-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IDsE3zRIGHAx+5P7dLnAn5RMy3uO80AkrqZ9izXPQPJo3gVt56r2jBCZDld/fwwu 4AKEiWyBXtRRySLZj7mDNQ== 0000713671-03-000043.txt : 20031114 0000713671-03-000043.hdr.sgml : 20031114 20031114143424 ACCESSION NUMBER: 0000713671-03-000043 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DNB FINANCIAL CORP /PA/ CENTRAL INDEX KEY: 0000713671 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232222567 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-16667 FILM NUMBER: 031003295 BUSINESS ADDRESS: STREET 1: 4 BRANDYWINE AVE CITY: DOWNINGTOWN STATE: PA ZIP: 19335 BUSINESS PHONE: 6102691040 MAIL ADDRESS: STREET 1: 4 BRANDYWINE AVENUE CITY: DOWNINGTOWN STATE: PA ZIP: 19335 10-Q 1 form_10qsept-03e.txt 10 Q 09/30/03 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2003 or [ ] 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: 0-16667 DNB Financial Corporation (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2222567 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 4 BRANDYWINE AVENUE - DOWNINGTOWN, PA 19335 (Address of principal executive offices and Zip Code) (610) 269-1040 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. COMMON STOCK ($1.00 Par Value) 1,799,930 (Class) (Shares Outstanding as of November 14, 2003) - --------------------------------------------------------------------------- DNB FINANCIAL CORPORATION AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION PAGE NO. ITEM 1. FINANCIAL STATEMENTS (Unaudited): CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, 2003 and December 31, 2002 3 CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended September 30, 2003 and 2002 4 CONSOLIDATED STATEMENTS OF OPERATIONS Nine Months Ended September 30, 2003 and 2002 5 CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2003 and 2002 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 and December 31, 2002 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 24 ITEM 4. CONTROLS AND PROCEDURES 25 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 26 ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS 26 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 26 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 26 SECURITY HOLDERS ITEM 5. OTHER INFORMATION 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 26 SIGNATURES 27 ITEM 1 FINANCIAL STATEMENTS (Unaudited)
DNB FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands, except share data) September 30, December 31, 2003 2002 - -------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks ..................................................................... $ 12,042 $ 11,551 Federal funds sold .......................................................................... -- 10,473 --------- --------- Total cash and cash equivalents ............................................................. 12,042 22,024 --------- --------- Investment securities available for sale, at market value ................................... 147,050 137,365 Investment securities held to maturity (market value $56,459 in 2003 and $22,811 in 2002) ............................................................. 57,207 22,430 Loans, net of unearned income ............................................................... 189,138 187,585 Allowance for loan losses ................................................................... (4,571) (4,546) --------- --------- Net loans ................................................................................... 184,567 183,039 --------- --------- Office property and equipment, net .......................................................... 7,781 8,092 Accrued interest receivable ................................................................. 1,860 1,890 Bank owned life insurance ................................................................... 5,746 5,577 Deferred income taxes ....................................................................... 1,327 980 Other assets ................................................................................ 3,680 2,971 --------- --------- TOTAL ASSETS ................................................................................ $ 421,260 $ 384,368 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Non-interest-bearing deposits ............................................................... $ 52,226 $ 45,117 Interest-bearing deposits: NOW accounts ............................................................................. 53,568 50,400 Money market ............................................................................. 56,463 59,457 Savings .................................................................................. 43,775 39,569 Time ..................................................................................... 73,944 93,259 --------- --------- TOTAL DEPOSITS .............................................................................. 279,976 287,802 --------- --------- Borrowings .................................................................................. 109,696 63,728 Trust preferred debt securities ............................................................. 5,000 5,000 --------- --------- TOTAL BORROWINGS ............................................................................ 114,696 68,728 --------- --------- Accrued interest payable .................................................................... 876 1,164 Other liabilities ........................................................................... 949 466 --------- --------- TOTAL LIABILITIES ........................................................................... 396,497 358,160 --------- --------- STOCKHOLDERS' EQUITY Preferred stock, $10.00 par value; 1,000,000 shares authorized; none issued ................................................. -- -- Common stock, $1.00 par value; 10,000,000 shares authorized; 1,923,725 and 1,902,478 issued, respectively ..................................................................... 1,924 1,902 Treasury stock, at cost (131,315 and 81,427 shares, respectively) ........................... (2,832) (1,687) Surplus ..................................................................................... 23,645 23,402 Retained earnings ........................................................................... 3,295 3,184 Accumulated other comprehensive loss, net ................................................... (1,269) (593) --------- --------- TOTAL STOCKHOLDERS' EQUITY .................................................................. 24,763 26,208 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................................................. $ 421,260 $ 384,368 ========= =========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share amounts) Three Months Ended September 30 - -------------------------------------------- ------------------------------- 2003 2002 ---------- ------------- INTEREST INCOME: Interest and fees on loans and leases ............ $ 3,413 $ 3,653 Interest on taxable investment securities ........ 1,064 1,528 Interest on tax-free investment securities ....... 163 47 Interest on tax-preferred equity securities ...... 93 158 Interest on Federal funds sold ................... 2 44 ------- ------- Total interest income ............................ 4,735 5,430 ------- ------- INTEREST EXPENSE: Interest on time deposits ........................ 475 877 Interest on NOW, money market and savings ........ 220 464 Interest on FHLB advances ........................ 975 903 Interest on trust preferred debt securities ...... 67 74 Interest on lease obligations .................... 25 25 Interest on Federal funds purchased .............. 7 4 ----- ----- Total interest expense ........................... 1,769 2,347 ----- ----- NET INTEREST INCOME ................................. 2,966 3,083 Provision for loan losses ........................... -- -- ----- ----- Net interest income after provision for loan losses . 2,966 3,083 ----- ----- NON-INTEREST INCOME: Service charges ..................................... 318 277 Wealth management ................................... 173 124 Net (loss) gain on sales of investment securities ... (466) 96 Increase in cash surrender value of BOLI ............ 145 44 Other ............................................... 186 168 ----- ----- Total non-interest income ........................... 356 709 ----- ----- NON-INTEREST EXPENSE: Salaries and employee benefits ...................... 2,135 1,552 Furniture and equipment ............................. 426 335 Occupancy ........................................... 225 210 Professional and consulting ......................... 224 145 Marketing ........................................... 93 124 Printing and supplies ............................... 96 65 Other ............................................... 497 395 ----- ----- Total non-interest expense .......................... 3,696 2,826 ----- ----- (Loss) income before income taxes ................... (374) 966 Income tax (benefit) expense ........................ (272) 236 ----- ----- NET (LOSS) INCOME ................................... $ (102) $ 730 ===== ===== COMMON SHARE DATA: EARNINGS PER SHARE: Basic ............................................... $ (0.06) $ 0.40 Diluted ............................................. (0.06) 0.39 CASH DIVIDENDS PER SHARE ............................ $ 0.13 $ 0.12 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic ............................................ 1,798,247 1,823,956 Diluted .......................................... 1,798,247 1,861,769
