10-K 1 d444167d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2012

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-19345

 

 

ESB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1659846

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

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

Registrant’s telephone number, including area code: (724) 758-5584

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, par value $.01 per share

 

NASDAQ Stock Market, LLC

(Title of each class)   (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x.

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

 

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x.

As of June 30, 2012, the aggregate value of the 12,900,701 shares of Common Stock of the Registrant outstanding on such date, which excludes 1,734,864 shares held by all directors and officers of the Registrant as a group, was approximately $170.3 million. This amount is based on the closing sales price of $13.20 per share of the Registrant’s Common Stock on June 30, 2012.

Number of shares of Common Stock outstanding as of March 1, 2013: 14,665,045

DOCUMENTS INCORPORATED BY REFERENCE

 

Documents

   Where Incorporated

1. Portions of the 2012 Annual Report to Stockholders.

   Part II

2. Portions of Proxy Statement for the April 17, 2013 Annual Meeting of Stockholders

   Part II

 

 

 


Table of Contents

ESB FINANCIAL CORPORATION

TABLE OF CONTENTS

 

  PART I   

Item 1.

 

Business

     2   

Item 1A.

 

Risk Factors

     31   

Item 1B.

 

Unresolved Staff Comments

     35   

Item 2.

 

Properties

     35   

Item 3.

 

Legal Proceedings

     36   

Item 4.

 

Mine Safety Disclosures

     36   
  PART II   

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

     37   

Item 6.

 

Selected Financial Data

     37   

Item 7.

 

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

     37   

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

     37   

Item 8.

 

Financial Statements and Supplementary Data

     37   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     37   

Item 9A.

 

Controls and Procedures

     38   

Item 9B.

 

Other Information

     38   
  PART III   

Item 10.

 

Directors, Executive Officers and Corporate Governance.

     38   

Item 11.

 

Executive Compensation

     38   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     39   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     39   

Item 14.

 

Principal Accountant Fees and Services

     39   
  PART IV   

Item 15.

 

Exhibits and Financial Statement Schedules

     40   

Signatures

     42   


Table of Contents

FORWARD-LOOKING STATEMENTS

In the normal course of business, we, in an effort to help keep our shareholders and the public informed about our operations, may from time to time issue or make certain statements, either in writing or orally, that are or contain forward-looking statements, as that term is defined in the U.S. federal securities laws. Generally, these statements relate to business plans or strategies, projected or anticipated benefits from acquisitions made by or to be made by us, projections involving anticipated revenues, earnings, profitability or other aspects of operating results or other future developments in our affairs or the industry in which we conduct business. Forward-looking statements may be identified by reference to a future period or periods or by the use of forward-looking terminology such as “anticipate,” “believe,” “expect,” “intend,” “plan,” “estimate” or similar expressions.

Although we believe that the anticipated results or other expectations reflected in our forward-looking statements are based on reasonable assumptions, we can give no assurance that those results or expectations will be attained. Forward-looking statements involve risks, uncertainties and assumptions (some of which are beyond our control), and as a result actual results may differ materially from those expressed in forward-looking statements. Factors that could cause actual results to differ from forward-looking statements include, but are not limited to, the following, as well as those discussed elsewhere herein:

 

   

our investments in our businesses and in related technology could require additional incremental spending, and might not produce expected deposit and loan growth and anticipated contributions to our earnings;

 

   

general economic or industry conditions could be less favorable than expected, resulting in a deterioration in credit quality, a change in the allowance for loan and lease losses or a reduced demand for credit or fee-based products and services;

 

   

changes in the interest rate environment could reduce net interest income and could increase credit losses;

 

   

the conditions of the securities markets could change, which could adversely affect, among other things, the value or credit quality of our assets, the availability and terms of funding necessary to meet our liquidity needs and our ability to originate loans and leases;

 

   

changes in the extensive laws, regulations and policies governing financial holding companies and their subsidiaries could alter our business environment or affect our operations;

 

   

the potential need to adapt to industry changes in information technology systems, on which we are highly dependent, could present operational issues or require significant capital spending;

 

   

competitive pressures could intensify and affect our profitability, including as a result of continued industry consolidation, the increased availability of financial services from non-banks, technological developments such as the internet or bank regulatory reform;

 

   

acquisitions may result in one-time charges to income, may not produce revenue enhancements or cost savings at levels or within time frames originally anticipated and may result in unforeseen integration difficulties; and

 

   

acts or threats of terrorism and actions taken by the United States or other governments as a result of such acts or threats, including possible military action, could further adversely affect business and economic conditions in the United States generally and in our principal markets, which could have an adverse effect on our financial performance and that of our borrowers and on the financial markets and the price of our common stock.

You should not put undue reliance on any forward-looking statements. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events except to the extent required by federal securities laws.

 

1


Table of Contents

PART I

Item 1. Business

General

ESB Financial Corporation (the Company) is a Pennsylvania corporation and thrift holding company that provides a wide range of retail and commercial financial products and services to customers in Western Pennsylvania through its wholly owned subsidiary bank, ESB Bank (ESB or the Bank). The Company is also the parent company of ESB Capital Trust II (the Trust II) , ESB Statutory Trust III (the Trust III) and ESB Capital Trust IV (the Trust IV), which are Delaware statutory business trusts established to facilitate the issuance of trust preferred securities to the public by the Company, and THF, Inc., a Pennsylvania corporation established as a title agency to provide residential and commercial loan closing services and title insurance services.

As of December 31, 2012, the Company had consolidated total assets of $1.9 billion, total deposits of $1.2 billion and stockholders’ equity of $194.8 million. For the year ended December 31, 2012, the Company realized consolidated net income and diluted net income per share of $14.9 million and $1.03, respectively.

The Bank is a Pennsylvania chartered, Federal Deposit Insurance Corporation (FDIC) insured stock savings bank, which conducts business through 23 offices in Allegheny, Beaver, Butler, and Lawrence counties, Pennsylvania. ESB operates two wholly-owned subsidiaries: (i) AMSCO, Inc., which engages in the management of certain real estate development partnerships on behalf of the Company and (ii) ESB Financial Services, Inc., a Delaware corporation which holds loans and other investments.

The Bank is a financial intermediary whose principal business consists of attracting deposits from the general public and investing such deposits in real estate loans secured by liens on residential and commercial properties, consumer loans, commercial business loans, securities and interest-earning deposits. In addition, the Company utilizes borrowed funds, primarily advances from the Federal Home Loan Bank (FHLB) of Pittsburgh and repurchase agreements, to fund the Company’s investing activities. The Company invests in securities issued by the U.S. government and agencies and other investments permitted by federal law and regulations.

The Company is subject to examination and regulation by the Board of Governors of the Federal Reserve System (Federal Reserve Board) as a savings and loan holding company. The Bank is subject to examination and comprehensive regulation by the FDIC and the Pennsylvania Department of Banking (Department). Additionally, the Company is subject to the various reporting and filing requirements of the Securities and Exchange Commission (SEC). Customer deposits with the Bank are insured to the maximum extent provided by law through the Deposit Insurance Fund of the FDIC. The Bank is a member of the FHLB of Pittsburgh, which is one of the twelve regional banks comprising the FHLB system. The Bank is further subject to regulations of the Federal Reserve Board, which governs the reserves required to be maintained against deposits and certain other matters.

Competition

The Company and its subsidiaries face substantial competition for both loans and deposits. Numerous financial institutions, some larger and several of which are similar in size and resources to the Company, are competitors of the Company to varying degrees. Competition for loans comes principally from commercial banks, credit unions, mortgage-banking companies and savings banks. The Company competes for loans principally through the interest rates and loan fees that are charged and the efficiency and quality of services provided to borrowers, sellers, real estate brokers and attorneys. The most direct competition for deposits has historically come from commercial banks, credit unions and other depository institutions. The Company faces additional competition for deposits from securities brokers, mutual funds and insurance companies. The Company competes for deposits through pricing, service, the branch network and by offering a wide variety of products and services. Internet banking, offered by both established financial institutions and internet only banks, constitutes another form of competition for the Company. Competition may increase as a result of reduced restrictions on the interstate operations of financial institutions and legislation authorizing the acquisition of savings institutions by bank holding companies. Finally, in addition to the competition for loans and deposits, the Company is affected by the actions of the Federal Reserve Board as it affects interest rates in order to improve the economy.

 

2


Table of Contents

Market Area

The Company’s primary market area includes Allegheny, Beaver, Butler, and Lawrence counties in Western Pennsylvania. The Company’s business is conducted through its corporate office located in Ellwood City, Pennsylvania, and the Bank’s 23 offices. Substantially all of the Bank’s deposits are received from residents of its principal market area and most loans are secured by properties in Western Pennsylvania.

Lending Activities

General. As of December 31, 2012, the Company’s net loans receivable amounted to $672.1 million or 34.9% of the Company’s total assets. Loans secured by real estate amounted to $502.9 million or 72.7% of the total loan receivable portfolio. Consumer loans and commercial business loans amounted to $134.9 million or 19.5% and $54.4 million or 7.9%, respectively, of the Company’s total loan portfolio.

The Company’s lending activities are conducted through the Bank. The Company’s loan origination activities are primarily involved in the origination of single-family residential loans and, to a lesser extent, multi-family residential mortgage loans, primarily secured by properties in the Company’s market area. In addition, the Company also offers other types of loans within its primary market area. These loans include construction loans, commercial real estate loans, commercial business loans including credit cards, a variety of consumer loans and indirect automobile loans. Loans originated in the Company’s market area, both fixed and adjustable rate, are made primarily for retention in the Company’s own portfolio. The Company estimates that approximately 95% of its mortgage loans are secured by properties located in Western Pennsylvania.

 

3


Table of Contents

The following table sets forth the composition of the Company’s portfolio of loans receivable in dollar amounts and in percentages as of December 31 for the years indicated:

 

     2012     2011     2010     2009     2008  

(Dollar amounts in thousands)

   Dollar
Amount
    %     Dollar
Amount
    %     Dollar
Amount
    %     Dollar
Amount
    %     Dollar
Amount
    %  

Mortgage loans:

                    

Residential Real Estate

                    

Single family

   $ 326,005        47.1   $ 312,723        46.7   $ 314,051        47.8   $ 329,984        47.9   $ 353,658        50.0

Construction

     46,418        6.7     45,363        6.8     48,687        7.4   $ 45,749        6.7   $ 45,861        6.5

Multi-family

     33,472        4.8     32,370        4.8     30,091        4.6     37,664        5.5     33,680        4.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total residential real estate

     405,895        58.6     390,456        58.3     392,829        59.8     413,397        60.1     433,199        61.3

Commercial Real Estate

                    

Commercial

     81,077        11.7     83,447        12.4     82,347        12.5     84,409        12.3     76,633        10.8

Construction

     15,878        2.3     17,307        2.6     9,701        1.5     5,360        0.8     10,118        1.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     96,955        14.0     100,754        15.0     92,048        14.0     89,769        13.1     86,751        12.2

Total mortgage loans

     502,850        72.6     491,210        73.3     484,877        73.8     503,166        73.2     519,950        73.5

Other loans:

                    

Consumer loans

                    

Home equity loans

     80,418        11.6     72,493        10.8     71,645        10.9     73,195        10.7     71,271        10.1

Dealer auto and RV loans

     46,571        6.7     47,039        7.0     50,781        7.7     56,876        8.3     60,896        8.6

Other loans

     7,896        1.2     9,255        1.4     9,960        1.5     10,421        1.5     10,656        1.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

     134,885        19.5     128,787        19.2     132,386        20.1     140,492        20.5     142,823        20.2

Commercial business loans

     54,445        7.9     50,337        7.5     40,431        6.1     43,377        6.3     44,508        6.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other loans

     189,330        27.4     179,124        26.7     172,817        26.2     183,869        26.8     187,331        26.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans receivable

     692,180        100.0     670,334        100.0     657,694        100.0     687,035        100.0     707,281        100.0
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Less:

                    

Allowance for loan losses

     6,709          6,537          6,547          6,027          6,006     

Net deferred loan fees and discounts

     (1,862       (1,852       (1,983       (2,334       (2,825  

Loans in process

     15,247          16,728          12,243          11,955          12,785     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Net loans receivable

   $ 672,086        $ 648,921        $ 640,887        $ 671,387        $ 691,315     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Loans Held for Sale

                    

Residential – single family

   $ —           $ —           $ 80        $ 201        $ —        
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

4


Table of Contents

The following table sets forth the scheduled contractual principal repayments of loans in the Company’s portfolio at December 31, 2012. Demand loans having no stated schedule of repayment and no stated maturity are reported as due within one year:

 

(Dollar amounts in thousands)

   Due in one
year or less
     Due from one
to five years
     Due from five
to ten years
     Due after
ten years
     Total  

Real estate loans

   $ 39,875       $ 118,230       $ 102,262       $ 242,483       $ 502,850   

Consumer loans

     21,320         69,703         28,583         15,279         134,885   

Commercial business loans

     19,110         17,279         10,528         7,528         54,445   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 80,305       $ 205,212       $ 141,373       $ 265,290       $ 692,180   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fixed and adjustable rate loans represented $588.1 million or 85.0% and $104.1 million or 15.0%, respectively, of the Company’s total loan portfolio as of December 31, 2012.

The following table sets forth the dollar amount of the Company’s fixed and adjustable rate loans due after one year as of December 31, 2012:

 

(Dollar amounts in thousands)

   Fixed
rate
     Adjustable
rate
 

Real estate loans

   $ 401,665       $ 61,310   

Consumer loans

     88,881         24,684   

Commercial business loans

     34,525         810   
  

 

 

    

 

 

 
   $ 525,071       $ 86,804   
  

 

 

    

 

 

 

Contractual maturities of loans do not reflect the actual term of the Company’s loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and enforcement of due-on-sale clauses which give the Company the right to declare a loan immediately payable in the event, among other things, that the borrower sells the real property subject to the mortgage. The average life of mortgage loans tends to increase when current market mortgage rates substantially exceed rates on existing mortgages and conversely, decrease when rates on existing mortgages substantially exceed current market interest rates.

Origination, Purchase and Sale of Loans. The Company originates loans secured by residential and commercial real estate as well as consumer and commercial business loans in its primary lending area, which includes Western Pennsylvania, through loan officers of the Company who evaluate applications received at all of the Company’s locations. Such applications are primarily the result of the Company’s presence, its business development and marketing efforts and through referrals by real estate agents, attorneys, accountants and builders. The Company also, to a much lesser extent, originates loans secured by residential and commercial real estate in its market area through a network of correspondent lenders who offer the Bank’s loan products to a variety of customers throughout Western Pennsylvania. Loans originated through correspondents are underwritten according to the same strict guidelines as loans originated directly by the Company.

