining the present value of future obligations for pension benefits at December 31, 2007, the Company used a discount rate of 6.25%, which is slightly higher than the discount rate used at December 31, 2006 of 5.75%. The Company uses the Citigroup Pension Liability Index rate as of the measurement date to determine the discount rate. The Company’s measurement date is currently October 31, but will change to December 31 effective January 1, 2008, concurrent with the Company’s adoption of the measurement provisions of Statement of Financial Accounting Standards No. 158. The Company’s pre-tax pension expense is forecasted to decrease from approximately $5.4 million for the year ended December 31, 2007 to approximately $4.8 million for the year ended December 31, 2008.
Financial Condition
Cash and equivalents. Cash and equivalents increased by $76.3 million, or 49.4%, to $230.6 million at December 31, 2007 from $154.3 million at December 31, 2006. This increase was attributable to cash flows received from a decrease in investment securities and an increase in deposits. Cash and equivalents increased by $2.2 million, or 1.5%, to $154.3 million at December 31, 2006 from $152.1 million at December 31, 2005. This increase was primarily attributable to cash flows received from an increase in deposits.
Investment securities. Investment securities decreased $252.3 million, or 29.5%, to $601.6 million at December 31, 2007 from $853.9 million at December 31, 2006. This decrease was primarily the result of the Company’s November 2007 divestiture of investments that carried higher credit risk as well as the redemption of callable agency securities throughout the year. Included in the sale of investments were securities previously classified as held-to-maturity. As a result of the sale of the held-to-maturity securities, the Company reclassified all of its securities as available-for-sale and going forward for approximately two years will be required to classify all security purchases as available-for-sale. Investment securities increased $119.6 million, or 16.3%, to $853.9 million at December 31, 2006 from $734.3 million at December 31, 2005. This increase was
primarily the result of funds received from loan sales being temporarily invested in investment securities until the Company used such funds to originate consumer and commercial loans.
Mortgage-backed securities. Mortgage-backed securities decreased $98.9 million, or 15.7%, to $531.7 million at December 31, 2007 from $630.6 million at December 31, 2006. This decrease was the result of accelerated principal repayments occurring throughout the year due to decreasing interest rates for mortgage loans. Mortgage-backed securities increased $116.8 million, or 22.7%, to $630.6 million at December 31, 2006 from $513.8 million at December 31, 2005. This increase was the result of the funds received from loan sales being invested in mortgage-backed securities pending the reinvestment into consumer and commercial loans.
Loans receivable. Net loans receivable increased $383.2 million, or 8.7%, to $4.796 billion at December 31, 2007 from $4.412 billion at December 31, 2006. This increase in loans was primarily attributable to growth in the Company’s consumer and commercial loan portfolios as well as the acquisition of CSB Bank. Consumer home equity loans increased $105.0 million, or 11.8%, commercial real estate loans increased $204.6 million, or 29.2%, and commercial business loans increased $132.1 million, or 56.2%. Included in these increases was the acquisition of CSB Bank which added loans of $144.4 million, including commercial loans of $102.3 million. Net loans receivable decreased $209.8 million, or 4.5%, to $4.412 billion at December 31, 2006 from $4.622 billion at December 31, 2005. The decrease in loans was primarily attributed to the sale of one- to four- family mortgage loans and education loans, offset by strong demand for consumer and commercial loans throughout the Company’s market area, as well as the acquisition of Maryland Permanent Bank in May of 2006, which provided loans of $62.2 million.
Deposits. Deposits increased $175.6 million, or 3.3%, to $5.542 billion at December 31, 2007 from $5.367 billion at December 31, 2006. This increase in deposits was primarily attributable to the acquisition of CSB Bank, which contributed deposits of $165.8 million. Deposits increased by $138.3 million, or 2.6%, to $5.367 billion at December 31, 2006 from $5.228 billion at December 31, 2005. This increase was primarily attributed to the acquisition of Maryland Permanent Bank with deposits of $83.3 million.
Shareholders’ equity. Shareholders’ equity increased by $8.3 million, or 1.4%, to $612.9 million at December 31, 2007 from $604.6 million at December 31, 2006. This increase in shareholders’ equity was primarily attributable to net income of $49.1 million and other comprehensive income of $12.4 million, which was partially offset by the payment of dividends of $15.7 million and the repurchase of treasury stock of $40.8 million. Shareholders’ equity increased by $18.9 million, or 3.2%, to $604.6 million at December 31, 2006 from $585.7 million at December 31, 2005. This increase was primarily attributed to net income of $51.5 million, which was partially offset by the payment of dividends of $13.7 million, the effect of the adoption of new pension accounting rules which decreased shareholders’ equity by $10.3 million and the repurchase of treasury stock of $8.1 million.
Results of Operations - Year ended December 31, 2007 compared to year ended December 31,
Interest income. Interest income increased $27.3 million, or 7.2%, on a taxable equivalent basis, to $404.6 million for the year ended December 31, 2007 from $377.3 million for the year ended December 31, 2006. The increase in interest income was due to both an increase in the average balance of interest-earning assets and an increase in the average yield on interest-earning assets. The average balance of interest-earning assets increased $163.9 million, or 2.7%, to $6.249 billion for the year ended December 31, 2007 from $6.085 billion for the year ended December 31, 2006. The average rate earned on interest-earnings assets increased by 25 basis points, to 6.45% for the year ended December 31, 2007 from 6.20% for the year ended December 31, 2006. The growth in average interest-earning assets was primarily attributable to the acquisition of CSB Bank and the increase in average rate was primarily attributable to the continued change in mix of the Company’s loan portfolio with an emphasis on increasing the percentage of consumer and commercial loans while decreasing the percentage of one- to four-family mortgage loans.
Interest income on loans receivable increased $29.3 million, or 10.2%, on a taxable equivalent basis, to $317.3 million for the year ended December 31, 2007 from $288.0 million for the year ended December 31, 2006. This increase was attributable to increases in both the average balance of loans receivable and the average yield on those loans. The average loans receivable balance increased $265.4 million, or 6.0%, to $4.661 billion for the year ended December 31, 2007 from $4.395 billion for the year ended December 31, 2006. This increase was attributable to both the Company’s efforts in attracting and maintaining quality consumer and commercial loan relationships as well as the acquisition of CSB Bank. During the year the Company increased commercial loan balances by $336.8 million, or 35.9% and consumer home equity loans by $105.0 million, or 11.8%. The average yield on loans receivable increased 19 basis points for the year ended December 31, 2007 to 6.78% from
6.59% for the year ended December 31, 2006. This increase was primarily attributable to the significant growth in consumer and commercial loans which generally carry higher rates of interest than mortgage loans.
Interest income on mortgage-backed securities decreased $2.1 million, or 6.8%, to $29.4 million for the year ended December 31, 2007 from $31.5 million for the year ended December 31, 2006. This decrease is primarily attributable to a decrease in the average balance of $76.9 million, or 11.6%, to $584.1 million for the year ended December 31, 2007 from $661.0 million for the year ended December 31, 2006. This decrease was attributable to the Company’s efforts to use cash flows from these securities to fund loan growth. The decrease in average balance was partially offset by an increase in the average yield of 26 basis points to 5.03% for the year ended December 31, 2007 from 4.77% for the year ended December 31, 2006 as the yield on floating rate bonds increased over the past 18 months with the movement of short-term interest rates.
Interest income on investment securities decreased $1.5 million, or 3.0%, on a taxable equivalent basis, to $48.0 million for the year ended December 31, 2007 from $49.5 million for the year ended December 31, 2006. This decrease was primarily attributable to a decrease in the average balance of $41.1 million, or 4.8%, to $820.3 million for the year ended December 31, 2007 from $861.4 million for the year ended December 31, 2006. This decrease was attributable to the Company’s efforts to use cash flows from these securities to fund loan growth. The decrease in average balance was partially offset by an increase in the average yield of 11 basis points to 5.85% for the year ended December 31, 2007 from 5.74% for the year ended December 31, 2006. This increase in average yield is primarily attributable to the Company purchasing securities during the year yielding higher interest rates than those in the investment portfolio.
Interest expense. Interest expense increased $19.9 million, or 10.4%, to 211.0 million for the year ended December 31, 2007 from $191.1 million for the year ended December 31, 2006. This increase was attributed to increases in both the average balance and the average rate paid on deposits. The average balance increased $235.0 million, or 4.7%, to $5.206 billion for the year ended December 31, 2007 from $4.971 billion for the year ended December 31, 2006. This increase was primarily due to the acquisition of CSB Bank, which contributed approximately $82.9 million to the average balance of deposits. The average rate paid on deposits increased 42 basis points to 3.58% for the year ended December 31, 2007 from 3.16% for the year ended December 31, 2006. This increase in the average rate was due to both a general increase in average short-term rates and the change in mix of deposits with an increase in higher cost certificates of deposit and a decrease in low-cost passbook and statement savings accounts. Partially offsetting the increase in the cost of deposits was a decrease in interest expense on trust preferred debentures of $8.4 million, as the Company redeemed approximately $99.0 million of trust preferred securities in December 2006.
Net interest income (including GAAP reconciliation). Net interest income increased $7.4 million, or 4.0%, on a taxable equivalent basis, to $193.6 million for the year ended December 31, 2007 from $186.2 million for the year ended December 31, 2006. This increase was a result of the factors previously discussed, primarily due to a larger increase in interest earning assets than in interest bearing liabilities contributing to a four basis point increase in net interest margin to 3.10% for the year ended December 31, 2007 from 3.06% for the year ended December 31, 2006. The interest earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than a taxable investment. To provide more meaningful comparisons of yields for all interest-earning assets, we also provide net interest income on a taxable-equivalent basis by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP in the Consolidated Statements of Income. Net interest income on a GAAP basis was $185.0 million, the taxable-equivalent adjustment was $8.6 million and the net interest income on a taxable equivalent basis was $193.6 million for the year ended December 31, 2007. Net interest income on a GAAP basis was $177.5 million, the taxable-equivalent adjustment was $8.7 million and the net interest income on a taxable equivalent basis was $186.2 million for the year ended December 31, 2006.