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share amounts) Nine Months Ended September 30 - -------------------------------------------- ------------------------------ 2003 2002 ---------- ----------- INTEREST INCOME: Interest and fees on loans ........................ $ 9,906 $ 10,696 Interest on taxable investment securities ......... 3,456 4,968 Interest on tax-free investment securities ........ 329 299 Interest on tax-preferred equity securities ....... 325 479 Interest on Federal funds sold .................... 43 89 ------ ------ Total interest income ............................. 14,059 16,531 ------ ------ INTEREST EXPENSE: Interest on time deposits ........................ 1,788 2,829 Interest on NOW, money market and savings ........ 812 1,393 Interest on FHLB advances ........................ 2,840 2,678 Interest on trust preferred debt securities ...... 199 227 Interest on lease obligations .................... 74 75 Interest on Federal funds purchased .............. 11 7 ----- ----- Total interest expense ........................... 5,724 7,209 ----- ----- NET INTEREST INCOME ................................. 8,335 9,322 Provision for loan losses ........................... -- -- ----- ----- Net interest income after provision for loan losses . 8,335 9,322 ----- ----- NON-INTEREST INCOME: Service charges ..................................... 923 781 Wealth management ................................... 486 322 Net (loss) gain on sales of investment securities ... (337) 165 Increase in cash surrender value of BOLI ............ 258 142 Other ............................................... 536 472 ----- ----- Total non-interest income ........................... 1,866 1,882 ----- ----- NON-INTEREST EXPENSE: Salaries and employee benefits ...................... 5,306 4,656 Furniture and equipment ............................. 1,158 980 Occupancy ........................................... 629 608 Professional and consulting ......................... 460 457 Marketing ........................................... 235 316 Printing and supplies ............................... 261 244 Other ............................................... 1,409 1,273 ----- ----- Total non-interest expense .......................... 9,458 8,534 ----- ----- Income before income taxes .......................... 743 2,670 Income tax (benefit) expense ........................ (75) 594 ----- ----- NET INCOME .......................................... $ 818 $2,076 ===== ====== COMMON SHARE DATA: EARNINGS PER SHARE: Basic ............................................... $ 0.45 $ 1.14 Diluted ............................................. 0.44 1.11 CASH DIVIDENDS PER SHARE ............................ $ 0.39 $ 0.37 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic ............................................ 1,812,135 1,829,440 Diluted .......................................... 1,852,252 1,867,632
See accompanying notes to consolidated financial statements.
Consolidated Statements of Cash Flows (Dollars in thousands) Nine Months Ended September 30 - ---------------------- ------------------------------ 2003 2002 ------------ ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ...................................................... $ 818 $ 2,076 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ................................... 2,649 1,501 Loss (gain) on sale of investments .............................. 337 (165) Decrease in accrued interest receivable ......................... 30 600 Increase in investment in BOLI .................................. (169) (142) (Increase) decrease in other assets ............................. (709) 1,147 Increase in deferred taxes ...................................... -- (79) Decrease in accrued interest payable ............................ (288) (359) Decrease in current taxes payables .............................. (442) (88) Increase in other liabilities ................................... 925 120 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES ....................... 3,151 4,611 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Maturities & paydowns of available for sale securities .......... 56,776 33,514 Maturities & paydowns of held to maturity securities ............ 12,682 25,685 Purchase of available for sale securities ....................... (104,367) (43,224) Purchase of held to maturity securities ......................... (47,788) (21,902) Proceeds from sale of available for sale securities ............. 35,013 25,107 Net increase in loans ........................................... (1,528) (7,485) Purchase of office property and equipment ....................... (476) (922) --------- -------- NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES ................ (49,688) 10,773 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net decrease in deposits ........................................ (7,826) (5,590) Increase in FHLB advances ....................................... 42,889 -- Increase in Federal funds purchased ............................. 3,085 -- Decrease in lease obligations ................................... (6) (5) Purchase of treasury stock ...................................... (1,145) (1,013) Proceeds from exercise of stock options ......................... 264 147 Dividends paid .................................................. (706) (677) ---- ---- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES ................ 36,555 (7,138) -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS ......................... (9,982) 8,246 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................ 22,024 18,628 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $ 12,042 $ 26,874 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest ........................................................ $ 6,058 $ 7,568 Taxes ........................................................... 166 686 SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW INFORMATION: Change in net unrealized losses on securities- available for sale $ (1,023) $ 758 Change in deferred taxes due to change in net unrealized losses on securities- available for sale .......................... 347 (253)
See accompanying notes to consolidated financial statements. DNB FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of DNB Financial Corporation (referred to herein as the "Corporation" or "DNB") and its subsidiaries, Downingtown National Bank (the "Bank") and DNB Capital Trust I (the "Trust"), have been prepared in accordance with the instructions for Form 10-Q and therefore do not include certain information or footnotes necessary for the presentation of financial condition, statement of operations and statement of cash flows required by generally accepted accounting principles. However, in the opinion of management, the consolidated financial statements reflect all adjustments (which consist of normal recurring adjustments) necessary for a fair presentation of the results for the unaudited periods. Prior amounts not affecting net income are reclassified when necessary to conform with current period classifications. The results of operations for the three and nine months ended September 30, 2003 are not necessarily indicative of the results which may be expected for the entire year. The consolidated financial statements should be read in conjunction with the Annual Report and report on Form 10-K for the year ended December 31, 2002. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS 148"). This statement amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The requirements of Statement No. 148 are effective for fiscal years ending after December 15, 2002, except for financial reports containing condensed financial statements for interim periods for which disclosure is effective for periods beginning after December 31, 2002. DNB applies APB Opinion No. 25 in accounting for its Stock Option Plan, and accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had DNB determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, DNB's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- 2003 2002 2003 2002 ----- ----- ------ ---- Net (loss) income as reported ......................................... $ (102) $730 $ 818 $ 2,076 Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects ........................... -- -- 68 183 ------ ----- ----- ------- Pro forma net (loss) income ........................................... $ (102) $ 730 $ 750 $ 1,893 ====== ===== ===== ======= Earnings per share Basic-as reported ................................................ $ (0.06) $ 0.40 $ 0.45 $ 1.14 Basic-pro forma .................................................. (0.06) 0.40 0.41 1.04 Diluted-as reported .............................................. $(0.06) $ 0.39 $ 0.44 $ 1.11 Diluted-pro forma ................................................ (0.06) 0.39 0.41 1.01