Applications are obtained by loan officers who are full-time, salaried employees of the Company as well as through the Company’s mortgage banking correspondent relationships. The processing, underwriting and approval of all loans is performed at the Company’s Ellwood City and Wexford offices. The Company believes this centralized approach to evaluating such loan applications allows it to review, process and approve such applications more efficiently and effectively than would be afforded by a decentralized approach. The Company also believes that this approach enhances its ability to service and monitor these types of loans. The Company’s mortgage banking correspondents originate and process one-to-four family residential mortgage loans for a fee generally equal to up to 1% of the loan amount. Underwriting of these loans is performed by the Company.

As of December 31, 2012, $5.2 million or 0.77% of the Company’s total loan portfolio consisted of whole loans and participation interests in loans purchased from other financial institutions.

The Company requires that all purchased loans be underwritten in accordance with its underwriting guidelines and standards. The Company reviews the loans, particularly scrutinizing the borrower’s ability to repay the obligation, the appraisal and the loan-to-value ratio. Servicing of loans for loan participations purchased by the Company generally is

 

5


Table of Contents

performed by the seller, with a portion of the interest being paid by the borrower retained by the seller to cover servicing costs. As of December 31, 2012, all of the Company’s purchased loans were serviced by sellers.

The Company’s residential non-construction real estate loans are generally originated under terms, conditions, and documentation requirements which permit their sale in the secondary market. The Company in the past has not been an active seller of loans in the secondary market and has chosen, instead, to hold the loans it originates in its own portfolio until maturity. However, from time to time over the past several years, the Company has originated and sold 15 to 30-year fixed rate residential loans, servicing released, as a means of satisfying the demand for such loans within the Company’s primary market area when market interest rates on such loans did not meet the Company’s prevailing asset/liability gap and investment objectives. Any loan held in the available for sale portfolio is subject to a takedown commitment from an investor.

The following table sets forth the Company’s loan activity including originations, purchases, principal repayments, sales, transfers to real estate acquired through foreclosure and other changes for the years ended December 31:

 

(Dollar amounts in thousands)

   2012     2011     2010  

Net loans receivable at beginning of period

   $ 648,921      $ 640,887      $ 671,387   

Originations:

      

Single-family residential real estate

     101,700        69,219        84,173   

Multi-familiy residential and commercial real estate

     23,944        33,584        17,758   

Construction

     14,982        12,538        14,695   

Consumer

     59,105        42,279        44,341   

Commercial business

     19,464        24,227        24,113   
  

 

 

   

 

 

   

 

 

 
     219,195        181,847        185,080   

Repayments on loans

     (201,232     (172,428     (216,767

Transfers to real estate acquired through foreclosure

     (1,237     (4,674     (1,757

Other changes

     6,259        3,289        2,944   
  

 

 

   

 

 

   

 

 

 

Net loans receivable at end of period

   $ 671,906      $ 648,921      $ 640,887   
  

 

 

   

 

 

   

 

 

 

Loan Underwriting Policies. The Company’s lending activities are subject to written non-discriminatory underwriting standards and loan procedures prescribed by the Board of Directors and management. Detailed loan applications are obtained to determine the borrower’s ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations. Property valuations are performed primarily by independent outside appraisers approved by the Board of Directors. The Company has established three levels of lending authority. Loans must be approved by loan officers, the internal loan committee and/or, depending on the amount and characteristics of the loan, the Board of Directors.

Loans may be approved by certain loan officers within designated characteristics and dollar limits, which are established and modified from time to time to reflect expertise and experience. All loans in excess of an individual’s designated limits are referred to the officer with the requisite authority or the Officers’ Loan Committee of the Bank. The President and Chief Executive Officer of the Company has approval authority equal to the Freddie Mac (FHLMC) maximum conforming loan amount as revised from time to time for loans secured by residential real estate and up to $200,000 for all other loan types. Other members of the Officers’ Loan Committee have individual lending authorities that range from $10,000 to the FHLMC maximum conforming loan amount. The Officers’ Loan Committee, which consists of the President and Chief Executive Officer, Group Senior Vice President of Lending and any loan officer designated by the President and approved by the Board of Directors, is authorized to act on individual loan applications up to $2.0 million so long as all of the loans and commitments to the individual applicant do not aggregate above $2.0 million.

The third level of lending authority is reserved for the Board of Directors or the Board’s Executive Committee, which serve as the approval bodies for all individual loans above $2.0 million and loans to individual borrowers with aggregate loans and commitments above $2.0 million.

For residential real estate loans, it is the Company’s policy to have a mortgage creating a valid lien on real estate and to obtain a title insurance policy, which ensures that the property is free of prior encumbrances. Borrowers must also obtain hazard insurance policies prior to closing and, when the property is in a flood plain as designated by the Department of Housing and Urban Development, flood insurance policies. Many borrowers are also required to advance funds on a

 

6


Table of Contents

monthly basis together with each payment of principal and interest to a mortgage escrow account from which disbursements for real estate taxes are made.

The Company is permitted by applicable regulations to lend up to 100% of the appraised value of the real property securing a mortgage loan. For loans secured by real property, the Company generally lends up to 80% of the appraised value of such property (the loan-to-value or LTV ratio). The Company also offers several other programs where loans are granted in excess of that limit. The primary program is available on all residential mortgage products, except new construction, and permits LTV ratios of up to 97% provided that private mortgage insurance is obtained. Loan programs involving new construction are limited to 95% LTV ratios. Depending on the term and LTV ratio, the Company requires such insurance coverage in amounts equal to 6% to 30% of the principal balance of the loan. On a more limited basis, the Company also offers another program where loans can be granted in excess of the 80% LTV ratio. This program is limited since it does not require private mortgage insurance. Total exposure limits have been established by the Board of Directors. The program is a 100% LTV ratio home equity product. In practice, the Company has reduced the acceptable maximum LTV ratio over the last two years and is currently limiting these loans to 90% LTV ratios. The Company has also offered products for low- and moderate-income borrowers or for properties in low- and moderate-income census tracks which can exceed the 80% LTV ratio. These low and moderate-income programs were designed to help the Company fulfill its responsibilities under the Community Reinvestment Act. With respect to loans for multi-family and commercial real estate mortgages, the Company generally limits the LTV ratio to 80%.

Under applicable regulations, loans-to-one borrower may not exceed 15% of unimpaired capital and surplus. As of December 31, 2012, ESB was permitted to lend approximately $24.6 million to any one borrower under this standard. Higher limits may be available in certain circumstances. The Company generally will limit its maximum exposure to any one borrower to $13.0 million. However, with the approval of the board, this limit can be exceeded. As of December 31, 2012, the highest amount loaned to one borrower is $15.0 million. As of December 31, 2012, the Company did not have any lending relationships that exceeded the Bank’s regulatory lending limit to one borrower at the time made or committed.

Residential Mortgage and Construction Lending. The Company offers single-family residential mortgage loans with fixed and adjustable rates of interest. As of December 31, 2012, $326.0 million or 47.1% of the total loan portfolio consisted of single-family residential mortgage loans.

Fixed rate residential loans are generally originated by the Company with 10 to 30 year terms. Substantially all of the Company’s long-term, fixed rate residential mortgage loans originated 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 real property subject to the mortgage. The Company enforces due-on-sale clauses.

In addition to standard fixed rate mortgage loans, the Company offers adjustable rate mortgage loans (ARMs) with 30 year terms, on which the interest rate adjusts based upon changes in various indices which generally reflect market rates of interest. The Company at times has offered one-year ARMs that have an interest rate which adjusts annually according to changes in an index that is based upon the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of one year, as made available by the Federal Reserve Board, plus a margin. The amount of any increase or decrease in the interest rate is limited to 2.0% per year, with a limit of 6.0% over the life of the loan. The Company also offers three, five and seven year ARM loan products with margins and caps similar to the one year ARM product whose interest rates are fixed for the first three, five or seven years after the origination date and then reprice periodically based upon an appropriate index. The first rate change on the Company’s seven year product is capped at a 6.0% increase. The ARMs offered by the Company, as well as many other financial institutions, provide for initial rates of interest below the rates which would prevail if the index used for repricing were applied initially. ARM loans decrease the risks associated with changing market interest rates, but involve certain risks because as interest rates increase, the underlying payments required of the borrower increase, and this could increase the potential for default. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. However, these risks have not had an adverse effect on the Company to date. When one year ARMs are originated, the customers are qualified at the second year cap rate or 2.0% higher than the initial note rate, whichever is higher.

The Company also grants loans to borrowers, including developers and construction contractors, for the construction of speculative homes and owner-occupied single-family dwellings in the Company’s primary market area. As of December 31, 2012, the Company had $62.3 million or 9.0% of the total loan portfolio outstanding in construction loans. Generally, the loan-to-value ratio for construction loans does not exceed 80%, provided that with respect to construction/permanent loans to individual borrowers for their primary residences, the Company will lend up to 95% subject to private mortgage insurance requirements. The interest rate on the permanent portion of the financing is set upon conversion to the permanent

 

7


Table of Contents

loan, based upon terms agreed to in the loan commitment, including the index to be used, the interest rate margin and the frequency of the adjustment.

The Company finances the purchase of developed lots and pre-sold residential dwellings and speculative homes with various contractors in the Company’s primary market area. These loans do not have a permanent portion as they are short-term loans repaid via the proceeds from the sale of the lots or speculative homes constructed with the loan proceeds. These projects are typically financed under acquisition and development loans or builder lines-of-credit. As of December 31, 2012, acquisition and development loans were extended on 12 projects with $8.0 million outstanding under commitments approved in the aggregate amount of $11.5 million and builder lines-of-credit were extended to 12 builders with $11.0 million outstanding under lines approved in the aggregate amount of $19.4 million.

Commercial Real Estate and Multi-family Residential Mortgage Lending. The Company originates commercial real estate and multi-family residential mortgage loans and has in its portfolio both whole loans and participation interests. As of December 31, 2012, the Company had $114.5 million, or 16.5% of the total loan portfolio, invested in mortgages secured by commercial real estate and multi-family residential properties.

Commercial real estate and multi-family mortgage loans are generally priced at prevailing market interest rates at the time of origination. The commercial real estate loans in the Company’s portfolio are generally secured by apartment buildings, office buildings, small retail shopping centers and other income-producing properties in the Company’s primary market area.

The Company generally will not originate a commercial real estate or multi-family mortgage loan with a loan balance of greater than 80% of the appraised value of the property. The Company generally requires a positive cash flow at least sufficient to cover the debt service by 1.2 times on all commercial real estate loans.

Commercial real estate and multi-family residential mortgage lending entails significant additional risks as compared with single-family residential mortgage lending. These loans typically involve large loan balances concentrated in single borrowers or groups of related borrowers. In addition, the repayment experience on loans secured by income producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy in general.

Consumer Lending. As of December 31, 2012, the Company’s consumer loan portfolio totaled $134.9 million or 19.5% of its total loan portfolio. Under applicable regulations, the Company, through the Bank, may make secured and unsecured consumer loans in an aggregate amount up to 30% of the respective institution’s total assets. The 30% limitation does not include home equity loans (loans secured by the equity in the borrower’s residence but not necessarily for the purpose of improvement), home improvement loans or loans secured by deposit accounts. The Company offers consumer loans in order to provide a broader range of financial services to its customers and because the shorter terms and normally higher interest rates on such loans help the Company maintain a profitable spread between its average loan yield and its cost of funds. The Company has increased its emphasis on the origination of consumer loans within its primary market area during the past several years. Consumer lending originations were augmented through marketing techniques, including the targeting of specific customer profiles through the Company’s branch office locations. The Company has adopted underwriting standards for such lending designed to maintain asset quality. The Company offers a variety of consumer loans, including loans secured by deposit accounts, automobile loans (both direct and indirect), home equity loans and secured and unsecured personal loans. On all consumer loans originated, the Company’s underwriting standards include a determination of the applicant’s payment history on other debts and an assessment of the borrower’s ability to meet existing obligations and payment on the proposed loan.

As of December 31, 2012, the Company’s largest group of consumer loans was home equity loans. The Company originates both adjustable rate home equity lines-of-credit and fixed rate home equity loans with terms of up to 30 years. As of December 31, 2012, $80.4 million or 59.6% of the Company’s consumer loan portfolio was made up of home equity loans. The Company’s second largest group of consumer loans was indirect automobile and recreational vehicle loans. These loans are made on terms up to six years on both new and used automobiles and are made on terms up to fifteen years on both new and used recreational vehicles. These loans are originated through a network of dealers and are underwritten in accordance with Bank guidelines intended to assess the applicant’s ability to repay and the collateral value adequacy of the financed vehicle. As of December 31, 2012, $46.6 million or 34.5% of the Company’s consumer loan portfolio was made up of indirect automobile and RV loans.

Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. The

 

8


Table of Contents

Company believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and that consumer loans are important in its efforts to maintain diversity as well as to shorten the average maturity of its loan portfolio.

Commercial Business Lending. Commercial business loans and lines-of-credit of both a secured and unsecured nature are made by the Company for business purposes to municipalities as well as incorporated and unincorporated businesses. Typically, these loans are made for the purchase of equipment, to finance accounts receivable and/or inventory, as well as other business purposes. As of December 31, 2012, commercial business loans amounted to $54.4 million or 7.9% of the Company’s total loan portfolio. Included in the $54.4 million of commercial business loans are $29.6 million of municipal loans.

Loan Servicing. The Company services all loans it has originated for its portfolio. In addition, fees are received for servicing loans which were originated by the Company and sold to third-party investors. As of December 31, 2012, the Company had $5.8 million in loans serviced for third-party investors. Loans purchased are generally serviced by the company which originated the loans. Those companies collect a fee for servicing the loans.

Loan Origination Fees and Other Fees. The Company receives income in the form of loan origination and other fees on both loans originated and on loans purchased in the secondary market. Such loan origination fees and certain related direct loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the related loan as an adjustment to the yield on the loan.

Delinquencies and Classified Assets

Delinquent Loans and Real Estate Acquired Through Foreclosure (REO). Typically, a loan is considered delinquent and a late charge is assessed when the borrower has not made a payment within fifteen days from the payment due date. When a borrower fails to make a required payment on a loan, the Company attempts to cure the deficiency by contacting the borrower. The initial contact with the borrower is made shortly after the seventeenth day following the due date for which a payment was not received. In most cases, delinquencies are cured promptly.