Provision for loan losses. Management analyzes the allowance for loan losses as described in the section “Allowance for Loan Losses.” The provision recorded adjusts this allowance to a level that reflects the loss inherent in the Company’s loan portfolio as of the reporting date. The provision for loan losses increased $263,000, or 3.1%, to $8.7 million for the year ended December 31, 2007 from $8.5 million for the year ended December 31, 2006. To the best of management’s knowledge, all known losses as of December 31, 2007 have been recorded.
Noninterest income. Noninterest income decreased $3.0 million, or 6.5%, to $43.0 million for the year ended December 31, 2007 from $46.0 million for the year ended December 31, 2006. This decrease in noninterest income was primarily due to the loss on sale of investment securities in the amount of $1.6 million and a noncash other-than temporary impairment of Freddie Mac preferred stock of $1.9 million. The decrease was also impacted by a $4.1 million gain on the sale of education loans in the previous year. The negative effect of the prior year gain on sale of education loans and the current year
losses on securities were partially offset by increases in service charges and fees of $3.3 million, trust and other financial services income of $902,000, insurance commission income of $155,000 and mortgage banking income of $1.2 million.
Noninterest expense. Noninterest expense increased $9.0 million, or 6.3%, to $152.7 million for the year ended December 31, 2007 from $143.7 million for the year ended December 31, 2006. This increase was primarily due to an increase in compensation and employee benefits of $5.6 million, an increase in processing expenses of $3.0 million, an increase in premises and occupancy costs of $1.0 million, an increase in advertising of $924,000 and an increase in amortization of intangible assets of $623,000 all of which are partially offset by a decrease in the loss on early extinguishment of debt of $3.1 million. These increases in operating expenses were a result of the Company’s continued expansion of its existing retail office network, both de novo and through the CSB acquisition, as well as the addition of commercial lending and investment management and trust personnel.
Income taxes. Income tax expense decreased $2.3 million, or 11.8%, to $17.5 million for the year ended December 31, 2007 from $19.8 million for the year ended December 31, 2006. This decrease is due to a decrease in income before income taxes of $4.8 million and a decrease in the effective tax rate from 27.7% to 26.2%. The decrease in the effective tax rate was primarily due to lower state incomes taxes and a higher percentage of earnings on tax free assets during the current year.
Results of Operations - Year ended December 31, 2006 compared to twelve months ended December 31, 2005
Interest income. Interest income increased $34.7 million, or 10.1%, on a taxable equivalent basis, to $377.3 million for the year ended December 31, 2006 from $342.6 million for the twelve-month period ended December 31, 2005. The increase in interest income was due to both an increase in the average balance of interest-earning assets and an increase in the average yield on interest-earning assets. The average balance of interest-earning assets increased $173.3 million, or 2.9%, to $6.085 billion for the year ended December 31, 2006 from $5.912 billion for the twelve months ended December 31, 2005. The average rate earned on interest-earning assets increased by 40 basis points, to 6.20% for the year ended December 31, 2006 from 5.80% for the twelve months ended December 31, 2005. The growth of average interest-earning assets is primarily attributable to the acquisition of Maryland Permanent Bank, while the increase in the average rate earned is primarily attributable to the increase in market interest rates that occurred during the year ended December 31, 2006.
Interest income on loans receivable increased $12.5 million, or 4.5%, on a taxable equivalent basis, to $288.0 million for the year ended December 31, 2006 from $275.5 million for the twelve-month period ended December 31, 2005. This increase is primarily attributable to an increase in the average yield on loans, partially offset by a decrease in the average balance. The average yield on loans receivable increased 36 basis points to 6.59% for the year ended December 31, 2006 from 6.23% for the twelve months ended December 31, 2005. This increase is primarily attributable to the Company’s effort to shift its lending focus from growing one- to four- family mortgage loans to originating more consumer and commercial loans which generally have higher interest rates. During the year, the Company increased home equity consumer loans by $106.9 million, or 13.7%, to $887.4 million from $780.5 million and commercial loans by $185.2 million, or 24.6%, to $937.3 million from $752.1 million while reducing one- to four-family mortgage loans by $394.9 million to $2.411 billion from $2.806 billion.
Interest income on mortgage-backed securities increased $7.4 million, or 30.5%, to $31.5 million for the year ended December 31, 2006 from $24.1 million for the twelve month period ended December 31, 2005. This increase in interest income resulted from increases in both the average balance of mortgage-backed securities and the average rate earned on mortgage-backed securities. The average balance increased $33.0 million, or 5.3%, to $661.0 million for the year ended December 31, 2006 from $628.0 million for the twelve months ended December 31, 2005. This increase is due primarily to the Company investing excess funds from the previously discussed loan sales in these and other types of securities until it can direct the funds to the loan portfolio. The average yield earned on mortgage-backed securities increased 92 basis points to 4.77% for the year ended December 31, 2006 from 3.85% for the twelve months ended December 31, 2005. This increase is the result of the generally higher market interest rates.
Interest income on investment securities increased $10.3 million, or 26.4%, on a taxable equivalent basis, to $49.5 million for the year ended December 31, 2006 from $39.2 million for the twelve-month period ended December 31, 2005. This increase in interest income is the result of increases in both the average balance of investment securities and the average yield earned on investment securities. The average balance increased $121.7 million, or 16.5% to $861.4 million for the year ended December 31, 2006 from $739.7 million for the twelve months ended December 31, 2005. This increase was due to the investment of funds received from loan sales until these funds could be reinvested in consumer and commercial loans. The average yield increased 45 basis points to 5.74% for the year ended December 31, 2006 from 5.29% at for the twelve months ended December 31, 2005. This increase is due to the general increase in market interest rates.
Interest expense. Interest expense increased $41.0 million, or 27.3%, to $191.1 million for the year ended December 31, 2006 from $150.1 million for the twelve-month period ended December 31, 2005. This increase is due to increases in both the average balance of interest-bearing liabilities and the average rate paid on interest-bearing liabilities. The average balance of interest-bearing liabilities increased $125.7 million, or 2.3%, to $5.578 billion for the year ended December 31, 2006 from $5.452 billion for the twelve months ended December 31, 2005. This increase is due primarily to the acquisition of Maryland Permanent Bank as well as the addition of approximately $100.0 million of trust preferred securities with interest rates 2.22% lower than the existing trust preferred securities. The average rate paid on interest-bearing liabilities increased 68 basis points to 3.43% for the year ended December 31, 2006 from 2.75% for the twelve months ended December 31, 2005. This increase is due to higher market interest rates as well as a shift by our customers from savings accounts to certificates of deposit.
Net interest income (including GAAP reconciliation). Net interest income decreased $6.3 million, or 3.3%, on a taxable equivalent basis, to $186.2 million for the year ended December 31, 2006 from $192.5 million for the twelve month period ended December 31, 2005. This decrease is a result of the factors discussed in the previous analysis, primarily the sustained increase in interest rates which caused interest bearing liabilities to reprice faster than interest earnings assets. The interest earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than a taxable investment. To provide more meaningful comparisons of yields for all interest-earning assets, we also provide net interest income on a taxable-equivalent basis by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP in the Consolidated Statements of Income. Net interest income on a GAAP basis was $177.5 million, the taxable-equivalent adjustment was $8.7 million and the net interest income on a taxable equivalent basis was $186.2 million for the year ended December 31, 2006. Net interest income on a GAAP basis was $184.6 million, the taxable-equivalent adjustment was $7.9 million and the net interest income on a taxable equivalent basis was $192.5 million for the twelve months ended December 31, 2005.
Provision for Loan Losses. Management analyzes the allowance for loan losses as described in the section “Allowance for Loan Losses.” The provision recorded adjusts this allowance to a level that reflects the loss inherent in the Company’s loan portfolio. The provision for loan losses decreased $1.8 million, or 17.6 %, to $8.5 million for the year ended December 31, 2006 from $10.3 million for the twelve-month period ended December 31, 2005. To the best of management’s knowledge, all known losses as of December 31, 2006 have been recorded.
Noninterest Income. Noninterest income increased $9.3 million, or 25.3%, to $46.0 million for the year ended December 31, 2006 from $36.7 million for the twelve-month period ended December 31, 2005. The increase in noninterest income was due primarily to increases in service charges and fees, trust and other financial services income and gains on sale of loans. Service charges and fees increased $5.6 million, or 27.1%, to $26.3 million for the year ended December 31, 2006 from $20.7 million for the twelve-month period ended December 31, 2005. This increase is due to a change in the way the Company processes overdraft items and the implementation of the Company’s overdraft protection program. Trust and other financial services income increased $875,000, or 19.7%, to $5.3 million for the year ended December 31, 2006 from $4.4 million for the twelve-month period ended December 31, 2005. This increase is due primarily to an increase in the balance of assets under management. The gain on sale of loans increased $3.1 million to $3.4 million for the year ended December 31, 2006 from $343,000 for the twelve-month period ended December 31, 2005. This large increase is due to the divestiture of the Company’s education loan portfolio of approximately $130 million.
Noninterest Expense. Noninterest expense increased $11.8 million, or 8.9%, to $143.7 million for the year ended December 31, 2006 from $131.9 million for the twelve-month period ended December 31, 2005. This increase is due primarily to increases in compensation and employee benefits, premises and occupancy costs, office operations, processing expenses and the loss on the early extinguishment of debt. Excluding the loss on the early extinguishment of debt, these major expense categories have all increased as a result of the growth of the Bank’s retail franchise. Compensation and employee benefits increased $5.9 million, or 8.1%, to $78.6 million for the year ended December 31, 2006 from $72.7 million for the twelve-month period ended December 31, 2005. The primary reason for this increase is the addition of commercial lenders, trust officers and business services personnel to assist in meeting the Company’s strategic objectives. The loss on the early extinguishment of debt of $3.1 million is related to the redemption of seasoned trust preferred securities issued in 2001. The loss recorded represents the write-off of the unamortized deferred issuance expenses that were capitalized when the securities were issued.
Income Taxes. Income tax expense decreased $2.6 million, or 11.5 %, to $19.8 million for the year ended December 31, 2006 from $22.4 million for the twelve-month period ended December 31, 2005. This decrease is due to a decrease in income before income taxes and a decrease in the effective tax rate. The effective tax rate for the year ended December 31, 2006 was 27.7% compared with 28.3% for the twelve-month period ended December 31, 2005. The decrease in the effective tax rate was due to a higher percentage of earnings on tax-free assets during 2006.