NOTE 2: EARNINGS PER SHARE (EPS) Basic earnings per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur from the conversion of common stock equivalents (i.e., stock options) and is computed using the treasury stock method. For the three and nine months ended September 30, 2003, 186,052 and 39,032 outstanding stock options were not included because such options were antidilutive. For the three and nine months ended September 30, 2002, 101,157 and 67,392 outstanding stock options were not included because such options were antidilutive. These shares may be dilutive in the future. Earnings per share, dividends per share and weighted average shares outstanding have been adjusted to reflect the effects of the 5% stock dividend paid in December 2002. Net income and the weighted average number of shares outstanding for basic and diluted EPS for the three and nine months ended September 30, 2003 and 2002 are reconciled as follows:
Three months ended Three months ended September 30, 2003 September 30, 2002 -------------------------- ------------------------- (Dollars in thousands) Income Shares Amount Income Shares Amount Basic EPS Income available to common stockholders ...... $ (102) $1,798 $ (0.06) $ 730 $1,824 $ 0.40 Effect of dilutive common stock equivalents- stock options ................................ -- -- -- -- 38 (0.01) ------ ------ ------- ------ ------ ------- Diluted EPS .................................. $ (102) $1,798 $ (0.06) $ 730 $1,862 $ 0.39 ====== ====== ======= ====== ====== =======
Nine months ended Nine months ended September 30, 2003 September 30, 2002. --------------------------- ---------------------------- (Dollars in thousands) Income Shares Amount Income Shares Amount Basic EPS Income available to common stockholders....... $ 818 $1,812 $0.45 $2,076 $1,829 $1.14 Effect of dilutive common stock equivalents- stock options................................. -- 40 (0.01) - 39 (0.03) ----- ------ ------ ------ ------ ------ Diluted EPS................................... $ 818 $1,852 $0.44 $2,076 $1,868 $1.11 ===== ====== ====== ====== ====== ======
NOTE 3: COMPREHENSIVE INCOME Comprehensive income includes all changes in stockholders' equity during the period, except those resulting from investments by owners and distributions to owners. Comprehensive income for all periods consisted of net income and other comprehensive income relating to the change in unrealized gains on investment securities available for sale, as shown in the following tables:
(Dollars in thousands) Three months ended Sept. 30 Nine months ended Sept. 30 --------------------------- -------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- COMPREHENSIVE INCOME: Net (loss) income ................................ $ (102) $ 730 $ 818 $2,076 Other comprehensive income (loss), net of tax, relating to net unrealized losses on investments 365 376 (676) 505 ------ ------ ----- ------ Total comprehensive income ....................... $ 263 $1,106 $ 142 $2,581 ====== ====== ===== ======
NOTE 4: TRUST PREFERRED DEBT SECURITIES On July 20, 2001, DNB's subsidiary DNB Capital Trust I (the "Trust"), a Delaware business trust in which DNB owns all of the common equity, issued $5.0 million of floating rate (6 month Libor plus 3.75% to a cap of 12%) capital preferred securities ("TRuPS") to a qualified institutional buyer. The proceeds of these securities were used by the Trust, along with DNB's capital contribution, to purchase $5.2 million principal amount of DNB's floating rate junior subordinated debentures (the "debentures"). The debentures are the sole asset of the Trust. DNB's obligations under the TRuPS and related documents, taken together, constitute a full and unconditional guarantee by DNB of the Trust's obligation under the preferred securities. The preferred securities are redeemable by DNB on or after July 25, 2006, or earlier in the event of certain adverse tax or bank regulatory developments. The preferred securities must be redeemed upon maturity of the subordinated debentures on July 25, 2031. NOTE 5: RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146"). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94.3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of this statement had no impact on DNB's financial condition, equity, results of operations or disclosures. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS 148"). This statement amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002. The disclosures required by this filing have been included in this filing. This Statement announces that "in the near future, the Board plans to consider whether it should propose changes to the U.S. standards on accounting for stock-based compensation". There was no impact of this statement on DNB's financial condition, equity, or results of operations. The annual and interim disclosure requirements of this statement have been complied with. In April 2003, the FASB issued SFAS No. 149, Amendment to Statement 133 on Derivative Instruments and Hedging Activities ("SFAS No. 149"). This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The statement is applied prospectively and is effective for contracts entered into or modified after June 30, 2003, except for SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003 and certain provisions relating to forward purchases and sales on securities that do not yet exist. The adoption on April 1, 2003 of the components of this statement which address SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003 did not have a material impact on the DNB's consolidated interim financial position and results of operations. The adoption of the remaining components of SFAS No. 149 is not anticipated to have a material impact on DNB's financial condition, equity or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity ("SFAS No. 150"). This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Some of the provisions of this Statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, "Elements of Financial Statements". The remaining provisions of this Statement are consistent with the Board's proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between the holder and the issuer. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement had no impact on DNB's financial condition, equity, results of operations or disclosures. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DESCRIPTION OF DNB'S BUSINESS DNB Financial Corporation is a bank holding company whose bank subsidiary, Downingtown National Bank (the "Bank"), is a nationally chartered commercial bank with trust powers, and a member of the FDIC. DNB has nine full service offices located in Chester County, Pennsylvania. In addition to its main office at 4 Brandywine Avenue, they are: Little Washington Office (Intersection of Route 322 and Culbertson Run Road, Downingtown), East End Office (701 East Lancaster Avenue, Downingtown), Exton Office (410 Exton Square Parkway, Exton), Lionville Office (Intersection of Route 100 and Welsh Pool Road, Exton), Ludwig's Corner Office (Intersection of Routes 100 and 401, Uwchland), Caln Office (1835 East Lincoln Highway, Coatesville), West Goshen Office (1115 West Chester Pike, West Chester), Kennett Square Office (215 E. Cypress St., Kennett Square). The Bank also has a limited service office at Tel Hai Retirement Community (Beaver Dam Road, Honey Brook). Through its DNB Advisors division, Downingtown National Bank provides wealth management and trust services to individuals and businesses throughout Chester County. The Bank and its subsidiary, DNB Financial Services, Inc., make available certain nondepositary products and services, such as securities brokerage, mutual