If the delinquency exceeds 60 days, the Company works with the borrower to set up a satisfactory repayment schedule. Loans are considered non-accruing upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but unpaid interest is deducted from interest income. The Company institutes foreclosure action on real estate secured loans only if all other remedies have been exhausted. If an action to foreclose is instituted and the loan is not reinstated or paid in full, the property is sold at a judicial or trustee’s sale at which the Company may be the buyer.

Real estate properties acquired through, or in lieu of, mortgage foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loss on foreclosed real estate. The Company generally attempts to sell its REO properties as soon as practical upon receipt of clear title. The original lender typically handles disposition of those REO properties resulting from loans purchased in the secondary market.

As of December 31, 2012, the Company’s non-performing assets, which include non-accrual loans, loans delinquent due to maturity, troubled debt restructuring, REO and repossessed vehicles, amounted to $10.0 million or 0.52% of the Company’s total assets.

Classified Assets. Regulations applicable to insured institutions require the classification of problem assets as “substandard”, “doubtful” or “loss” depending upon the existence of certain characteristics as discussed below. A category designated “special mention” must also be maintained for assets currently not requiring the above classifications but having potential weakness or risk characteristics that could result in future problems. An asset is classified as substandard if not adequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. A substandard asset is characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified as substandard. In addition, these weaknesses 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 considered uncollectible and of such little value that their continuance as assets is not warranted.

 

9


Table of Contents

The Company’s classification of assets policy requires the establishment of valuation allowances for loan losses in an amount deemed prudent by management. Valuation allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities.

The Company regularly reviews the problem loans and other assets in its portfolio to determine whether any require classification in accordance with the Company’s policy and applicable regulations. As of December 31, 2012, the Company’s classified and criticized assets amounted to $76.7 million, with $68.0 million classified as substandard, $2,000 classified as doubtful, $221,000 classified as loss and $7.3 million identified as special mention.

The following table sets forth information regarding the Company’s non-performing assets as of December 31, for the years indicated:

 

(Dollar amounts in thousands)

   2012     2011     2010     2009     2008  

Non-accrual loans:

          

Real estate loans

   $ 6,554      $ 5,089      $ 4,077      $ 2,921      $ 1,718   

Commercial business loans

     35        54        837        417        —     

Consumer loans

     436        474        768        492        528   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-accrual loans

     7,025        5,617        5,682        3,830        2,246   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total as a percentage of total assets

     0.36     0.29     0.30     0.20     0.11
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate acquired through foreclosure and repossessed vehicles

     2,622        3,952        1,276        890        832   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total as a percentage of total assets

     0.14     0.20     0.07     0.05     0.04
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Troubled debt restructurings

     368        7,762        7,469        254        257   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total as a percentage of total assets

     0.02     0.40     0.39     0.01     0.01
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 10,015      $ 17,331      $ 14,427      $ 4,974      $ 3,335   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets as a percentage of total assets

     0.53     0.88     0.75     0.25     0.17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate acquired through foreclosure was $2.4 million and $3.9 million as of December 31, 2012 and 2011, respectively. Of the $2.4 million in real estate acquired through foreclosure in 2012, all was single family residential and four of the properties totaling $637,000 were sold during the year. Of the $3.9 million in real estate acquired through foreclosure in 2011, $2.2 million relates to a multi-family development project and $867,000 relates to a commercial property. The commercial property was sold in 2012. The decrease in TDRs in 2012 was the result of $8.2 million worth of TDRs performing according to their modified terms for more than six months.

Allowance for Loan Losses. Management establishes the allowance for losses on loans based upon its evaluation of the pertinent factors underlying the types and quality of loans in the portfolio. Commercial loans and commercial real estate loans are reviewed on a regular basis with a focus on larger loans along with loans which have experienced past payment or financial deficiencies. Larger commercial loans, multi-family, residential real estate construction and commercial real estate loans which are 60 days or more past due are selected for impairment testing in accordance with U.S. Generally Accepted Accounting Principles (GAAP). These loans are analyzed to determine if they are “impaired”, which means that it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. All loans that are delinquent 90 days and are placed on nonaccrual status are classified on an individual basis. Residential loans 60 days past due, which are still accruing interest are classified as substandard as per the Company’s asset classification policy. The remaining loans are evaluated and classified as groups of loans with similar risk characteristics. The Company allocates allowances based on the factors described below, which conform to the Company’s asset classification policy. In reviewing risk within the Bank’s loan portfolio, management has determined there to be several different risk categories within the loan portfolio. Factors considered in this process included general loan terms, collateral, and availability of historical data to support the analysis. Historical loss percentages for each risk category are calculated and used as the basis for calculating allowance allocations. Certain qualitative factors are then added to the historical loss percentages to get the adjusted factor to be applied to non-classified loans. The following qualitative factors are analyzed:

 

   

Levels of and trends in delinquencies and nonaccruals

 

   

Trends in volume and terms

 

10


Table of Contents
   

Changes in lending policies and procedures

 

   

Volatility of losses within each risk category

 

   

Loans and Lending staff acquired through acquisition

 

   

Economic trends

 

   

Concentrations of credit

 

   

Experience depth and ability of management

The Company also maintains an unallocated allowance to account for any factors or conditions that may cause a potential loss but are not specifically addressed in the process described above. The Company analyzes its loan portfolio each quarter to determine the appropriateness of its allowance for loan losses. Management believes that the Company’s allowance for losses as of December 31, 2012 of $6.7 million is appropriate to cover inherent losses in the portfolio.

The following table sets forth an analysis of the allowance for losses on loans receivable for the years ended December 31:

 

(Dollar amounts in thousands)

   2012     2011     2010     2009     2008  

Balance at beginning of period

   $ 6,537      $ 6,547      $ 6,027      $ 6,006      $ 5,414   

Provision for loan losses

     1,100        1,130        1,404        912        1,406   

Charge-offs

          

Real estate loans

     (452     (709     (345     (168     (294

Commercial business loans

     (32     (187     (58     (154     (12

Consumer loans

     (562     (478     (583     (697     (690
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (1,046     (1,374     (986     (1,019     (996
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries

          

Real estate loans

     17        49        3        2        7   

Commercial business loans

     —          25        1        —          3   

Consumer loans

     101        160        98        126        172   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     118        234        102        128        182   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 6,709      $ 6,537      $ 6,547      $ 6,027      $ 6,006   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs to average loans outstanding

     0.14     0.18     0.13     0.13     0.12
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of allowance to total loans at end of period

     0.97     0.98     1.00     0.88     0.85
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period applicable to:

          

Real estate loans

   $ 4,616      $ 4,557      $ 4,404      $ 3,826      $ 3,791   

Commercial business loans

     550        384        784        864        663   

Consumer loans

     1,031        1,045        1,125        1,093        1,156   

Unallocated

     512        551        234        244        396   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 6,709      $ 6,537      $ 6,547      $ 6,027      $ 6,006   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

11


Table of Contents

The following table sets forth the allocation of the allowance by category and the percent of loans in each category to total loans for the years ended December 31:

 

(Dollar amounts in thousands)

   2012     2011     2010     2009     2008  
     $      %     $      %     $      %     $      %     $      %  

Residential Real Estate Loans

   $ 2,541         58.6   $ 2,115         58.3   $ 2,573         59.8   $ 2,206         60.1   $ 2,210         61.3

Commercial Real Estate Loans

     2,075         14.0     2,442         15.0     1,831         14.0     1,620         13.1     1,580         12.2

Consumer Loans

     1,031         19.5     1,045         19.2     1,125         20.1     1,093         20.5     1,156         20.2

Commercial Business Loans

     550         7.9     384         7.5     784         6.1     864         6.3     664         6.3

Unallocated

     512         N/A        551         N/A        234         N/A        244         N/A        396         N/A   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 6,709         100.0   $ 6,537         100.0   $ 6,547         100.0   $ 6,027         100.0   $ 6,006         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Interest-Earning Deposits

The Company maintains daily interest-earning cash accounts at the Federal Reserve Bank of Cleveland (FRB of Cleveland) and the FHLB of Pittsburgh. The accounts consist generally of excess funds, which are available to meet loan funding requirements, investment and mortgage-backed securities purchases and withdrawal of deposit accounts. The accounts earn interest daily at a rate which approximates the rate on federal funds. Such funds are able to be withdrawn upon demand and are not federally insured. Interest-earning deposits at the FRB of Cleveland and the FHLB of Pittsburgh totaled $112,000 and $9.0 million, respectively, as of December 31, 2012.

Investment Activities

General. The Company’s investment activities involve investment in numerous types of investment securities, including U.S. Treasury obligations and securities of various federal agencies, certificates of deposit at insured banks and savings institutions, commercial paper, corporate debt securities, tax-exempt obligations (including primarily municipal obligations of state and local governments), mutual funds and federal funds.

The Company also maintains a portfolio of mortgage-backed securities which are insured or guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage Association (FNMA) and the Government National Mortgage Association (GNMA). Mortgage-backed securities increase the quality of the Company’s assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company.

 

12


Table of Contents

The following table summarizes the Company’s investment securities as of the dates indicated:

 

(Dollar amounts in thousands)

   Amortized
cost
     Unrealized
gains
     Unrealized
losses
    Fair value  

Available for sale:

          

December 31, 2012:

          

Trust preferred securities

   $ 45,894       $ 367       $ (8,234   $ 38,027   

Municipal securities

     177,414         13,717         (244     190,887   

Equity securities

     1,142         676         —           1,818   

Corporate bonds

     219,700         7,186         (1,091     225,795   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 444,150       $ 21,946       $ (9,569   $ 456,527   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011:

          

Trust preferred securities

   $ 45,894       $ 265       $ (8,615   $ 37,544   

Municipal securities

     174,288         10,427         (230     184,485   

Equity securities

     1,754         351         (2     2,103   

Corporate bonds

     165,923         1,784         (2,928     164,779   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 387,859       $ 12,827       $ (11,775   $ 388,911   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2010:

          

Trust preferred securities

   $ 46,467       $ 116       $ (7,607   $ 38,976   

Municipal securities

     165,479         2,040         (4,342     163,177   

Equity securities

     1,424         434         (8     1,850   

Corporate bonds

     118,862         3,800         —           122,662   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 332,232       $ 6,390       $ (11,957   $ 326,665   
  

 

 

    

 

 

    

 

 

   

 

 

 

Included in the $38.0 million of trust preferred securities are standalone trust preferred securities with a fair value of $36.2 million. In addition, there was one pooled trust preferred security with a par value of $2.5 million and a fair value of $173,000 that was not investment-grade rated. The Company took impairment charges of approximately $5,000 in 2012, $78,000 in 2011 and $810,000 in 2010 on this $2.5 million collateralized debt obligation that is comprised of ten financial institutions. At December 31, 2011, the Company had an independent third party analyze this bond. During this analysis, the value of this security was derived using a discounted cash flow method which is a level three pricing method. The Company believes the factors have improved for this bond since December 2011. Therefore, a third party analysis was not used in 2012.

 

13


Table of Contents

The following table summarizes the Company’s mortgage-backed securities as of the dates indicated:

 

(Dollar amounts in thousands)

   Amortized
cost
     Unrealized
gains
     Unrealized
losses
    Fair value  

Available for sale:

          

December 31, 2012

          

GNMA

   $ 34,157       $ 1,696       $ —        $ 35,853   

FNMA

     320,998         19,556         (214     340,340   

FHLMC

     252,467         11,664         (24     264,107   

Collateralized mortgage obligations

     13,675         282         (8     13,949   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 621,297       $ 33,198       $ (246   $ 654,249   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

GNMA

   $ 31,278       $ 1,519       $ —        $ 32,797   

FNMA

     387,743         21,550         —          409,293   

FHLMC

     262,282         14,337         (8     276,611   

Collateralized mortgage obligations

     22,335         471         (302     22,504   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 703,638       $ 37,877       $ (310   $ 741,205   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2010

          

GNMA

   $ 30,324       $ 1,232       $ —        $ 31,556   

FNMA

     339,730         17,462         (575     356,617   

FHLMC

     321,439         14,601         (949     335,091   

Collateralized mortgage obligations

     26,987         920         (164     27,743   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 718,480       $ 34,215       $ (1,688   $ 751,007   
  

 

 

    

 

 

    

 

 

   

 

 

 

The following table sets forth the activity in the Company’s mortgage-backed securities for the years ended December 31:

 

(Dollar amounts in thousands)

   2012     2011     2010  

Mortgage-backed securities at the beginning of period

   $ 741,205      $ 751,007      $ 827,151   

Purchases

     138,278        205,580        190,041   

Sales

     (2,197     (24,358     —     

Repayments

     (215,121     (194,243     (263,731

Net amortization of premium

     (3,300     (1,821     (1,545

Change in unrealized (gain) loss on mortgage-backed securities available for sale

     (4,616     5,040        (909
  

 

 

   

 

 

   

 

 

 

Mortgage-backed securities at the end of period

   $ 654,249      $ 741,205      $ 751,007   
  

 

 

   

 

 

   

 

 

 

Weighted average yield at the end of the period

     3.15     3.78     4.20
  

 

 

   

 

 

   

 

 

 

Due to prepayments of the underlying loans collateralizing mortgage-backed securities, the actual maturities of the securities are expected to be substantially less than the scheduled maturities.

As a member of the FHLB system, the Bank is required to meet certain minimum levels of liquid assets, which are subject to change from time to time. The Company’s liquidity fluctuates with deposit flows, funding requirements for loans and other assets and the relative returns between liquid investments and various loan products.

The Board of Directors has established an investment policy, which provides for priorities for the Company’s investments with respect to the safety of the principal amount, liquidity, generation of income, management of interest rate risk and capital appreciation. The policy permits investment in various types of liquid assets including, among others, U.S. Treasury and federal agency securities, municipal obligations, investment grade corporate bonds and federal funds.

 

14


Table of Contents

Sources of Funds

General. The Company’s primary sources of funds for its lending and investment activities are deposits, principal and interest payments on loans and mortgage-backed securities, interest on securities and interest-bearing deposits, advances from the FHLB of Pittsburgh and repurchase agreement borrowings.

