EX-13 5 exhibit-13.txt EXHIBIT 13 Letter to Shareholders Building our Future... "Building our future" defined our strategic initiatives in 2001. Our ability to embrace change without compromising our core values and strengths is a testament to the dedication of our employees and Board of Directors. We are pleased with the very significant progress we have made in improving our infrastructure and we will continue to invest in and grow our highly valued business lines like DNB Advisors, DNB Financial Services and DNB Leasing. We continued to expand our presence and grow market share in Chester County by opening our ninth branch location in Exton, at the former site of the "Guernsey Cow". The Exton branch provided us with a new office location for our wealth management group, comprised of DNB Advisors and DNB Financial Services, while enabling us to preserve a structure of historic significance. We introduced our newest business line, DNB Leasing and we have been successful in providing our commercial customers with additional options to meet their financing needs. We also launched both consumer and commercial Internet Banking capabilities and we continued to improve our internal technology platform. While we have implemented strategies intended to deliver more consistent, higher-quality customer service, we have not lost sight of our most important asset -- our employees. To this end, we have implemented sales and service training programs, which were designed and delivered by our own employees. Additionally, 25% of our retail employees voluntarily opted to obtain their Health and Life insurance licenses. By dedicating a significant portion of their time to studying and learning about our new insurance-based products, they have expanded their career opportunities with the Bank. Early in the year, we conducted internal focus groups with more than half of our employees to improve communication at all levels of the organization and to learn first-hand how we can better serve our customers and our community. Our mission has not changed over the past 141 years -- to help our customers become successful by providing them with a comprehensive array of financial products and services delivered through caring, knowledgeable bankers. Building Financial Strength... One of the Bank's key strategic objectives is to reduce our reliance on net interest income and we are making progress in this endeavor. We are seeing encouraging signs that our efforts to offer non-traditional banking services, such as annuities, insurance and mutual funds, are meeting with success. We plan to continue our efforts to market these services, along with our investment management and trust services, by presenting ourselves as a trusted advisor to our customers. Our core business growth in loans and deposits remained essentially flat during 2001, due primarily to eleven Federal Reserve interest rate cuts. These unprecedented rate cuts made managing our net interest margin a significant challenge. One of our difficult choices was how rapidly to reduce interest rates on our deposit products. We tried to balance our responsibilities to our customers and to our shareholders and we believe we have been largely successful. As was true last year, branch expansion, continued investment in technology, along with key additions to staff caused an unfavorable impact on earnings. However, we remain confident that these investments in our future will result in revenue growth that will greatly exceed our expenses, especially now that our largest capital expenditures are behind us. In July, the Board of Directors authorized the buyback of up to 175,000 shares of common stock over an indefinite period. We believe our shares represent an attractive investment for our Company, especially at its current market valuation. The buyback, if fully completed, will reduce the number of outstanding shares by approximately 10%. We also completed a $5 million Trust Preferred Securities offering, issued through our subsidiary DNB Capital Trust I. The bulk of the net proceeds will be invested in the Bank to increase capital levels and to provide the resources required to support our business strategies. Building Our Team... In keeping with another key strategic objective of growing our commercial and small business lending, we have separated our Credit Services Division into a Business Development Group and a Credit Support Group. This reorganization will enable us to focus our efforts on meeting the needs of our commercial and small business customers. In April of 2001, Kristen LaDow joined the Bank as Senior Vice President and Senior Loan Officer to lead our commercial business development efforts. Kristen, along with our Commercial Loan Officers and a new business development officer, Mike Rist, have been focusing their efforts on growing the small to mid-size business segment by offering competitive products and services delivered in a customer-focused manner. In January 2002, we hired an experienced small business lending specialist, Jenny Vanwijk, to work with our Branch Managers to improve service delivery to our small business customers. In July 2001, Andrew Mone, Vice President and Financial Consultant, joined DNB Advisors as a business development officer bringing his 18 years of experience selling investment management, insurance and brokerage services to strengthen our efforts to grow fee income. Finally, Sandy Mattern, a Branch Manager with 36 years of local financial services experience and a strong sales background, joined us at our West Goshen Branch. Building Success... We look forward to 2002 with excitement and optimism. We are evolving our own unique sales culture, developing high-growth business lines and carefully monitoring these endeavors to ensure shareholder value. We will aggressively continue to grow our customer base by offering additional products and services to our existing customers and to develop new customer relationships. Our goal is simple -- to be the Bank of choice in Chester County. In short, our future is deeply rooted in our 141 years of service to our community, where we have worked to earn the trust and confidence of our customers. Going forward, we expect to build on that trust and confidence to meet the needs of our customers and shareholders. 2001, the first year of the new Millennium, brought unprecedented historical changes. The tragic events of September 11th, which left our Nation shocked and irrevocably changed, has impacted Downingtown National Bank; not just as a community bank, but also as a community citizen. While we often speak about our global community, never has this phrase held so much relevance. We now fully understand how changes in the world's economy directly affect all of us. Perhaps, one of the best changes we have experienced this year is a renewed sense of patriotism, community pride, family values and an appreciation of tradition and stability. Downingtown National Bank was founded on and continues to be committed to these values. On behalf of the entire DNB family, we thank you for your continued confidence. Sincerely, /s/ Henry F. Thorne Henry F. Thorne President & Chief Executive Officer DNB Financial Corporation and Subsidiaries Table of Contents 1 Selected Financial Data 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Market for Common Stock 19 Consolidated Financial Statements and Notes 40 Independent Auditors' Report 41 Corporate Information DNB FINANCIAL CORPORATION AND SUBSIDIARIES Selected Financial Data (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
At or For the Year Ended December 31 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ RESULTS OF OPERATIONS Interest income $24,389 $23,752 $20,500 $17,903 $16,364 Interest expense 13,109 12,790 9,825 8,266 6,984 ------------------------------------------------------------------------------------------------------------------------------------ Net interest income 11,280 10,962 10,675 9,637 9,380 Provision for loan losses -- -- -- -- -- Non-interest income 2,303 1,740 1,634 1,506 1,283 Non-interest expense 9,894 8,931 8,231 6,969 7,083 ------------------------------------------------------------------------------------------------------------------------------------ Income before income taxes 3,689 3,771 4,078 4,174 3,580 ------------------------------------------------------------------------------------------------------------------------------------ Income tax expense 967 1,063 1,246 1,252 865 Net income $ 2,722 $ 2,708 $ 2,832 $ 2,922 $ 2,715 PER SHARE DATA* Basic earnings $ 1.53 $ 1.52 $ 1.60 $ 1.66 $ 1.54 Diluted earnings 1.50 1.50 1.55 1.59 1.51 Cash dividends 0.50 0.47 0.45 0.39 0.34 Book value 14.24 13.08 11.62 11.68 10.40 Weighted average Common shares outstanding 1,776,084 1,776,051 1,768,056 1,764,782 1,764,268 FINANCIAL CONDITION Total assets $389,404 $356,670 $301,349 $265,418 $219,451 Loans, less unearned income 186,050 191,201 171,456 148,726 129,954 Allowance for loan losses 4,809 4,917 5,085 5,205 5,281 Deposits 293,383 290,791 254,881 225,373 199,237 Stockholders' equity 25,288 23,230 20,538 20,606 18,356 SELECTED RATIOS Return on average stockholders' equity 10.97% 12.64% 13.66% 15.13% 15.77% Return on average assets 0.74 0.83 0.99 1.22 1.29 Average equity to average assets 6.76 6.60 7.28 8.07 8.21 Loans to deposits 63.42 65.75 67.27 65.99 65.22 Dividend payout ratio 32.32 30.93 28.07 23.85 22.41 ------------------------------------------------------------------------------------------------------------------------------------ * Per share data and shares outstanding have been adjusted for the 2 for 1 stock split in September 1997 and for the 5% stock dividends in December of 2001, 2000, 1999, 1998 and 1997. ------------------------------------------------------------------------------------------------------------------------------------ Downingtown National Bank [LOGO] 1
Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides an overview of the financial condition and results of operations of DNB Financial Corporation (the "Corporation" or "DNB") and its wholly owned subsidiaries, Downingtown National Bank (the "Bank") and DNB Capital Trust I (the "Trust"). The Bank is a community bank providing personal and business banking services as well as trust services, which is managed as a single operating segment. This discussion should be read in conjunction with the Corporation's consolidated financial statements presented elsewhere in this annual report. Results of Operations Summary of Performance For the year ended December 31, 2001, DNB reported net income of $2.7 million or $1.50 per share on a diluted basis. This represents a $14,000 increase from $2.7 million or $1.50 per share in 2000. For the year ended December 31, 1999, net income was $2.8 million or $1.55 per share. Interest income grew $637,000 or 3% to $24.4 million for the year ended December 31, 2001, compared to $23.8 million for the year ended December 31, 2000. Significant growth in commercial mortgage loans and investments contributed to the increase year over year. Total interest expense increased $319,000 or 2% to $13.1 million for the year ended December 31, 2001, from $12.8 million for the year ended December 31, 2000. Interest expense from FHLB advances increased $1.4 million in 2001, reflecting an average balance increase of $25.1 million year over year. This increase was largely offset by lower levels of deposit expense, resulting from lower rates on certificate and money market products. Net interest income increased by $318,000 or 3% to $11.3 million in 2001, compared to $11.0 million in 2000. Net interest income was $10.7 million in 1999. Non-interest income was $2.3 million for the year ended December 31, 2001. Non-interest income for 2000 and 1999 was $1.7 million and $1.6 million, respectively. The $563,000 or 32% increase in 2001 was due to higher levels of service charges and other fee income, as well as an increase in the cash surrender value of bank owned life insurance policies and gains on investments. Non-interest expense was $9.9 million for the year ended December 31, 2001. This represented a $963,000 or 11% increase from $8.9 million in 2000. Non-interest expense in 1999 was $8.2 million. The majority of the increase can be attributed to salary & employee benefits, professional & consulting, occupancy and other expenses. Salaries & employee benefits expense increased $543,000 or 11% year over year. The increase in this category reflects staff additions relating to the reorganization of our Credit Services Division which included two new business development officers, as well as employees hired for our new Exton branch. Professional & consulting expense increased $182,000 or 34%, due to legal fees relating to the formation of a new subsidiary, as well as consultant fees incurred for employee training and DNB's Wealth Management group. Occupancy expenses rose $87,000 or 14%, with notable increases in rental, depreciation, repairs, maintenance and real estate tax expenses. Other expenses increased $97,000 or 7%, reflecting higher levels of MAC expense, underwriting costs and other less significant expenditures. 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. During 2001, net interest income increased $482,000 or 4.3% on a tax equivalent basis, to $11.7 million, from $11.2 million in 2000. As shown in the Rate/Volume Analysis below, the increase in net interest income during 2001 was due to the positive effects of changes in volume, which was partially offset by the negative effects of rate changes. Average loan balances for 2001 rose Downingtown National Bank [LOGO] 2 Management's Discussion and Analysis -------------------------------------------------------------------------------- $13.3 million and average investment securities rose $17.9 million. The impact from higher volumes of earning assets amounted to an increase of $2.9 million in interest income. Average NOW, money market and savings accounts increased a total of $16.8 million. Average time deposits decreased $4.5 million and borrowings increased on average $27.0 million (FHLB advances, Junior subordinated debentures and Federal funds purchased). The impact of higher volumes of interest-bearing liabilities amounted to an increase of $2.1 million in interest expense. The net impact from volume changes amounted to a positive $766,000. The overall impact of rate changes amounted to a negative $284,000, reflecting the Federal Reserves' unprecedented lowering of rates to stimulate the economy, as well as continued strong competition for loans and deposits. During 2000, net interest income increased $329,000 or 3% to $11.2 million on a tax equivalent basis, from $10.9 million in 1999. As shown in the Rate/Volume Analysis below, the increase in net interest income during 2000 was due to the positive effects of changes in volume, which was partially offset by the negative effects of rate changes. The increased volume resulted from significant loan, investment and Federal funds growth, which exceeded interest-bearing liability growth by $1.7 million. Average loan balances for 2000 rose $15.1 million and average investment securities rose $21.9 million. The impact from higher volumes of earning assets amounted to an increase of $3.3 million in interest income. Average NOW, money market and savings accounts increased a total of $10.9 million. Average time deposits increased $14.7 million ($8.0 million from deposits over $100,000) and borrowings increased on average $9.4 million (FHLB advances and Federal funds purchased). The net impact on earnings of higher volumes of interest-bearing liabilities amounted to $1.7 million, partially offsetting the impact from the increased volume of interest-earning assets. The overall impact of rate changes amounted to a negative $713,000, reflecting strong competition for loans as well as deposits. Rising interest rates negatively impacted earnings as DNB's deposits repriced earlier, while loans and investments lagged. As a result of these rate pres- --------------------------------------------------------------------------------