funds, life insurance and annuities. Customers may also visit DNB on its website at http://www.dnb4you.com. ECONOMIC OUTLOOK AND BUSINESS STRATEGY DNB's year-to-date net interest margin and earnings have been impacted by the historically low interest rate environment and recent economic uncertainties. Banks nationwide have experienced margin compression, slow loan growth and significant cash outflows from prepayments of their assets backed by residential loans. This current environment, as well as the market's outlook for a stronger economy and higher long-term interest rates were critical factors in management's initial step in a comprehensive plan designed to reposition its balance sheet and improve core earnings. During the quarter DNB sold $20 million of investment securities and invested the proceeds in higher yielding securities which management expects to provide improved cash flows. As further steps in the plan, DNB's management currently intends to reduce substantially the size of its investment portfolio during the next eighteen months and expand its loan portfolio through new originations, increased loan participations, as well as strategic loan and lease receivable purchases. Management also intends to reduce the absolute level of borrowings with cash flows from existing loans and investments as well from new core deposit growth. With regard to DNB's balance sheet repositioning, the degree to which these steps can be accomplished will depend on a number of factors, including changes in the interest rate environment for loans, investments and deposits, loan prepayments, market opportunities for new loan and participation originations, and the availability of loan and lease receivables for purchase at attractive prices and yields, as well as management's assessment of the timing of each of these opportunities and steps in light of future, unknown developments affecting DNB's business generally. Also during the last six months, two key additions were made to DNB's management team. William J. Hieb joined the Bank as Executive Vice President and Chief Operating Officer in April and Richard M. Wright joined DNB in September to head up the Bank's retail network. In addition to these two important changes, management is in the process of expanding its lending and support staff to facilitate loan growth as part of its balance sheet restructuring plan. CRITICAL ACCOUNTING POLICIES The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. In management's opinion, the most critical accounting policies impacting DNB's consolidated financial statements are: 1. Determination of the allowance for loan losses. Loan loss allowance policies involve significant judgments and assumptions by management which may have a material impact on the carrying value of net loans and, potentially, on the net income recognized by DNB from period to period. For a description of DNB's accounting policies in connection with its allowance for loan losses, see, "Provision for Loan Losses," below. 2. Accrual and recognition of interest on loans. These policies involve significant judgments and assumptions by management which may have a material impact on the interest income recognized by DNB from period to period. For a description of DNB's accounting policies in connection with accrual and recognition of interest on loans, see, "Asset Quality," below. 3. Realization of deferred income tax items. Estimates of deferred tax assets and deferred tax liabilities make up the asset category titled, " net deferred tax asset." These estimates involve significant judgments and assumptions by management which may have a material impact on the carrying value of net deferred tax assets for financial reporting purposes. For a more detailed description of these items and estimates, see Note 11 (Federal Income Taxes) to DNB's audited consolidated financial statements for the fiscal year ended December 31, 2002 (the "Annual Financial Statements"), incorporated in DNB's 10-K for the year ended December 31, 2002. The Notes to DNB's consolidated financial statements set forth herein and in DNB's Annual Financial Statements identify other significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of DNB and its results of operations. FINANCIAL CONDITION DNB's total assets were $421.3 million at September 30, 2003 compared to $384.4 million at December 31, 2002. Investment securities (AFS and HTM) increased $44.5 million or 27.8% to $204.3 million at September 30, 2003. Trust preferred securities decreased $19.6 million while US Agency and US Agency CMO's increased a combined $46.4 million and tax-free securities increased $23.4 million as DNB restructured its investment portfolio to achieve higher yields and provide improved cash flows. US Agency mortgage-backed securities and other CMO's decreased a combined $26.4 million due to high levels of prepayments in the low interest rate environment. Total loans increased $1.6 million or 0.8% to $189.1 million at September 30, 2003, compared to $187.6 million at December 31, 2002. Significant increases occurred in the commercial and commercial mortgage portfolios, which grew a combined $6.8 million or 5.3%. In addition, consumer loans increased $3.6 million or 12.4%, as customers took advantage of historically low home equity rates. These increases were largely offset by a $8.8 million or 33.4% decline in residential mortgage loans, as customer refinancings reached unprecedented levels. Deposits at September 30, 2003 totaled $280.0 million, down $7.8 million or 2.7% from $287.8 million at December 31, 2002. Time deposits were down $19.3 million and money market accounts decreased $3.0 million. Non-interest-bearing, savings and NOW accounts increased $7.1 million, $4.2 million and $3.2 million, respectively, reflecting customer preferences for short-term deposits in this low interest rate environment. Total borrowings increased $46.0 million to $114.7 million at September 30, 2003, compared to $68.7 million at December 31, 2003. Federal funds purchased rose $3.1 million and short-term FHLB advances rose $42.9 million as DNB borrowed to meet short-term liquidity needs. At September 30, 2003, stockholders' equity was $24.8 million or $13.81 per share, compared to $26.2 million or $14.33 per share at December 31, 2002. The decrease in stockholders' equity was the result of a $676,000 decrease in the fair market value of available-for-sale securities, net of taxes, as well as the purchase of 49,888 shares to be held as treasury stock ($1.1 million) and dividends paid of approximately $706,000 or $.39 per share, partially offset by net income of $818,000 for the nine months ended September 30, 2003. RESULTS OF OPERATIONS NET INTEREST INCOME DNB's earnings performance is primarily dependent upon its level of net interest income, which is the excess of interest revenue over interest expense. Interest revenue includes interest earned on loans (net of interest reversals on non-performing loans), investments, Federal funds sold and interest-earning cash, as well as net loan fee amortization and dividend income. Interest expense includes the interest cost for deposits, FHLB advances, Federal funds purchased and other borrowings. On a tax-equivalent basis, net interest income decreased $93,000 or 3.0% to $3.1 million, and $1.0 million or 10.8% to $8.6 million, respectively, for the three and nine month periods ended September 30, 2003, compared to the same periods in 2002. As shown in the following tables, the decrease in net interest income was largely attributable to rate changes, as interest-earning assets repriced less favorably and more quickly than interest-bearing liabilities. The effects of these rate changes reduced net interest income by $200,000 and $1.3 million, respectively, for the periods. Volume changes resulted in a $107,000 and $298,000 benefit to net interest income for the respective periods. The following tables sets forth, among other things, the extent to which changes in interest rates and changes in the average balances of interest-earning assets and interest-bearing liabilities have affected interest income and expense during the three and nine months ended September 30, 2003 compared to the same periods in 2002 (tax-exempt yields and yields on agency-preferred stock that have a 70% dividend received deduction have been adjusted to a tax equivalent basis using a 34% tax rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (i) changes in rate (change in rate multiplied by old volume) and (ii) changes in volume (change in volume multiplied by old rate). The net change attributable to the combined impact of rate and volume has been allocated proportionately to the change due to rate and the change due to volume.