Deposits. The Company offers a wide variety of deposit accounts with a range of interest rates and terms. The primary types of deposit accounts are regular savings, checking and money market accounts and certificate accounts. The primary source of these deposits is the market area in which the Bank’s offices are located. The Company typically relies on customer service, advertising and existing relationships with customers to attract and retain deposits. Deposit flows are significantly influenced by the general state of the economy, general market interest rates and the effects of competition. The Company typically pays competitive interest rates within the market area but does not seek to match the highest rates paid by competing institutions in its primary market area.

The following table sets forth the distribution of the Company’s deposits by type as of December 31, for the years indicated:

 

(Dollar amounts in thousands)

Type of Account

   2012     2011     2010  
   Amount      %     Amount      %     Amount      %  

Noninterest-bearing deposits

   $ 109,964         9.3   $ 95,691         8.3   $ 84,272         8.3

NOW account deposits

     223,736         19.0     208,975         18.1     128,020         12.6

Money Market deposits

     39,255         3.3     34,484         3.0     32,759         3.2

Passbook account deposits

     173,343         14.7     153,644         13.3     136,730         13.6

Time deposits

     631,759         53.7     663,616         57.3     630,864         62.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 1,178,057         100.0   $ 1,156,410         100.0   $ 1,012,645         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company had a total of $244.8 million, $246.6 million and $198.6 million in time deposits of $100,000 or more as of December 31, 2012, 2011 and 2010, respectively.

The following table sets forth, by various rate categories, the amount of time deposits outstanding as of December 31, 2012, which mature in the periods presented:

 

(Dollar amounts in thousands)

Range of Rates

   1 to 12
months
     More than
1 to 2 years
     More
than 2 to
3 years
     More
than 3 to
4 years
     More
than 4 to
5 years
     After 5
years
     Total  

0.00% to 2.49%

   $ 366,522       $ 90,586       $ 51,763       $ 22,839       $ 16,349       $ 1,542       $ 549,601   

2.50% to 4.49%

     8,524         27,747         26,729         14,081         757         3,504         81,342   

4.50% to 6.49%

     816         —           —           —           —           —           816   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 375,862       $ 118,333       $ 78,492       $ 36,920       $ 17,106       $ 5,046       $ 631,759   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth, by various rate categories, the amount of time deposit accounts outstanding as of December 31, for the years indicated:

 

(Dollar amounts in thousands)

Range of Rates

   2012      2011      2010  

0.00% to 2.49%

   $ 549,601       $ 561,200       $ 466,711   

2.50% to 4.49%

     81,342         101,136         159,481   

3.00% to 6.00%

     816         1,280         4,672   
  

 

 

    

 

 

    

 

 

 
   $ 631,759       $ 663,616       $ 630,864   
  

 

 

    

 

 

    

 

 

 

 

15


Table of Contents

As of December 31, 2012, the Company had certificates in amounts of $100,000 or more maturing as follows:

 

(Dollar amounts in thousands)

   Amount  

Three months or less

   $ 58,228   

More than three through six months

     54,939   

More than six through twelve months

     38,406   

More than twelve months

     93,201   
  

 

 

 
   $ 244,774   
  

 

 

 

The following table sets forth the net deposit flows during the year ended December 31:

 

(Dollar amounts in thousands)

   2012      2011      2010  

Increase before interest credited and acquisition

   $ 12,297       $ 131,783       $ 53,998   

Interest credited

     9,350         11,982         14,300   
  

 

 

    

 

 

    

 

 

 

Net deposit increase

   $ 21,647       $ 143,765       $ 68,298   
  

 

 

    

 

 

    

 

 

 

Borrowings. While deposits are the preferred source of funds for the Company’s lending and investment activities and general business purposes, the Company also borrows funds from the FHLB of Pittsburgh and through repurchase agreements with third parties. Advances from the FHLB of Pittsburgh are secured by the Company’s stock in the FHLB, a portion of its first mortgage loans and certain investment securities. The FHLB has a variety of different advance programs, each with different interest rates, provisions, maximum sizes and maturities. As of December 31, 2012, the Company had outstanding advances with the FHLB of $213.2 million. The Company has entered into sales of securities under agreements to repurchase (repurchase agreements). Fixed coupon repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability of the Company. The dollar amount of securities underlying the agreements remains as an asset of the Company. The securities underlying the agreements are delivered to independent third party brokerage firms who arrange the transaction.

The following table sets forth the Company’s borrowings as of December 31, for the years indicated:

 

(Dollar amounts in thousands)

   2012      2011      2010  

FHLB advances

   $ 213,232       $ 207,355       $ 290,440   

Repurchase agreements

     268,000         343,000         363,000   

ESOP borrowings

     3,250         4,250         —      

Corporate borrowings

     —            4,200         11,200   

Treasury tax and loan note payable

     —            —            191   

Borrowings for joint ventures

     74         1,762         4,232   

Junior subordinated notes

     46,393         46,393         46,393   
  

 

 

    

 

 

    

 

 

 
   $ 530,949       $ 606,960       $ 715,456   
  

 

 

    

 

 

    

 

 

 

FHLB Advances are secured by FHLB stock, qualifying residential mortgage loans and mortgage-backed securities to the extent that the fair value of such pledged collateral must be at least equal to the advances outstanding. At December 31, 2012, the Company had a maximum borrowing capacity with the FHLB of $338.1 million, with $94.2 million available for use.

The Company enters into sales of securities under agreements to repurchase. Such repurchase agreements are treated as borrowed funds. The dollar amount of the securities underlying the agreements remain in their respective asset accounts.

Repurchase agreements are collateralized by various securities that are either held in safekeeping at the FHLB or delivered to the dealer who arranged the transaction; the Company maintains control of these securities.

 

16


Table of Contents

The market value of such securities exceeded the amortized cost of the securities sold under agreements to repurchase. The market value of the securities as of December 31, 2012 was $318.9 million with an amortized cost of $297.8 million. The market value of the securities as of December 31, 2011 was $402.1 million with an amortized cost of $375.0 million. The average maturity date of the mortgage backed securities sold under agreements to repurchase was greater than 90 days for the years ended December 31, 2012 and 2011.

Included in the $213.2 million of FHLB advances at December 31, 2012 are $50.0 million in structured advances with imbedded caps at various strike rates based on the 3 month LIBOR rate. If during the term of the advance, the 3 month LIBOR rate exceeds the strike rate, the interest rate on the structured advance is reduced by the difference between the rate and the strike rate.

Included in the $268.0 million of Repurchase Agreements (REPOs) are $30.0 million in structured REPOs with imbedded caps at various strike rates based on the 3 month LIBOR rate. If during the term of the REPO, the 3 month LIBOR rate exceeds the strike rate, the interest rate on the structured REPO is reduced by the difference between the rate and the strike rate. In addition, the Company has $25.0 million in structured REPOs with double, or $50.0 million notional amount of imbedded caps, at a strike rate of 3.75% based on the 3 month LIBOR rate. The terms and conditions of these structured REPOs are that the rate is fixed for five years and after 5 years, on a specified date the counterparty has the one time right (European Call) to call the REPO. If the counterparty does not call the REPO on the specified date, the rate remains the same for the remaining five years. These structured REPOs also include a double imbedded cap for the first five year period with a strike rate to the 3 month LIBOR rate. If during the first five years, the 3 month LIBOR rate exceeds the strike rate, the interest rate on the structured REPO is reduced by two times the difference between the rate and the strike rate. At no point shall the interest rate on these structured REPOs with imbedded caps be less than zero.

Also included in the $268.0 million of REPOs is a $25.0 million structured REPO in which the Company pays a fixed rate of interest. At the reset date and every quarterly period thereafter, the counterparty has the right to terminate the transaction. It has historically been the Company’s position to pay off any borrowings and replace them with fixed rate funding if converted by the counterparty.

As of December 31, 2012 and 2011, the Company had repurchase agreements with Citigroup of $115.0 million and $145.0 million respectively, Barclays Capital of $40.0 million and $70.0 million, respectively, Credit Suisse of $83.0 million and $93.0 million, respectively, PNC Bank of $0 and $5.0 million, respectively and Morgan Stanley of $30.0 million and $30.0 million, respectively.

As of December 31, 2012, the Company had repurchase agreements with Citigroup with $14.4 million at risk (where the market value of the securities exceeds the borrowing), with a weighted average maturity of 17 months, repurchase agreements with Barclays Capital with $3.9 million at risk with a weighted average of maturity of 42 months, repurchase agreements with Credit Suisse with $14.1 million at risk with a weighted average maturity of 22 months and repurchase agreements with Morgan Stanley with $4.2 million at risk with a weighted average maturity of 13 months.

Borrowings under repurchase agreements averaged $305.5 million, $356.8 million and $359.7 million during 2012, 2011, and 2010, respectively. The maximum amount outstanding at any month-end was $343.0 million, $368.0 million and $363.0 million during 2012, 2011, and 2010, respectively.

 

17


Table of Contents

The following table presents certain information regarding aggregate short-term borrowings of the Company as of and for the years ended December 31:

 

(Dollar amounts in thousands)

   2012     2011     2010  

FHLB advances:

      

Average balance outstanding for the year

   $ 3,433      $ 2,550      $ —     

Maximum amount outstanding at any month end during the year

     27,500        21,300        —     

Balance outstanding at year end

     27,500        —          —     

Weighted average interest rate during the year

     0.25     0.71     0.00

Weighted average interest rate at year end

     0.25     0.00     0.00

Repurchase agreements:

      

Average balance outstanding for the year

   $ 18,000      $ 18,417      $ 18,000   

Maximum amount outstanding at any month end during the year

     18,000        23,000        18,000   

Balance outstanding at year end

     18,000        18,000        18,000   

Weighted average interest rate during the year

     0.74     0.48     0.42

Weighted average interest rate at year end

     0.76     0.55     0.45

Treasury tax and loan note:

      

Average balance outstanding for the year

   $ —        $ 119      $ 169   

Maximum amount outstanding at any month end during the year

     —          150        191   

Balance outstanding at year end

     —          —          191   

Weighted average interest rate during the year

     0.00     0.00     0.00

Weighted average interest rate at year end

     0.00     0.00     0.00

Total short term borrowings:

      

Average balance outstanding for the year

   $ 21,433      $ 21,086      $ 18,169   

Maximum amount outstanding at any month end during the year

     45,500        44,450        18,191   

Balance outstanding at year end

     45,500        18,000        18,191   

Weighted average interest rate during the year

     0.66     0.51     0.42

Weighted average interest rate at year end

     0.45     0.55     0.45

Junior Subordinated Notes. On April 10, 2003, ESB Capital Trust II (Trust II), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $10.0 million variable rate preferred securities with a stated value and liquidation preference of $1,000 per share. The Company purchased $310,000 of common securities of Trust II. The preferred securities reset quarterly to equal the 3-month LIBOR Index plus 3.25%. Trust II’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by the Trust II to invest in $10.3 million of variable rate Subordinated Debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of the Trust II. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the Subordinated Debt prior to the maturity date of April 24, 2033, on or after April 24, 2008, at the redemption price, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated April 10, 2003, the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the principal amount of the subordinated debt redeemed. There were no unamortized deferred debt issuance costs associated with the preferred securities at December 31, 2011 and 2010. On July 23, 2008 the Company redeemed $5.0 million of the preferred securities and $155,000 of the common securities of ESB Capital Trust II with proceeds from a $14.0 million loan with First Tennessee Bank, National Association (“First Tennessee”), with a fixed interest rate of 6.30%. The remainder of

 

18


Table of Contents

the First Tennessee loan was used to repay an existing loan with First Tennessee with a remaining balance of $9.0 million, which had an interest rate of 5.55% and was due on December 31, 2008. On January 24, 2013, the Company redeemed the remaining $5.1 million of the preferred securities of ESB Capital Trust II with proceeds from a $10.0 million loan from WesBanco, with a fixed interest rate of 3.75%. The remaining $5.0 million of the WesBanco loan will be drawn on March 15, 2013 and used to redeem the $5.1 million of the preferred securities of ESB Capital Trust III.

On December 17, 2003, ESB Statutory Trust III (Trust III), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $5.0 million variable rate preferred securities with a stated value and liquidation preference of $1,000 per share. The Company purchased $155,000 of common securities of Trust III. The preferred securities reset quarterly to equal the 3-month LIBOR Index plus 2.95%. Trust III’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by Trust III to invest in $5.2 million of variable rate subordinated debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of Trust III. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the subordinated debt prior to the maturity date of December 17, 2033, on or after December 17, 2008, at the redemption price, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated December 17, 2003; the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the principal amount of the subordinated debt redeemed. There were no unamortized deferred debt issuance costs associated with the preferred securities at December 31, 2012 and 2011. On January 22, 2013, the Company provided a notice of redemption to redeem the preferred securities of ESB Capital Trust III on March 18, 2013, with the aforementioned proceeds of a $10.0 million loan from WesBanco.

On February 10, 2005, ESB Capital Trust IV (Trust IV), a statutory business trust established under Delaware law that is a subsidiary of the Company, issued $35.0 million fixed rate preferred securities. The Company purchased $1.1 million of common securities of Trust IV. The preferred securities are fixed at a rate of 6.03% for six years and then are variable with a quarterly reset equal to the 3-month LIBOR Index plus 1.82%. The preferred securities have a stated maturity of thirty years. Trust IV’s obligations under the preferred securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the preferred securities and the common securities were utilized by Trust IV to invest in $36.1 million of fixed/variable rate subordinated debt of the Company. The subordinated debt is unsecured and ranks subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The subordinated debt primarily represents the sole assets of Trust IV. Interest on the preferred securities is cumulative and payable quarterly in arrears. The Company has the right to optionally redeem the subordinated debt prior to the maturity date of February 10, 2035, on or after February 10, 2011, at the redemption price, which is equal to the liquidation amount, plus accrued and unpaid distributions, if any, at the redemption date. Under the occurrence of certain events, specifically, a tax event, investment company event or capital treatment event as more fully defined in the Indenture dated February 10, 2005, the Company may redeem in whole, but not in part, the subordinated debt at any time within 90 days following the occurrence of such event. Proceeds from any redemption of the subordinated debt would cause a mandatory redemption of the preferred securities and the common securities having an aggregate liquidation amount equal to the principal amount of the subordinated debt redeemed. The issuance of these preferred securities did not have any deferred debt issuance costs associated with it.