Results of Operations - Six months ended December 31, 2005 compared to six months ended December 31, 2004
Interest income. Interest income increased by $13.0 million, or 8.0%, on a taxable equivalent basis, to $174.5 million for the six-month transition period ended December 31, 2005 from $161.5 million for the six-month period ended December 31, 2004. The increase was primarily due to an increase in the average rate earned on interest-earning assets of 44 basis points. This increase in average rate earned was primarily due to an increase in the yield on variable rate assets during a period of increasing short-term interest rates.
Interest income on loans receivable increased by $13.4 million, or 10.4%, on a taxable equivalent basis, to $142.0 million for the six-month transition period ended December 31, 2005 from $128.6 million for the six-month period ended December 31, 2004. This increase resulted from continued portfolio growth and an increase in the portfolio yield. Average loans outstanding increased by $375.1 million, or 9.0%, to $4.533 billion from $4.157 billion, while the average taxable equivalent yield on these loans increased eight basis points to 6.27% from 6.19%. The increase in yield was due primarily to the Company’s efforts to shift the loan mix to consumer and commercial loans carrying higher interest rates.
Interest income on mortgage-backed securities decreased by $2.0 million, or 14.7%, to $11.3 million for the six-month transition period ended December 31, 2005 from $13.3 million for the six-month period ended December 31, 2004 as the average balance outstanding decreased by $203.5 million, or 26.4%, to $568.9 million for the six months ended December 31, 2005 from $772.4 million for the six months ended December 31, 2004. Partially offsetting this decrease in average balance was an increase in the average rate earned of 54 basis points to 3.98% for the six months ended December 31, 2005 from 3.44% for the six months ended December 31, 2004.
Interest income on investment securities increased by $2.7 million, or 16.0%, on a taxable equivalent basis, to $19.6 million for the six-month transition period ended December 31, 2005 from $16.9 million for the six-month period ended December 31, 2004. This increase was due to the average balance increasing by $99.2 million, or 15.7%, to $731.6 million for the six months ended December 31, 2005 from $632.4 million for the six months ended December 31, 2004 as the average yield remained relatively unchanged at 5.35%. The increase in average balance results from a change in investment philosophy where more available funds were allocated to the purchase of investment securities than the purchase of mortgage-backed securities.
Interest expense. Interest expense increased by $12.0 million, or 17.9%, to $79.4 million for the six-month transition period ended December 31, 2005 from $67.4 million for the six-month period ended December 31, 2004. This increase in interest expense resulted from a 46 basis point increase in the average rate paid on interest-bearing liabilities while the average balance decreased by $80.3 million, or 1.5%, to $5.439 billion for the six months ended December 31, 2005 from $5.520 billion for the six months ended December 31, 2004. The increase in average rate paid on interest-bearing liabilities was a result of the overall increases in market rates, which significantly increased the rates paid on interest-bearing checking, money market and certificate accounts.
Net interest income (including GAAP reconciliation). Net interest income increased by $880,000, or 1.0%, on a taxable equivalent basis, to $95.0 million for the six-month transition period ended December 31, 2005 from $94.2 million for the six-month period ended December 31, 2004. This increase is the combined result of the factors discussed above. The interest earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than a taxable investment. To provide more meaningful comparisons of yields for all interest-earning assets, we also provide net interest income on a taxable-equivalent basis by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP in the Consolidated Statements of Income. Net interest income on a GAAP basis was $91.0 million, the taxable-equivalent adjustment was $4.0 million and the net interest income on a taxable equivalent basis was $95.0 million for the six months ended December 31, 2005. Net interest income on a GAAP basis was $90.2 million, the taxable-equivalent adjustment was $4.0 million and the net interest income on a taxable equivalent basis was $94.2 million for the six months ended December 31, 2004.
Provision for Loan Losses. Management analyzes the allowance for loan losses as described in the section “Allowance for Loan Losses.” The provision recorded adjusts this allowance to a level that reflects the loss inherent in the Company’s loan portfolio. The provision for loan losses increased by $719,000, or 18.0%, to $4.7 million for the six-month transition period ended December 31, 2005 from $4.0 million for the six-month period ended December 31, 2004. The increase in the provision relates to an increase in delinquencies and nonperforming assets.
Noninterest income. Noninterest income increased by $4.8 million, or 31.4%, to $19.9 million for the six-month transition period ended December 31, 2005 from $15.1 million for the six-month period ended December 31, 2004. The increase in noninterest income is primarily due to increases in service charges and fees, trust and other financial services income and insurance commission income. Service charges and fees increased $3.9 million, or 49.0%, to $11.9 million while trust and other financial services income and insurance commission income had modest increases of $155,000 and $251,000, respectively. The increase in service charges and fees were largely attributable to a new overdraft product the Company implemented during the six-month transition period. The increases in trust and other financial services income and insurance commission income are largely volume related.
Noninterest expense. Noninterest expense increased $3.3 million, or 5.2%, to $66.3 million for the six-month transition period ended December 31, 2005 from $63.0 million for the six-month period ended December 31, 2004. Most major expense categories increased during the six-month transition period with the largest single increases in compensation and employee benefits and premises and occupancy costs. Contributing to these increases were an increase in full-time equivalent employees, the increased cost of health insurance and related benefits as well as an increased number of offices operated by the Company. Increases in the other major expense categories are attributed to the overall growth of the Company. As the Company positions its focus on increased business related services, commercial lending and investment management and trust the Company anticipates that related expense such as compensation and benefits will increase.
Income taxes. Income tax expense decreased by $376,000, or 3.3%, to $11.0 million for the six-month transition period ended December 31, 2005 from $11.4 million for the six-month period ended December 31, 2004. The effective tax rate at December 31, 2005 was 27.6%. This low effective tax rate is primarily due to the receipt of federal and state tax credits during the six month period.
Results of Operations - Fiscal year ended June 30, 2005 compared to fiscal year ended June 30,
Interest income. Interest income increased by $21.7 million, or 7.1%, on a taxable equivalent basis, to $329.7 million for the fiscal year ended June 30, 2005 from $308.0 million for the fiscal year ended June 30, 2004. The increase was primarily due to increases in both average interest-earning assets of $89.4 million and average rate earned on interest-earning assets of 29 basis points. The increase in interest-earning assets was due to the continued growth of the Northwest franchise, while the increase in average rates earned was due to an increase in the yield on variable rate assets during a period of increasing short-term interest rates.
Interest income on loans receivable increased by $17.3 million, or 7.0%, on a taxable equivalent basis, to $262.2 million for the fiscal year ended June 30, 2005 from $244.9 million for the fiscal year ended June 30, 2004. This increase resulted from continued portfolio growth, the effects of which were offset by a decrease in the portfolio yield. Average loans outstanding increased by $388.0 million, or 10.1%, to $4.234 billion from $3.846 billion, while the average taxable equivalent yield on these loans decreased 18 basis points to 6.19% from 6.37%. The decrease in yield was due primarily to the refinancing of loans with rates that were higher than current market rates.
Interest income on mortgage-backed securities increased by $287,000, or 1.1%, to $26.1 million for the fiscal year ended June 30, 2005 from $25.8 million for the fiscal year ended June 30, 2004. Interest income on mortgage-backed securities increased due to the average rate increasing by 66 basis points from 2.92% to 3.58%, which was largely offset by a decrease in the average balance of $154.1 million, or 17.4% to $729.8 million from $883.9 million. The increase in yield reflects an increase in the rates for variable rate securities and the decrease in average balance reflects the Company’s effective deployment of funds from mortgage-backed securities to loans.
Interest income on investment securities increased by $3.3 million, or 9.9%, on a taxable equivalent basis, to $36.4 million for the fiscal year ended June 30, 2005 from $33.1 million for the fiscal year ended June 30, 2004. This increase was due to the average balance increasing by $27.4 million, or 4.1%, from $662.7 million to $690.1 million and the average rate increasing 28 basis points from 5.00% to 5.28%. The increase in average balance results from the Company’s ongoing management of its balance sheet where overnight funds were moved into investment securities that provide higher yields. The increase in interest rates resulted from rates on variable rate investments increasing with the general upward movement in market interest rates.
Interest expense. Interest expense increased by $3.5 million, or 2.7%, to $138.0 million for the fiscal year ended June 30, 2005 from $134.5 million for the fiscal year ended June 30, 2004. This relatively modest increase in interest expense resulted from a $16.3 million, or less than 1%, increase in interest bearing liabilities combined with a 5 basis points increase in the average cost to 2.51% from 2.46%.
Net interest income (including GAAP reconciliation). Net interest income increased by $18.2 million, or 10.5%, on a taxable equivalent basis, to $191.7 million for the fiscal year ended June 30, 2005 from $173.5 million for the fiscal year ended June 30, 2004. This increase is the combined result of all of the factors discussed above. The interest earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than a taxable investment. To provide more meaningful comparisons of yields for all interest-earning assets, we also provide net interest income on a taxable-equivalent basis by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP in the Consolidated Statements of Income. Net interest income on a GAAP basis was $183.8 million, the taxable-equivalent adjustment was $7.9 million and the net interest income on a taxable equivalent basis was $191.7 million for the fiscal year ended June 30, 2005. Net interest income on a GAAP basis was $165.8 million, the taxable-equivalent adjustment was $7.7 million and the net interest income on a taxable equivalent basis was $173.5 million for the fiscal year ended June 30, 2004.
Provision for Loan Losses. Management analyzes the allowance for loan losses as described in the section “Allowance for Loan Losses.” The provision recorded adjusts this reserve to a level that reflects the loss inherent in the Company’s loan portfolio. The provision for loan losses increased by $2.7 million, or 39.5%, to $9.6 million for the year ended June 30, 2005 from $6.9 million for the year ended June 30, 2004. The increase in the provision is a result of increased charge-offs during the current fiscal year and the current trend in delinquencies.