Three Months Ended September 30, 2003 Compared to 2002 ------------------------- Increase (Decrease) Due to -------------------------- (Dollars in Thousands) Rate Volume Total ----- ------ ----- Interest-earning assets: Loans ............................................................................................. $ (63) $(179) $(242) Investment securities-taxable ..................................................................... (706) 242 (464) Investment securities-tax exempt .................................................................. (47) 212 165 Investment securities-tax preferred ............................................................... (99) 11 (88) Federal funds sold ................................................................................ (12) (30) (42) ------ ------ ------ Total ........................................................................................ $(927) $ 256 $(671) ------ ------ ------ Interest-bearing liabilities: Savings, NOW and money market deposits ............................................................ $(259) $ 15 $(244) Time deposits ..................................................................................... (264) (139) (403) Federal funds purchased ........................................................................... (5) 9 4 Trust preferred securities ........................................................................ (7) -- (7) FHLB advances ..................................................................................... (192) 264 72 ------ ------ ----- Total ........................................................................................ (727) 149 (578) ------ ------ ----- Net interest income/interest rate spread .......................................................... $(200) $ 107 $ (93) ====== ====== =====
Nine Months Ended September 30, 2003 Compared to 2002 -------------------------- Increase (Decrease) Due to -------------------------- (Dollars in Thousands) Rate Volume Total ----- ------- ----- Interest-earning assets: Loans ........................................................................................... $ (553) $ (237) $ (790) Investment securities-taxable ................................................................... (2,300) 788 (1,512) Investment securities-tax exempt ................................................................ (48) 86 38 Investment securities-tax preferred ............................................................. (267) 57 (210) Federal funds sold .............................................................................. (23) (23) (46) ------- ------- ------- Total ...................................................................................... $(3,191) $ 671 $(2,520) ------- ------- ------- Interest-bearing liabilities: Savings, NOW and money market deposits .......................................................... $ (613) $ 33 $ (580) Time deposits ................................................................................... (746) (295) (1,041) FHLB advances ................................................................................... (465) 626 161 Trust preferred securities ...................................................................... (28) -- (28) Federal funds purchased ......................................................................... (6) 10 4 Lease obligations ............................................................................... -- (1) (1) ------- ------- ------- Total ...................................................................................... (1,858) 373 (1,485) ------- ------- ------- Net interest income/interest rate spread ........................................................ $(1,333) $ 298 $(1,035) ======= ======= =======
PROVISION FOR LOAN LOSSES To provide for known and inherent losses in the loan portfolio, DNB maintains an allowance for loan losses. Provisions for loan losses are charged against income to increase the allowance when necessary. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. In establishing its allowance for loan losses, management considers the size and risk exposure of each segment of the loan portfolio, past loss experience, present indicators of risk such as delinquency rates, levels of nonaccruals, the potential for losses in future periods, and other relevant factors. Management's evaluation of the loan portfolio generally includes reviews, on a sample basis, of individual borrowers regardless of size and reviews of problem borrowers of $100,000 or greater. Consideration is also given to examinations performed by regulatory agencies, primarily the Office of the Comptroller of the Currency ("OCC"). In determining the allowance, DNB utilizes a methodology which includes an analysis of historical loss experience for the commercial real estate, commercial, residential real estate, home equity and consumer installment loan pools to determine a historical loss factor. The historical loss factors are then applied to the current portfolio balances to determine the required reserve percentage for each loan pool based on risk rating. In addition, specific allocations are established for loans where loss is probable and reasonably identifiable, based on management's judgment and an evaluation of the individual credit, which includes various factors mentioned above. The allocated portion of the reserve is then determined as a result of an analysis of the loan pools and specific allocations. In establishing and reviewing the allowance for adequacy, emphasis has been placed on utilizing the methodology prescribed in the OCC's Handbook (which utilizes BC 201 qualitative risk factors). As a result, management has taken into consideration factors and variables which may influence the risk of loss within the loan portfolio, including: (i) trends in delinquency and nonaccrual loans; (ii) changes in the nature and volume of the loan portfolio; (iii) effects of any changes in lending policies; (iv) experience, ability, and depth of management/quality of loan review; (v) national and local economic trends and conditions; (vi) concentrations of credit; and (vii) effect of external factors on estimated credit losses. The unallocated portion of the allowance is intended to provide for probable losses that are not otherwise identifiable using the BC201 risk factors such as (i) the effect of expansion into new markets or lines of business that are not as familiar as DNB's current market or business lines; (ii) the risk that the information we receive from our borrowers is inaccurate or misleading and (iii) the non-qualifiable impact that a terrorist action or threat of action may have on a particular industry. There were no provisions made during the nine months ended September 30, 2003 based on management's analysis of the loan portfolio and the level of net charge-offs compared to the total allowance. Net loan recoveries were $25,000 for the nine months ended September 30, 2003, compared to net loan charge-offs of $263,000 for the year ended December 31, 2002 and net loan charge-offs of $33,000 for the nine months ended September 30, 2002. The percentage of net recoveries (charge-offs) to total average loans was .02%, (0.14)% and (.02)% for the same respective periods. Another measure of the allowance is the coverage ratio of the allowance to non-performing loans, which was 357.5% at September 30, 2003, compared to 176.6% at September 30, 2002 and 117.5% at December 31, 2002. In addition, the ratio of non-performing loans to total loans was 0.7% at September 30, 2003, compared to 1.4% at September 30, 2002 and 2.1% at December 31, 2002. The following table summarizes the changes in the allowance for loan losses for the periods indicated. Real estate includes both residential and commercial real estate.
9 Months Year 9 Months Ended Ended Ended (Dollars in Thousands) 9/30/03 12/31/02 9/30/02 ------- -------- ------- Beginning balance .................................................... $ 4,546 $ 4,809 $ 4,809 Provisions ........................................................... -- -- -- Loans charged off: Real estate ................................................... (11) -- -- Commercial .................................................... (204) (221) -- Consumer ...................................................... (89) (89) (72) ------ ------- ------- Total charged off ......................................... (304) (310) (72) ------ ------- ------- Recoveries: Real estate ................................................... 110 18 15 Commercial .................................................... 198 18 15 Consumer ...................................................... 21 11 9 -- -- ------- Total recoveries .......................................... 329 47 39 --- -- ------- Net recoveries (charge-offs) ......................................... 25 (263) (33) ------- ------- ------- Ending balance ....................................................... $ 4,571 $ 4,546 $ 4,776 ======= ======= =======