 

19


Table of Contents

Subsidiaries

As of December 31, 2012, the Company had investments in ESB Capital Trust II (the Trust II), ESB Statutory Trust III (the Trust III), ESB Capital Trust IV (the Trust IV) and THF, Inc., totaling approximately $1.7 million. The Trust II, Trust III and Trust IV are Delaware statutory business trusts established to facilitate the issuance of trust preferred securities to the public by the Company. THF, Inc. is a Pennsylvania corporation established as a title agency to provide residential and commercial loan closing services.

At December 31, 2012, as a Pennsylvania chartered, FDIC insured stock savings bank ESB was authorized under applicable regulations to have a maximum investment of $15.7 million in service corporations. On that date, ESB had a $10.9 million investment in AMSCO, Inc. (AMSCO), its wholly owned subsidiary.

AMSCO was incorporated in 1974 as a wholly owned subsidiary of ESB and is engaged in real estate development and construction of 1-4 family residential units independently or in conjunction with its joint ventures. All of the existing joint ventures are 51% or more owned by AMSCO and the Bank has provided all development and construction financing. These joint ventures have been included in the consolidated financial statements and their operations are reflected within other non-interest income or expense. AMSCO owns a commercial office building partially utilized as a branch office and loan production office for ESB. ESB provided financing for the project. In 1999, the Company opened its newly constructed full service branch office located in Wexford, Allegheny County, Pennsylvania a quarter mile north of the former branch location. The Company also houses its settlement company THF, Inc. in the Wexford office building. The office space is leased from AMSCO. The Bank’s loans to AMSCO and related interest have been eliminated in consolidation. As of December 31, 2012, AMSCO had total assets, consisting primarily of investments in nine joint ventures, of $19.5 million.

AMSCO’s first joint venture, Madison Woods, consists of a 55% interest in a partnership with a local developer. Madison Woods purchased approximately 57 acres of undeveloped land in Moon Township, Allegheny County, Pennsylvania in October 1998 and developed the land into a 56-lot subdivision for the purpose of selling the lots for single-family residential construction. ESB provided Madison Woods the capital and financing for the project and Madison Woods has since repaid its loan to ESB. As of December 31, 2012, 4 of the 56 lots remain unsold. On that date, AMSCO had a $86,000 investment in Madison Woods.

The second joint venture, The Links at Deer Run, consists of a 51% interest in a limited liability corporation (LLC) with a local developer/builder. The Links at Deer Run purchased approximately 39 acres of undeveloped land adjacent to a golf course in West Deer Township, Allegheny County, Pennsylvania in April 2001. The LLC has developed the land and began construction on a total of 72 quadplex, 34 duplex and 6 single-family homes. ESB is providing both development and construction financing for the project. As of December 31, 2012, The Links at Deer Run had outstanding lines of credit with ESB in the amount of $1.6 million with outstanding balances of $1.6 million and development costs of $1.9 million. As of December 31, 2012, 81 units were closed and 7 units remained in various stages of construction. On that date, AMSCO had a $464,000 investment in The Links at Deer Run.

The third joint venture, McCormick Farms, consists of a 51% interest in a LLC with the local developer involved in Madison Woods. McCormick Farms purchased approximately 147 acres in Moon Township, Allegheny County, Pennsylvania, in May 2001 and developed the land into a 76-lot subdivision for the purpose of selling the lots for single-family residential construction. ESB is providing the financing for the project. As of December 31, 2012, McCormick Farms had no outstanding loan balances with ESB. As of December 31, 2012, 57 lots were closed and 19 developed lots are remaining. On that date, AMSCO had a $882,000 investment in McCormick Farms.

The fourth joint venture, Brandy One, consists of a 51% interest in a LLC with a local developer/builder. Brandy One purchased approximately 35 acres of undeveloped land in Connoquenessing Township, Butler County, Pennsylvania in October 2001. The LLC has begun development work for the purpose of constructing 112 quadplex homes. ESB is providing financing for the project. As of December 31, 2012, Brandy One had outstanding loans with ESB in the amount of $855,000. As of December 31, 2012, all 112 units of the original project were sold and closed. After completing the development and construction of the 112 units, two parcels of land remained. One of these parcels was sold and the second parcel consisting of 2.2 acres was developed for 8 townhouses, one duplex building and one triplex building known as Napa Ridge. At December 31, 2012, all eight of the townhouse units and the duplex building were under construction and four townhouses have been sold. On that date, AMSCO had a $3,000 investment in Brandy One.

The fifth joint venture, The Vineyards at Brandywine, consists of a 51% interest in a limited partnership (LP) with a local developer/builder. The Vineyards at Brandywine purchased a 100-acre site of undeveloped land adjacent to the Brandy One joint venture project in Connoquenessing Township, Butler County, Pennsylvania in December 2004. The LP is currently

 

20


Table of Contents

developing 48 single-family home lots in Phase I and constructing single-family detached homes thereon. As of December 31, 2012, The Vineyards at Brandywine had outstanding lines of credit with ESB in the amount of $1.0 million with outstanding balances of $1.0 million. As of December 31, 2012, 20 of the 48 lots in Phase I were sold. During 2012 the land for Phase II was sold to the partner. It is being developed into a quadplex project and was financed by another lender. AMSCO will be repaid its investment as units are sold. At December 31, 2012, AMSCO had a $298,000 investment in The Vineyards at Brandywine.

The sixth joint venture, The Meadows at Hampton, consists of a 100% interest in a LP. The partnership purchased a 42 acre site in June 2005 in Hampton Township, Allegheny County, Pennsylvania. The partnership developed the site into 32 duplex building lots to construct 64 duplex units. ESB Bank is providing the financing for the project in the form of two loans, a development loan in the amount of $2.0 million and a line of credit for the construction of the units. This line of credit paid off during 2012 and there will be no further borrowings. The partnership no longer constructs units for resale and has contracted with a local builder to purchase the remaining fifty lots. To date, four lots have been sold. At year-end AMSCO had an investment of ($114,000).

The seventh joint venture, Cobblestone Village, consists of a 51% interest in a LP with a local developer/builder. The partnership purchased a 33 acre site in June 2005 in Adams Township, Butler County, Pennsylvania. The partnership developed the site into 25 quadplex building lots to construct 25 buildings containing a total of 100 units. ESB Bank provided financing in the form of a line of credit in the amount of $1.8 million for the construction of the buildings. The project sold out during 2012 and all loans were repaid.

The eighth joint venture, BelleVue Park, consists of a 51% interest in a LP with a local developer/builder. The partnership purchased a 121 acre site in September 2007 in Cranberry Township, Butler County, Pennsylvania. The partnership developed the site into 185 single family lots along with 26 quadplex building lots to construct 26 buildings containing a total of 104 units. ESB Bank is providing financing in the form of four loans. The first loan is a development loan in the amount of $7.6 million to develop the single family lots. ESB has sold 39.6% of this loan to other lenders. The second loan is a development loan in the amount of $5.5 million to develop the quadplex building lots. This loan repaid in full during 2012. The third loan is a line of credit in the amount of $2.5 million for the construction of the quadplex buildings. The fourth loan is a line of credit in the amount of $1.8 million for the construction of the single family units. As of December 31, 2012, 129 single family lots were closed and 4 single family units remained in various stages of construction. As of December 31, 2012, 94 quadplex units were closed and 10 units remained in various stages of construction. The outstanding loan balances at December 31, 2012, totaled $1.3 million and AMSCO had an investment of $3.4 million.

The Bank’s second wholly owned subsidiary, ESB Financial Services, Inc. (EFS), a Delaware corporation, was founded in July of 2000. EFS is engaged in the management of single-family and commercial real estate loans through a participation agreement with the Bank. At year-end the Bank had an investment of $496.9 million.

An insured state-chartered bank is required to deduct the amount of investment in, and extensions of credit to, a subsidiary engaged in activities not permissible for national banks. Because the acquisition and development of real estate is not a permissible activity for national banks, the investments in and loans to any subsidiary of the Bank which are engaged in such activities are subject to exclusion from the Bank’s regulatory capital calculation. See “Regulation – Regulation of the Bank – Regulatory Capital Requirements”.

REGULATION

Set forth below is a brief description of certain laws and regulations, which relate to the regulation of the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

 

21


Table of Contents

Recently Enacted Regulatory Reform

On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The law imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. In addition, the law changed the jurisdictions of existing bank regulatory agencies and in particular transferred the regulation of federal savings associations from the Office of Thrift Supervision (OTS) to the Office of the Comptroller of the Currency (OCC). Savings and loan holding companies are regulated by the Federal Reserve Board. The law also established an independent federal consumer protection bureau within the Federal Reserve Board. The following discussion summarizes significant aspects of the law that may affect the Company and the Bank. All of the regulations implementing these changes have not been promulgated, so we cannot determine the full impact on our business and operations at this time.

The following aspects of the financial reform and consumer protection act are related to the operations of the Bank:

 

   

A new independent consumer financial protection bureau has been established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. However, smaller financial institutions, like the Bank, continue to be subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

 

   

Tier 1 capital treatment for “hybrid” capital items like trust preferred securities has been eliminated subject to various grandfathering and transition rules.

 

   

The prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011.

 

   

Deposit insurance was permanently increased to $250,000 and unlimited deposit insurance for noninterest-bearing transaction accounts was provided through the end of 2012.

 

   

The deposit insurance assessment base calculation is now equal to the depository institution’s total assets minus the sum of its average tangible equity during the assessment period.

 

   

The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or assessment base; however, the Federal Deposit Insurance Corporation is directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.

The following aspects of the financial reform and consumer protection act are related to the operations of the Company:

 

   

Authority over savings and loan holding companies was transferred to the Federal Reserve Board.

 

   

Leverage capital requirements and risk based capital requirements applicable to depository institutions and bank holding companies has been extended to thrift holding companies. However, the Federal Reserve Board has not issued regulations that address the levels of these capital requirements and when they will apply to the Company.

 

   

The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.

 

   

The Securities and Exchange Commission is authorized to adopt rules requiring public companies to make their proxy materials available to shareholders for nomination of their own candidates for election to the board of directors.

 

   

Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a “say on pay” vote every one, two or three years.

 

   

A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments.

 

22


Table of Contents
   

Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain “significant” matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant.

 

   

Stock exchanges are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information.

 

   

Disclosure in annual proxy materials will be required concerning the relationship between the executive compensation paid and the financial performance of the issuer.

 

   

Item 402 of Regulation S-K will be amended to require companies to disclose the ratio of the Chief Executive Officer’s annual total compensation to the median annual total compensation of all other employees.

 

   

Smaller reporting companies are exempt from complying with the internal control auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act.

Recent Regulatory Capital Proposals

The Federal Reserve Board and the FDIC were part of a joint proposal in June 2012 seeking comment on three notices of proposed rulemaking (“NPR”) that would revise and replace the agencies’ current capital rules in connection with the Basel accords. The two NPRs discussed below concern capital issues of significant importance to the Bank and the Company. The third NPR, relates to advanced approaches and market risk capital rules, is not applicable to the organization’s current operations.

The first NPR relates to Basel III and proposes to revise risk-based and leverage capital requirements, including the implementation of new common equity Tier 1 capital requirements and a higher minimum Tier 1 capital requirement. Also included in the NPR are proposed limitations on capital distributions and certain discretionary bonus payments for any banking organization not holding a specified buffer of common equity Tier 1 capital in excess of its minimum risk-based capital requirement. Revisions to the prompt correction action framework and the tangible common equity definition are also included in the NPR. The other NPR applicable to the organization’s operations proposes a standardized approach for risk-weighted assets to enhance risk sensitivity and to address certain weaknesses identified over recent years, including methods for determining risk-weighted assets for residential mortgages, securitization exposures and counterparty credit risk. The proposed changes in the two NPRs would be applicable to the Bank and the Company.

The comment period for these NPRs ended on October 22, 2012. Since Basel III was intended to be implemented beginning January 1, 2013, the regulators intended to finalize the rules by that date. However, on November 9, 2012, the federal agencies, including the Federal Reserve Board and the FDIC, that proposed the NPRs announced that they did not expect that any of the proposed rules would become effective on January 1, 2013. Moreover, the announcement did not indicate the likely new effective date.

Regulation of the Company

General. The Company is a registered savings and loan holding company pursuant to the Home Owners’ Loan Act, as amended (HOLA). As such, the Company is subject to regulations, examinations, supervision and reporting requirements of the Federal Reserve Board. As a subsidiary of a savings and loan holding company, the Bank is subject to certain restrictions in its dealings with the Company and affiliates thereof.

Regulatory Capital Requirement

The Dodd-Frank Act included an amendment to the Home Owners’ Loan Act that authorizes the Federal Reserve Board to issue regulations and orders related to the capital levels of savings and loan holding companies. Also included as part of the Dodd-Frank Act was a provision (generally referred to as the Collins Amendment) that directs the federal banking regulators

 

23


Table of Contents

to establish minimum leverage and risk-based capital requirements for various types of financial institutions, including savings and loan holding companies. The Collins Amendment includes several provisions that delay its application or exempt certain types of institutions from its requirements. Among those provisions is one that postpones for five years the effective date of capital requirements established under the Collins Amendment for holding companies, such as the Company, that were not supervised by the Federal Reserve Board as of May 19, 2010.

Activities Restrictions. There are generally no restrictions on the activities of a savings and loan holding company, which controlled only one subsidiary savings association on or before May 4, 1999 (a “grandfathered holding company”). However, if the Federal Reserve Board determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings association, the Federal Reserve Board may impose such restrictions as it deems necessary to address such risk, including limiting (i) payment of dividends by the savings association; (ii) transactions between the savings association and its affiliates; and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the qualified thrift lender (QTL) test, then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings association requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. As of December 31, 2011, the Company was a grandfathered holding company and qualifies as a QTL.

If a savings and loan holding company acquires control of a second savings association and holds it as a separate institution, the holding company becomes a multiple savings and loan holding company. As a general rule, multiple savings and loan holding companies are subject to restrictions on their activities that are not imposed on a grandfathered holding company. They could not commence or continue any business activity other than: (i) those permitted for a bank holding company under section 4(c) of the Bank Holding Company Act (unless the Federal Reserve Board by regulation prohibits or limits such 4(c) activities); (ii) furnishing or performing management services for a subsidiary savings association; (iii) conducting an insurance agency or escrow business; (iv) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association; (v) holding or managing properties used or occupied by a subsidiary savings association; (vi) acting as trustee under deeds of trust; or (vii) those activities authorized by regulation as of March 5, 1987, to be engaged in by multiple savings and loan holding companies.