Noninterest income. Noninterest income increased by $142,000, or less than 1%, to $32.0 million for the year ended June 30, 2005 from $31.9 million for the year ended June 30, 2004. The increase in noninterest income is primarily due to an increase in service charges and fees, trust and other financial services income as well as an increase in insurance commission income. Service charges and fees increased $2.7 million, or 19.3%, to $16.8 million, trust and other financial services income increased $309,000, or 7.8%, to $4.3 million and insurance commission income increased $1.3 million, or 134.4%, to $2.2 million. The increase in service charges and other financial services income is due to increased volume and growth. Insurance commission income increased primarily as a result of the Company again offering insurance products on consumer loans. Offsetting these increases was a decrease in the gain on sale of marketable securities. Gain on sale of marketable securities decreased by $4.0 million to $523,000 for the fiscal year ended June 30, 2005 from $4.5 million for the fiscal year ended June 30, 2004. The gain on sale of marketable securities during the prior fiscal year was heavily influenced by the Company’s restructuring of its balance sheet after its acquisition of Bell Federal Savings and Loan Association. The gains recorded in the current year resulted primarily from securities being called at prices that exceeded the Company’s carrying value. It is not the Company’s policy to actively sell investments to increase noninterest income.
Noninterest expense. Noninterest expense decreased $146,000, or less than 1%, to $128.7 million for the year ended June 30, 2005 from $128.8 million for the year ended June 30, 2004. Most major expense categories increased during the year with the largest increase recorded in compensation and employee benefits. Prior year noninterest expense includes a goodwill impairment charge of $7.9 million and a penalty on the prepayment of FHLB borrowings of $2.5 million, both recorded by First Carnegie prior to its acquisition by the Company. Excluding these items, noninterest expense increased $10.3 million, or 8.7%, to $128.7 million for the year ended June 30, 2005 from $118.4 million for the prior fiscal year. Compensation and employee benefits increased by $6.3 million, or 9.5%, to $71.8 million for the year ended June 30, 2005 from $65.6 million for the year ended June 30, 2004. Contributing to this increase was an increase in full-time equivalent employees and the overall cost of health insurance. Other increases in the major expense categories are attributed to the overall growth of the Company. During the year ended June 30, 2005, the Company increased its core banking franchise by four retail offices.
Income taxes. Income tax expense increased by $3.0 million, or 14.7%, to $22.8 million for the year ended June 30, 2005 from $19.8 million for the year ended June 30, 2004. Primarily contributing to the increase was an increase in pre-tax income of $15.6 million, or 25.2%.
Average Balance Sheets. The following tables set forth certain information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.
(1)
Average gross loans receivable includes loans held as available-for-sale and loans placed on nonaccrual status.
(2)
Interest income includes accretion/amortization of deferred loan fees/expenses, which were not material.
(3)
Interest income on tax-free loans is presented on a taxable equivalent basis including adjustments of $1,751, $1,721 and $1,519, respectively.
(4)
Interest income on tax-free investment securities is presented on a taxable equivalent basis including adjustments of $6,798, $6,992 and $6,435, respectively.
(5)
Average balances do not include the effect of unrealized gains or losses on securities held as available-for-sale.
(6)
Average balances include Fannie Mae and Freddie Mac stock.
(7)
Average balances include the effect of unrealized gains or losses on securities held as available-for-sale.
(8)
Average balances include FHLB advances, securities sold under agreements to repurchase and other borrowings.
(9)
Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(10)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
(1)
Average gross loans receivable includes loans held as available-for-sale and loans placed on nonaccrual status.
(2)
Interest income includes accretion/amortization of deferred loan fees/expenses, which were not material.
(3)
Interest income on tax-free loans is presented on a taxable equivalent basis including adjustments of $819 and $625, respectively.
(4)
Interest income on tax-free investment securities is presented on a taxable equivalent basis including adjustments of $3,188 and $3,318, respectively.
(5)
Average balances do not include the effect of unrealized gains or losses on securities held as available-for-sale.
(6)
Average balances include Fannie Mae and Freddie Mac stock.
(7)
Average balances include the effect of unrealized gains or losses on securities held as available-for-sale.
(8)
Average balances include FHLB advances, securities sold under agreements to repurchase and other borrowings.
(9)
Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(10)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
(11)
Presented on an annualized basis.
(1)
Average gross loans receivable includes loans held as available-for-sale and loans placed on nonaccrual status.
(2)
Interest income includes accretion/amortization of deferred loan fees/expenses, which were not material.
(3)
Interest income on tax-free loans is presented on a taxable equivalent basis including adjustments of $1,325 and $1,296, respectively.
(4)
Interest income on tax-free investments is presented on a taxable equivalent basis including adjustments of $5,565 and $6,442, respectively.
(5)
Average balances do not include the effect of unrealized gains or losses on securities held as available-for-sale.
(6)
Average balances include Fannie Mae and Freddie Mac stock.
(7)
Average balances include the effect of unrealized gains or losses on securities held as available-for-sale.
(8)
Average balances include FHLB advances, securities sold under agreements to repurchase and other borrowings.
(9)
Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(10)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
Rate/Volume Analysis. Net interest income can also be analyzed in terms of the impact of changes in interest rates on interest-earning assets and interest-bearing liabilities and changes in the volume or amount of these assets and liabilities. The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (change in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) the net change. Changes that cannot be attributed to either rate or volume have been allocated to both rate and volume.
Regulatory Capital Requirements. The FDIC’s capital regulations establish a minimum 3.0% Tier I 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 will increase the minimum Tier I leverage ratio for such other banks to 4.0% to 5.0% or more. Under the FDIC’s 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, and usually rated composite 1 under the Uniform Financial Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders’ equity (including retained earnings, but excluding accumulated other comprehensive income), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain qualifying supervisory goodwill, and certain purchased mortgage servicing rights and purchased credit card relationships.
The FDIC also requires that savings banks meet a risk-based capital standard. The risk-based capital standard for savings banks requires the maintenance of total capital, which is defined as Tier I 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 I capital are equivalent to those discussed above under the 3% leverage standard. The components of supplementary (Tier 2) capital include certain perpetual preferred stock, certain mandatory convertible securities, certain subordinated debt and intermediate preferred stock and general allowances 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 capital counted toward supplementary capital cannot exceed 100% of core capital. At December 31, 2007, the Bank exceeded its capital requirements.
A bank which has less than the minimum leverage capital requirement shall, within 60 days of the date as of which it fails to comply with such requirement, submit to its FDIC regional director for review and approval a reasonable plan describing the means and timing by which the bank shall achieve its minimum leverage capital requirement. A bank which fails to file such plan with the FDIC is deemed to be operating in an unsafe and unsound manner, and could be subject to a cease-and-desist order from the FDIC. The FDIC’s regulation also provides that any insured depository institution with a ratio of Tier I 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 FDIA and is subject to potential termination of deposit insurance. However, such an institution will not be subject to an enforcement proceeding thereunder solely on account of its capital ratios if it has entered into and is in compliance with a written agreement with the FDIC to increase its Tier I leverage capital ratio to such level as the FDIC deems appropriate and to take such other action as may be necessary for the institution to be operated in a safe and sound manner. The FDIC capital regulation also provides, among other things, for the issuance by the FDIC or its designee(s) of a capital directive, which is a final order issued to a bank that fails to maintain minimum capital to restore its capital to the minimum leverage capital requirement within a specified time period. Such directive is enforceable in the same manner as a final cease-and-desist order.
The following table summarizes the Bank’s total shareholder’s equity, regulatory capital, total risk-based assets, and leverage and risk-based regulatory ratios at December 31, 2007 and 2006.
(1)
Tier 2 capital consists of the allowance for loan losses, which is limited to 1.25% of total risk-weighted assets as detailed under regulations of the FDIC, and 45% of pre-tax net unrealized gains on securities available-for-sale.
(2)
The FDIC has indicated that the most highly rated institutions which meet certain criteria will be required to maintain a ratio of 3.00%, and all other institutions will be required to maintain an additional cushion of 100 to 200 basis points.
The Bank is also subject to Pennsylvania Department of Banking (“Department”) capital guidelines. Although not adopted in regulation form, the Department utilizes capital standards of 6% leverage capital and 10% risk-based capital. The components of leverage and risk-based capital are substantially the same as those defined by the FDIC.
Liquidity and Capital Resources. The Bank is required to maintain a sufficient level of liquid assets, as determined by management and defined and reviewed for adequacy by the FDIC during their regular examinations. The FDIC, however, does not prescribe by regulation a minimum amount or percentage of liquid assets. The FDIC allows any marketable security, whose sale would not impair the capital adequacy of the Company, to be eligible for liquidity. Liquidity is quantified through the use of a standard liquidity ratio of liquid assets to borrowings plus deposits. Using this formula, the Bank’s liquidity ratio was 18.0% as of December 31, 2007. The Bank adjusts its liquidity level in order to meet funding needs of deposit outflows, repayment of borrowings and loan commitments. The Company also adjusts liquidity as appropriate to meet its asset and liability management objectives.
In addition to deposits, the Company’s primary sources of funds are the amortization and repayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rate levels, economic conditions, and competition. The Company manages the pricing of its deposits to maintain a desired deposit balance. In addition, the Company invests excess funds in short-term interest earning and other assets, which provide liquidity to meet lending requirements. Short-term interest-earning deposits amounted to $154.7 million at December 31, 2007. For additional information about cash flows from the Company’s operating, financing, and investing activities, see the Statements of Cash Flows included in the Consolidated Financial Statements.
A portion of the Company’s liquidity consists of cash and cash equivalents, which are a product of its operating, investing, and financing activities. The primary sources of cash were net income, principal repayments on loans and mortgage-backed securities, and increases in deposit accounts.
Liquidity management is both a daily and long-term function of business management. If the Company requires funds beyond its ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. At December 31, 2007, the Company had $257.0 million in advances from the FHLB. The Company borrows from the FHLB to reduce interest rate risk and to provide liquidity when necessary.
At December 31, 2007, the Company’s customers had $328.4 million of unused lines of credit available and $69.9 million in loan commitments. This amount does not include the unfunded portion of loans in process. Certificates of deposit scheduled to mature in less than one year at December 31, 2007, totaled $2.541 billion. Based on prior experience, management believes that a significant portion of such deposits will remain with the Company.