Rate / Volume Analysis (Dollars in thousands) 2001 Versus 2000 2000 Versus 1999 Change Due To Change Due To Rate Volume Total Rate Volume Total ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Loans $ (652) $ 900 $ 248 $ (48) $1,279 $1,231 Investment securities: Taxable (1,303) 1,210 (93) 523 1,272 1,795 Tax-exempt (21) (8) (29) (6) 76 70 Tax-preferred DRD (11) 688 677 -- 135 135 Federal funds sold (125) 123 (2) 84 (21) 63 ------------------------------------------------------------------------------------------------------------------------------------ Total $(2,112) $2,913 $ 801 $ 553 $2,741 $3,294 ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing liabilities: Time deposits $ (393) $ (252) $ (645) $ 550 $ 823 $1,373 NOW, money market and savings deposits (1,376) 778 (598) 532 350 882 FHLB advances (56) 1,444 1,388 184 492 676 Federal funds purchased (3) (2) (5) -- 9 9 Junior subordinated debentures -- 180 180 -- -- -- Other borrowings -- (1) (1) -- 25 25 ------------------------------------------------------------------------------------------------------------------------------------ Total (1,828) 2,147 319 1,266 1,699 2,965 ------------------------------------------------------------------------------------------------------------------------------------ Net interest income $ (284) $ 766 $ 482 $ (713) $1,042 $ 329 ------------------------------------------------------------------------------------------------------------------------------------ Downingtown National Bank [LOGO] 3
Management's Discussion and Analysis -------------------------------------------------------------------------------- sures, DNB experienced declines in both its net interest spread and net interest margin. The table on the preceding page set 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 2001 and 2000 (tax-exempt yields and yields on agency-preferred stock that have a 70% dividend received deduction ("DRD") 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 -------------------------------------------------------------------------------- Average Balances, Rates, and Interest Income and Expense (Dollars in thousands)
Year Ended December 31 2001 2000 1999 Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Interest-earning assets: Investment securities: Taxable $121,241 $ 7,548 6.23% $112,629 $ 7,641 6.78% $ 93,441 $ 5,846 6.26% Tax-exempt 10,392 715 6.88 10,502 744 7.08 9,423 674 7.16 Tax-preferred DRD 11,026 812 7.36 1,677 135 8.05 -- -- -- ------------------------------------------------------------------------------------------------------------------------------------ Total securities 142,659 9,075 6.36 124,808 8,520 6.83 102,864 6,520 6.34 Federal funds sold 10,366 446 4.30 7,114 448 6.30 7,572 385 5.08 Total loans 191,456 15,304 7.99 178,190 15,056 8.45 163,053 13,825 8.48 ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets 344,481 24,825 7.21 310,112 24,024 7.75 273,489 20,730 7.58 Non-interest-earning assets 22,794 14,643 11,376 ------------------------------------------------------------------------------------------------------------------------------------ Total assets $367,275 $324,755 $284,865 ------------------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Savings deposits $137,869 $ 3,641 2.64% $121,037 $ 4,239 3.50% $110,180 $ 3,357 3.05% Time deposits 112,015 6,106 5.45 116,465 6,751 5.80 101,741 5,378 5.29 ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 249,884 9,747 3.90 237,502 10,990 4.63 211,921 8,735 4.12 Federal funds purchased 131 4 3.05 171 9 5.26 -- -- -- FHLB advances 52,644 3,078 5.85 27,913 1,690 6.05 18,901 1,014 5.36 Junior subordinated debentures 2,264 180 7.95 -- -- -- -- -- -- Other borrowings 738 100 13.55 743 101 13.59 569 76 13.36 ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 305,661 13,109 4.29 266,329 12,790 4.80 231,391 9,825 4.25 Demand deposits 35,255 35,390 31,379 Other liabilities 1,544 1,604 1,362 Stockholders' equity 24,815 21,432 20,733 ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $367,275 $324,755 $284,865 ------------------------------------------------------------------------------------------------------------------------------------ Net interest income $11,716 $11,234 $10,905 ------------------------------------------------------------------------------------------------------------------------------------ Interest rate spread 2.92% 2.95% 3.33% Net interest margin 3.40% 3.62% 3.99%
Downingtown National Bank [LOGO] 4 Management's Discussion and Analysis -------------------------------------------------------------------------------- impact of rate and volume has been allocated proportionately to the change due to rate and the change due to volume. The table on the preceding page provides, for the periods indicated, information regarding: (i) DNB's average balance sheet; (ii) the total dollar amounts of interest income from interest-earning assets and the resulting average yields (tax-exempt yields and yields on agency preferred stock that have a 70% dividend received deduction ("DRD") have been adjusted to a tax equivalent basis using a 34% tax rate); (iii) the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs; (iv) net interest income; (v) net interest rate spread; and (vi) net interest margin. Average balances were calculated based on daily balances. Nonaccrual loan balances are included in total loans. Loan fees and costs are included in interest on total loans. Provision for Loan Losses To provide for known and inherent losses in the loan portfolio, DNB maintains an allowance for loan losses. There were no provisions for loan losses made during the three years ended December 31, 2001, since management determined the allowance for loan losses was adequate based on its analysis. Net loan charge-offs were $108,000 in 2001, compared to $168,000 and $120,000 in 2000 and 1999, respectively. The percentage of net charge-offs to total average loans was 0.06%, 0.09% and 0.07% during the same respective periods. Another measure of the adequacy of the allowance is the coverage ratio of the allowance to non-performing loans, which was 150% at December 31, 2001. Non-Interest Income Total non-interest income includes service charges on deposit products; fees 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, lockbox services and similar activities. Non-interest income was $2.3 million in 2001, compared to $1.7 million in 2000 and $1.6 million in 1999. Service charges on deposit accounts increased $281,000 or 37% to $1.0 million in 2001, from $755,000 in 2000 and $627,000 in 1999. Most of the increase in this category came from non-sufficient funds ("NSF") fees, which rose $257,000, due to an increase in the volume of accounts as well as a concerted effort by management to reduce the percentage of fees waived on deposit account overdrafts. Income from DNB Advisors (the Bank's Trust & Investment Group) was $404,000 in 2001, compared to $448,000 in 2000 and $399,000 in 1999. The $44,000 or 10% decrease in 2001 was due to a lower volume of commissions earned on estate settlements. DNB earns income on its investments in bank owned life insurance policies. During the year ended December 31, 2001, income from these policies amounted to $194,000 versus $58,000 in 2000. The increase in this category resulted from an average balance increase of $2.9 million year over year. There was no such income in 1999. Other non-interest income rose by $190,000 or 40% to $669,000 for the year ended Decem-ber 31, 2001, from $479,000 in 2000. Other non-interest income was $608,000 in 1999. $101,000 of the increase in 2001 can be attributed to gains on sales of investment securities along with gains on sales of OREO properties. Gains in these two categories totaled $15,000 in 2000 and $159,000 in 1999. In addition to these gains, fees from other services, such as cash management, debit cards, and mortgage correspondent fees increased a combined $89,000. Non-Interest Expense Non-interest expense includes salaries & employee benefits, furniture & equipment, occupancy, professional & consulting fees as well as marketing, printing & supplies and other less sig- Downingtown National Bank [LOGO] 5 Management's Discussion and Analysis -------------------------------------------------------------------------------- nificant expense items. Non-interest expenses were $9.9 million in 2001, compared to $8.9 million and $8.2 million in 2000 and 1999, respectively. The $963,000 or 11% increase in 2001 reflects the overall growth of DNB, with higher levels of expenditures in nearly all categories. The most significant increase occurred in salaries & employee benefits expense which totaled $5.3 million in 2001, compared to $4.7 million in 2000 and $4.3 million in 1999. Salary & employee benefits expense for 2001 reflects increased staffing at the branch level, as well as additional investments in several lines of business, most notably DNB Advisors, DNB Leasing, as well as DNB's Business Lending Development group. This was in addition to the normal merit increases and increased expenditures for medical insurance. The increase in salary & employee benefits expense in 2000 over 1999 resulted from more full-time equivalent employees, due to the two new branches which opened in 1999. Furniture & equipment expense includes depreciation, rent, maintenance and miscellaneous purchases of office equipment and furniture. Furniture & equipment expense increased $40,000 or 4% to $1.1 million during 2001, compared to $1.0 million in 2000 and $927,000 in 1999. The increase in 2001 related to a partial year of depreciation on fixed asset purchases for the new Exton branch, the relocation of DNB Advisors, as well as continued software upgrades. The increase in 2000 was attributable to a full year's depreciation on several key hardware and software upgrades as well as the added repairs and miscellaneous purchases associated with maintaining two additional branch offices. Occupancy expense includes office building depreciation, rent, taxes, maintenance and utilities. Occupancy expense totaled $709,000 in 2001, compared to $622,000 in 2000 and $519,000 in 1999. Similar to the furniture and equipment expense, the increase in this category over the past three years is directly related to the three new offices. DNB experienced, and will continue to experience higher levels of utility usage, real estate taxes, maintenance, security and other costs associated with maintaining these additional buildings. Professional & consulting expense includes fees for legal, audit & accounting and asset/liability management services, as well as consulting fees for technology, human resources and other special projects. Professional & consulting expense for 2001 was $715,000, compared to $533,000 in 2000 and $492,000 in 1999. The $182,000 increase in this category comes from legal expenses incurred in forming a new subsidiary, as well as consulting services for our Wealth Management group and training programs for all employees. Marketing expense increased $50,000 or 18% to $325,000 in 2001, primarily due to expenditures for branch and Wealth Management advertising. Marketing expense decreased $77,000 to $275,000 for the year ended December 31, 2000, compared to $352,000 in 1999. Expenditures in 1999 included approximately $74,000 associated with branch grand opening celebrations, direct mailings and new brochures. Printing & supplies declined $36,000 to $242,000 in 2001. The decrease from 2000 relates to fewer promotions, direct mailings and brochure printing expenses in 2001. In 1999, printing and supplies included added expenditures for flyers, posters, mailers and other items related to the new branch openings, as well as new brochures for retail products. Other expenses include such items as postage, insurance, director fees, appraisal fees, telephone and other miscellaneous expenses. Other expenses increased $97,000 or 7% to $1.5 million in 2001. This compares to $1.4 million and $1.3 million in 2000 and 1999. The largest single increase in this category during 2001 was MAC and other bank charges which increased $47,000 as a result of increased levels of system transactions. The increase in 2000 over 1999 relates to the aforementioned technology upgrades and branch expansion. Income Taxes Income tax expense was $1.0 million in 2001, $1.1 million in 2000 and $1.2 million in 1999. DNB's effective tax rate was 26%, 28%, and 31% for the three years, respectively. The effective tax rates were less than the statutory rate due to Downingtown National Bank [LOGO] 6 Management's Discussion and Analysis -------------------------------------------------------------------------------- the effect of increasing amounts of tax exempt income, tax credits recognized on a low-income housing limited partnership and DNB's ownership of bank-owned life insurance investments. Financial Condition Analysis Investment Securities DNB's investment portfolio consists of US Treasury, US agency securities, mortgage-backed securities issued by US Government agencies, corporate bonds, collateralized mortgage obligations, asset-backed securities, state and municipal securities, agency and bank stocks, certificates of deposit and other bonds and notes. In addition to generating revenue, DNB maintains the investment portfolio to manage interest rate risk, provide liquidity, provide collateral for borrowings and to diversify the credit risk of earning assets. The portfolio is structured to maximize DNB's net interest income given changes in the economic environment, liquidity position and balance sheet mix. Given the nature of the portfolio, and its generally high credit quality, management expects to realize all of its investment upon the maturity of such instruments, and believes that any market value decline is temporary in nature. Management determines the appropriate classification of securities at the time of purchase. Investment securities are classified as: (a) securities held to maturity ("HTM") based on management's intent and ability to hold them to maturity; (b) trading account ("TA") securities that are bought and held principally for the purpose of selling them in the near term; and (c) securities available for sale ("AFS"). DNB does not currently maintain a trading account portfolio. -------------------------------------------------------------------------------- Investment Maturity Schedule, Including Weighted Average Yield (Dollars in thousands)
December 31, 2001 Less than Over No Stated Held to Maturity 1 Year 1-5 Years 5-10 Years 10 Years Maturity Total Yield ------------------------------------------------------------------------------------------------------------------------------------ US Government agency obligations $-- $-- $4,997 $ 4,155 $-- $ 9,152 7.38% Collateralized mortgage obligations -- -- -- 10,905 -- 10,905 5.91 US agency mortgage-backed securities -- 131 18 3,619 -- 3,768 5.84 Equity securities -- -- -- -- 4,265 4,265 6.22 Other securities 4,000 -- -- 999 -- 4,999 5.73 ------------------------------------------------------------------------------------------------------------------------------------ Total $4,000 $ 131 $5,015 $19,678 $ 4,265 $ 33,089 ------------------------------------------------------------------------------------------------------------------------------------ Percent of portfolio 12% 1% 15% 59% 13% 100% Weighted average yield 5.7% 7.6% 8.0% 6.0% 6.2% 6.3% Less than Over No Stated Available for Sale 1 Year 1-5 Years 5-10 Years 10 Years Maturity Total Yield ------------------------------------------------------------------------------------------------------------------------------------ US Treasury $4,624 $-- $-- $-- $-- $ 4,624 3.40% US Government agency obligations -- -- 3,647 10,209 -- 13,856 6.19 Corporate bonds 1,248 6,674 -- 25,343 -- 33,265 4.34 Collateralized mortgage obligations-- -- -- 13,340 -- 13,340 5.40 State and municipal tax-exempt -- -- 504 9,590 -- 10,094 7.19 US agency mortgage-backed securities -- 12,082 874 34,726 -- 47,682 5.28 DRD agency preferred stock -- -- -- -- 12,485 12,485 7.14 Other securities -- 273 -- -- -- 273 2.36 ------------------------------------------------------------------------------------------------------------------------------------ Total $5,872 $19,029 $5,025 $93,208 $12,485 $135,619 ------------------------------------------------------------------------------------------------------------------------------------ Percent of portfolio 4% 14% 4% 69% 9% 100% ------------------------------------------------------------------------------------------------------------------------------------ Weighted average yield 1.9% 4.9% 5.3% 5.4% 7.1% 5.3% Downingtown National Bank [LOGO] 7