The HOLA requires every savings association subsidiary of a savings and loan holding company to give the Federal Reserve Board at least 30 days advance notice of any proposed dividends to be made on its guarantee, permanent or other non-withdrawable stock, or else such dividend will be invalid.

Limitations on Transactions with Affiliates. Transactions between savings associations and any affiliate are governed by Section 11 of the HOLA and Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings association includes any company or entity which controls the savings association or, is controlled by a company that controls the savings association. In a holding company context, the parent holding company of a savings association (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the savings association. Generally, Section 23A (i) limits the extent to which the savings association or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such association’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to “covered transactions” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least favorable, to the association or subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans to, purchase of assets from, issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also include the provision of services and the sale of assets by a savings association to an affiliate. In addition to the restrictions imposed by Sections 23A and 23B, Section 11 of the HOLA prohibits a savings association from (i) making a loan or other extension of credit to an affiliate, except for any affiliate which engages only in certain activities which are permissible for bank holding companies, or (ii) purchasing or investing in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association.

In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings institution (“a principal stockholder”), and certain affiliated interests of such a person, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings institution’s loans to one borrower limit (generally equal to 15% of the institution’s unimpaired capital and surplus). Section 22(h) also requires that loans to

 

24


Table of Contents

directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (i) is widely available to employees of the institution and (ii) does not give preference to any director, executive officer or principal stockholder, or certain affiliated interests of such a person, over other employees of the savings institution. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2012, the Bank was in compliance with the above restrictions.

Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Federal Reserve Board, (i) control of any other savings association or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings association or holding company thereof which is not a subsidiary. Except with the prior approval of the Federal Reserve Board, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company’s stock, may acquire control of any savings association, other than a subsidiary savings association, or of any other savings and loan holding company.

The Federal Reserve Board may only approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state if (i) the multiple savings and loan holding company involved controls a savings association which operated a home or branch office located in the state of the association to be acquired as of March 5, 1987; (ii) the acquirer is authorized to acquire control of the savings association pursuant to the emergency acquisition provisions of the Federal Deposit Insurance Act (FDIA); or (iii) the statutes of the state in which the association to be acquired is located specifically permit institutions to be acquired by the state-chartered banks or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations).

The Federal Reserve Board may approve an application by a bank holding company to acquire control of a savings association. A bank holding company that controls a savings association may merge or consolidate the assets and liabilities of the savings association with, or transfer assets and liabilities to, any subsidiary bank, which is a member of the Deposit Insurance Fund (DIF) with the approval of the appropriate federal banking agency and the Federal Reserve Board.

No company may acquire control of a savings and loan holding company after May 4, 1999, unless the company is engaged only in activities traditionally permitted to a multiple savings and loan holding company or permitted to a financial holding company under section 4(k) of the Bank Holding Company Act. Existing savings and loan holding companies and those formed pursuant to an application filed with the OTS before May 4, 1999 (see “Activities Restrictions” and “grandfathered holding companies” above) may engage in any activity including non-financial or commercial activities provided such companies control only one savings and loan association that meets the QTL test. Corporate reorganizations are permitted, but the transfer of grandfathered unitary thrift holding company status through acquisition is not permitted.

Sarbanes-Oxley Act of 2002. The Company is subject to the Sarbanes-Oxley Act of 2002, which generally established a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies and strengthen the independence of auditors. Among other things, the legislation (i) created a public company accounting oversight board which is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review; (ii) strengthened auditor independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer their public company audit clients; (iii) heightened the responsibility of public company directors and senior managers for the quality of the financial reporting and disclosure made by their companies; (iv) adopted a number of provisions to deter wrongdoing by corporate management; (v) imposed a number of new corporate disclosure requirements; (vi) adopted provisions which generally seek to limit and expose to public view possible conflicts of interest affecting securities analysts; and (vii) imposed a range of new criminal penalties for fraud and other wrongful acts, as well as extended the period during which certain types of lawsuits can be brought against a company or its insiders.

Regulation of the Bank

General. As a Pennsylvania chartered savings bank, the Bank is subject to extensive regulation and examination by the Department and by the FDIC, which insures its deposits to the maximum extent permitted by law. The federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of

 

25


Table of Contents

and collateral for certain loans. 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 insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The Bank is also a member of the FHLB of Pittsburgh and is subject to certain limited regulation by the Federal Reserve Board. Any change in such regulation, whether by the Department, the FDIC or the Congress could have a material adverse impact on the Bank and its operations.

Pennsylvania Savings Bank Law. The Pennsylvania Banking Code of 1965, as amended (Banking Code) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, employees and members, 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 and 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 no 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 present 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 director, 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.

Interstate Acquisitions. The Interstate Banking Act allows federal regulators to approve mergers between adequately capitalized banks from different states regardless of whether the transaction is prohibited under any state law, unless one of the banks’ home states enacted a law expressly prohibiting out-of-state mergers before June 1997. The Commonwealth of Pennsylvania did not “opt out” of this interstate merger provision. Therefore, the federal provision permitting interstate acquisitions applies to banks chartered in Pennsylvania. Pennsylvania law, however, retained the requirement that an acquisition of a Pennsylvania institution by a Pennsylvania or a non-Pennsylvania-based holding company must be approved by the Department. In addition, recent federal legislation permits a bank headquartered in Pennsylvania to enter another state through de novo branching (as compared to an acquisition) if under the state law in the state which the proposed branch is to be located a state-chartered institution would be permitted to establish the branch.

Insurance of Accounts. The deposits of the Bank are insured to the maximum extent permitted by the Deposit Insurance Fund and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions.

The recently enacted financial institution reform legislation permanently increased deposit insurance on most accounts to $250,000. In addition, pursuant to Section 13(c)(4)(G) of the Federal Deposit Insurance Act, the FDIC implemented two temporary programs to provide deposit insurance for the full amount of most non-interest bearing transaction deposit accounts and to guarantee certain unsecured debt of financial institutions and their holding companies. Under the unsecured debt program, the FDIC’s guarantee expired on the earlier of the maturity date of the debt or December 31, 2012. The unlimited deposit insurance for noninterest-bearing transaction accounts was extended by the Dodd-Frank Act through the end of 2012 for all insured institutions without a separate insurance assessment (but the cost of the additional insurance coverage was considered under the risk-based assessment system). Financial institutions had the option to opt out of either or both of these programs. We chose not to opt out of the temporary liquidity guarantee program.

The FDIC’s risk-based premium system provides for quarterly assessments. Each insured institution is placed in one of four risk categories depending on supervisory and capital considerations. Within its risk category, an institution is assigned to an initial base assessment rate which is then adjusted to determine its final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The Federal Deposit Insurance Corporation recently amended its deposit insurance

 

26


Table of Contents

regulations (1) to change the assessment base for insurance from domestic deposits to average assets minus average tangible equity and (2) to lower overall assessment rates. The revised assessment rates are between 2.5 to 9 basis points for banks in the lowest risk category and between 30 to 45 basis points for banks in the highest risk category. The amendments became effective for the quarter beginning April 1, 2011 with the new assessment methodology being reflected in the premium invoices due September 30, 2011.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the Deposit Insurance Fund. The annual assessment rate set for the fourth quarter of 2012 was 0.00165% of insured deposits and is adjusted quarterly. These assessments will continue until the Financing Corporation bonds mature in 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Bank’s deposit insurance.

On May 22, 2009, the FDIC announced a five basis point special assessment on each insured depository institution’s assets minus its Tier 1 capital as of June 30, 2009. The amount of the Bank’s special assessment was $891,000, which the FDIC collected on September 30, 2009.

On November 12, 2009, the FDIC adopted regulations that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012, along with their quarterly risk-based assessment for the third quarter of 2009. The amount of the Bank’s prepayment under this requirement was $6.7 million. The prepaid assessments were collected instead of imposing additional special assessments.

Capital Requirements. The FDIC has promulgated regulations and adopted a statement of policy regarding the capital adequacy of state-chartered banks which, like the Bank, are not members of the Federal Reserve System. 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, highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain qualifying supervisory goodwill, and certain purchased mortgage servicing rights and purchased credit and 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 losses. Allowance for loan 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, 2012, the Bank met each of its capital requirements.

 

27


Table of Contents

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 subject the bank 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 Bank is also subject to more stringent Department capital guidelines. Although not adopted in regulation form, the Department utilizes capital standards requiring a minimum 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.

Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies (including the FDIC) have adopted substantially similar regulations to implement Section 38 of the FDIA. Under the regulations, a savings 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 ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 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 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), (iv) “significantly undercapitalized” if it has a total risk-based ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 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%. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which the FDIC may reclassify a well capitalized savings bank as adequately capitalized and may require an adequately capitalized savings bank or an undercapitalized savings bank to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized savings bank as critically undercapitalized). At December 31, 2012, the Bank was in the “well capitalized” category.

Loans-to-One Borrower Limitation. 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 no greater than 15% of its capital accounts.

Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA 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 FDIC has adopted regulations pertaining to the other activity restrictions imposed upon insured savings banks and their subsidiaries by Section 24. Pursuant to such regulations, insured savings banks engaging in impermissible activities may seek approval from the FDIC to continue such activities. Savings banks not engaging in such activities but that desire to engage in otherwise impermissible activities either directly or through a subsidiary may apply for approval from the FDIC to do so; however, if such bank fails to meet the minimum capital requirements or the activities present a significant risk to the FDIC insurance funds, such application will not be approved by the FDIC. Pursuant to this authority, the FDIC has determined that investments in certain majority-owned subsidiaries of insured state banks do not represent a significant risk

 

28


Table of Contents

to the deposit insurance funds. Investments permitted under that authority include real estate investment activities and securities activities.

Safety and Soundness. The federal banking agencies, including the FDIC, have implemented rules and guidelines concerning standards for safety and soundness required pursuant to Section 39 of the FDIA. In general, the standards relate to (1) operational and managerial matters; (2) asset quality and earnings; and (3) compensation. The operational and managerial standards cover (a) internal controls and information systems, (b) internal audit systems, (c) loan documentation, (d) credit underwriting, (e) interest rate exposure, (f) asset growth, and (g) compensation, fees and benefits. Under the asset quality and earnings standards, the Bank is required to establish and maintain systems to (i) identify problem assets and prevent deterioration in those assets, and (ii) evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital reserves. Finally, the compensation standard states that compensation will be considered excessive if it is unreasonable or disproportionate to the services actually performed by the individual being compensated. The federal banking agencies have also adopted asset quality and earnings standards. If an insured state-chartered bank fails to meet any of the standards promulgated by regulation, then such institution will be required to submit a plan within 30 days to the FDIC specifying the steps it will take to correct the deficiency. In the event that an insured state-chartered bank fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the federal banking agency, Section 39 of the FDIA provides that the FDIC must order the institution to correct the deficiency and may (1) restrict asset growth; (2) require the savings bank to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the savings institution may pay; or (4) take any other action that would better carry out the purpose of prompt corrective action. The Bank believes that it has been and will continue to be in compliance with each of the standards as they have been adopted by the FDIC.

Regulatory Enforcement Authority. Federal banking regulators have substantial enforcement authority over the financial institutions that they regulate including, 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. Except under certain circumstances, federal law requires public disclosure of final enforcement actions by the federal banking agencies.

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank.

As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank of Pittsburgh in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding advances from the Federal Home Loan Bank. At December 31, 2012, the Bank was in compliance with this requirement.

Federal Reserve Board System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, which are primarily checking and NOW accounts, and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy the liquidity requirements that are imposed by the Department. At December 31, 2012, the Bank was in compliance with these reserve requirements.

FEDERAL AND STATE TAXATION

General. The Company and the Bank are subject to federal income taxation in the same general manner as other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of federal taxation is intended to only summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the thrifts.

Method of Accounting. For federal income tax purposes, the Company currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal income tax returns.

Bad Debt Reserves. Prior to 1996, the Bank was permitted under the Code to deduct an annual addition to a reserve for bad debts in determining taxable income, subject to certain limitations. Subsequent to 1995, the Bank’s bad debt deduction is

 

29


Table of Contents

based on actual net charge-offs. Bad debt deductions for income tax purposes are included in taxable income of later years only if the Bank’s base year bad debt reserve is used subsequently for purposes other than to absorb bad debt losses. Because the Bank does not intend to use the reserve for purposes other than to absorb losses, no deferred income taxes have been provided prior to 1987. Retained earnings at December 31, 2011 (the most recent date for which a tax return has been filed) include approximately $17.7 million representing such bad debt deductions for which no deferred income taxes have been provided.

Distributions. If the Bank distributes cash or property to its sole stockholder, and the distribution is treated as being from its pre-1987 bad debt reserves, the distribution will cause the Bank to have additional taxable income. A distribution to stockholders is deemed to have been made from pre–1987 bad debt reserves to the extent that (a) the distribution exceeds the Bank’s accumulated earnings and profit subsequent to December 31, 1951 or (b) the distribution is a “non-dividend distribution”. A distribution in respect of stock is a non-dividend distribution to the extent that, for federal income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a liquidation of the institution, or (iii) in the case of a current distribution, together with all other such distributions during the taxable year, exceeds the current and post-1951 accumulated earnings and profits of the Bank. The amount of additional taxable income created by a non-dividend distribution is an amount that when reduced by the tax attributable to it is equal to the amount of the distribution.

Minimum Tax. For taxable years beginning after December 31, 1986, the Code imposes an alternative minimum tax at a rate of 20%. The alternative minimum tax generally will apply to a base of regular taxable income plus certain tax preferences (alternative minimum taxable income or AMTI) and will be payable to the extent such AMT tax is in excess of regular income tax. Items of tax preference that constitute AMTI include (a) tax-exempt interest on newly issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) 75% of the excess (if any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). Net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. As of December 31, 2012, the Company has a minimum tax credit carry forward of $3.8 million.

Pennsylvania Taxation. The Company is subject to the Pennsylvania Corporate Net Income Tax and Capital Stock Franchise Tax. The Corporate Net Income Tax rate is currently 9.99% and is imposed on the Company’s unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Franchise Tax is a property tax on a corporation’s capital stock value, which is determined in accordance with a fixed formula based on average net income and net worth. Capital Stock Franchise Tax was imposed at a rate of 0.189% in 2012 and is being reduced gradually over the next year. The Capital Stock Franchise Tax will be phased out completely by 2014.