The major sources of the Company’s cash flows are in the areas of loans, marketable securities, deposits and borrowed funds.
Deposits are the Company’s primary source of externally generated funds. The level of deposit inflows during any given period is heavily influenced by factors outside of management’s control, such as the general level of short-term and long- term market interest rates, as well as higher alternative yields that investors may obtain on competing investments such as money market mutual funds. Financial institutions, such as the Company, are also subject to deposit outflows. The Company’s net deposits increased/(decreased) by $9.7 million, $54.9 million, $(32.7) million and $(3.6) million for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005, respectively.
Similarly, the amount of principal repayments on loans and the amount of new loan originations is heavily influenced by the general level of market interest rates. Funds received from loan maturities and principal payments on loans for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005 were $1.235 billion, $1.118 billion, $584.0 million and $997.3 million, respectively. Loan originations for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005 were $1.742 billion, $1.488 billion, $856.4 million and $1.430 billion, respectively. The Company also sells a portion of the loans it originates in the current period and the cash flows from such sales for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005 were $250.3 million, $624.6 million, $86.2 million and $78.2 million, respectively.
The Company also experiences significant cash flows from its portfolio of marketable securities as principal payments are received on mortgage-backed securities and as investment securities mature. Cash flow from the repayment of principal and the maturity of marketable securities for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005 were $333.8 million, $254.2 million, $157.7 million and $483.1 million, respectively.
When necessary, the Company utilizes borrowings as a source of liquidity and as a source of funds for long-term investment when market conditions permit. The net cash flow from the receipt and repayment of borrowings was a net increase/(decrease) of $(65.8) million, $(23.7) million, $2.3 million and $(37.9) million for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005, respectively. During 2008, the Company will have $84.0 million of FHLB advances mature.
Other activity with respect to cash flow was the payment of cash dividends on common stock in the amount of $15.7 million, $13.7 million, $6.1 million and $20.2 million for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005, respectively. Northwest Bancorp MHC first began waiving dividends in the quarter ending June 30, 2002. They accepted payment of dividends during the fourth fiscal quarter of the year ended June 30, 2004 and the first three quarters of the fiscal year ending June 30, 2005. Since that time, they have continued to waive the receipt of dividends. Dividends waived by Northwest Bancorp, MHC during the year ended December 31, 2007 were $25.7 million. In September 2005, the Company initiated the first of its three common stock repurchase plans. Since that time the Company has used $40.8 million, $8.1 million and $17.2 million to repurchase a total of 2.6 million treasury shares during the years ended December 31, 2007 and 2006 and the six-month transition period ended December 31, 2005.
Contractual Obligations. The Company is obligated to make future payments according to various contracts. The following table presents the expected future payments of the contractual obligations aggregated by obligation type.
(1)
See Note 11, Borrowed funds, of the Notes to Consolidated Financial Statements for additional information.
(2)
See Note 22, Junior Subordinated Debentures/Trust-Preferred Securities, of the Notes to Consolidated Financial Statements for additional information.
(3)
See Note 8, Premises and Equipment, of the Notes to Consolidated Financial Statements for additional information.
Impact of Inflation and Changing Prices. The Consolidated Financial Statements of the Company and notes thereto, presented elsewhere 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 the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset and Liability Management-Interest Rate Sensitivity Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During
a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income.
The Company’s policy in recent years has been to reduce its exposure to interest rate risk generally by better matching the maturities of its interest rate sensitive assets and liabilities and by increasing the interest rate sensitivity of its interest-earning assets. The Company (i) purchases adjustable-rate investment securities and mortgage-backed securities which at December 31, 2007 totaled $386.0 million; and (ii) originates adjustable-rate mortgage loans, adjustable-rate consumer loans, and adjustable-rate commercial loans, which at December 31, 2007, totaled $1.043 billion or 21.0% of the Company’s total loan portfolio. Of the Company’s $6.084 billion of interest-earning assets at December 31, 2007, $1.583 billion, or 26.0%, consisted of assets with adjustable rates of interest. When market conditions are favorable, the Company also attempts to reduce interest rate risk by lengthening the maturities of its interest-bearing liabilities by using FHLB advances as a source of long-term fixed-rate funds, and by promoting longer-term certificates of deposit.
At December 31, 2007, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same period by $858.4 million, representing a cumulative negative one-year gap ratio of 12.88%. The Company has an Asset/Liability Committee with members consisting of various individuals from Senior Management. This committee meets monthly in an effort to effectively manage the Company’s balance sheet and to monitor activity and set pricing. The Company also has a Risk Management Committee comprised of certain members of the Board of Directors, which among other things, is responsible for reviewing the Company’s level of interest rate risk. The Committee meets quarterly and, as part of their risk management assessment, reviews interest rate risks and trends, the Company’s interest sensitivity position and the liquidity and market value of the Company’s investment portfolio.
The following table sets forth, on an amortized cost basis, the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2007, which are expected to reprice or mature, based upon certain assumptions, in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown that reprice or mature during a particular period were determined in accordance with the earlier of the term of repricing or the contractual term of the asset or liability. Management believes that these assumptions approximate the standards used in the savings industry and considers them appropriate and reasonable. For information regarding the contractual maturities of the Company’s loans, investments and deposits, see “Business of the Company-Lending Activities,” “-Investment Activities” and “-Sources of Funds.”
When assessing the interest rate sensitivity of the company, analysis of historical trends indicates that loans will prepay at various speeds (or annual rates) depending on the variance between the weighted average portfolio rates and the current market rates. In preparing the table above, it has been assumed market rates will remain constant at current levels and as a result, the Company’s loans will be affected as follows: (i) adjustable-rate mortgage loans will prepay at an annual rate of 10% to 12%; (ii) fixed-rate mortgage loans will prepay at an annual rate of 7% to 10%; (iii) commercial loans will prepay at an annual rate of 8% to 12%; (iv) consumer loans held by the Bank will prepay at an annual rate of 20%; and (v) consumer loans held by Northwest Consumer will prepay at an annual rate of 60% to 65%. In regards to the Company’s deposits, it has been assumed that (i) fixed maturity deposits will not be withdrawn prior to maturity; (ii) money market accounts will gradually reprice over the next five years; and (iii) savings accounts and checking accounts will reprice either when the rates on such accounts reprice as interest rate levels change, or when deposit holders withdraw funds from such accounts and select other types of deposit accounts, such as certificate accounts, which may have higher interest rates. For purposes of this analysis, management has estimated, based on historical trends, that $130.0 million of the Company’s checking accounts and $166.0 million of the Company’s savings accounts are interest sensitive and may reprice in one year or less, and that the remainder may reprice over longer time periods.
The above assumptions utilized by management are annual percentages based on remaining balances and should not be regarded as indicative of the actual prepayments and withdrawals that may be experienced by the Company. Moreover, certain shortcomings are inherent in the analysis presented by the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of or lag behind changes in market interest rates. Additionally, certain assets, such as some adjustable-rate loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the asset. Moreover, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.
In an effort to assess the market risk, the Company utilizes a simulation model to determine the effect of immediate incremental increases or decreases in interest rates on net interest income and the market value of the Company’s equity. Certain assumptions are made regarding loan prepayments and decay rates of passbook and NOW accounts. Because it is difficult to accurately project the market reaction of depositors and borrowers, the effects of actual changes in interest on these assumptions may differ from simulated results.
The Company has established the following guidelines for assuming interest rate risk:
•
Net income simulation. Given a parallel shift of 2% in interest rates, the estimated net income may not decrease by more than 20% within a one-year period.
•
Market value of equity simulation. The market value of the Company’s equity is the net present value of the Company’s assets and liabilities. Given a parallel shift of 2% in interest rates, equity may not decrease by more than 35% of total shareholder’ equity.
The following table illustrates the simulated impact of a 1% or 2% upward or downward movement in interest rates on net income, return on average equity, diluted earnings per share and market value of equity. This analysis was prepared assuming that interest-earning asset levels at December 31, 2007 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from the December 31, 2007 levels.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
Management, including the principal executive officer and principal financial officer, has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal control - Integrated Framework. Based on such assessment, management believes that, as of December 31, 2007, the Company’s internal control over financial reporting is effective based upon those criteria.
KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Report and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting.
/s/ William J. Wagner
William J. Wagner
/s/ William W. Harvey, Jr.
William W. Harvey, Jr.
Chief Executive Officer
Chief Financial Officer
Report of Independent Registered Public Accounting Firm
On Internal Control Over Financial Reporting
The Board of Directors and Shareholders
Northwest Bancorp, Inc.:
We have audited Northwest Bancorp, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Northwest Bancorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Northwest Bancorp, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2007, the six-month period ended December 31, 2005, and for the year ended June 30, 2005, and our report dated March 12, 2008 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG
Pittsburgh, Pennsylvania
March 12, 2007
Report of Independent Registered Public Accounting Firm
On Consolidated Financial Statements
The Board of Directors and Shareholders
Northwest Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Northwest Bancorp, Inc. and subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2007, the six-month period ended December 31, 2005, and for the year ended June 30, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibly is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the 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 Northwest Bancorp, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2007, the six-month period ended December 31, 2005, and the year ended June 30, 2005 in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for pension and postretirement benefits effective December 31, 2006 in accordance with Statement of Financial Accounting Standards No. 158, Employers’ Accounting for defined Benefit Pension and Other Postretirement Plans.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of quantifying errors in 2006, in accordance with SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Northwest Bancorp, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG
Pittsburgh, Pennsylvania
March 12, 2008
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(Amounts in thousands, excluding share data)
See accompanying notes to consolidated financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Amounts in thousands, excluding share data)
See accompanying notes to consolidated financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity Years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and
year ended June 30, 2005
(Amounts in thousands, excluding share data)
See accompanying notes to consolidated financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows
(Amounts in thousands)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows
(Amounts in thousands)
See accompanying notes to consolidated financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(1)
Summary of Significant Accounting Policies
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
reported as accumulated other comprehensive income, a separate component of shareholders’ equity, net of tax. Securities classified as available-for-sale include securities that may be sold in response to changes in interest rates, resultant prepayment risk, or other market factors. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and are reported at fair value, with unrealized gains and losses included in earnings. The cost of securities sold is determined on a specific identification basis. The Company held no securities classified as trading at December 31, 2007 and 2006.