Management's Discussion and Analysis -------------------------------------------------------------------------------- --------------------------------------------------------------------------------
Composition of Investment Securities (Dollars in thousands) December 31 2001 2000 Held to Available Held to Available Maturity for Sale Maturity for Sale ------------------------------------------------------------------------------------------------------------------------------------ US Treasury $ -- $ 4,624 $ -- $ 1,000 US Government agency obligations 9,152 13,856 19,805 26,563 Corporate bonds -- 33,265 -- 30,445 Collateralized mortgage obligations 10,905 13,340 16,047 -- State and municipal tax-exempt -- 10,094 -- 9,724 US agency mortgage-backed securities 3,768 47,682 2,161 5,434 DRD agency preferred stock -- 12,485 -- 6,020 Equity securities 4,265 -- 3,316 -- Other securities 4,999 273 999 6,902 ------------------------------------------------------------------------------------------------------------------------------------ Total $33,089 $135,619 $42,328 $86,088 ------------------------------------------------------------------------------------------------------------------------------------
Securities classified as AFS include securities that may be sold in response to changes in interest rates, changes in prepayment assumptions, the need to increase regulatory capital or other similar requirements. DNB does not necessarily intend to sell such securities, but has classified them as AFS to provide flexibility to respond to liquidity needs. DNB's investment portfolio (HTM and AFS securities) totaled $168.7 million at December 31, 2001, up 31% from $128.4 million at December 31, 2000. The growth in the investment portfolio was funded by increased deposits and borrowings during the year. DNB had certain private label CMOs which represented a significant concentration (greater than 10% of stockholders' equity) as follows: 2001 -------------------------- Amortized Estimated (Dollars in thousands) Cost Fair Value -------------------------------------------------------- Credit Suisse First Boston Mortgage Securities Corp. $2,777 $2,782 -------------------------------------------------------- 2000 -------------------------- Amortized Estimated Cost Fair Value -------------------------------------------------------- Chase Mortgage Finance Corp. $3,011 $2,987 Bear Stearns Mortgage Securities, Inc. 2,489 2,479 -------------------------------------------------------- The table on the previous page sets forth information regarding the composition, stated maturity and average yield of DNB's investment security portfolio as of December 31, 2001 (tax-exempt yields and yields on agency-preferred stock that have a 70% dividend received deduction ("DRD") have been adjusted to a tax equivalent basis using a 34% tax rate). This table does not include amortization or anticipated prepayments on mortgage-backed securities. Callable securities are included at their stated maturity dates. Loans The loan portfolio consists primarily of commercial and residential real estate loans, commercial loans and lines of credit (including commercial construction), and consumer loans. The loan portfolio provides a stable source of interest income, monthly amortization of principal and, in the case of adjustable rate loans, repricing opportunities. Net loans were $181.2 million at December 31, 2001, down $5.1 million or 3% from 2000. Commercial mortgage loans increased $3.0 million or 4% to $70.3 million, consumer loans decreased $5.3 million or 13% to $34.4 million, and residential loans decreased $3.9 million or 9% to $39.3 million. The increase in the commercial and commercial mortgage portfolios continues to reflect DNB's commitment to commercial development in Chester County and northern Delaware. The decreases in the consumer and residential mortgage portfolios are a result of the low interest rate environment in 2001, that prompted many of DNB's customers to refinance their first and second mortgages. Downingtown National Bank [LOGO] 8 Management's Discussion and Analysis -------------------------------------------------------------------------------- Non-Performing Assets Total non-performing assets increased $1.2 million to $3.2 million at December 31, 2001, compared to $2.0 million and $2.1 million at December 31, 2000 and 1999, respectively. The increase in 2001 was attributable to two loans to a single borrower which were placed on nonaccrual/cash basis in accordance with DNB's policy, set forth below. The loans are fully guaranteed and no loss is expected. DNB, which has a significant level of commercial, and commercial real estate loans, continues to work diligently to improve asset quality and position itself for possible economic downturns by tightening underwriting standards and improving lending policies and procedures. Non-performing assets have, and will continue to have, an impact on earnings, therefore management intends to continue working aggressively to reduce the level of such assets. Non-performing assets are comprised of nonaccrual loans, loans delinquent over ninety days and still accruing, troubled debt restructurings ("TDRs") and other real estate owned ("OREO"). Nonaccrual loans are loans on 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 The following table sets forth information concerning the composition of total loans outstanding, net of the allowance for loan losses, as of the dates indicated. --------------------------------------------------------------------------------
Total Loans Outstanding, Net of Allowance for Loan Losses (Dollars in thousands) December 31 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ Residential mortgage $ 39,298 $ 43,227 $ 39,873 $ 29,656 $ 20,392 Commercial mortgage 70,282 67,302 57,656 51,434 46,130 Commercial 42,081 41,000 38,734 35,549 34,966 Consumer 34,389 39,672 35,193 32,087 28,466 ------------------------------------------------------------------------------------------------------------------------------------ Total loans, net of unearned income 186,050 191,201 171,456 148,726 129,954 Less allowance for loan losses (4,809) (4,917) (5,085) (5,205) (5,281) ------------------------------------------------------------------------------------------------------------------------------------ Net loans $181,241 $186,284 $166,371 $143,521 $124,673 ------------------------------------------------------------------------------------------------------------------------------------
The following table sets forth information concerning the contractual maturities of the loan portfolio, net of unearned income and fees. For amortizing loans, scheduled repayments for the maturity category in which the payment is due are not reflected below, because such information is not readily available. --------------------------------------------------------------------------------
Loan Maturities December 31, 2001 (Dollars in thousands) Less than 1 Year 1-5 Years Over 5 Years Total ------------------------------------------------------------------------------------------------------------------------------------ Real estate $13,237 $37,253 $59,090 $109,580 Commercial 38,202 3,700 179 42,081 Consumer 5,438 9,814 19,137 34,389 ------------------------------------------------------------------------------------------------------------------------------------ Total loans, net of unearned income 56,877 50,767 78,406 186,050 ------------------------------------------------------------------------------------------------------------------------------------ Loans with predetermined interest rates 17,985 26,867 77,232 122,084 Loans with variable interest rates 38,892 23,900 1,174 63,966 ------------------------------------------------------------------------------------------------------------------------------------ Total loans, net of unearned income $56,877 $50,767 $78,406 $186,050 ------------------------------------------------------------------------------------------------------------------------------------ Downingtown National Bank [LOGO] 9
Management's Discussion and Analysis -------------------------------------------------------------------------------- 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. OREO includes both real estate obtained as a result of, or in lieu of, foreclosure. Any significant change in the level of non-performing assets is dependent, to a large extent, on the economic climate within DNB's market area. DNB's Special Assets Committee monitors the performance of the loan portfolio to identify potential problem assets on a timely basis. Committee members meet to design, implement and review asset recovery strategies which serve to maximize the recovery of each troubled asset. DNB had $4.0 million of loans which, although performing at December 31, 2001, are believed to require increased supervision and review; and may, depending on the economic environment and other factors, become non-performing assets in future periods. The amount of such loans at December 31, 2000 was $8.0 million. The majority of the loans are secured by commercial real estate, with lesser amounts being secured by residential real estate, inventory and receivables. Allowance for Loan Losses The allowance for loan losses is increased by the provision for loan losses which is charged to operations. 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, -------------------------------------------------------------------------------- The following table sets forth those assets that are: (i) placed on nonaccrual status; (ii) contractually delinquent by 90 days or more and still accruing; (iii) troubled debt restructurings other than those included in items (i) and (ii); and (iv) OREO as a result of foreclosure or voluntary transfer to DNB.
December 31 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ Nonaccrual loans: Residential mortgage $ 224 $ 137 $-- $ 250 $ 676 Commercial mortgage 567 157 361 1,063 1,301 Commercial 1,964 573 674 990 821 Consumer 301 317 292 114 107 ------------------------------------------------------------------------------------------------------------------------------------ Total nonaccrual loans 3,056 1,184 1,327 2,417 2,905 Loans 90 days past due and still accruing 155 609 694 699 70 Troubled debt restructurings -- 40 -- -- -- ------------------------------------------------------------------------------------------------------------------------------------ Total non-performing loans 3,211 1,833 2,021 3,116 2,975 Other real estate owned -- 183 83 139 231 ------------------------------------------------------------------------------------------------------------------------------------ Total non-performing assets $3,211 $2,016 $2,104 $3,255 $3,206 ------------------------------------------------------------------------------------------------------------------------------------ Asset quality ratios: Non-performing loans to total loans 1.72% 0.96% 1.17% 2.10% 2.29% Non-performing assets to total assets 0.82 0.57 0.69 1.23 1.46 Allowance for loan losses to: Total loans 2.58 2.56 2.96 3.50 4.06 Non-performing loans 149.77 268.10 251.61 167.04 177.51 ------------------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 10 Management's Discussion and Analysis -------------------------------------------------------------------------------- present indicators of risk such as delinquency rates, levels of nonaccruals, and other relevant factors. Management's evaluation of the loan portfolio generally includes reviews, on a sample basis, of individual borrowers of $350,000 or greater 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 estab- -------------------------------------------------------------------------------- The following table sets forth the changes in DNB's allowance for loan losses for the years indicated. Real estate includes both residential and commercial real estate.
Analysis of Allowance for Loan Losses (Dollars in thousands) Year Ended December 31 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ Beginning balance $4,917 $5,085 $5,205 $5,281 $5,112 Provisions -- -- -- -- -- Loans charged off: Real estate (209) (138) (171) (59) -- Commercial (66) (65) (35) (233) (32) Consumer (9) (21) (10) (11) (16) ------------------------------------------------------------------------------------------------------------------------------------ Total charged off (284) (224) (216) (303) (48) ------------------------------------------------------------------------------------------------------------------------------------ Recoveries: Real estate 132 13 21 144 1 Commercial 36 33 68 71 167 Consumer 8 10 7 12 49 ------------------------------------------------------------------------------------------------------------------------------------ Total recoveries 176 56 96 227 217 ------------------------------------------------------------------------------------------------------------------------------------ Ending balance $4,809 $4,917 $5,085 $5,205 $5,281 ------------------------------------------------------------------------------------------------------------------------------------
Composition of Allowance for Loan Losses (Dollars in thousands) December 31 2001 2000 1999 1998 1997 Percent of Percent of Percent of Percent of Percent of Loan Type to Loan Type to Loan Type to Loan Type to Loan Type to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ------------------------------------------------------------------------------------------------------------------------------------ Real estate $1,685 59% $1,449 58% $1,272 57% $1,537 54% $1,104 51% Commercial* 1,609 23 1,555 21 1,275 23 1,192 24 1,220 27 Consumer 145 18 270 21 199 20 185 22 164 22 Unallocated 1,370 -- 1,643 -- 2,339 -- 2,291 -- 2,793 -- ------------------------------------------------------------------------------------------------------------------------------------ Total $4,809 100% $4,917 100% $5,085 100% $5,205 100% $5,281 100% ------------------------------------------------------------------------------------------------------------------------------------ *includes commercial construction Downingtown National Bank [LOGO] 11
Management's Discussion and Analysis -------------------------------------------------------------------------------- lished 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. The table on the previous page sets forth the composition of DNB's allowance for loan losses at the dates indicated. The portion allocated to each category is generally not the total amount available for future losses that might occur within such categories. The allocation of the allowance should also not be interpreted as an indication that charge-offs will occur in these amounts or proportions. The specific allocations in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category. 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 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 BC 201 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 effect of receiving incomplete, inaccurate or misleading information from our borrowers; and (iii) the non-qualifiable impact that a terrorist action or threat of action has on a particular industry. Liquidity and Capital Resources Management maintains liquidity to meet depositors' needs for funds, to satisfy or fund loan commitments, and for other operating purposes. DNB's foundation for liquidity is a stable and loyal customer deposit base and a marketable investment portfolio that provides periodic cash flow through regular maturities and amortization, or that can be used as collateral to secure funding. DNB's primary source of liquidity is dependent upon its ability to maintain and expand its customer deposit base. As of December 31, 2001, deposits totaled $293.4 million, up modestly from $290.8 million at December 31, 2000. Certificates of deposit de- -------------------------------------------------------------------------------- The following table sets forth the composition of DNB's deposits at the dates indicated.