The Bank is subject to tax under the Pennsylvania Mutual Thrift Institutions Tax Act (MITA), which imposes a tax at a rate of 11.5% of a qualified thrift savings institution’s net earnings, determined in accordance with generally accepted accounting principles, as shown on its books. For fiscal years beginning in 1983, and thereafter, net operating losses may be carried forward and allowed as a deduction for three succeeding years. MITA exempts qualified savings institutions from all other corporate taxes imposed by Pennsylvania for state tax purposes, and from all local taxes imposed by political subdivisions thereof, except taxes on real estate and real estate transfers. Interest earned on U.S. and Commonwealth of Pennsylvania government obligations are partially exempt from MITA income tax.

Other Matters. The Company and its subsidiaries file a consolidated federal income tax return. Tax years 2009, 2010, 2011 and 2012 are open under the statute of limitations and subject to review by the Internal Revenue Service.

Personnel

As of December 31, 2012, the Company had 235 full-time and 71 part-time employees, respectively. The employees are not represented by a collective bargaining unit, and the Company considers its relationship with its employees to be good.

Availability of Information

The Company makes available on its website, which is located at www.esbbank.com, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K on the date which these reports are filed electronically with the SEC and the Company’s Code of Ethics. Investors are encouraged to access these reports and other information about the Company’s business and operations on the website.

 

30


Table of Contents

Item 1A. Risk Factors

In analyzing whether to make or to continue an investment in our securities, investors should consider, among other factors, the following risk factors.

Our results of operations are significantly dependent on economic conditions and related uncertainties.

Commercial banking is affected, directly and indirectly, by domestic and international economic and political conditions and by governmental monetary and fiscal policies. Conditions such as inflation, recession, unemployment, volatile interest rates, real estate values, government monetary policy, international conflicts, the actions of terrorists and other factors beyond our control may adversely affect our results of operations. Changes in interest rates, in particular, could adversely affect our net interest income and have a number of other adverse effects on our operations, as discussed in the immediately succeeding risk factor. Adverse economic conditions also could result in an increase in loan delinquencies, foreclosures and nonperforming assets and a decrease in the value of the property or other collateral which secures our loans, all of which could adversely affect our results of operations. We are particularly sensitive to changes in economic conditions and related uncertainties in Western Pennsylvania because we derive substantially all of our loans, deposits and other business from this area. Accordingly, we remain subject to the risks associated with prolonged declines in national or local economies.

Changes in interest rates could have a material adverse effect on our operations.

The operations of financial institutions such as us are dependent to a large extent on net interest income, which is the difference between the interest income earned on interest-earning assets such as loans and investment securities and the interest expense paid on interest-bearing liabilities such as deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted average yield earned on our interest-earning assets and the weighted average rate paid on our interest-bearing liabilities, or interest rate spread, and the average life of our interest-earning assets and interest-bearing liabilities. Changes in interest rates also can affect our ability to originate loans; the value of our interest-earning assets and our ability to realize gains from the sale of such assets; our ability to obtain and retain deposits in competition with other available investment alternatives; the ability of our borrowers to repay adjustable or variable rate loans; and the fair value of the derivatives carried on our balance sheet, derivative hedge effectiveness testing and the amount of ineffectiveness recognized in our earnings. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we believe that the estimated maturities of our interest-earning assets currently are well balanced in relation to the estimated maturities of our interest-bearing liabilities (which involves various estimates as to how changes in the general level of interest rates will impact these assets and liabilities), there can be no assurance that our profitability would not be adversely affected during any period of changes in interest rates.

There are increased risks involved with multi-family residential, commercial real estate, commercial business and consumer lending activities.

Our lending activities include loans secured by existing multi-family residential and commercial real estate. In addition, from time to time we originate loans for the construction of multi-family residential real estate and land acquisition and development loans. Multi-family residential, commercial real estate and construction lending generally is considered to involve a higher degree of risk than single-family residential lending due to a variety of factors, including generally larger loan balances, the dependency on successful completion or operation of the project for repayment, the difficulties in estimating construction costs and loan terms which often do not require full amortization of the loan over its term and, instead, provide for a balloon payment at stated maturity. Our lending activities also include commercial business loans to small to medium businesses, which generally are secured by various equipment, machinery and other corporate assets, and a wide variety of consumer loans, including home improvement loans, home equity loans, education loans and loans secured by automobiles, boats, mobile homes, recreational vehicles and other personal property. Although commercial business loans and leases and consumer loans generally have shorter terms and higher interests rates than mortgage loans, they generally involve more risk than mortgage loans because of the nature of, or in certain cases the absence of, the collateral which secures such loans.

Our allowance for losses on loans and leases may not be adequate to cover probable losses.

We have established an allowance for loan losses based upon various assumptions and judgments about the collectability of our loan portfolio which we believe is adequate to offset probable losses on our existing loans. While we are not aware of any specific factors indicating a deficiency in the amount of our allowance for loan losses, in light of the current economic slowdown, the increased number of foreclosures and lower real estate values, one of the most pressing current

 

31


Table of Contents

issues faced by financial institutions is the adequacy of their allowance for loan losses. Federal and state bank regulators have increased their scrutiny of the level of the allowance for losses maintained by regulated institutions. Many banks and other lenders are reporting significantly higher provisions to their allowance for loan losses, which are materially impacting their earnings. In the event that we have to increase our allowance for loan losses beyond current levels, it would have an adverse effect on our results in future periods. As of December 31, 2012, our allowance for loan losses amounted to $6.7 million.

We face strong competition which may adversely affect our profitability.

We are subject to vigorous competition in all aspects and areas of our business from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, credit unions and other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. We also compete with non-financial institutions, including retail stores that maintain their own credit programs and governmental agencies that make available low cost or guaranteed loans to certain borrowers. Certain of our competitors are larger financial institutions with substantially greater resources, lending limits, larger branch systems and a wider array of commercial banking services. Competition from both bank and non-bank organizations will continue.

Our ability to successfully compete may be reduced if we are unable to make technological advances.

The banking industry is experiencing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. As a result, our future success will depend in part on our ability to address our customers’ needs by using technology. We cannot assure you that we will be able to effectively develop new technology-driven products and services or be successful in marketing these products to our customers. Many of our competitors have far greater resources than we have to invest in technology.

We and our banking subsidiary are subject to capital and other requirements which restrict our ability to pay dividends.

Our ability to pay dividends to our shareholders depends to a large extent upon the dividends we receive from ESB Bank. Dividends paid by the Bank are subject to restrictions under Pennsylvania and federal laws and regulations. In addition, ESB Bank must maintain certain capital levels, which may restrict the ability of the Bank to pay dividends to us and our ability to pay dividends to our shareholders.

Holders of our common stock have no preemptive rights and are subject to potential dilution.

Our articles of incorporation do not provide any shareholder with a preemptive right to subscribe for additional shares of common stock upon any increase thereof. Thus, upon the issuance of any additional shares of common stock or other voting securities of the Company or securities convertible into common stock or other voting securities, shareholders may be unable to maintain their pro rata voting or ownership interest in us.

If our investment in the common stock the Federal Home Loan Bank of Pittsburgh is classified as other-than-temporarily impaired or as permanently impaired, our earnings and Stockholders’ Equity could decrease.

We own common stock of the Federal Home Loan Bank (“FHLB”) of Pittsburgh. We hold this stock to qualify for membership in the FHLB System and to be eligible to borrow funds under the FHLB of Pittsburgh’s advance program. The aggregate cost and fair value of our FHLB of Pittsburgh common stock as of December 31, 2012 was $15.1 million based on its par value. There is no market for our FHLB of Pittsburgh common stock.

Published reports indicate that certain member banks of the FHLB System may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capital of a FHLB, including the FHLB of Pittsburgh, could be substantially diminished or reduced to zero. In December of 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock. Consequently, we believe that there is a risk that our investment in FHLB of Pittsburgh common stock could be impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the after-tax amount of the impairment charge. Offsetting this risk, the FHLB has reinstituted redemptions and dividends and redeemed approximately $6.2 million of our stock in 2012.

 

32


Table of Contents

Increased and/or special Federal Deposit Insurance Corporation assessments will adversely impact our earnings.

There has been a high level of bank failures in recent years, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In lieu of imposing a special assessment, the FDIC required all institutions to prepay their assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012. Additional increases in the base assessment rate or special assessments would negatively impact our earnings.

The requirement to account for certain assets at estimated fair value, and a proposal to account for additional financial assets and liabilities at estimated fair value, may adversely affect our Stockholders’ Equity and results of operations.

We report certain assets, including securities, at fair value, and a recent proposal would require us to report nearly all of our financial assets and liabilities at fair value. Generally, for assets that are reported at fair value, we use quoted market prices or valuation models that utilize observable market inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may incur losses even if the asset in question presents minimal credit risk. Under current accounting requirements, elevated delinquencies, defaults, and estimated losses from the disposition of collateral in our mortgage-backed securities portfolio may require us to recognize additional other-than-temporary impairment in future periods with respect to our securities portfolio. The amount and timing of any impairment recognized will depend on the severity and duration of the decline in the estimated fair value of the asset and our estimate of the anticipated recovery period. Under proposed accounting requirements, we may be required to record reductions in the fair value of nearly all of our financial assets and liabilities (including loans) either through a charge to net income or through a reduction to accumulated other comprehensive income (loss). Accordingly, we could be required to record charges on assets such as loans where we have no intention to sell the loan and expect to receive repayment in full on the loan. This could result in a decrease in net income, or a decrease in our stockholders’ equity, or both.

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

We and our subsidiaries are subject to extensive regulation, supervision and examination by the Federal Reserve Board, the Pennsylvania Department of Banking and by the FDIC. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

Other than temporary declines in the value of our investment securities may require us to take additional charges to earnings.

We evaluate our securities portfolio for other-than-temporary-impairment (“OTTI”) throughout the year. Each investment with a fair value less than book value of at least 15% is reviewed quarterly. In order to determine if a decline in fair value is other than temporary, the Company reviews corporate ratings of the investment, analyst reports and SEC filings of the issuers and other criteria under GAAP to indicate if any OTTI exists. Declines in the fair value of securities that can attributed to specific adverse conditions affecting the credit quality of the investment are recorded as OTTI losses and charged to earnings as an impairment charge while non-credit related OTTI on securities not expected to be sold is recognized in other comprehensive income. During the years ended December 31, 2012, 2011 and 2010, the Company recorded charges of $31,000, $447,000 and $1.2 million, respectively, for OTTI on securities. In 2012, the Company recorded impairment charges of approximately $5,000 on a $2.5 million collateralized debt obligation and $26,000 on one of its equity investments in various banks that had experienced a decline in their market value for the last several quarters. As of December 31, 2012, our investment securities portfolio totaled $1.07 billion with a fair value of $1.11 billion, including trust preferred securities with an aggregate amortized cost of $45.9 million, an aggregate fair value of $38.0 million and gross unrealized losses of $8.2 million and corporate bonds with an aggregate amortized cost of $219.7 million, an aggregate fair value of $225.8 million and gross unrealized losses of $1.1 million. Because the declines in the fair value of individual securities are deemed to be temporary, the investment securities have not been written down to their fair value. We closely monitor our investment portfolio and additional declines in market value or credit quality could result in a

 

33


Table of Contents

conclusion in future periods that the securities are other-than-temporarily impaired. Such a conclusion of OTTI would require us to take additional charges to earnings to write down the value of these securities.

The current economic environment poses significant challenges and could adversely affect the Company’s financial condition and results of operations.

Although the economy in Western Pennsylvania continues to be strong in comparison to many other areas of the country and the United States as a whole, challenging conditions in the broader economy could adversely affect the financial capacity of businesses and individuals in the Company’s market areas. The impact of current economic conditions on the Company’s financial results could also include increased levels of nonperforming loans, provisions for loan losses and expense associated with loan collection efforts. Additions to the allowance for loan losses will result in a decrease in net earnings and capital and could hinder the Company’s ability to grow.

Historically low interest rates may adversely affect our net interest income and profitability.

During the past three years it has been the policy of the Federal Reserve Board to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at lower levels than as available prior to 2008. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets, which has been a contributing factor to increases in net interest income in the short term. Our ability to further lower our interest expense is limited as these interest rate levels already are at very low levels, while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve Board has indicated its intention to maintain low interest rates in the future. Accordingly, our net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may decrease, which may have an adverse affect on our profitability.

Legislative or regulatory responses to perceived financial and market problems could impair our rights against borrowers.

Current and future proposals made by members of Congress would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans, and may limit the ability of lenders to foreclose on mortgage collateral. If proposals such as these, or other proposals limiting the Bank’s rights as creditor, were to be implemented, we could experience increased credit losses on our loans and mortgage-backed securities or increased expense in pursuing our remedies as a creditor.

Government responses to economic conditions may adversely affect our operations, financial condition and earnings.

The Dodd-Frank Wall Street Reform and Consumer Protection Act has changed the bank regulatory framework, created an independent consumer protection bureau that has assumed the consumer protection responsibilities of the various federal banking agencies, and established more stringent capital as standards for banks and bank holding companies. Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations. Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of the Dodd-Frank Act and regulatory actions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms or foreclose on property securing loans. These risks could affect the performance and value of our loan and investment securities portfolios, which also would negatively affect our financial performance.

The recent repeal of federal prohibitions on payment of interest on demand deposits could increase our interest expense.

All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. As a result, beginning on July 21, 2011, financial institutions could commence offering interest on demand deposits to compete for clients. Our interest expense will increase and our net interest margin will decrease if we determine that, due to competitive pressures in the marketplace or otherwise, we begin offering interest on demand deposits to attract additional customers or maintain current customers. Consequently, our business, financial condition or results of operations may be adversely affected, perhaps materially.