NON-INTEREST INCOME Total non-interest income includes service charges on deposit products; fees received in connection with the sale of nondepository products and services, including fiduciary and investment advisory services offered through DNB Advisors; securities brokerage products and services and insurance brokerage products and services offered through DNB Financial Services; and other sources of income such as increases in the cash surrender value of bank owned life insurance, net gains on sales of investment securities and other real estate owned ("OREO") properties. In addition, DNB receives fees for cash management, merchant services, debit cards, safe deposit box rentals, check cashing, lockbox services and similar activities. For the three and nine month periods ended September 30, 2003, non-interest income was $356,000 and $1.9 million, respectively, compared to $709,000 and $1.9 million for the same periods in 2002. Service charges increased $41,000 and $142,000, to $318,000 and $923,000 for the three and nine month periods ended September 30, 2003, compared with the same periods in 2002. Much of the increase in this category came from non-sufficient funds ("NSF") fees, which rose $23,000 and $82,000, respectively, due to an increase in the volume of accounts as well as a concerted effort by management to reduce the waived fee percentage on deposit account overdrafts. ATM income also contributed to increased income with increases of $7,000 and $27,000 for the three and nine month periods ended September 30, 2003, compared with the same periods in 2002. Income from Wealth Management rose $49,000 or 39% to $173,000 and $164,000 or 51% to $486,000 for the three and nine month periods, respectively. (Losses) gains and from sales of investments were ($466,000) and ($337,000) in 2003 and $96,000 and $165,000 in 2002 for the three and nine month periods, respectively. In addition, income from bank owned life insurance was $145,000 and $258,000, respective, for the three and nine month periods ending on September 30, 2002, an increase of $101,000 and $116,000 over the same respective periods in 2002. Other non-interest income increased $18,000 and $65,000 to $186,000 and $536,000 for the three and nine month periods ended September 30, 2003, respectively. The increase in other income for the three and nine month periods reflected higher commissions on STAR/Visa debit card products and cash management fees. NON-INTEREST EXPENSE Non-interest expense includes salaries & employee benefits, furniture & equipment, occupancy, professional & consulting fees as well as printing & supplies, marketing and other less significant expense items. Non-interest expenses increased $870,000 to $3.7 million and $924,000 to $9.5 million for the three and nine month periods ended September 30, 2003, compared to the same periods in 2002. The increase during the three and nine month periods was due to increases in a majority of the expense categories, as discussed below. Salaries & employee benefits increased $583,000 or 38.0% to $2.1 million and $650,000 or 14.0% to $5.3 million for the three and nine months ended September 30, 2003, compared to $1.6 million and $4.7 million for the same periods in 2002. The increase in this category reflects higher levels of salaries, medical insurance benefits, and pension costs. Officer and employee salaries rose $199,000 year-over-year due to the increase in full-time equivalent employees, as well as normal merit increases. Medical insurance benefits expense increased $89,000 due to higher premiums, reflecting increased medical claims. Pension expense rose $350,000 as a direct result of increased service cost coupled with lower returns on plan assets. Furniture & equipment expense increased $91,000 or 27.1% to $426,000 and $179,000 or 18.2% to $1.2 million for the three and nine months ended September 30, 2003, respectively. This compars to $335,000 and $980,000 for the same periods in 2002. The increase for the three and nine month periods in these categories was due to higher levels of equipment depreciation relating to a new bank-wide voice-mail system and depreciation on other recent equipment/software upgrades. Occupancy expense increased approximately $15,000 or 7.2% to $225,000 and $21,000 or 3.4% to $629,000 for the three and nine months ended September 30, 2003, compared to $210,000 and $608,000 for the same periods in 2002. The modest increase was due to higher levels of depreciation and utility costs. Marketing expense declined $32,000 or 25.4% to $93,000 and $81,000 or 25.4% to $235,000 for the three and nine months ended September 30, 2003, respectively, compared to $124,000 and $316,000 for the same periods in 2002. Professional & consulting expense increased $79,000 or 55.2% to $224,000 for the three month period ended September 30, 2003, compared to $145,000 for the same period in 2002. The increase was due to costs incurred in the third quarter for services relating to human resources, legal services and other professional services. Professional & consulting expense increased slightly to $460,000 for the nine month period ended September 30, 2003, compared to $457,000 for the same period in 2002. Printing & supplies expense increased $30,000 or 46.0% to $96,000 for the three month period ended September 30, 2003 compared to $65,000 same period in 2002. Printing & supplies expense increased $17,000 or 6.8% to $261,000 for the nine month period ended September 30, 2003, compared to $244,000 for the same period in 2002. Other expenses include such items as postage, PA shares tax, insurance, ATM charges, OREO expense, satisfaction fees, appraisal fees, telephone & fax, and other miscellaneous expenses. Other expenses increased $102,000 or 25.8% and $136,000 or 10.6% to $497,000 and $1.4 million for the three and nine months ended September 30, 2003 compared to $395,000 and $1.3 million for the same periods in 2002. INCOME TAXES Income tax (benefit) expense was ($272,000) and ($75,000) for the three and nine months ending September 30, 2003 compared with $236,000 and $594,000 for the three and nine months ending September 30, 2002. The effective tax rate was (73%) and (10%) for the three and nine month period ending September 30, 2003, respectively, compared to 24% and 22% for the three and nine month periods ending September 30, 2002. The effective tax rates for both periods were less than the statutory rate due to the effect of tax-exempt income, tax credits recognized on a low-income housing limited partnership and income from bank-owned life insurance policies, relative to DNB's pre-tax income. ASSET QUALITY Non-performing assets are comprised of nonaccrual loans, loans delinquent over ninety days and still accruing and Other Real Estate Owned ("OREO"). Nonaccrual loans are loans for which the accrual of interest ceases when the collection of principal or interest payments is determined to be doubtful by management. It is the policy of DNB to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more (unless the loan principal and interest are determined by management to be fully secured and in the process of collection), or earlier, if considered prudent. Interest received on such loans is applied to the principal balance, or may in some instances, be recognized as income on a cash basis. A nonaccrual loan may be restored to accrual status when management expects to collect all contractual principal and interest due and the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms. OREO consists of real estate acquired by foreclosure or deed in lieu of foreclosure. OREO is typically carried at the lower of cost or estimated fair value, less estimated disposition costs. Any significant change in the level of nonperforming assets is dependent, to a large extent, on the economic climate within DNB's market area. The following table sets forth those assets that are on nonaccrual status or contractually delinquent by 90 days or more and still accruing for the periods presented. DNB had no OREO at the end of all reported periods.