Federal law requires a member institution of the Federal Home Loan Bank (FHLB) system to hold stock of its district FHLB according to a predetermined formula. This stock is recorded at cost and may be pledged to secure FHLB advances.
(e)
Loans Receivable
Loans are stated at their unpaid principal balance net of any deferred origination fees or costs and the allowance for estimated loan losses. Interest income on loans is credited to income as earned. Interest earned on loans for which no payments were received during the month is accrued at month end. Interest accrued on loans more than 90 days delinquent is reversed, and such loans are placed on nonaccrual status.
The Company has identified certain residential and education loans which will be sold prior to maturity. These loans are recorded at the lower of amortized cost or market value and at December 31, 2007 and 2006 were $28,412,000 and $23,390,000, respectively.
Loan fees and certain direct loan origination costs are deferred, and the net deferred fee or cost is then recognized using the level-yield method over the contractual life of the loan as an adjustment to interest income.
(f)
Provision for Loan Losses
Provisions for estimated loan losses and the amount of the allowance for loan losses are based on losses inherent in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements. Management believes, to the best of their knowledge, that all known losses as of the statement of condition dates have been recorded.
Management considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Nonaccrual loans are deemed to be impaired unless fully secured with liquid collateral. In evaluating whether a loan is impaired, management considers not only the amount that the Company expects to collect but also the timing of collection. Generally, if a delay in payment is insignificant (e.g., less than 30 days), a loan is not deemed to be impaired.
When a loan is considered to be impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or at the loan’s market price or fair value of the collateral if the loan is collateral dependent. Larger loans are evaluated individually for impairment. Smaller balance, homogeneous loans (e.g., primarily consumer and residential mortgages) are evaluated collectively for impairment. Impairment losses are included in the allowance for loan losses. Impaired loans are charged off when management believes that the ultimate collectibility of a loan is not likely.
Interest income on impaired loans is recognized using the cash basis method. Such interest ultimately collected is credited to income in the period of recovery or applied to reduce principal if there is sufficient doubt about the collectibility of principal. Interest that has been accrued on impaired loans that are contractually past due 90 days and over is reversed.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(g)
Real Estate Owned
Real estate owned is comprised of property acquired through foreclosure or voluntarily conveyed by delinquent borrowers. These assets are recorded on the date acquired at the lower of the related loan balance or market value of the collateral less disposition cost with the market value being determined by an appraisal. Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or the current market value, less estimated disposition costs. Gains or losses realized from the disposition of such property are credited or charged to noninterest income.
(h)
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is accumulated on a straight-line basis over the estimated useful lives of the related assets. Estimated lives range from three to thirty years. Amortization of leasehold improvements is accumulated on a straight-line basis over the terms of the related leases or the useful lives of the related assets, whichever is shorter.
(i)
Goodwill
In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), goodwill is allocated to various reporting units, which are either the Company’s reportable segments or one level below. Goodwill is no longer amortized but is tested for impairment on an annual basis and between annual tests if events occur, or if circumstances change, that would more likely than not reduce the fair value below its carrying amount. The annual impairment test is based on discounted cash flow models that incorporate variables including growth in net income, discount rates, and terminal values. If the carrying amount of goodwill exceeds its fair value, an impairment loss is recognized as a non-cash charge.
(j)
Core Deposit Intangibles
The Company engages an independent third party of experts to analyze and prepare a core deposit study for substantially all acquisitions. This study reflects the cumulative present value benefit of acquiring deposits versus an alternative source of funding. Based upon this analysis, the amount of the premium related to the core deposits of the business purchased is calculated along with the estimated life of the acquired deposits. The core deposit intangible, which is recorded in other intangible assets, is then amortized to expense on an accelerated basis over an approximate life of seven years.
(k)
Bank-Owned Life Insurance
The Company owns insurance on the lives of a certain group of key employees and directors. The policies were purchased to help offset the increase in the costs of various fringe benefit plans including healthcare as well as the directors deferred compensation plan. The cash surrender value of these policies is included as an asset on the consolidated statements of financial condition, and any increases in the cash surrender value are recorded as noninterest income on the consolidated statements of income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit, which would be recorded as noninterest income.
(l)
Deposits
Interest on deposits is accrued and charged to expense monthly and is paid or credited in accordance with the terms of the accounts.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(q)
Off-Balance-Sheet Instruments
In the normal course of business, the Company extends credit in the form of loan commitments, undisbursed lines of credit, and standby letters of credit. These off-balance-sheet instruments involve, to various degrees, elements of credit and interest rate risk not reported in the consolidated statement of financial condition.
(r)
Use of Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates.
(s)
Reclassification of Prior Years’ Statements
Certain items previously reported have been reclassified to conform with the current year’s reporting format.
(2)
Recent Accounting Pronouncements
Business Combinations: In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R applies to all transactions or other events in which an entity obtains control of one or more businesses, including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration. SFAS 141R applies to all business entities, including mutual entities that previously used the pooling-of-interest method of accounting for some business combinations. The objective of SFAS 141R is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS 141R establishes principles and requirements for how the acquirer recognizes and measures the identifiable assets acquired and the liabilities assumed, recognizes and measures the goodwill acquired, and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effect of the business combination. SFAS 141R does not apply to the acquisition of an asset or a group of assets that does not constitute a business or a combination between entities under common control. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.
The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115: In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. No entity is permitted to apply this Statement retrospectively to fiscal years preceding the effective date unless the entity chooses early adoption. The Company will apply SFAS 159 beginning January 1, 2008 and does not anticipate that it will have a material effect on the financial condition or operations of the Company.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans: In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”). On December 31, 2006 the Company adopted certain provisions of SFAS 158 which resulted in the recognition of the funded status of its pension and postretirement plans as a liability on the Consolidated Statement of Financial Condition and the recognition of unrecognized actuarial losses and prior service costs totaling $10,366,000 as a separate component of accumulated other comprehensive loss, net of tax. Additional disclosures related to the pension and postretirement obligations have also been implemented. See note 15 for these disclosures and further discussion on the Company’s pension and postretirement plans.
SFAS 158 will also require the Company to change the date used to measure its defined benefit pension and other postretirement obligations from October 31 to December 31. The measurement date change will be effective as of December 31, 2008. The incremental pension cost recognized as a result of this change in measurement date will be recognized as an adjustment to retained earnings. The measurement date change is not expected to have a material impact on the financial condition or operations of the Company.
Fair Value Measurements: In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), which upon adoption will replace various definitions of fair value in existing accounting literature with a single definition, will establish a framework for measuring fair value, and will require additional disclosures about fair value measurements. SFAS 157 clarifies that fair value is the price that would be received to sell an asset or the price paid to transfer a liability in the most advantageous market available to the Company and emphasizes that fair value is a market-based measurement and should be based on the assumptions market participants would use. SFAS 157 also creates a three-level hierarchy under which individual fair value estimates are ranked based on the relative reliability of the inputs used in the valuation. This hierarchy is the basis for the disclosure requirements, with fair value estimates based on the least reliable inputs requiring more extensive disclosures about the valuation method used. SFAS 157 is required to be applied whenever another financial accounting standard requires or permits an asset or liability to be measured at fair value. SFAS 157 does not expand the use of fair value to any new circumstances. SFAS 157 is effective for years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect it to have a material impact on the financial condition or operations of the Company.
Accounting for Uncertainty in Income Taxes: In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies that accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This interpretation was implemented as of January 1, 2007 and did not have a material impact on the Company’s financial condition or operations.
Considering the Effects of Prior Year Misstatements: In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how the effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. The Company adopted the provisions of SAB 108 effective January 1, 2006 and the impact on the January 1, 2006 opening consolidated shareholders’ equity was $2.8 million, net of tax.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(3) Marketable Securities
Marketable securities at December 31, 2007 are as follows:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Marketable securities at December 31, 2006 are as follows:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table presents information regarding the issuers and the carrying value of the Company’s mortgage-backed securities:
Marketable securities having a carrying value of $428,290,000 at December 31, 2007 were pledged under collateral agreements. During the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005, the Company sold marketable securities classified as available-for-sale for $105,361,000, $5,333,000, $2,145,000, and $22,713,000, respectively. The gross realized gains on these sales were $5,275,000, $368,000, $0, and $523,000, respectively. The gross realized losses on the sales for the year ended December 31, 2007 were $(7,204,000). Due to deterioration in the credit markets, the Company sold the majority of its non-agency corporate debt portfolio. Included therein was $15,277,000 of securities classified as held-to-maturity. These held-to-maturity securities were sold for a net gain of $375,000. In conjunction with the sale of held-to-maturity securities, the Company was required under generally accepted accounting principles to transfer the remaining held-to-maturity portfolio of $649,658,000 to available-for-sale. At the time of transfer, the transferred securities had an unrealized gain of $4,690,000. The Company recognized a noncash other-than-temporary impairment in its investment portfolio resulting in writedowns of $1,900,000 related to Freddie Mac preferred stock in the fourth quarter of 2007.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table shows the fair value and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2007:
The following table shows the fair value and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2006:
The decline in the fair value of securities primarily resulted from changes in the levels of interest rates. The Company has the ability and intent to hold these securities until the market value recovers or maturity and the Company believes the collection of the contractual principal and interest is probable. For these reasons, the Company considers the unrealized losses to be temporary impairment losses. There are approximately 284 positions that are temporarily impaired at
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
December 31, 2007. The aggregate carrying amount of cost-method investments at December 31, 2007 was $1,133,367,000 of which all were evaluated for impairment.
(4) Loans Receivable
Loans receivable at December 31, 2007 and 2006 are summarized in the table below:
At December 31, 2007 and 2006, the Company serviced loans for others approximating $998,285,000, and $849,247,000, respectively. These loans serviced for others are not assets of the Company and are appropriately excluded from the Company’s financial statements.
At December 31, 2007 and 2006, approximately 77% and 80%, respectively, of the Company’s loan portfolio was secured by properties located in Pennsylvania. The Company does not believe it has significant concentrations of credit risk to any one group of borrowers given its underwriting and collateral requirements.