 

34


Table of Contents

Item 1B. Unresolved Staff Comments

Not Applicable

Item 2. Properties

The following table sets forth certain information with respect to the offices and real property of the Company as of December 31, 2012:

 

Location

   Owned
or
Leased
     Lease
Expiration
Date
     Net Book
Value or
Annual Rent
     Percent
of Total
Deposits
 

Corporate Headquarters and ESB Main Office:

           

Ellwood City Office

     Owned         —         $ 922,143         12.2

600 Lawrence Avenue, Ellwood City, PA 16117

           

ESB Branch Offices:

           

Aliquippa Office

     Owned         —         $ 25,159         3.7

2301 Sheffield Road, Aliquippa, PA 15001

           

Ambridge Office

     Owned         —         $ 75,071         2.8

506 Merchant Street, Ambridge, PA 15003

           

Baldwin Office

     Owned         —         $ 552,877         5.0

5035 Curry Road, Pittsburgh, PA 15236

           

Beaver Office

     Owned         —         $ 347,620         4.4

701 Corporation Street, Beaver, PA 15009

           

Beaver Falls Office

     Owned         —         $ 86,936         3.2

1427 Seventh Avenue, Beaver Falls, PA 15010

           

Beechview Office

     Leased         10/31/15       $ 30,000         1.6

1550 Beechview Avenue, Pittsburgh, PA 15216

           

Butler Office

     Owned          $ 1,396,898         1.4

831 Evans City Road, Renfrew, PA 16053

           

Center Township Office

     Owned         —         $ 616,319         6.5

3531 Brodhead Road, Monaca, PA 15061

           

Chippewa Township Office

     Owned         —         $ 448,184         7.6

2521 Darlington Road, Beaver Falls, PA 15010

           

Coraopolis Office

     Owned         —         $ 64,559         2.0

900 Fifth Avenue, Coraopolis, PA 15108

           

Cranberry Township Office

     Owned         —         $ 1,608,074         0.4

2630 Rochester Road, Cranberry Twp, PA 16066

           

Fox Chapel Office

     Owned         —         $ 126,244         6.4

1060 Freeport Road, Pittsburgh, PA 15238

           

Franklin Township Office

     Owned         —         $ 411,778         4.4

1793 Mercer Road, Ellwood City, PA 16117

           

Hopewell Township Office

     Owned         —         $ 145,420         2.9

2293 Brodhead Road, Aliquippa, PA 15001

           

Neshannock Township Office

     Owned         —         $ 1,214,796         4.8

3360 Wilmington Road, New Castle, PA 16105

           

New Brighton Office

     Owned         —         $ 65,050         1.9

800 Third Avenue, New Brighton, PA 15066

           

North Shore Office

     Owned         —         $ 19,766         2.3

807 Middle Street, Pittsburgh, PA 15212

           

Northern Lights Office

     Leased         07/31/19       $ 45,253         2.5

1555 Beaver Road, Baden, PA 15005

           

Shenango Township Office

     Owned         —         $ 1,641,094         8.7

2731 Ellwood Road, New Castle, PA 16101

           

Troy Hill Office

     Owned         —         $ 302,186         4.5

1706 Lowrie Street, Pittsburgh, PA 15212

           

Wexford Office

     Owned         —         $ 1,026,831         6.2

101 Wexford Bayne Road, Wexford, PA 15090

           

Zelienople Office

     Owned         —         $ 1,824,230         4.6

527 South Main Street, Zelienople, PA 16063

           

 

35


Table of Contents

Item 2. Properties – Continued

 

Location

   Owned
or
Leased
     Lease
Expiration
Date
     Net Book
Value or
Annual Rent
     Percent
of Total
Deposits
 

Other Properties:

           

Drive-through Facility

     Owned         —         $ 23,518         NA   

618 Beaver Avenue, Ellwood City, PA 16117

           

Parking Lot

     Owned         —         $ 17,639         NA   

611 Lawrence Avenue, Ellwood City, PA 16117

           

Training Center

     Owned         —         $ 73,449         NA   

632 Lawrence Avenue, Ellwood City, PA 16117

           

Parking Lot

     Owned          $ 18,000         NA   

628 Lawrence Avenue, Ellwood City, PA 16117

           

Findlay Township Property

     Owned         —         $ 54,000         NA   

Route 30, Clinton, PA 15026

           

Rental Property

     Owned         —         $ 51,067         NA   

914 5th Avenue, Coraopolis, PA 15108

           

Rental Property

     Owned         —         $ 62,088         NA   

926 5th Avenue, Coraopolis, PA 15108

           

Darlington Office

     Owned         —         $ 103,450         NA   

233 Second Street, Darlington, PA 16115

           

Spring Hill Office

     Owned         —         $ 130,000         NA   

Itin & Rhine Streets, Pittsburgh, PA 15212

           

Item 3. Legal Proceedings

The Company is subject to a number of asserted and unasserted potential legal claims encountered in the normal course of business. In the opinion of management, there is no present basis to conclude that the resolution of these claims will have a material adverse impact on the consolidated financial condition or results of operations of the Company.

Item 4. Mine Safety Disclosures

Not applicable

 

36


Table of Contents

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equities

The information required herein is incorporated by reference from the section captioned “Stock and Dividend Information” of the Company’s 2012 Annual Report to Stockholders included as Exhibit 13 hereto (2012 Annual Report).

The following table sets forth information with respect to purchases made by or on behalf of the Company of shares of common stock of the Company during indicated periods.

 

Period

   Total Number of
Shares Purchased
     Average Price
Paid per Share
     Total Number of
Shares as Part of
Publicly Announced
Plans or Programs
     Maximum Number of
Shares that May Yet Be
Purchased Under
the Plans or Programs (1)
 

October 1-31, 2012

     242       $ 13.41         242         62,181   

November 1-30, 2012

     26,141         13.53         26,141         36,040   

December 1-31, 2012

     678         12.92         678         35,362   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

     27,061       $ 13.51         27,061         35,362   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) On May 20, 2009, the Company announced its current program to repurchase up to 5% of the outstanding shares of common stock of the Company, or 600,000 shares. The program does not have an expiration date and all shares are purchased in the open market or by privately negotiated transactions, as in the opinion of management, market conditions warrant.

Item 6. Selected Financial Data

The information required herein is incorporated by reference from the section captioned “Selected Consolidated Financial Data” of the Company’s 2012 Annual Report.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information required herein is incorporated by reference from the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s 2012 Annual Report.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The information required herein is incorporated by reference from the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset and Liability Management” of the Company’s 2012 Annual Report.

Item 8. Financial Statements and Supplementary Data

The information required herein is incorporated by reference from the sections captioned “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements,” “Management’s Responsibility for Financial Statements”, “Report on Management’s Assessment of Internal Controls Over Financial Reporting,” “Report of Independent Registered Public Accounting Firm” (which report relates to management’s assessment of internal controls), and the “Report of S R Snodgrass, A.C., Independent Registered Public Accounting Firm” of the Company’s 2012 Annual Report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable

 

37


Table of Contents

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures. As of December 31, 2012, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, on the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2012.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that the information required to be disclosed by the Company in its reports filed and submitted under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Management Report on Internal Control over Financial Reporting. The Company’s 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 Exchange Act. Management’s assessment of internal control over financial reporting for the fiscal year ended December 31, 2012 is included in Item 8.

Accountants Report. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012 has been audited by S R Snodgrass, A.C., an independent registered public accounting firm, as stated in its report included in Item 8.

Changes in Internal Controls Over Financial Reporting. No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information

Not applicable

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information required herein is incorporated by reference from the section captioned “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” of the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders to be held in April 2013 (“Proxy Statement”).

Item 11. Executive Compensation

The information required herein is incorporated by reference from the section captioned “Compensation of Directors and Executive Officers” of the Proxy Statement.

 

38


Table of Contents

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required herein is incorporated by reference from the sections captioned “Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management” of the Proxy Statement.

Equity Compensation Plan Information. The following table sets forth certain information for all equity compensation plans of the Company and individual compensation arrangements (whether with employees or non-employees, such as directors) in effect as of December 31, 2012.

Equity Compensation Plan Information

 

Plan Category

  

Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights (1)

    

Weighted-average
exercise price of
outstanding options,
warrants and rights (1)

    

Number of securities
remaining available for
future issuance under
equity compensations plans
(excluding securities
reflected in the first
column)

 

Equity compensation plans approved by security holders

     1,055,687       $ 11.51         635,587   

Equity compensation plans not approved by security holders

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     1,055,687       $ 11.51         635,587   
  

 

 

    

 

 

    

 

 

 

 

(1) The table does not include information for equity compensation plans assumed by the Company in connection with acquisitions of the companies which originally established those plans. As of December 31, 2012, no options and 12,697 shares of restricted stock were outstanding which had not yet vested under those assumed plans. No additional options and or shares of restricted stock may be granted under the assumed plans.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required herein is incorporated by reference from the subsections captioned “Certain Relationships and Related Transactions” and “Election of Directors – Information with respect to Nominees for Director and Continuing Directors” of the Proxy Statement.

Item 14. Principal Accountant Fees and Services

The information required herein is incorporated by reference from the sections captioned “Ratification of Selection of Independent Registered Public Accounting Firm – Auditor Fees” and “-Pre-Approval Policy and Procedures” of the Proxy Statement.

 

39


Table of Contents

PART IV

Item 15. Exhibits and Financial Statement Schedules

 

(a) DOCUMENTS FILED AS PART OF THIS REPORT

 

  (1) The following financial statements are incorporated by reference from Item 8 hereof (See Exhibit 13):

Report of Independent Registered Public Accounting Firm

Consolidated Statements of Financial Condition as of December 31, 2012 and 2011

Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011 and 2010

Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010

Notes to Consolidated Financial Statements

 

  (2) All schedules for which provision is made in the applicable accounting regulations of the SEC are omitted because of the absence of conditions under which they are required or because the required information is included in the Consolidated Financial Statements and related notes thereto.

 

  (3) (a) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index.

 

    

No.

  

Exhibits

    3.1    Amended and Restated Articles of Incorporation (1)
    3.2    Amended and Restated Bylaws (2)
    4    Specimen Common Stock Certificate (3)
  10.1    ESB Financial Corporation Employee Stock Ownership Plan (3)(7)
  10.2    PennFirst Bancorp, Inc. Amended and Restated 1997 Stock Option Plan (4)(7)
  10.3    ESB Financial Corporation Amended and Restated 2001 Stock Option Plan (4)(7)
  10.4    ESB Financial Corporation Amended and Restated 2005 Stock Incentive Plan (4)(7)
  10.5    ESB Financial Corporation 2012 Stock Incentive Plan (5)(7)
  10.6    Amended and Restated Troy Hill Bancorp, Inc. Recognition and Retention Plan for Officers and Trust Agreement (4)(7)
  10.7    Amended and Restated Employment Agreement between ESB Financial Corporation and Charlotte A. Zuschlag, dated as of November 20, 2012 (6)(7)
  10.8    Amended and Restated Employment Agreement between ESB Bank and Charlotte A. Zuschlag, dated as of November 20, 2012 (6)(7)
  10.9    Form of Amended and Restated Change in Control Agreement, dated November 20, 2012, among ESB Financial Corporation, ESB Bank and each of the following Group Senior Vice Presidents of ESB Financial Corporation: Charles P. Evanoski, Frank D. Martz and Todd F. Palkovich (6)(7)
  10.10    Form of Amended and Restated Change in Control Agreement, dated November 20, 2012, among ESB Financial Corporation, ESB Bank and Richard E. Canonge and certain other Senior Vice Presidents of ESB Financial Corporation and ESB Bank (6)(7)
  10.11    Amended and Restated Supplemental Executive Retirement Plan of ESB Financial Corporation and ESB
Bank (4)(7)
  10.12    Amended and Restated ESB Financial Corporation Excess Benefit Plan (4)(7)
  10.13    Form of Amended and Restated Director Retirement Agreement entered into between ESB Financial Corporation, ESB Bank and each director of ESB Financial Corporation (4)(7)
  10.14    Form of Amended and Restated Director Retirement Agreement entered into between ESB Bank and each director of ESB Bank (4)(7)
  13    2012 Annual Report to Shareholders (8)
  21    Subsidiaries of the Registrant – Reference is made to Item 1. “Business – Subsidiaries” for the required information.
  23    Consent of S R Snodgrass, A.C. (8)
  31.1    Certification of Chief Executive Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 (8)

 

40


Table of Contents
  31.2    Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 (8)
  32.1    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (8)
  32.2    Certification of the Chief Financial Officer Pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (8)
  101.INS    XBRL Instance Document*
  101.SCH    XBRL Taxonomy Extension Schema Document*
  101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document*
  101.LAB    XBRL Taxonomy Extension Label Linkbase Document*
  101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document*
  101.DEF    XBRL Taxonomy Extension Definitions Linkbase Document*

 

(1) Incorporated by reference from the Annual Report on Form 10-K for the year ended December 31, 2008 filed by the Company with the SEC on March 12, 2009
(2) Incorporated by reference from the Current Report on Form 8-K filed by the Company with the SEC on December 19, 2007
(3) Incorporated by reference from the Registration Statement on Form S-4 (Registration No. 33-39219) filed by the Company with the SEC on March 1, 1991.
(4) Incorporated by reference from the Current Report on Form 8-K filed by the Company with the SEC on November 21, 2007.
(5) Incorporated by reference from the Definitive Proxy Statement filed by the Company with the SEC on March 16, 2012.
(6) Incorporated by reference from the Current Report on Form 8-K filed by the Company with the SEC on November 21, 2012.
(7) Management contract or compensatory plan or arrangement.
(8) Filed herewith
(*) These interactive data files shall not be deemed filed for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.

The Company has no instruments defining the rights of holders of its long-term debt where the amount of securities authorized under any such instrument exceeds 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company hereby agrees to furnish a copy of any such instrument, where the amount of securities is less than 10% of total assets of the Company, to the SEC upon request.

 

(b) See (a)(3) above for all exhibits filed herewith and the exhibit index.
(c) There are no other financial statements and financial statement schedules which were excluded from the 2012 Annual Report, which are required to be included herein.

 

41


Table of Contents

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.

 

Date: March 15, 2013     ESB FINANCIAL CORPORATION
      By:   /s/    CHARLOTTE A. ZUSCHLAG        
       

Charlotte A. Zuschlag

President and Chief Executive Officer

(Duly Authorized Representative)

Pursuant to the requirements of the Securities Exchange Act 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.

 

By:  

/s/    CHARLOTTE A. ZUSCHLAG        

Charlotte A. Zuschlag

President and Chief Executive Officer, Director

(Principal Executive Officer)

    

Date: March 15, 2013

By:  

/s/    CHARLES P. EVANOSKI        

Charles P. Evanoski

Group Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

    

Date: March 15, 2013

By:  

/s/    WILLIAM B. SALSGIVER        

William B. Salsgiver

Chairman of the Board of Directors

    

Date: March 15, 2013

By:  

/s/    HERBERT S. SKUBA        

Herbert S. Skuba

Vice Chairman of the Board of Directors

    

Date: March 15, 2013

By:  

/s/    MARIO J. MANNA        

Mario J. Manna – Director

    

Date: March 15, 2013

By:  

/s/    JAMES P. WETZEL, JR.        

James P. Wetzel, Jr. – Director

    

Date: March 15, 2013

 

42