Deposits By Major Classification (Dollars in thousands) December 31 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ Non-interest-bearing deposits $ 40,355 $ 38,898 $ 31,864 $ 30,001 $ 27,150 Interest-bearing deposits: NOW 46,346 44,450 39,501 37,075 33,387 Money market 64,491 59,250 47,517 32,582 19,289 Savings 34,480 29,811 30,199 28,321 27,714 Certificates 90,387 101,794 89,691 82,424 78,509 IRA 17,324 16,588 16,109 14,970 13,188 ------------------------------------------------------------------------------------------------------------------------------------ Total deposits $293,383 $290,791 $254,881 $225,373 $199,237 ------------------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 12 Management's Discussion and Analysis -------------------------------------------------------------------------------- creased $11.4 million to $90.4 million, while money market, savings, NOW and non-interest-bearing accounts increased $5.2 million, $4.7 million, $1.9 million and $1.5 million, respectively. The flow of deposits from certificates to transaction accounts reflects our customers' liquidity preferences in the current low-interest rate environment. DNB maintains borrowing arrangements with a correspondent bank and the Federal Home Loan Bank of Pittsburgh, as well as access to the discount window at the Federal Reserve Bank of Philadelphia, to meet short-term liquidity needs. Through these relationships, DNB has additional available short-term credit of approximately $102.7 million. -------------------------------------------------------------------------------- The following table sets forth certain information relating to DNB's financial instruments that are sensitive to changes in interest rates and categorized by expected maturity or repricing.
Interest Rate Sensitivity Analysis (Dollars in thousands) December 31, 2001 More Than More Than More Than More Than More Than One Year Two Years Three Years Four Years Five Years Under One Through Through Through Through and Year Two Years Three Years Four Years Five Years Non-repricing Total ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks and Federal funds sold $ 9,888 $-- $-- $-- $-- $ 8,740 $ 18,628 Investments 74,373 36,656 12,613 10,305 6,419 28,342 168,708 Commercial loans 31,949 3,876 2,743 1,086 268 2,369 42,291 Mortgage loans 20,867 18,296 12,114 10,473 8,312 39,915 109,977 Consumer loans 10,404 4,380 3,794 3,042 2,327 9,836 33,783 Other assets -- -- -- -- -- 16,017 16,017 ------------------------------------------------------------------------------------------------------------------------------------ Total assets $147,481 $63,208 $31,264 $24,906 $ 17,326 $105,219 $389,404 ------------------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND EQUITY Non-interest-bearing demand $-- $-- $-- $ 6,726 $ 6,726 $ 26,903 $ 40,355 NOW 13,904 4,635 9,269 4,635 4,635 9,269 46,347 Money market 58,166 3,162 3,162 -- -- -- 64,490 Savings 8,620 5,172 6,896 3,448 3,448 6,896 34,480 Certificates and IRAs less than $100,000 56,182 16,686 3,522 211 454 -- 77,055 Certificates and IRAs at or more than $100,000 26,474 3,019 -- 262 827 74 30,656 ------------------------------------------------------------------------------------------------------------------------------------ Total deposits 163,346 32,674 22,849 15,282 16,090 43,142 293,383 Borrowings 5,000 3,000 6,000 9,000 17,000 23,735 63,735 Junior subordinated debentures 5,000 -- -- -- -- -- 5,000 Other liabilities -- -- -- -- -- 1,998 1,998 Stockholders' equity -- -- -- -- -- 25,288 25,288 ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and equity $173,346 $35,674 $28,849 $24,282 $ 33,090 $ 94,163 $389,404 ------------------------------------------------------------------------------------------------------------------------------------ Gap $ (25,865) $27,534 $ 2,415 $ 624 $(15,764) $ 11,056 ------------------------------------------------------------------------------------------------------------------------------------ Cumulative gap $ (25,865) $ 1,669 $ 4,084 $ 4,708 $(11,056) $-- Cumulative gap to total assets (6.64%) 0.43% 1.05% 1.21% (2.84%) ------------------------------------------------------------------------------------------------------------------------------------ Downingtown National Bank [LOGO] 13
Management's Discussion and Analysis -------------------------------------------------------------------------------- At December 31, 2001, DNB has $18.1 million in commitments to fund commercial real estate, construction and land development loans. In addition, there are $5.1 million in unfunded home equity lines of credit and $14.4 million in other unused loan commitments. Management anticipates the majority of these commitments will be funded by means of normal cash flows. There are approximately $82.7 million in certificates of deposit scheduled to mature during the twelve months ending December 31, 2002. To meet its funding needs, DNB maintains assets which comprise its primary liquidity totaling $155.3 million on December 31, 2001. Primary liquidity includes Federal funds sold, investments and interest-bearing cash balances, less pledged securities. DNB also anticipates scheduled payments and prepayments on its loan and mortgage-backed securities portfolios. Interest Rate Sensitivity Analysis The largest component of DNB's total income is net interest income, and the majority of DNB's financial instruments are composed of interest rate-sensitive assets and liabilities with various terms and maturities. The primary objective of management is to maximize net interest income while minimizing interest rate risk. Interest rate risk is derived from timing differences in the repricing of assets and liabilities, loan prepayments, deposit withdrawals, and differences in lending and funding rates. The Asset-Liability Committee ("ALCO") actively seeks to monitor and control the mix of interest rate-sensitive assets and interest rate-sensitive liabilities. One measure of interest rate risk is the gap ratio, which is defined as the difference between the dollar volume of interest-earning assets and interest-bearing liabilities maturing or repricing within a specified period of time as a percentage of total assets. A positive gap results when the volume of interest rate-sensitive assets exceeds that of interest rate-sensitive liabilities within comparable time periods. A negative gap results when the volume of interest rate-sensitive liabilities exceeds that of interest rate-sensitive assets within comparable time periods. As indicated in the table on the previous page, the one year gap position at December 31, 2001 was a negative 6.6%. Generally, a financial institution with a negative gap position will most likely experience decreases in net interest income during periods of rising rates and increases in net interest income during periods of falling interest rates. The negative gap was due largely to customer preferences for short-term and floating rate deposit products and fixed rate loans which caused interest-rate sensitive liabilities to exceed interest- rate sensitive assets during the earlier time periods presented. While gap analysis represents a useful asset/liability management tool, it does not necessarily indicate the effect of general interest rate movements on DNB's net interest income, due to discretionary repricing of assets and liabilities, and other competitive pressures. DNB reports its callable agency, callable corporate notes and callable municipal investments ($55.0 million at December 31, 2001) at their Option Adjusted Spread ("OAS") modified duration date, as opposed to the call or maturity date. In management's opinion, using modified duration dates on callable securities provides a better estimate of the option exercise date under any interest rate environment. The OAS methodology is an approach whereby the likelihood of option exercise takes into account the coupon on the security, the distance to the call date, the maturity date and current interest rate volatility. In addition, prepayment assumptions derived from historical data have been applied to mortgage-related securities, which are included in investments. Included in the analysis of the gap position are certain savings and demand accounts which are less sensitive to fluctuations in interest rates than other interest-bearing sources of funds. In determining the sensitivity of such deposits, management reviews the movement of its deposit rates relative to changes in market rates. The ALCO has estimated that these deposits are approximately 25-75% sensitive to interest rate changes (i.e., if short term rates were to increase 100 basis points, the interest rate on such deposits would increase 25-75 basis points). DNB continually evaluates interest rate risk management opportunities, including the use of derivative financial instruments. Management be- Downingtown National Bank [LOGO] 14 Management's Discussion and Analysis -------------------------------------------------------------------------------- lieves that hedging instruments currently available are not cost-effective, and therefore, has focused its efforts on increasing DNB's spread by attracting lower-costing retail deposits and in some instances, borrowing from the FHLB of Pittsburgh. In addition to utilizing the gap ratio for interest rate risk management, the ALCO utilizes simulation analysis whereby the model estimates the variance in net interest income with a change in interest rates of plus or minus 300 basis points over a twelve and twenty-four month period. Given today's low interest rate environment, our simulation model measures the effect of a 150 basis point decline in earnings, versus the 300 basis points decline used historically. Recent simulations indicate that net interest income would be within policy guidelines regardless of the direction of market rates. Market Risk Analysis 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 as interest rates change. Results falling outside prescribed ranges require action by the ALCO. At December 31, 2001 and 2000, 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 is within DNB's negative 3% policy guideline, as shown in the tables below. The market capitalization of DNB should not be equated to the EVPE, which only deals with the valuation of balance sheet cash flows using conservative assumptions. Calculated core deposit premiums may be less than what is available in an outright sale. The model does not consider potential premiums on floating rate loan sales, the impact of overhead expense, non-interest income, taxes, industry market price multiples and other factors reflected in the market capitalization of a company. Market Risk Analysis (Dollars in thousands) December 31, 2001 Change in Rates Flat -200 bp +200 bp ------------------------------------------------------------------------ EVPE $29,379 $25,078 $24,237 Change (4,301) (5,142) Change as a % of assets (1.10%) (1.32%) ------------------------------------------------------------------------ December 31, 2000 Change in Rates Flat -200 bp +200 bp ------------------------------------------------------------------------ EVPE $28,870 $27,205 $23,082 Change (1,665) (5,788) Change as a % of assets (0.47%) (1.62%) ------------------------------------------------------------------------ Capital Resources Stockholders' equity increased to $25.3 million at December 31, 2001. Net income of $2.7 million was supplemented by the net year over year unrealized gain in the available-for-sale investment portfolio ($490,000) and offset by dividends paid ($880,000), as well as the purchase of treasury stock ($266,000). Management believes that the Corporation and the Bank have each met the definition of "well capitalized" for regulatory purposes on December 31, 2001. The Bank's capital category is determined for the purposes of applying the bank regulators' "prompt corrective action" regulations and for determining levels of deposit insurance assessments and may not constitute an accurate representation of the Corporation's or the Bank's overall financial condition or prospects. The Corporation's capital exceeds the FRB's minimum leverage ratio requirements for bank holding companies (see additional discussion in Regulatory Matters -- Footnote 17). 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 Downingtown National Bank [LOGO] 15 Management's Discussion and Analysis -------------------------------------------------------------------------------- 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, which amounted to $5.9 million for the year ended December 31, 2001. Forward-Looking Statements Certain statements in this report, including any which are not statements of historical fact, may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Without limiting the foregoing, the words "expect", "anticipate", "plan", "believe", "seek", "estimate", "predict", "internal" and similar words are intended to identify expressions that may be forward-looking statements. Forward-looking statements involve certain risks and uncertainties, and actual results may differ materially from those contemplated by such statements. For example, actual results may be adversely affected by the following possibilities: (1) competitive pressures among financial institutions may increase; (2) changes in interest rates may reduce banking interest margins; (3) general economic conditions and real estate values may be less favorable than contemplated; (4) adverse legislation or regulatory requirements may be adopted; (5) other unexpected contingencies may arise. Many of these factors are beyond DNB's ability to control or predict. 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. Recent Accounting Pronouncements In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"), which was subsequently amended. This statement standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and those used for hedging activities, by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. SFAS No. 133 generally provides for matching of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, so long as the hedge is effective. SFAS No. 133 was adopted on January 1, 2001 and there was no impact on operations, financial condition, equity or comprehensive income. DNB currently has no derivatives covered by this statement and currently conducts no hedging activities. In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS No. 140"). This statement supercedes and replaces the guidance in Statement 125. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, although it carries over most of Statement 125's provisions without reconsideration. The Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral for fiscal years ending after December 15, 2000. This statement is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. SFAS No. 140 was adopted by DNB during the fiscal year ended December 31, 2001. There was no impact of this statement on DNB's financial condition, equity, results of operations or disclosures. In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS No. 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All Business combinations in the scope of the Statement are to be accounted for using the purchase method. The provisions of the Statement apply to all Business combinations initiated after June 30, 2001. The Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. SFAS No. 141 was adopted by DNB on July 1, 2001. There was no Downingtown National Bank [LOGO] 16 Management's Discussion and Analysis -------------------------------------------------------------------------------- impact of this statement on DNB's financial condition, equity, results of operations or disclosures. In June 2001, the FASB issued SFAS No. 142, Goodwill and other Intangible Assets ("SFAS No. 142"). This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. The Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of the statement are required to be applied starting with fiscal years beginning after December 15, 2001, except that goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the nonamortization and amortization provisions of the Statement. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. The Statement is required to be applied at the beginning of an entity's fiscal year and to be applied to all goodwill and other intangible assets recognized in its financial statements at that date. DNB expects any impact from the adoption of this statement to be immaterial to its financial condition, equity, results of operations and disclosures. In June 2001, the FASB issued SFAS No. 143 Accounting for Asset Retirement Obligation. ("SFAS No. 143"). This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. As used in this Statement, a legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement amends FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies, and it applies to all entities. It is effective for financial statements issued for fiscal years beginning after June 15, 2002. Earlier application is encouraged. DNB expects that there will be no impact of this statement on its financial condition, equity, results of operations or disclosures when adopted. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset. ("SFAS No. 144"). This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. However, the Statement retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. This Statement supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, this Statement retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in distribution to owners) or is classified as held for sale. This Statement also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a temporarily controlled subsidiary. The provisions of this Downingtown National Bank [LOGO] 17 Management's Discussion and Analysis -------------------------------------------------------------------------------- Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with earlier application encouraged. The provisions of this Statement generally are to be applied prospectively. DNB expects that there will be no impact of this statement on its financial condition, equity, results of operations or disclosures when adopted. Market for Common Stock DNB Financial Corporation's common stock is listed under the symbol "DNBF" on the Over The Counter Electronic Bulletin Board, an automated quotation service, made available through and governed by the NASDAQ system. Current price information is available from account executives at most brokerage firms as well as the firms listed at the back of this report who are market makers of DNB's common stock. There were approximately 900 stockholders who owned 1.8 million shares of common stock outstanding at December 31, 2001. The following table sets forth the quarterly high and low prices for a share of DNB's common stock during the periods indicated. Prices for the sale of stock are based upon transactions reported by the brokerage firms of F. J. Morrissey & Co., Inc. and Ferris, Baker Watts, Inc. The quoted high and low bids prices are limited only to those transactions known by management to have occurred and there may, in fact, have been additional transactions of which management is unaware. Prices have been adjusted for stock dividends. 2001 2000 High Low High Low ----------------------------------------------------------- First quarter $14.64 $13.33 $15.19 $11.79 Second quarter 15.86 14.64 13.61 12.02 Third quarter 19.37 15.33 14.74 12.36 Fourth quarter 21.75 18.37 14.63 13.33 ----------------------------------------------------------- -------------------------------------------------------------------------------- The following table sets forth selected quarterly financial data and earnings per share for the periods indicated. Per share data have been adjusted for the five percent (5%) stock dividends declared in 2001 and 2000.