Loans receivable at December 31, 2007 and 2006 include $1,042,691,000 and $881,843,000 of adjustable rate loans and $3,922,057,000 and $3,623,785,000, respectively, of fixed rate loans.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The Company’s exposure to credit loss in the event of nonperformance by the other party to off-balance-sheet financial instruments is represented by the contract amount of the financial instrument. The Company uses the same credit policies in making commitments for off-balance-sheet financial instruments as it does for on-balance-sheet instruments. Financial instruments with off-balance-sheet risk as of December 31, 2007 and 2006 are presented in the following table:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained by the Company upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies but generally may include cash, marketable securities, and property.
Outstanding loan commitments at December 31, 2007, for fixed rate loans, are $32,841,000. The interest rates on these commitments approximate market rates at December 31, 2007. Outstanding loan commitments at December 31, 2007 for adjustable rate loans are $37,010,000. The fair value of these commitments are affected by fluctuations in market rates of interest.
The Company issues standby letters of credit in the normal course of business. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party. The Company is required to perform under a standby letter of credit when drawn upon by the guaranteed third party in the case of nonperformance by the Company’s customer. The credit risk associated with standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal credit policies. Collateral may be obtained based on management’s credit assessment of the customer. The maximum potential amount of future payments the Company could be required to make under these standby letters of credit is $14,955,000, of which $11,161,000 is fully collateralized. A liability (which represents deferred income) of $104,000 and $120,000 has been recognized by the Company for the obligations as of December 31, 2007 and 2006, respectively, and there are no recourse provisions that would enable the Company to recover any amounts from third parties.
The Company automatically places loans on nonaccrual status when they become more than 90 days contractually delinquent or when the paying capacity of the obligor becomes inadequate to meet the requirements of the contract. When a loan is placed on nonaccrual, all previously accrued and uncollected interest is reversed against current period interest income. Nonaccrual loans at December 31, 2007, 2006 and 2005 and June 30, 2005 were $49,610,000, $40,525,000, $43,016,000, and $33,610,000, respectively.
A loan is considered to be impaired, as defined by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement including both contractual principal and interest payments. The amount of impairment is required to be measured using one of the three methods prescribed by SFAS 114: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price;
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
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 reserve is allocated for the impairment. Impaired loans at December 31, 2007, 2006 and 2005 and June 30, 2005 were $49,610,000, $40,525,000, $43,016,000, and $33,610,000, respectively. Average impaired loans during the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005 were $41,179,000, $41,625,000, $40,261,000, and $34,011,000, respectively.
There were no commitments to lend additional funds to debtors on nonaccrual status.
(5) Accrued Interest Receivable
Accrued interest receivable as of December 31, 2007 and 2006 is presented in the following table:
(6) Allowance for Loan Losses
Changes in the allowance for losses on loans receivable for the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005 are presented in the following table:
While management uses available information to provide for losses, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Management believes, to the best of their knowledge, that all known losses as of the balance sheet dates have been recorded.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(7)
Federal Home Loan Bank Stock
The Company’s banking subsidiary is a member of the Federal Home Loan Bank system. As a member, Northwest maintains an investment in the capital stock of the Federal Home Loan Bank of Pittsburgh, at cost, in an amount not less than 4.65% of borrowings outstanding plus 0.65% of unused FHLB borrowing capacity.
(8)
Premises and Equipment
Premises and equipment at December 31, 2007 and 2006 are summarized by major classification in the following table:
Depreciation and amortization expense for the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005, was $9,264,000, $8,706,000, $4,301,000, and $7,684,000, respectively.
Premises used by certain of the Company’s branches and offices are occupied under formal operating lease arrangements. The leases expire on various dates through 2027. Minimum annual rentals by fiscal year are summarized in the following table:
Rental expense for the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005 was $4,555,000, $4,142,000, $1,776,000, and $3,221,000, respectively.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(9)
Goodwill and Other Intangible Assets
The following table provides information for intangible assets subject to amortization for the periods indicated:
The following information shows the actual aggregate amortization expense for the current and prior fiscal years as well as the estimated aggregate amortization expense, based upon current levels of intangible assets, for each of the five succeeding fiscal years:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table provides information for the changes in the carrying amount of goodwill:
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 at December 31, 2007 and 2006 was $681,695,000 and $634,127,000, respectively. Generally, deposits in excess of $100,000 are not federally insured.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table summarizes the contractual maturity of the certificate accounts:
The following table summarizes the interest expense incurred on the respective deposits:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Borrowings from the Federal Home Loan Bank of Pittsburgh are secured by the Company’s investment securities, mortgage-backed securities, and qualifying residential first mortgage loans. Certain of these borrowings are subject to restrictions or penalties in the event of prepayment.
The revolving line of credit with the Federal Home Loan Bank of Pittsburgh carries a commitment of $150,000,000 maturing on December 7, 2011. The rate is adjusted daily by the Federal Home Loan Bank, and any borrowings on this line may be repaid at any time without penalty.
The securities sold under agreements to repurchase are collateralized by various securities held in safekeeping by the Federal Home Loan Bank of Pittsburgh. The market value of such securities exceeds the value of the securities sold under agreements to repurchase. The average amount of agreements outstanding in the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005 was $70,875,000, $44,860,000, $28,416,000, and $26,889,000, respectively. The maximum amount of security repurchase agreements outstanding during the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005 was $83,432,000, $55,705,000, $34,025,000, and $33,670,000, respectively.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Income tax expense (benefit) applicable to income before taxes consists of:
A reconciliation from the expected federal statutory income tax rate to the effective rate, expressed as a percentage of pretax income, is as follows:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2007 and 2006 are presented below:
The Company has determined that no valuation allowance is necessary for the deferred tax assets because it is more likely than not that these assets will be realized through carryback to taxable income in prior years, future reversals of existing temporary differences, and through future taxable income. Net deferred tax assets of $877,000 were recorded in 2007 related to the acquisition of CSB Bank. The Company will continue to review the criteria related to the recognition of deferred tax assets on a regular basis.
Under provisions of the Internal Revenue Code (“IRC”), Northwest has approximately $10,617,000 of federal net operating losses, which expire in years 2008 through 2027. The net operating losses, which were acquired as part of the First Carnegie, Maryland Permanent and Penn Laurel acquisitions, are subject to annual carryforward limitations imposed by IRC code section 382. The Company believes the limitations will not prevent the carryforward benefits from being utilized. In addition, the Company has approximately $1,950,000 of alternative minimum tax credit carryforwards, which can be carried forward indefinitely.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 also provides related guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption did not require us to recognize any increase or decrease in our liability for unrecognized tax benefits. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006, and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(14)
Earnings Per Share
Basic earnings per common share (EPS) is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period, without considering any dilutive items. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. There were no anti-dilutive options in any period presented in the table below. The computation of basic and diluted earnings per share follows:
(a)
Pension Plans
The Company maintains noncontributory defined benefit pension plans covering substantially all employees and the members of its board of directors. Retirement benefits are based on certain compensation levels, age, and length of service. Contributions are based on an actuarially determined amount to fund not only benefits attributed to service to date but also for those expected to be earned in the future. In addition, the Company has an unfunded Supplemental Executive Retirement Plan (SERP) to compensate those executive participants eligible for the Company’s defined benefit pension plan whose benefits are limited by Section 415 of the Internal Revenue Code.
The Company also sponsors a retirement savings plan in which substantially all employees participate. The Company provides a matching contribution of 50% of each employee’s contribution to a maximum of 6% of the employee’s compensation.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Total expense for all retirement plans, including defined benefit pension plans, was approximately $6,639,000, $6,310,000, $3,278,000 and $5,801,000, for the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005, respectively.
Components of net periodic pension cost and other amounts recognized in other comprehensive income:
The following table sets forth the net periodic pension cost for the Company’s defined benefit pension plans:
The following table sets forth other changes in the Company’s defined benefit pension plans’ plan assets and benefit obligations recognized in other comprehensive income:
The estimated net loss and prior service cost for the Company’s defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic cost over the next year are $125,000 and $51,000, respectively.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table sets forth, for the Company’s defined benefit pension plans’ funded status at December 31, 2007 and 2006:
The following table sets forth the assumptions used to develop the net periodic pension cost:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table sets forth the assumptions used to determine benefit obligations at end of period:
The expected long-term rate of return on assets is based on the expected return of each of the asset categories, weighted based on the median of the target allocation for each category.
The accumulated benefit obligation for the funded defined benefit pension plan was $51,010,000, $48,325,000, $40,646,000, and $40,198,000 at December 31, 2007, 2006, and 2005 and June 30, 2005, respectively. The accumulated benefit obligation for all unfunded defined benefit plans was $3,659,000, $4,014,000, $3,808,000, and $4,569,000 at December 31, 2007, 2006, and 2005 and June 30, 2005, respectively.
The following table sets forth information for pension plans with an accumulated benefit obligation in excess of plan assets:
The Company anticipates making contributions to its defined benefit pension plan of $2 million to $8 million during the fiscal year ending December 31, 2008.
The investment policy as established by the Plan Administrative Committee, to be followed by the Trustee, is to invest assets based on the target allocations shown in the table below. To meet target allocation ranges set forth by the Plan Administrative Committee, periodically, the assets are reallocated by the Trustee. The investment policy is reviewed periodically to determine if the policy should be changed. Pension assets are conservatively invested with the goal of providing market or better returns with below market risks. Assets are invested in a balanced portfolio composed primarily of equities, fixed income, and cash or cash equivalent investments. The Trustee tries to maintain an approximate asset mix position of 30-60% equities and 20-50% bonds.
A maximum of 10% may be invested in any one stock, including the stock of Northwest Bancorp, Inc. The objective of holding equity securities is to provide capital appreciation consistent with the ownership of the common stocks of medium to large companies. Acceptable bond investments are direct or agency obligations of the U.S. Government or investment grade corporate bonds. The average maturity of the bond portfolio shall not exceed 10 years.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table sets forth the weighted average asset allocation of defined benefit plans:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The following table sets forth other changes in the Company’s postretirement healthcare plan’s plan assets and benefit obligations recognized in other comprehensive income:
The estimated net loss for the postretirement healthcare benefit plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next year is $43,000.