Sept. 30 Dec. 31 Sept. 30 (Dollars in Thousands) 2003 2002 2002 ------- ------ ------- Nonaccrual Loans: Residential mortgage ...................................................... $ 322 $ 285 $ 247 Commercial mortgage ....................................................... 190 1,057 190 Commercial ................................................................ 146 1,758 1,506 Consumer .................................................................. 16 254 253 ------- ------- ------- Total nonaccrual loans ......................................................... 674 3,354 2,196 Loans 90 days past due and still accruing ...................................... 605 514 512 ------- ------- ------- Total non-performing assets .................................................... $ 1,279 $ 3,868 $ 2,708 ======= ======= ======= The following table sets forth the DNB's asset quality and allowance coverage ratios at the dates indicated: Sept. 30 Dec. 31 Sept. 30 2003 2002 2002 Non-performing Loans/Total Loans ............................................... 0.7% 2.1% 1.4% Non-performing Assets/Total Assets ............................................. 0.3 1.0 0.7 Allowance for Loan Losses/Total Loans .......................................... 2.5 2.4 2.5 Allowance for Loan Losses/Total Loans and OREO ................................. 2.5 2.4 2.5 Allowance for Loan Losses/Non-performing Assets ................................ 176.4 117.5 176.4 Allowance for Loan Losses/Non-performing Loans ................................. 176.4 117.5 176.4 If interest income had been recorded on nonaccrual loans, interest would have increased as shown in the following table: 9 Months Year 9 Months Ended Ended Ended (Dollars in thousands) 9/30/03 12/31/02 9/30/02 Interest income which would have been recorded under original terms .................................................... $ 66 $ 230 $ 117 Interest income recorded during the period ..................................... (47) (159) (47) ------- ------- ------- Net impact on interest income .................................................. $ 19 $ 71 $ 70 ======= ======= ======= 9 Months Year 9 Months Ended Ended Ended (Dollars in thousands) 9/30/03 12/31/02 9/30/02 Total recorded investment ...................................................... $ 255 $ 2,400 $ 1,620 Average recorded investment .................................................... 382 2,000 1,194 Specific ALLL allocation ....................................................... -- -- -- Total cash collected ........................................................... 3 47 123 Interest income recorded ....................................................... $ -- $ 21 $ 21
LIQUIDITY AND CAPITAL RESOURCES For a financial institution, liquidity is a measure of the ability to fund customers' needs for loans and deposit withdrawals. Management regularly evaluates economic conditions in order to maintain a strong liquidity position. One of the most significant factors considered by management when evaluating liquidity requirements is the stability of DNB's core deposit base. In addition to cash, DNB maintains a portfolio of short-term investments to meet its liquidity requirements. DNB has historically relied on cash flow from operations and other financing activities. Liquidity is provided by investing activities, including the repayment and maturing of loans and investment securities. At September 30, 2003 DNB has $17.7 million in commitments to fund commercial real estate, construction and land development. In addition, DNB had commitments to fund $6.9 million in home equity lines of credit and $5.8 million in other unused commitments. Management anticipates the majority of these commitments will be funded by means of normal cash flows. In addition, $25.3 million of time deposits at DNB are scheduled to mature during the three months ending December 31, 2003. Management believes that the majority of such deposits will be reinvested with DNB and that certificates that are not renewed will be funded by a reduction in Federal funds sold or by paydowns and maturities of loans and investments. On July 25, 2001, DNB authorized the buyback of up to 175,000 shares of its Common Stock over an indefinite period. The buyback, if fully completed, would reduce the number of outstanding shares by approximately 10%. The repurchases are conducted through open market or privately negotiated transactions. Shares purchased in the program are held as treasury stock. Through September 30, 2003, DNB had repurchased 131,315 shares of its Common Stock pursuant to the program at a total cost of $2,832,000. Stockholders' equity was $24.8 million or $13.81 per share, compared to $26.2 million or $14.33 per share at December 31, 2002. The decrease in stockholders' equity was the result of a $676,000 decrease in the fair market value of available-for-sale securities, net of taxes, as well as the purchase of 49,888 shares of treasury stock ($1.1 million) and dividends paid of approximately $706,000 or $.39 per share, partially offset by net income of $818,000 for the nine months ended September 30, 2003. The Corporation's common equity position at September 30, 2003 exceeds the regulatory required minimums. The following table summarizes data and ratios pertaining to the Corporation and the Bank's capital structure.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------- ----------------- -------------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio - ---------------------- ------ ----- ------- ------ --------- ------ DNB Financial Corporation As of September 30, 2003: Total risk-based capital ................. $ 32,063 13.60% $20,362 8.00% $25,452 10.00% Tier 1 capital ........................... 28,864 11.34 10,181 4.00 15,271 6.00 Tier 1 (leverage) capital ................ 28,864 7.24 15,953 4.00 19,941 5.00
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------- ----------------- ----------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------- ----- Downingtown National Bank As of September 30, 2003: Total risk-based capital $30,575 12.02% $20,351 8.00% $25,439 10.00% Tier 1 capital .......... 27,378 10.76 10,175 4.00 15,263 6.00 Tier 1 (leverage) capital 27,378 6.87 15,947 4.00 19,934 5.00
In addition, the Federal Reserve Bank (the "FRB") leverage ratio rules require bank holding companies to maintain a minimum level of "primary capital" to total assets of 5.5% and a minimum level of "total capital" to total assets of 6%. For this purpose, (i) "primary capital" includes, among other items, common stock, certain perpetual debt instruments such as eligible Trust preferred securities, contingency and other capital reserves, and the allowance for loan losses, (ii) "total capital" includes, among other things, certain subordinated debt, and "total assets" is increased by the allowance for loan losses. DNB's primary capital ratio and its total capital ratio are both 7.2%, well in excess of FRB requirements. REGULATORY MATTERS Dividends payable to the Corporation by the Bank are subject to certain regulatory limitations. Under normal circumstances, the payment of dividends in any year without regulatory permission is limited to the net profits (as defined for regulatory purposes) for that year, plus the retained net profits for the preceding two calendar years. OPERATING ENVIRONMENT AND CERTAIN TRENDS DNB operates its franchise throughout Chester County, PA. Chester County has extremely attractive demographics, which makes it one of the fastest growing counties in Pennsylvania. Due to these factors, the operating environment is very competitive as Chester County hosts over 40 banks, thrifts and credit unions. In addition, brokerage firms, mutual fund companies and boutique investment firms dot the landscape. This intense competition continually puts pressures on DNB's margins and operating results as competitors offer a full range of loan, deposit and investment products and services. In addition, many of these competitors are much larger than DNB and consistently outspend the Bank in marketing to attract new customers. We anticipate these pressures will continue to adversely affect our margins. FACTORS THAT MAY AFFECT FUTURE RESULTS As a financial institution, DNB's earnings are significantly affected by general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the United States economy and local economies in which we operate. For example, an economic downturn, increase in unemployment, or other events that negatively impact household and/or corporate incomes could decrease the demand for DNB's loan and non-loan products and services and increase the number of customers who fail to pay interest or principal on their loans. The Financial Accounting Standards Board's Interpretation No. 46 and its Statement of Financial Accounting Standards ("SFAS") 150 will affect certain special-purpose entities ("SPEs") that banking and other companies hold off the balance sheet. Companies with SPEs may be required to consolidate them onto their balance sheets. One of the potential results of this change could be to reclassify trust-preferred securities as debt rather than equity. This raises the question whether, as a result, bank regulatory agencies would begin to treat trust preferred securities as debt not qualifying for Tier 1 capital status for purposes of calculating certain regulatory capital ratios of bank holding companies and federally insured depository institutions. On July 2, 2003, the Federal Reserve Board announced that, for the time being, bank holding companies should continue to include trust preferred securities