Quarterly Financial Data (Dollars in thousands, except per share data) 2001 2000 Fourth Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------------------------------------------ Interest income $5,897 $6,093 $6,169 $6,230 $6,433 $6,166 $5,698 $5,455 Interest expense 2,922 3,205 3,406 3,576 3,675 3,429 2,965 2,721 ------------------------------------------------------------------------------------------------------------------------------------ Net interest income 2,975 2,888 2,763 2,654 2,758 2,737 2,733 2,734 Provision for loan losses -- -- -- -- -- -- -- -- Non-interest income 738 582 526 457 490 438 419 393 Non-interest expense 2,593 2,609 2,448 2,244 2,265 2,284 2,232 2,150 ------------------------------------------------------------------------------------------------------------------------------------ Income before income taxes 1,120 861 841 867 983 891 920 977 Income tax expense 223 249 233 262 219 266 285 293 ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 897 $ 612 $ 608 $ 605 $ 764 $ 625 $ 635 $ 684 ------------------------------------------------------------------------------------------------------------------------------------ Basic earnings per share $ 0.50 $ 0.34 $ 0.34 $ 0.34 $ 0.43 $ 0.35 $ 0.36 $ 0.39 Diluted earnings per share 0.49 0.34 0.34 0.34 0.42 0.35 0.35 0.38 ------------------------------------------------------------------------------------------------------------------------------------ Cash dividends per share $0.124 $0.124 $0.124 $0.124 $0.118 $0.118 $0.118 $0.118 ------------------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 18 DNB FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition
December 31 2001 2000 ------------------------------------------------------------------------------------------------------------------------------------ Assets Cash and due from banks $ 11,466 $ 13,002 Federal funds sold 7,162 14,350 ------------------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents 18,628 27,352 ------------------------------------------------------------------------------------------------------------------------------------ Investment securities available for sale, at market value 135,619 86,088 Investment securities (market value $33,618 in 2001 and $42,358 in 2000) 33,089 42,328 Loans, net of unearned income 186,050 191,201 Allowance for loan losses (4,809) (4,917) ------------------------------------------------------------------------------------------------------------------------------------ Net loans 181,241 186,284 ------------------------------------------------------------------------------------------------------------------------------------ Office property and equipment 7,701 5,889 Accrued interest receivable 2,230 2,580 Bank owned life insurance 5,203 1,858 Deferred income taxes 1,213 1,427 Other real estate owned -- 183 Other assets 4,480 2,681 ------------------------------------------------------------------------------------------------------------------------------------ Total assets $389,404 $356,670 ------------------------------------------------------------------------------------------------------------------------------------ Liabilities and Stockholders' Equity Liabilities Non-interest-bearing deposits $ 40,355 $ 38,898 Interest-bearing deposits: NOW 46,346 44,450 Money market 64,491 59,250 Savings 34,480 29,811 Time 107,711 118,382 ------------------------------------------------------------------------------------------------------------------------------------ Total deposits 293,383 290,791 ------------------------------------------------------------------------------------------------------------------------------------ Borrowings 63,735 40,741 Junior subordinated debentures 5,000 -- Accrued interest payable 1,455 1,450 Other liabilities 543 458 ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 364,116 333,440 ------------------------------------------------------------------------------------------------------------------------------------ Commitments and contingencies (note 15) 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; 1,785,595 and 1,691,575 issued and outstanding, respectively 1,786 1,692 Treasury stock, at cost (14,854 shares) (266) -- Surplus 21,292 19,676 Retained earnings 3,235 3,111 Accumulated other comprehensive loss (759) (1,249) ------------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 25,288 23,230 ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $389,404 $356,670 ------------------------------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements. Downingtown National Bank [LOGO] 19
DNB FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations
Year Ended December 31 2001 2000 1999 Interest Income: Interest and fees on loans $15,304 $15,057 $13,825 Interest and dividends on investment securities: Taxable 7,548 7,641 5,846 Exempt from Federal taxes 494 512 445 Tax-preferred 597 94 -- Interest on Federal funds sold 446 448 384 ------------------------------------------------------------------------------------------------------------------------------------ Total interest income 24,389 23,752 20,500 ------------------------------------------------------------------------------------------------------------------------------------ Interest Expense: Interest on NOW, money market and savings 3,641 4,239 3,357 Interest on time deposits 6,106 6,751 5,378 Interest on FHLB advances 3,078 1,690 1,014 Interest on other borrowings 284 110 76 ------------------------------------------------------------------------------------------------------------------------------------ Total interest expense 13,109 12,790 9,825 ------------------------------------------------------------------------------------------------------------------------------------ Net interest income 11,280 10,962 10,675 Provision for loan losses -- -- -- ------------------------------------------------------------------------------------------------------------------------------------ Net interest income after provision for loan losses 11,280 10,962 10,675 ------------------------------------------------------------------------------------------------------------------------------------ Non-interest Income: Service charges 1,036 755 627 DNB Advisors 404 448 399 Increase in cash surrender value of BOLI 194 58 -- Gains on sales of investment securities 85 15 -- Other 584 464 608 ------------------------------------------------------------------------------------------------------------------------------------ Total non-interest income 2,303 1,740 1,634 ------------------------------------------------------------------------------------------------------------------------------------ Non-interest Expense: Salaries and employee benefits 5,315 4,772 4,324 Furniture and equipment 1,069 1,029 927 Occupancy 709 622 519 Professional and consulting 715 533 492 Marketing 325 275 352 Printing and supplies 242 278 283 Other 1,519 1,422 1,334 ------------------------------------------------------------------------------------------------------------------------------------ Total non-interest expense 9,894 8,931 8,231 ------------------------------------------------------------------------------------------------------------------------------------ Income before income taxes 3,689 3,771 4,078 Income tax expense 967 1,063 1,246 ------------------------------------------------------------------------------------------------------------------------------------ Net Income $ 2,722 $ 2,708 $ 2,832 ------------------------------------------------------------------------------------------------------------------------------------ Earnings per share: Basic $1.53 $1.52 $1.60 Diluted 1.50 1.50 1.55 Cash dividends per share $0.50 $0.47 $0.45 Weighted average common shares outstanding: Basic 1,776,084 1,776,051 1,768,056 Diluted 1,813,220 1,800,614 1,824,275 ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. Downingtown National Bank [LOGO] 20 DNB FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Income
Accumulated Other Comprehensive Common Treasury Retained Comprehensive Income Stock Stock Surplus Earnings Income (Loss) Total ------------------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 1999 $1,524 $-- $17,105 $1,924 $ 53 $20,606 Comprehensive Income: Net income $2,832 -- -- -- 2,832 -- 2,832 Other comprehensive income, net of tax, relating to net unrealized losses on investments (2,108) -- -- -- -- (2,108) (2,108) Total comprehensive income 724 Cash dividends -- -- -- (795) -- (795) Issuance of stock dividends 76 -- 1,450 (1,526) -- -- Cash payment for fractional shares -- -- -- (6) -- (6) Exercise of stock options 9 -- -- -- -- 9 ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1999 1,609 -- 18,555 2,429 (2,055) 20,538 Comprehensive Income: Net income 2,708 -- -- -- 2,708 -- 2,708 Other comprehensive income, net of tax, relating to net unrealized gains on investments 806 -- -- -- -- 806 806 Total comprehensive income 3,514 Cash dividends -- -- -- (838) -- (838) Issuance of stock dividends 80 -- 1,103 (1,183) -- -- Cash payment for fractional shares -- -- -- (5) -- (5) Exercise of stock options 3 -- 18 -- -- 21 ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2000 1,692 -- 19,676 3,111 (1,249) 23,230 Comprehensive Income: Net income 2,722 -- -- -- 2,722 -- 2,722 Other comprehensive income, net of tax, relating to net unrealized gains on investments 490 -- -- -- -- 490 490 Total comprehensive income 3,212 Cash dividends -- -- -- (880) -- (880) Issuance of stock dividends 84 -- 1,627 (1,711) -- -- Purchase of treasury shares -- (266) -- -- -- (266) Cash payment for fractional shares -- -- -- (7) -- (7) Exercise of stock options 10 -- (11) -- -- (1) ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 $1,786 $(266) $21,292 $3,235 $ (759) $25,288 ------------------------------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements. Downingtown National Bank [LOGO] 21
DNB FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows
Year Ended December 31 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows From Operating Activities: Net income $ 2,722 $ 2,708 $ 2,832 Adjustments to reconcile net income to net cash (used) provided by operating activities: Depreciation, amortization and accretion 1,137 702 821 Gains on sale of OREO (31) -- (159) Net gain on sale of securities (85) (15) -- Increase (decrease) in interest receivable 350 (776) (134) Increase in other assets (1,798) (234) (685) Increase in investment in BOLI (3,345) (193) (1,665) Increase in interest payable 5 372 176 (Decrease) increase in current taxes payable (69) 13 (137) Decrease in deferred income tax expense 18 198 26 Increase (decrease) in other liabilities 153 (663) 706 ------------------------------------------------------------------------------------------------------------------------------------ Net Cash (Used) Provided By Operating Activities (943) 2,112 1,781 ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows From Investing Activities: Proceeds from maturities and paydowns - AFS securities 33,835 7,954 4,104 Proceeds from maturities and paydowns - HTM securities 17,284 9,161 15,145 Purchase of AFS securities (97,633) (42,273) (24,725) Purchase of HTM securities (8,160) (10,869) (8,578) Proceeds from sale of securities - AFS 14,767 12,466 -- Proceeds from sale of OREO 214 -- 683 Net decrease (increase) in loans 5,043 (20,012) (23,319) Purchase of bank property and equipment (2,565) (800) (1,854) ------------------------------------------------------------------------------------------------------------------------------------ Net Cash Used By Investing Activities (37,215) (44,373) (38,544) ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows From Financing Activities: Net increase in deposits 2,592 35,910 29,508 Increase in FHLB advances greater than ninety days 23,000 17,000 5,000 Proceeds from issuance of junior subordinated debentures 5,000 -- -- (Decrease) increase in lease obligations (5) (5) 746 Dividends paid (887) (838) (801) Proceeds from issuance of stock under stock option plan -- 16 9 Purchase of treasury stock (266) -- -- ------------------------------------------------------------------------------------------------------------------------------------ Net Cash Provided By Financing Activities 29,434 52,083 34,462 ------------------------------------------------------------------------------------------------------------------------------------ Net Change in Cash and Cash Equivalents (8,724) 9,822 (2,301) Cash and Cash Equivalents at Beginning of Period 27,352 17,530 19,831 ------------------------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of Period $18,628 $27,352 $17,530 ------------------------------------------------------------------------------------------------------------------------------------ Supplemental Disclosure Of Cash Flow Information: Cash paid during the period for: Interest $13,104 $12,418 $ 9,649 Income taxes 750 825 1,357 Supplemental Disclosure Of Non-cash Flow Information: Net transfer of loans to OREO $-- $ 99 $ 469 Change in unrealized gains (losses) on securities - AFS 686 1,184 (3,098) Change in deferred taxes due to change in unrealized gains or losses on securities - AFS (196) (378) 990 ------------------------------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements.