The following table sets forth the funded status of the Company’s postretirement healthcare benefit plan at December 31, 2007 and 2006:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
The assumptions used to develop the preceding information for postretirement healthcare benefits are as follows:
(1) Not in thousands
If the assumed rate of increase in healthcare costs was increased by one percentage point to 5% from the level of 4% presented above, the service and interest cost components of net periodic postretirement healthcare benefit cost would increase by $6,000, in the aggregate, and the accumulated postretirement benefit obligation for healthcare benefits would increase by $87,000.
The following table sets forth amounts recognized in accumulated other comprehensive income:
The accumulated benefit obligation for the Company’s postretirement healthcare benefit plan at December 31, 2007 and 2006 was $1,637,000 and $1,701,000, respectively.
The following table sets forth information for plans with an accumulated benefit obligation in excess of plan assets:
(c)
Employee Stock Ownership Plan
The Company had continued its previously leveraged employee stock ownership plan (ESOP) for employees who have attained age 21 and who have completed a 12-month period of employment with the Company during which they worked at least 1,000 hours. The Company can make contributions to the ESOP at the board’s discretion. Company shares would then be purchased periodically in the open market and allocated to employee accounts based on each employee’s relative portion of the Company’s total eligible compensation recorded during the year.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
employees at an exercise price of $22.93 per share. On January 18, 2006 the Company granted 158,333 incentive stock options to employees at an exercise price of $22.18 per share. On January 17, 2007 the Company granted 179,806 stock options to employees at an exercise price of $25.89 per share. On June 20, 2007 the Company granted 2,000 stock options to a director at an exercise price of $28.09 per share. These options are exercisable for a period of ten years from the grant date with each recipient vesting at the rate of 20% per year commencing one year from the grant date.
The following table summarizes the activity in the Company’s option plans during the years ended December 31, 2007 and 2006, the six-month period ended December 31, 2005 and the fiscal year ended June 30, 2005:
The aggregate intrinsic value of all options expected to vest and fully vested options at December 31, 2007 is $1,039,000 and $7,135,000, respectively. The following table summarizes the number of options outstanding, number of options exercisable, and weighted average remaining life of all option grants:
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(16)
Disclosures About Fair Value of Financial Instruments
SFAS No. 107, Disclosure about Fair Value of Financial Instruments (SFAS 107), requires disclosure of fair value information about financial instruments whether or not recognized in the consolidated statement of financial condition. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts reported in the consolidated statement of financial condition approximate fair value for the following financial instruments: cash on hand, interest-earning deposits in other institutions, federal funds sold and other short-term investments, accrued interest receivable, accrued interest payable, and marketable securities available-for-sale.
The following table sets forth the carrying amount and estimated fair value of the Company’s financial instruments included in the consolidated statement of financial condition as of December 31, 2007 and 2006:
Fair value estimates are made at a point-in-time, based on relevant market data and information about the instrument. The following methods and assumptions were used in estimating the fair value of financial instruments at December 31, 2007 and 2006.
Marketable Securities
Estimated market values are based on quoted market prices, dealer quotes, and prices obtained from independent pricing services. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Refer to note 3 of the consolidated financial statements for the detail of the type of investment securities.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Loans Receivable
Loans with comparable characteristics including collateral and repricing structures were segregated for valuation purposes. Each loan pool was separately valued utilizing a discounted cash flow analysis. Projected monthly cash flows were discounted to present value using a market rate for comparable loans. Characteristics of comparable loans included remaining term, coupon interest, and estimated prepayment speeds. Delinquent loans were evaluated separately, given the impact delinquency has on the projected future cash flow of the loan and the approximate discount or market rate.
Deposit Liabilities
SFAS 107 defines the estimated fair value of deposits with no stated maturity, which includes demand deposits, money market, and other savings accounts, to be the amount payable on demand. Although market premiums paid for depository institutions reflect an additional value for these low-cost deposits, SFAS 107 prohibits adjusting fair value for any value expected to be derived from retaining those deposits for a future period of time or from the benefit that results from the ability to fund interest-earning assets with these deposit liabilities. The fair value estimates of deposit liabilities do not include the benefit that results from the low-cost funding provided by these deposits compared to the cost of borrowing funds in the market. Fair values for time deposits are estimated using a discounted cash flow calculation that applies contractual cost currently being offered in the existing portfolio to current market rates being offered locally for deposits of similar remaining maturities. The valuation adjustment for the portfolio consists of the present value of the difference of these two cash flows, discounted at the assumed market rate of the corresponding maturity.
Borrowed Funds
The fixed rate advances were valued by comparing their contractual cost to the prevailing market cost.
Trust-Preferred Securities
The fair value of the trust-preferred securities are calculated using the discounted cash flows at the prevailing rate of interest.
Off-Balance Sheet Financial Instruments
These financial instruments generally are not sold or traded, and estimated fair values are not readily available. However, the fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. Commitments to extend credit issued by the Company are generally short-term in nature and, if drawn upon, are issued under current market terms. At December 31, 2007 and 2006, there was no significant unrealized appreciation or depreciation on these financial instruments.
(17)
Regulatory Capital Requirements
The Company’s banking subsidiary is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by the regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices must be met. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company’s banking subsidiary to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined). At December 31, 2007
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
and 2006, the Company’s banking subsidiary exceeds all capital adequacy requirements to which they are subject. At December 31, 2007, the maximum amount available for dividend payments by Northwest to the Company, while maintaining its “well capitalized” status, is approximately $104.5 million.
As of December 15, 2007, the most recent notification from the FDIC categorized Northwest as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the bank must maintain total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the bank’s categories.
The actual, required, and well capitalized levels as of December 31, 2007 and 2006:
(18)
Contingent Liabilities
The Company and its subsidiaries are subject to a number of asserted and unasserted claims encountered in the normal course of business. Management believes that the aggregate liability, if any, that may result from such potential litigation will not have a material adverse effect on the Company’s financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(20) Northwest Bancorp, Inc. (Parent Company Only)
Statements of Financial Condition
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Statements of Income
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
Statements of Cash Flows
(21)
Business Segments
The Company has identified two reportable business segments based upon the operating approach currently used by management. The Community Banking segment includes the savings bank subsidiary of the Company, Northwest Savings Bank, as well as the subsidiaries of the savings bank that provide similar products and services. The savings bank is a
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
community-oriented institution that offers a full array of traditional deposit and loan products, including mortgage, consumer, and commercial loans as well as trust, investment management, actuarial and benefit plan administration, and brokerage services typically offered by a full service financial institution. The Consumer Finance segment is comprised of Northwest Consumer Discount Company, a subsidiary of Northwest Savings Bank, which operates offices in Pennsylvania and New York. This subsidiary compliments the services of the bank by offering personal installment loans for a variety of consumer and real estate products. This activity is funded primarily through its intercompany borrowing relationship with Allegheny Services, Inc. Net income is primarily used by management to measure segment performance. The following tables provide financial information for these segments. The All Other column represents the parent company, other nonbank subsidiaries, and elimination entries necessary to reconcile to the consolidated amounts presented in the financial statements.
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
*
Eliminations consist of intercompany interest income and interest expense.
(22)
Guaranteed Preferred Beneficial Interests in Company’s Junior Subordinated Deferrable Interest Debentures (Trust-Preferred Securities)
The Company has three statutory business trusts: Northwest Bancorp Capital Trust III, a Delaware statutory business trust, and Northwest Bancorp Statutory Trust IV, a Connecticut statutory business trust and Penn Laurel Financial Corp. Trust I, a Delaware statutory business trust (the Trusts). The Penn Laurel Financial Corp, Trust I was assumed with the acquisition of Penn Laurel Financial Corporation in June 2007. These trusts exist solely to issue preferred securities to third parties for cash, issue common securities to the Company in exchange for capitalization of the Trusts, invest the proceeds from the sale of trust securities in an equivalent amount of debentures of the Company, and engage in other activities that are incidental to those previously listed. Northwest Bancorp Capital Trust III issued 50,000 cumulative
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
•
the interest on the debentures to no longer be deductible by the Company for federal income tax purposes;
•
the trust to become subject to federal income tax or to certain other taxes or governmental charges;
•
the trust to register as an investment company; and
•
the Company to become subject to capital requirements and the preferred securities do not qualify as Tier I capital.
The Company may, at any time, dissolve the trust and distribute the debentures to the trust security holders, subject to receipt of any required regulatory approval(s).
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
(23)
Selected Quarterly Financial Data (Unaudited)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
NORTHWEST BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005 and June 30, 2005
(All dollar amounts presented in tables are in thousands)
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
ITEM 9A.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The “Proposal I-Election of Directors” section of the Company’s definitive proxy statement for the Company’s 2008 Annual Meeting of Stockholders (the “2008 Proxy Statement”) is incorporated herein by reference.
The “Proposal I-Election of Directors” section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The “Proposal I-Election of Directors” section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
The Company does not have any equity compensation program that was not approved by stockholders, other than its employee stock ownership plan.
Set forth below is certain information as of December 31, 2007 regarding equity compensation plans that have been approved by stockholders.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The “Transactions with Certain Related Persons” section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The “Proposal II - Ratification of Appointment of Independent Registered Public Accounting Firm” Section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following documents are filed as part of this Form 10-K.
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
Regulation
Reference to Prior Filing
S-K Exhibit
or Exhibit Number
Number
Document
Attached Hereto
Plan of acquisition, reorganization, arrangement, liquidation or succession
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NORTHWEST BANCORP, INC.
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The “Proposal I-Election of Directors” section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
The Company does not have any equity compensation program that was not approved by stockholders, other than its employee stock ownership plan.
Set forth below is certain information as of December 31, 2007 regarding equity compensation plans that have been approved by stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The “Transactions with Certain Related Persons” section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The “Proposal II - Ratification of Appointment of Independent Registered Public Accounting Firm” Section of the Company’s 2008 Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following documents are filed as part of this Form 10-K.
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
Regulation
Reference to Prior Filing
S-K Exhibit
or Exhibit Number
Number
Document
Attached Hereto
Plan of acquisition, reorganization, arrangement, liquidation or succession
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NORTHWEST BANCORP, INC.
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.