as elements of Tier 1 capital. However, it is uncertain whether the Federal Reserve Board will maintain this position indefinitely or, if it decides to disqualify trust preferred securities as elements of Tier 1 capital, whether the Federal Reserve Board will "grandfather" the Tier 1 capital status of existing issues of trust preferred securities. If the Federal Reserve Board were to change its treatment of trust preferred securities and not grandfather existing issues, DNB (and not the Bank) would be required to reduce its Tier 1 capital for regulatory purposes. Management does not believe that such an adjustment would have a material adverse impact on DNB or the Bank. Geopolitical conditions can also affect DNB's earnings. Acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and our military conflicts including the aftermath of the war with Iraq, could impact business conditions in the United States. FORWARD-LOOKING STATEMENTS This report contains statements, that are not of historical facts and may pertain to future operating results or events or management's expectations regarding those results or events. These are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. These forward-looking statements may include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", or words of similar meaning, or future or conditional verbs, such as "will", "would", "should", "could", or "may" are generally intended to identify forward-looking statements. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are either beyond our control or not reasonably capable of predicting at this time. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements. Readers of this report are accordingly cautioned not to place undue reliance on forward-looking statements. DNB disclaims any intent or obligation to update publicly any of the forward-looking statements herein, whether in response to new information, future events or otherwise. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK To measure the impacts of longer-term asset and liability mismatches beyond two years, DNB utilizes Modified Duration of Equity and Economic Value of Portfolio Equity ("EVPE") models. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rates ranging up or down 200 basis points. The economic value of equity is likely to be different if rates change. Results falling outside prescribed ranges require action by management. At September 30, 2003 and December 31, 2002, DNB's variance in the economic value of equity as a percentage of assets with an instantaneous and sustained parallel shift of 200 basis points was within its negative 3% guideline, as shown in the tables below. However, the change as a percentage of the present value of equity with a 200 basis point decline at December 31, 2002, was negative 35.1% and outside of DNB's negative 25% policy. This occurred as the duration of DNB's assets shortened more quickly than the duration of DNB's liabilities. Subsequent to December 31, 2002, management has taken the necessary steps to move this ratio within policy guidelines, including but not limited to reducing the level of Federal funds sold, purchasing municipal securities with positive convexity, promoting five year fixed rate lending and attempting to shorten the overall duration of deposits through pricing. At September 30, 2003 DNB's change as a percentage of the present value of equity with a 200 basis point rise was negative 28.3% and out of compliance. This occurred as the duration of DNB's liabilities shortened more quickly than the duration of DNB's assets. Management has focused on reducing the amount of its short-term borrowings and reducing the duration of its investment portfolio to bring this measure within policy guidelines.
September 30, 2003 December 31, 2002 ------------------------- ------------------------------- Change in rates ........................................... Flat -200bp +200bp Flat -200bp +200 bp ------ ------- ------- -------- -------- ------- EVPE ...................................................... $ 29,444 $ 26,617 $ 21,112 $ 27,381 $ 17,760 $ 28,553 Change .................................................... (2,827) (8,332) (9,621) 1,172 Change as a % of assets ................................ (0.7%) (2.0%) (2.5%) 0.3% Change as a % of PV equity ................................ (9.6%) (28.3%) (35.1%) 4.3%
ITEM 4 - CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 240.13a-14(c) and 15d-14(c)) as of September 30, 2003. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company's current disclosure controls and procedures are effective and timely, providing them with material information relating to the Company required to be disclosed in the reports we file or submit under the Exchange Act. CHANGES IN INTERNAL CONTROLS Management and the Board of Directors of the Bank recently reviewed recent declines in the Bank's net interest margin and return on average assets, and in that connection evaluated the Bank's funds management practices to assess the quantity and quality of risk management over interest rate risk and liquidity risk. In that connection, management and the Board of Directors determined that the decline in net interest margin and the relatively high level of interest rate risk resulted from a number of factors. Those factors, and the related actions management and the Board of Directors presently intend to take include the following: improving the Bank's strategic plan and related controls to address recent slow loan growth, reduce dependency on investment portfolio income and improve the net income contribution of the loan portfolio; completing a review of the Bank's liquidity, asset and liability management policy and revising it where necessary; strengthening management of the investment portfolio, particularly to mitigate risks of future prepayments; reducing reliance on wholesale borrowings to fund investments; increasing monitoring and assessment of leverage strategies; strengthening asset-liability and interest rate risk management with regular monitoring; making greater use of available outside resources for monitoring and managing interest rate risk and asset-liability risks; evaluating asset-liability policies to determine that risk limits are appropriate; and providing for independent periodic evaluation of information and methods used in asset-liability and interest rate risk management. These proposed actions are subject to change in the future as management and the Board of Directors complete their evaluation of appropriate adjustments to the Bank's policies and procedures. With the exception of the foregoing, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, and management is not aware of any significant deficiencies or material weaknesses, and therefore no corrective actions other than as described above were taken. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable ITEM 2. CHANGES IN SECURITIES Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. (a) EXHIBITS: 31.1 Certification Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 for the Chief Executive Officer. 31.2 Certification Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 for the Chief Financial Officer. 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of Sarbanes- Oxley Act of 2002. (b) REPORTS ON FORM 8-K Current report on Form 8-K dated and filed July 31, 2003. Items 7 and 12, DNB Financial Corporation discloses the Company's press release announcing second quarter 2003 earnings. Item 9, Regulation FD Disclosure - Sarbanes-Oxley Section 906 Certifications. Current report on Form 8-K dated and filed August 28, 2003. Items 7, The Board of Directors of DNB Financial Corporation declared a cash dividend of $0.13 per share for the third quarter of 2003 to shareholders of record on September 10, 2003. Item 9, Regulation FD Disclosure - Sarbanes-Oxley Section 906 Certifications. SIGNATURES Pursuant to the requirements 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. DNB FINANCIAL CORPORATION (Registrant) DATE: November 14, 2003 /S/ Henry F. Thorne Henry F. Thorne, President and Chief Executive Officer DATE: November 14, 2003 /S/ Bruce E. Moroney Bruce E. Moroney Chief Financial Officer EX-31 2 hank_cert09-03t.txt HANKS 302 CERTIFICATION CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CHIEF EXECUTIVE OFFICER I, Henry F. Thorne, certify that: 1. I have reviewed this report on Form 10-Q of DNB FINANCIAL CORPORATION; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Henry F. Thorne ------------------- Henry F. Thorne Chief Executive Officer November 14, 2003 EX-31 3 bruce_cert-0903t.txt BRUCES 302 CERTIFICATION CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CHIEF FINANCIAL OFFICER I, Bruce E. Moroney, certify that: 1. I have reviewed this report on Form 10-Q of DNB Financial Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Bruce E. Moroney -------------------- Bruce E. Moroney Chief Financial Officer November 14, 2003 EX-32 4 section906_cert.txt 906 CERTIFICATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 of DNB Financial Corp. (the "Company") as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Henry F. Thorne, President and Chief Executive Officer, and Bruce E. Moroney, Chief Financial Officer, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to our knowledge: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/Henry F. Thorne /s/Bruce E. Moroney - ----------------------------------- ------------------------ Henry F. Thorne Bruce E. Moroney President and Chief Executive Officer Chief Financial Officer November 14, 2003 -----END PRIVACY-ENHANCED MESSAGE-----