Downingtown National Bank [LOGO] 22 Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DNB Financial Corporation (the "Corporation" or "DNB") through its wholly owned subsidiary, Downingtown National Bank (the "Bank"), has been serving individuals and small to medium sized businesses of Chester County, Pennsylvania since 1861. DNB Capital Trust I (the "Trust") is a special purpose Delaware business trust (see additional discussion in Junior Subordinated Debentures-Footnote 9). The Bank is a locally managed commercial bank providing personal and commercial loans and deposit products, in addition to investment and trust services from nine community offices. The Bank encounters vigorous competition for market share from commercial banks, thrift institutions, credit unions and other financial intermediaries. The consolidated financial statements of DNB and its subsidiary, the Bank, which together are managed as a single operating segment, are prepared in accordance with generally accepted accounting principles applicable to the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and affect revenues and expenses for the period. Actual results could differ significantly from those estimates. The material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. In connection with the determination of the allowance for losses on loans, independent appraisals for significant properties are obtained when practical. The more significant accounting policies are summarized below. Prior period amounts not affecting net income are reclassified when necessary to conform with current year classifications. Principles of Consolidation -- The accompanying consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiary, the Bank. All significant intercompany transactions have been eliminated. Cash and Due From Banks -- DNB is required to maintain certain daily reserve balances in accordance with Federal Reserve Board requirements. The average reserve balance maintained in accordance with such requirements for the years ended December 31, 2001 and 2000 was approximately $868,000 and $1.6 million, respectively. Investment Securities -- Investment securities are classified and accounted for as follows: Held-To-Maturity ("HTM") -- includes debt and non-readily marketable equity securities that DNB has the positive intent and ability to hold to maturity. Debt securities are reported at cost, adjusted for amortization of premiums and accretion of discounts. Non-readily marketable equity securities are carried at cost, which approximates liquidation value. Trading Account ("TA") -- includes securities which are generally held for a short term in anticipation of market gains. Such securities would be carried at fair value with realized and unrealized gains and losses on trading account securities included in the statement of operations. DNB did not have any securities classified as TA during 2001, 2000, or 1999. Available-For-Sale ("AFS") -- includes debt and equity securities not classified as HTM or TA securities. Securities classified as AFS are securities that DNB intends to hold for an indefinite period of time, but not necessarily to maturity. Such securities are reported at fair value, with unrealized holding gains and losses excluded from earnings and reported, net of tax (if applicable), as a separate component of stockholders' equity. Realized gains and losses on the sale of AFS securities are computed on the basis of specific identification of the adjusted cost of each security. Amortization of premiums and accretion of discounts for all types of securities are computed using a method approximating a level-yield basis. Loans -- Loans are stated net of unearned discounts, unamortized net loan origination fees and the allowance for loan losses. Interest income is recognized on the accrual basis. The accrual of interest on loans is generally discontinued when loans become 90 days past due or Downingtown National Bank [LOGO] 23 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- earlier when, in management's judgment, it is determined that a reasonable doubt exists as to its collectibility. When a loan is placed on nonaccrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Additional interest payments on such loans are applied to principal or recognized in 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. Deferred Loan Fees -- Loan origination and commitment fees and related direct-loan origination costs of completed loans are deferred and accreted to income as a yield adjustment over the life of the loan using the level-yield method. The accretion to income is discontinued when a loan is placed on nonaccrual status. When a loan is paid off, any unamortized net deferred-fee balance is credited to income. When a loan is sold, any unamortized net deferred-fee balance is considered in the calculation of gain or loss. Allowance for Loan Losses -- The allowance for loan losses ("allowance") is based on a periodic evaluation of the portfolio and is maintained at a level that represents management's best estimate of known and inherent losses in the portfolio. Management considers a variety of factors when establishing the allowance, recognizing that an inherent risk of loss always exists in the lending process. Consideration is given to the impact of current economic conditions, diversification of the loan portfolio, historical loss experience, delinquency statistics, results of detailed loan reviews, borrowers' financial and managerial strengths, the adequacy of underlying collateral, and other relevant factors. While management utilizes the latest available information to determine the likelihood for losses on loans, future additions to the allowance may be necessary based on changes in economic conditions as well as adverse changes in the financial condition of borrowers. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance. Such agencies may require DNB to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. The allowance is increased by the provision for loan losses, which is charged to operations. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. For purposes of applying the measurement criteria for impaired loans, DNB excludes large groups of smaller-balance homogeneous loans, primarily consisting of residential real estate loans and consumer loans, as well as commercial loans with balances less than $100,000. For applicable loans, management evaluates the need for impairment recognition when a loan becomes nonaccrual, or earlier, if based on an assessment of the relevant facts and circumstances, it is probable that DNB will be unable to collect all proceeds due according to the contractual terms of the loan agreement. DNB's policy for the recognition of interest income on impaired loans is the same as for nonaccrual loans. Impairment is charged to the allowance when management determines that foreclosure is probable or the fair value of the collateral is less than the recorded investment of the impaired loan. Other Real Estate Owned -- Other real estate owned ("OREO") consists of properties acquired as a result of, or in-lieu-of, foreclosure. Properties classified as OREO are reported at the lower of carrying value or fair value, less estimated costs to sell. Costs relating to the development or improvement of the properties are capitalized and costs relating to holding the properties are charged to expense. Office Properties and Equipment -- Office properties and equipment are recorded at cost. Depreciation is computed using the straight-line method over the expected useful lives of the assets. The costs of maintenance and repairs are expensed as they are incurred; renewals and betterments are capitalized. All long-lived assets are reviewed for impairment, based on the fair value of the asset. In addition, long-lived assets to be disposed of are generally reported at the lower of carrying amount or fair value, less costs Downingtown National Bank [LOGO] 24 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- to sell. Gains or losses on disposition of premises and equipment are reflected in operations. Other Assets -- Financing costs related to the issuance of DNB's junior subordinated debentures are being amortized over the life of the debentures and are included in other assets. Federal Income Taxes -- DNB accounts for income taxes in accordance with the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Corporation files a consolidated Federal income tax return with the Bank. Pension Plan -- The Bank maintains a noncontributory defined benefit pension plan covering substantially all employees over the age of 21 with one year of service. Plan benefits are based on years of service and the employee's monthly average compensation for the highest five consecutive years of their last ten years of service. Stock Option Plan -- SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), permits entities to recognize as expense over the vesting period, the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and subsequent years as if the fair-value-based method defined in SFAS No. 123 had been applied. DNB has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Earnings Per Share -- Basic earnings per share is computed based on the weighted average number of common shares outstanding during the year. Diluted earnings per share reflects the potential dilution that could occur from the conversion of common stock equivalents and is computed using the treasury stock method. Earnings per share, dividends per share and weighted average shares outstanding have been adjusted to reflect the effects of the 5% stock dividends paid in December 2001, 2000 and 1999 and the September 1997 two-for-one stock split, effected in the form of a 100% dividend. Trust Assets -- Assets held by DNB Advisors in fiduciary or agency capacities are not included in the consolidated financial statements since such items are not assets of DNB. Operating income and expenses of DNB Advisors are included in the consolidated statements of operations and are recorded on an accrual basis. Statements of Cash Flows -- For purposes of the statements of cash flows, DNB considers cash in banks, amounts due from banks, and Federal funds sold to be cash equivalents. Generally, Federal funds are sold for one-day periods. Recent Accounting Pronouncements -- In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"), which was subsequently amended. This statement standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and those used for hedging activities, by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. SFAS No. 133 generally provides for matching of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, so long as the hedge is effective. SFAS No. 133 was adopted on January 1, 2001 and there was no impact on operations, financial condition, equity or compre- Downingtown National Bank [LOGO] 25 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- hensive income. DNB currently has no derivatives covered by this statement and currently conducts no hedging activities. In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS No. 140"). This statement supercedes and replaces the guidance in Statement 125. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, although it carries over most of Statement 125's provisions without reconsideration. The Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral for fiscal years ending after December 15, 2000. This statement is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. SFAS No. 140 was adopted by DNB during the fiscal year ended December 31, 2001. There was no impact of this statement on DNB's financial condition, equity, results of operations or disclosures. In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS No. 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All Business combinations in the scope of the Statement are to be accounted for using the purchase method. The provisions of the Statement apply to all Business combinations initiated after June 30, 2001. The Statement also applies to business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. SFAS No. 141 was adopted by DNB on July 1, 2001. There was no impact of this statement on DNB's financial condition, equity, results of operations or disclosures. In June 2001, the FASB issued SFAS No. 142, Goodwill and other Intangible Assets ("SFAS No. 142"). This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. The Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of the statement are required to be applied starting with fiscal years beginning after December 15, 2001, except that goodwill and intangible assets acquired after June 30, 2001, will be subject immediately to the non-amortization and amortization provisions of the Statement. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. The Statement is required to be applied at the beginning of an entity's fiscal year and to be applied to all goodwill and other intangible assets recognized in its financial statements at that date. DNB expects any impact from the adoption of this statement to be immaterial to its financial condition, equity, results of operations and disclosures. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligation. ("SFAS No. 143"). This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. As used in this Statement, a legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. Downingtown National Bank [LOGO] 26 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement amends FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies, and it applies to all entities. It is effective for financial statements issued for fiscal years beginning after June 15, 2002. Earlier application is encouraged. DNB expects that there will be no impact of this statement on its financial condition, equity, results of operations or disclosures when adopted. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"). This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. However, the Statement retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. This Statement supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, this Statement retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in distribution to owners) or is classified as held for sale. This Statement also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a temporarily controlled subsidiary. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with earlier application encouraged. The provisions of this Statement generally are to be applied prospectively. DNB expects that there will be no impact of this statement on its financial condition, equity, results of operations or disclosures when adopted. Downingtown National Bank [LOGO] 27 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- (2) INVESTMENT SECURITIES Amortized cost and estimated fair values of investment securities, as of the dates indicated, are summarized as follows:
December 31, 2001 Amortized Unrealized Unrealized Estimated Held to Maturity Cost Gains Losses Fair Value ------------------------------------------------------------------------------------------------------------------------------------ US Government agency obligations $ 9,152 $291 $ (3) $ 9,440 Collateralized mortgage obligations 10,905 168 -- 11,073 US agency mortgage-backed securities 3,768 53 (3) 3,818 Equity securities 4,265 -- -- 4,265 Other securities 4,999 23 -- 5,022 ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities $ 33,089 $535 $ (6) $ 33,618 ------------------------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------------------------------ Amortized Unrealized Unrealized Estimated Available for Sale Cost Gains Losses Fair Value ------------------------------------------------------------------------------------------------------------------------------------ US Treasury $ 4,624 $-- $ (1) $ 4,623 US Government agency obligations 13,709 178 (30) 13,857 US agency mortgage-backed securities 47,473 219 (10) 47,682 Corporate bonds 34,161 222 (1,118) 33,265 Collateralized mortgage obligations 13,339 68 (67) 13,340 State and municipal tax-exempt 10,680 30 (616) 10,094 DRD agency preferred stock 12,513 58 (86) 12,485 Other securities 273 -- -- 273 ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities $136,772 $775 $(1,928) $135,619 ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2000 Amortized Unrealized Unrealized Estimated Held to Maturity Cost Gains Losses Fair Value ------------------------------------------------------------------------------------------------------------------------------------ US Government agency obligations $ 19,805 $182 $ (21) $ 19,966 Collateralized mortgage obligations 16,047 19 (118) 15,948 US agency mortgage-backed securities 2,161 3 (26) 2,138 Equity securities 3,316 -- -- 3,316 Other securities 999 -- (9) 990 ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities $ 42,328 $204 $ (174) $ 42,358 ------------------------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------------------------------ Amortized Unrealized Unrealized Estimated Available for Sale Cost Gains Losses Fair Value ------------------------------------------------------------------------------------------------------------------------------------ US Treasury $ 1,000 $-- $ (1) $ 999 US Government agency obligations 26,501 104 (41) 26,564 US agency mortgage-backed securities 5,417 36 (19) 5,434 Corporate bonds 31,893 129 (1,577) 30,445 State and municipal tax-exempt 10,146 -- (422) 9,724 DRD agency preferred stock 6,014 8 (2) 6,020 Other securities 6,956 1 (55) 6,902 ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities $ 87,927 $278 $(2,117) $ 86,088 ------------------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 28 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- The amortized cost and estimated fair value of investment securities as of December 31, 2001, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid without penalties.
Investment Securities Investment Securities Held to Maturity Available for Sale Amortized Estimated Amortized Estimated (Dollars in thousands) Cost Fair Value Cost Fair Value ------------------------------------------------------------------------------------------------------------------------------------ Due in one year or less $ 4,000 $ 4,000 $ 5,868 $ 5,872 Due after one year through five years 131 135 18,816 19,029 Due after five years through ten years 5,015 5,199 5,022 5,025 Due after ten years 19,678 20,019 94,553 93,208 No stated maturity 4,265 4,265 12,513 12,485 Total investment securities $33,089 $33,618 $136,772 $135,619
DNB sold $14.8 million and $12.5 million of securities from the AFS portfolio during 2001 and 2000. No securities were sold during 1999. Gains and losses from sales of investment securities were as follows: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------ Gross realized gains $129 $ 56 $-- Gross realized losses 44 41 -- ------------------------------------------------------------ Net realized gain $ 85 $ 15 $-- ------------------------------------------------------------ At December 31, 2001 and 2000, investment securities with a carrying value of approximately $29.1 million and $39.3 million, respectively, were pledged to secure public funds and for other purposes as required by law. (3) LOANS December 31 (Dollars in thousands) 2001 2000 ------------------------------------------------------------ Residential mortgage $ 39,298 $ 43,227 Commercial mortgage 70,282 67,302 Commercial 42,081 41,000 Consumer 34,389 39,672 ------------------------------------------------------------ Total loans 186,050 191,201 ------------------------------------------------------------ Less allowance for loan losses (4,809) (4,917) ------------------------------------------------------------ Net loans $181,241 $186,284 ------------------------------------------------------------ Included in the loan portfolio are loans for which DNB has ceased the accrual of interest. Loans of approximately $3.1 million, $1.2 million and $1.3 million were on a nonaccrual basis as of December 31, 2001, 2000 and 1999, respectively. DNB also had loans of approximately $155,000, $609,000 and $694,000 that were more than 90 days delinquent, but still accruing as of December 31, 2001, 2000 and 1999, respectively. If contractual interest income had been recorded on nonaccrual loans, interest would have been increased as shown in the following table: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------ Interest income which would have been recorded under original terms $220 $ 98 $105 Interest income recorded during the year (111) (21) (21) ------------------------------------------------------------ Net impact on interest income $109 $ 77 $ 84 ------------------------------------------------------------ DNB had $4.0 million of loans which, although performing at December 31, 2001, are believed to require increased supervision and review, and may, depending on the economic environment and other factors, become non-performing assets in future periods. There was $8.0 million of such loans at December 31, 2000. The majority of these loans are secured by commercial real estate with lesser amounts being secured by residential real estate, inventory and receivables. Although DNB has a significant concentration of residential and commercial mortgage loans Downingtown National Bank [LOGO] 29 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- collateralized by first mortgage liens located in Chester County, DNB has no concentration of loans to borrowers engaged in similar activities which exceed 10% of total loans at December 31, 2001, except for loans of approximately $44.1 million relating to local multi-unit office buildings. (4) ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses, for the years indicated, are as follows: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------ Beginning balance $4,917 $5,085 $5,205 Provisions -- -- -- Loans charged off (284) (224) (216) Recoveries 176 56 96 ------------------------------------------------------------ Net charge-offs (108) (168) (120) ------------------------------------------------------------ Ending balance $4,809 $4,917 $5,085 ------------------------------------------------------------ At December 31, 2001, 2000 and 1999, DNB had impaired loans with total recorded investments of $1.2 million, $651,000 and $715,000 and average recorded investments of $1.1 million, $693,000 and $1.0 million for the years ended December 31, 2001, 2000, and 1999. Total cash collected on impaired loans was credited to the outstanding principal balance in the amounts of $3,000, $25,000 and $113,000 during the same respective periods. No interest income was recorded on such loans during the three years ended December 31, 2001. (5) OFFICE PROPERTY AND EQUIPMENT December 31 Estimated (Dollars in thousands) Useful Lives 2001 2000 --------------------------------------------------------------- Land $ 935 $ 935 Buildings 25-33 years 6,568 4,905 Furniture, fixtures and equipment 5-20 years 7,580 6,800 --------------------------------------------------------------- Total cost 15,083 12,640 Less accumulated depreciation (7,382) (6,751) --------------------------------------------------------------- Office property and equipment, net $ 7,701 $ 5,889 --------------------------------------------------------------- Amounts charged to operating expense for depreciation for the years ended December 31, 2001, 2000 and 1999 amounted to $753,000, $687,000 and $637,000, respectively. (6) DEPOSITS Included in interest-bearing time deposits are certificates of deposit issued in amounts of $100,000 or more. These certificates and their remaining maturities were as follows: December 31 (Dollars in thousands) 2001 2000 ------------------------------------------------------------ Three months or less $13,338 $10,118 Over three through six months 9,619 8,934 Over six through twelve months 3,517 6,419 Over one year through two years 3,019 4,184 Over two years 1,163 106 ------------------------------------------------------------ Total $30,656 $29,761 ------------------------------------------------------------ (7) FHLB ADVANCES AND SHORT TERM BORROWED FUNDS DNB's short-term borrowed funds consist of Federal funds purchased which generally represent one-day borrowings. DNB had an average of $186,000 and $171,000 outstanding in short-term borrowed funds during 2001 and 2000, respectively. In addition to Federal funds purchased, DNB maintains borrowing arrangements with a correspondent bank and the Federal Home Loan Bank (FHLB) of Pittsburgh. As of September 30, 2001, DNB has a maximum borrowing capacity at the FHLB of approximately $158 million. Advances totaled $63 million at December 31, 2001 ($50 million-Convertible term advances and $13 million-Fixed rate advances). These advances mature at various dates through the year ended December 31, 2011, as shown in the table below. Convertible term advances are callable, at the FHLB's option, at various dates starting on January 25, 2002 and ending on January 25, 2006. If an advance is called by the FHLB, DNB has the option of repaying the borrowing, or it may continue to borrow at three month Libor plus 10-14 basis points. FHLB advances are collateralized by a pledge of the Bank's entire portfolio of unen- Downingtown National Bank [LOGO] 30 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- cumbered investment securities, certain mortgage loans and a lien on the Bank's FHLB stock. (Dollars in thousands) December 31, 2001 ------------------------------------------------------------ Due by Weighted December 31st Average Rate Amount ------------------------------------------------------------ 2006 4.99% $16,000 Thereafter 5.82 47,000 ------------------------------------------------------------ Total 5.61% $63,000 ------------------------------------------------------------ (8) CAPITAL LEASE OBLIGATIONS Included in other borrowings is a long-term capital lease agreement, which relates to DNB's West Goshen branch. As of December 31, 2001 the branch has a carrying amount of $662,000, net of accumulated depreciation of $88,000, and is included in the balance of office properties and equipment in the accompanying statements of financial condition. The following is a schedule of the future minimum lease payments, together with the present value of the net minimum lease payments, as of December 31, 2001: (Dollars in thousands) Year ending December 31 Amount ------------------------------------------------------------ 2002 $ 81 2003 84 2004 86 2005 89 2006 92 Thereafter 1,767 ------------------------------------------------------------ Total minimum lease payments 2,199 ------------------------------------------------------------ Less amount representing interest (1,464) ------------------------------------------------------------ Present value of net minimum lease payments $ 735 ------------------------------------------------------------ (9) JUNIOR SUBORDINATED DEBENTURES In July 2001, DNB issued $5.0 million of floating rate (6 month Libor plus 3.75%) junior subordinated debentures (the "debentures") to DNB Capital Trust I (the "Trust"), a Delaware business trust, in which DNB owns all of the common equity. The debentures are the sole asset of the Trust. The Trust issued $5.0 million preferred securities to investors. DNB's obligations under the debentures 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 debentures on July 25, 2031. (10) FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value assumptions, methods, and estimates are set forth below for DNB's financial instruments. Limitations Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time DNB's entire holdings of a particular financial instrument. Because no market exists for a significant portion of DNB's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. The following methods and assumptions were used to estimate the fair value of each class of financial instruments. Cash, Federal Funds Sold and Investment Securities The carrying amounts for short-term investments (cash and Federal funds sold) approximate fair value. The fair value of investment securities is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The carrying amount of non-readily marketable equity securities approximates liquidation value. Downingtown National Bank [LOGO] 31 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial mortgages, residential mortgages, consumer and student loans, and nonaccrual loans. The fair value of performing loans is calculated by discounting expected cash flows using an estimated market discount rate. Expected cash flows include both contractual cash flows and prepayments of loan balances. Prepayments on consumer loans were determined using the median of estimates of securities dealers for mortgage-backed investment pools. The estimated discount rate considers credit and interest rate risk inherent in the loan portfolios and other factors such as liquidity premiums and incremental servicing costs to an investor. Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented below would be indicative of the value negotiated in an actual sale. The fair value for nonaccrual loans was derived through a discounted cash flow analysis, which includes the opportunity costs of carrying a non-performing asset. An estimated discount rate was used for all nonaccrual loans, based on the probability of loss and the expected time to recovery. Deposits and Borrowings The fair value of deposits with no stated maturity, such as non-interest-bearing deposits, savings, NOW and money market accounts, is equal to the amount payable on demand as of December 31, 2001 and 2000. The fair values of certificates of deposit and borrowings are based on the present value of contractual cash flows. The discount rates used to compute present values are estimated using the rates currently offered for deposits of similar maturities in DNB's marketplace and rates currently being offered for borrowings of similar maturities. Off-balance-sheet Instruments Off-balance-sheet instruments are primarily comprised of loan commitments which are generally priced at market at the time of funding. Fees on commitments to extend credit and standby letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments. At December 31, 2001 and 2000, loan commitments were $37.6 million and $28.6 million, respectively. Stand-by letters of credit were $5.5 million and $5.8 million at December 31, 2001 and 2000, respectively. The following table summarizes information for all on-balance-sheet financial instruments.
December 31 2001 2000 ------------------------------------------------------------------------------------------ Estimated Estimated Carrying Fair Carrying Fair (Dollars in thousands) Amount Value Amount Value ------------------------------------------------------------------------------------------ Financial assets Cash and Federal funds sold $ 18,628 $ 18,628 $ 27,352 $ 27,352 Investment securities, AFS 135,619 135,619 86,088 86,088 Investment securities, HTM 33,089 33,618 42,328 42,358 Net loans 181,241 182,893 186,284 184,875 Accrued interest receivable 2,230 2,230 2,580 2,580 Financial liabilities Deposits 293,383 295,274 290,791 291,365 Borrowings 63,735 70,432 40,741 42,729 Junior subordinated debentures 5,000 5,009 -- -- Accrued interest payable 1,455 1,455 1,450 1,450 ------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 32 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- (11) FEDERAL INCOME TAXES Income tax expense was comprised of the following: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------ Current tax expense: Federal $ 944 $ 865 $1,220 State 5 -- -- Deferred income tax expense 18 198 26 ------------------------------------------------------------ Income tax expense $ 967 $1,063 $1,246 ------------------------------------------------------------ The effective income tax rates of 26% for 2001, 28% for 2000, and 31% for 1999 were less than the applicable statutory Federal income tax rate. The reason for these differences follows: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------ Federal income taxes at statutory rate $1,254 $1,282 $1,386 State income taxes, net 4 -- -- Decrease resulting from: Low income housing credits (23) (24) -- Tax-exempt interest and dividend preference (299) (160) (147) Bank owned life insurance (66) (20) -- Other, net 97 (15) 7 ------------------------------------------------------------ Income tax expense $ 967 $1,063 $1,246 ------------------------------------------------------------ The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below. Based upon DNB's current and historical tax history and the anticipated level of future taxable income, management believes the existing net deferred tax asset will, more likely than not, be realized based on future taxable income. December 31 (Dollars in thousands) 2001 2000 ------------------------------------------------------------ Deferred tax assets: Allowance for loan losses $1,635 $1,672 Valuation adjustment for debt securities 394 590 Other 152 99 ------------------------------------------------------------ Total gross deferred tax assets2,181 2,361 Deferred tax liabilities: Depreciation (240) (210) Pension expense (421) (412) Tax bad debt reserve (143) (142) Other (164) (170) ------------------------------------------------------------ Total gross deferred tax liabilities (968) (934) ------------------------------------------------------------ Net deferred tax asset $1,213 $1,427 ------------------------------------------------------------ (12) EARNINGS PER SHARE The following is a reconcilement of net income and the weighted average number of shares outstanding for basic and diluted EPS:
Year Ended December 31 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------------------ Income Shares Amount Income Shares Amount Income Shares Amount ------------------------------------------------------------------------------------------------------------------------------------ Basic EPS Income available to common stockholders $2,722 1,776 $ 1.53 $2,708 1,776 $ 1.52 $2,832 1,768 $ 1.60 Effect of dilutive common stock equivalents - stock options -- 37 (0.03) -- 25 (0.02) -- 56 (0.05) ------------------------------------------------------------------------------------------------------------------------------------ Diluted EPS Income available to common stockholders after assumed conversions $2,722 1,813 $ 1.50 $2,708 1,801 $ 1.50 $2,832 1,824 $ 1.55 ------------------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 33 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- (12) EARNINGS PER SHARE Options to purchase 29,957 shares of common stock at $15.87 per share have been outstanding since June 30, 1997. These share were included in the computation of diluted EPS during 2001, but were not included in the computation of diluted EPS for 2000 because these options were anti-dilutive during such period. The options, which expire on June 30, 2007, were still outstanding at December 31, 2001. Options to purchase 33,895 shares of common stock in 2001, 2000 and 1999 at $29.00 per share have been outstanding since June 30, 1998, but were not included in the computation of diluted EPS for 2001 and 2000 because these options were anti-dilutive during such periods. The options, which expire on June 30, 2008, were still outstanding at December 31, 2001. Also, options to purchase 28,418 shares of common stock in 2001, 2000 and 1999 at $23.32 per share have been outstanding since June 30, 1999, but were not included in the computation of diluted EPS for 2001 and 2000 because these options were anti-dilutive during such periods. These options, which expire on June 30, 2009, were still outstanding at December 31, 2001. (13) OTHER COMPREHENSIVE INCOME The tax effects allocated to each component of "Other Comprehensive Income" are as follows: Tax Before-Tax (Expense) Net-of-Tax (Dollars in thousands) Amount Benefit Amount --------------------------------------------------------------------------- Year Ended December 31, 2001: Unrealized gains on securities: Unrealized holding gains arising during the period $ 771 $ (225) $ 546 Less reclassification for gains included in net income (85) 29 (56) --------------------------------------------------------------------------- Other Comprehensive Income $ 686 $ (196) $ 490 --------------------------------------------------------------------------- Year Ended December 31, 2000: Unrealized gains on securities: Unrealized holding gains arising during the period $ 1,199 $ (383) $ 816 Less reclassification for gains included in net income (15) 5 (10) --------------------------------------------------------------------------- Other Comprehensive Income $ 1,184 $ (378) $ 806 --------------------------------------------------------------------------- Year Ended December 31, 1999: Unrealized losses on securities: Unrealized holding losses arising during the period $(3,098) $ 990 $(2,108) Less reclassification for gains included in net income -- -- -- --------------------------------------------------------------------------- Other Comprehensive Income $(3,098) $ 990 $(2,108) --------------------------------------------------------------------------- (14) BENEFIT PLANS Pension Plan The Bank maintains a qualified pension plan (the "Plan") covering all employees, including officers, who have been employed for one year and have attained 21 years of age. Prior to May 1, 1985, an individual must have attained the age of 25 and accrued one year of service. The Plan provides pension benefits to eligible retired employees at 65 years of age equal to 1.5% of their average monthly pay multiplied by their years of accredited service (maximum 40 years). The accrued benefit is based on the monthly average of their highest five consecutive years of their last ten years of service. Downingtown National Bank [LOGO] 34 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- The following table sets forth the Plan's funded status, as of the measurement dates of December 31, 2001 and 2000 and amounts recognized in DNB's consolidated financial statements at December 31, 2001 and 2000: December 31 (Dollars in thousands) 2001 2000 -------------------------------------------------------------------------- Actuarial present value of benefit obligation: Vested benefit obligation $(3,678) $(3,955) -------------------------------------------------------------------------- Accumulated benefit obligation (3,749) (4,037) -------------------------------------------------------------------------- Plan assets at fair value 5,785 6,243 Projected benefit obligation (5,179) (4,427) -------------------------------------------------------------------------- Plan assets over projected benefit obligation 606 1,816 Unrecognized net asset at January 1, 1987 being amortized over 17 years (57) (75) Unrecognized net loss (gain) 690 (523) -------------------------------------------------------------------------- Prepaid pension cost included in other assets $ 1,239 $ 1,218 -------------------------------------------------------------------------- Net periodic pension benefits for the years indicated include the following components: Year Ended December 31 (Dollars in thousands) 2001 2000 1999 -------------------------------------------------------------------------- Service cost-benefits earned during the period $ 216 $ 199 $ 183 Interest cost on projected benefit obligation 304 302 297 Actual return on plan assets 290 (563) (230) Asset (loss) gain (813) 74 (247) Amortization of unrecognized net asset at transition (19) (19) (19) -------------------------------------------------------------------------- Net pension benefit $ (22) $ (7) $ (16) -------------------------------------------------------------------------- Assumptions used: Discount rate 7.00% 7.00% 7.00% Rate of increase in compensation level 5.00 5.00 5.00 Expected long-term rate of return on assets 8.50 8.50 8.50 -------------------------------------------------------------------------- The Pension Plan's assets are invested using an asset allocation strategy in units of certain equity, bond, real estate and money market funds. DNB adopted an arrangement for supplemental compensation (the "Supplemental Plan") for its Chief Executive Officer (the "Executive") during 1999. The Supplemental Plan provides that the Bank and the Executive share in the rights to the cash surrender value and death benefits of a split-dollar life insurance policy (the "Split-dollar Policy") and provides for additional compensation to the Executive, equal to any income tax consequences related to the Supplemental Plan until retirement. The Split-dollar Policy is designed to provide the Executive, upon attaining age 65, with projected annual after-tax distributions of approximately $35,000, funded by loans against the cash surrender value of the Split-dollar Policy. In addition, the Split-dollar Policy is intended to provide the Executive with a projected death benefit of $750,000. Neither the insurance company nor DNB has guaranteed any minimum cash value under the Supplemental Plan. To fund the annual premium on the Split-dollar Policy and mitigate the obligations under this Plan, the Bank has purchased an additional life insurance policy on the Executive's life (the "BOLI Policy") with an initial deposit of $1.5 million ($1.7 million market value at December 31, 2001). The amount of the BOLI Policy has been calculated so that the projected increases in its cash surrender value will substantially offset the Bank's expense related to the Split-dollar Policy. 401(k) Retirement Savings Plan The Bank's retirement savings plan enables employees to become eligible to participate after six months of service, and will thereafter participate in the 401(k) plan for any year in which they have been employed for at least 501 hours. In general, amounts held in a participant's account are not distributable until the participant terminates employment, reaches age 59 1/2, dies or becomes permanently disabled. Downingtown National Bank [LOGO] 35 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- Participants are permitted to authorize pre-tax savings contributions to a separate trust established under the 401(k) plan, subject to limitations on deductibility of contributions imposed by the Internal Revenue Code. The Bank makes matching contributions of $.25 for every dollar of deferred salary up to 6% of each participant's annual compensation. Each participant is 100% vested at all times in employee and employer contributions. The matching contributions to the 401(k) plan were $47,000, $41,000 and $35,000 in 2001, 2000 and 1999, respectively. Stock Option Plan DNB has a Stock Option Plan for employees and directors. Under the plan, options (both qualified and non-qualified) to purchase a maximum of 298,686 shares of DNB's common stock could be issued to employees and directors. On February 24, 1999, the Board of Directors of the Corporation amended and restated DNB Financial Corporation's 1995 Stock Option Plan (the "Plan"), to increase by 100,000 the number of shares for which options may be issued under the Plan. This amendment was approved by shareholders at the April 27, 1999 Annual Meeting. Under the plan, option exercise prices must equal the fair market value of the shares on the date of option grant and the option exercise period may not exceed ten years. Vesting of options under the plan is determined by the Plan Committee. There were 65,124 and 91,121 shares available for grant at December 31, 2001 and 2000, respectively. At December 31, 2001 and 2000, the number of options exercisable was 197,802 and 176,103, respectively, and the weighted average exercise price of those options was $17.21 and $17.54, respectively. The per share weighted-average fair value of stock options granted during 2001, 2000 and 1999 was $2.86, $3.03 and $7.57 on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: for 2001-expected dividend yield of 3.11%, risk-free interest rate of 5.00%, expected life of 9.5 years and an expected volatility of stock over the expected life of the options was 15%; for 2000-expected dividend yield of 3.48%, risk-free interest rate of 5.02%, expected life of 9.5 years and an expected volatility of stock over the expected life of the options of 24%; for 1999-expected dividend yield of 1.88%, risk-free interest rate of 6.44%, expected life of 9.5 years and an expected volatility of stock over the expected life of the options of 16%. 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: Year Ended December 31 2001 2000 1999 ------------------------------------------------------------ Net income As reported $2,722 $2,708 $2,832 Pro forma 2,625 2,615 2,617 Diluted net income per share As reported $1.50 $1.50 $1.55 Pro forma 1.45 1.45 1.43 ------------------------------------------------------------ Stock option activity is indicated below. Shares have been adjusted for the 2 for 1 stock split in September 1997 and the 5% stock dividends in December of 2001, 2000 and 1999. Number Weighted Average Outstanding Exercise Price ------------------------------------------------------------ Outstanding January 1, 1999 151,259 $17.66 Granted 30,948 23.32 Exercised (15,581) 8.09 Terminated (1,824) 29.00 ------------------------------------------------------------ Outstanding December 31, 1999 164,802 18.86 Granted 31,222 12.36 Exercised (2,069) 8.09 Terminated (9,049) 23.15 ------------------------------------------------------------ Outstanding December 31, 2000 184,906 17.68 Granted 34,026 14.95 Exercised (21,130) 9.33 ------------------------------------------------------------ Outstanding December 31, 2001 197,802 $17.21 ------------------------------------------------------------ Downingtown National Bank [LOGO] 36 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- The weighted average price and weighted average remaining contractual life for the outstanding options are listed below for the dates indicated. All outstanding options are exercisable. December 31, 2001 ------------------------------------------------------------ Range of Number Weighted Average Exercise Prices Outstanding Remaining Contractual Life ------------------------------------------------------------ $8.09-$10.91 41,583 4.0 years 15.88 29,957 5.5 years 29.00 33,895 6.5 years 23.32 28,418 7.5 years 12.36-14.95 63,949 9.0 years --------- ---------- 197,802 7.0 years ------------------------------------------------------------ December 31, 2000 ------------------------------------------------------------ Range of Number Weighted Average Exercise Prices Outstanding Remaining Contractual Life ------------------------------------------------------------ $8.09-$10.91 61,414 5.0 years 15.88 29,957 6.5 years 29.00 33,895 7.5 years 23.32 28,418 8.5 years 12.36-14.95 31,222 9.5 years --------- ---------- 184,906 7.0 years ------------------------------------------------------------ (15) COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE-SHEET RISK In the normal course of business, various commitments and contingent liabilities are outstanding, such as guarantees and commitments to extend credit, borrow money or act in a fiduciary capacity, which are not reflected in the consolidated financial statements. Management does not anticipate any significant losses as a result of these commitments. DNB had outstanding standby letters of credit in the amount of approximately $5.5 million and unfunded loan and lines of credit commitments in the amount of approximately $37.6 million at December 31, 2001. Of the $37.6 million, $31.8 million was for variable rate loans and $5.8 million was for fixed rate loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet. The exposure to credit loss in the event of non-performance by the party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount. Management uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Standby letters of credit are conditional commitments issued by DNB to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risks involved in issuing letters of credit are essentially the same as those involved in extending loan facilities to customers. DNB holds various collateral to support these commitments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. DNB evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral, if any, obtained upon the extension of credit, usually consists of real estate, but may include securities, property or other assets. DNB maintains borrowing arrangements with a correspondent bank and the FHLB of Pittsburgh, as well as access to the discount window at the Federal Reserve Bank of Philadelphia to meet short-term liquidity needs. Through these relationships, DNB has available short-term credit of approximately $102.7 million. Approximately $101.7 million of assets are held by DNB Advisors in a fiduciary or agency capacity. These assets are not assets of DNB, and are not included in the consolidated financial statements. DNB is a party to a number of lawsuits arising in the ordinary course of business. While any litigation causes an element of uncertainty, management is of the opinion that the liability, if any, resulting from the actions, will not have a material effect on the accompanying financial statements. Downingtown National Bank [LOGO] 37 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- (16) PARENT COMPANY FINANCIAL INFORMATION Condensed financial information of DNB Financial Corporation (parent company only) follows: Condensed Statements of Financial Condition December 31 (Dollars in thousands) 2001 2000 ---------------------------------------------------------- Assets US Treasury securities $ 4,625 $ -- Investment in subsidiary 25,888 23,230 Other assets 180 -- ---------------------------------------------------------- Total assets $30,693 $23,230 ---------------------------------------------------------- Liabilities and Stockholders' Equity Liabilities Junior subordinated debentures $ 5,155 $ -- Other liabilities 250 -- ---------------------------------------------------------- Total liabilities 5,405 -- ---------------------------------------------------------- Stockholders' Equity Total stockholders' equity 25,288 23,230 ---------------------------------------------------------- Total liabilities and stockholders' equity $30,693 $23,230 ---------------------------------------------------------- Condensed Statements of Operations Year Ended December 31 (Dollars in thousands) 2001 2000 1999 ------------------------------------------------------------------ Income: Dividends from subsidiary $ 880 $ 838 $ 801 Interest income 1 -- -- Interest expense (177) -- -- Other expenses (3) -- -- Equity in undistributed income of subsidiary 2,021 1,870 2,031 ------------------------------------------------------------------ Net income $ 2,722 $ 2,708 $ 2,832 ------------------------------------------------------------------ Condensed Statements of Cash Flows Year Ended December 31 (Dollars in thousands) 2001 2000 1999 -------------------------------------------------------------------------- Cash Flows From Operating Activities: Net income $ 2,722 $ 2,708 $ 2,832 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiary (2,021) (1,870) (2,031) Net change in other liabilities 250 -- -- Net change in other assets (335) -- -- -------------------------------------------------------------------------- Net Cash Provided by Operating Activities 616 838 801 -------------------------------------------------------------------------- Cash Flows From Investing Activities: Purchase of AFS security (4,625) -- -- Purchase of Bank subsidiary stock -- (16) (9) -------------------------------------------------------------------------- Net Cash Used In Investing Activities (4,625) (16) (9) -------------------------------------------------------------------------- Cash Flows From Financing Activities: Proceeds from issuance of junior subordinated debentures 5,155 -- -- Payment to repurchase common stock (266) -- -- Dividends paid (880) (838) (801) Proceeds from issuance of stock under Stock Option Plan -- 16 9 -------------------------------------------------------------------------- Net Cash Provided by (Used) in Financing Activities 4,009 (822) (792) -------------------------------------------------------------------------- Net Change in Cash and Cash Equivalents $-- $-- $-- -------------------------------------------------------------------------- Downingtown National Bank [LOGO] 38 Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- (17) 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, which amounted to $5.9 million for the year ended December 31, 2001. Federal banking agencies impose three minimum capital requirements -- Total risk-based, Tier 1 and leverage capital. The risk-based capital ratios measure the adequacy of a bank's capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for "prompt corrective action" or other regulatory enforcement action. In assessing a bank's capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level of earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management's overall ability to monitor and control risks. Quantitative measures established by regulation to ensure capital adequacy require DNB to maintain certain minimum amounts and ratios as set forth below. Management believes that DNB and the Bank meet all capital adequacy requirements to which they are subject. The Bank is considered "Well Capitalized" under the regulatory framework for prompt corrective action. To be categorized as Well Capitalized, the Bank must maintain minimum ratios as set forth below. There are no conditions or events since that notification, that management believes would have changed the Bank's category. Actual capital amounts and ratios are presented below.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------------------------------------------------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------------------------------------------------------------------------------ DNB Financial Corporation December 31, 2001: Total risk-based capital $33,693 12.96% $20,802 8.00% $26,002 10.00% Tier 1 capital 30,424 11.70 10,401 4.00 15,601 6.00 Tier 1 (leverage) capital 30,424 8.05 15,126 4.00 18,908 5.00 ------------------------------------------------------------------------------------------------------------------------ December 31, 2000: Total risk-based capital $26,975 10.78% $20,016 8.00% $25,020 10.00% Tier 1 capital 23,825 9.52 10,008 4.00 15,012 6.00 Tier 1 (leverage) capital 23,825 6.90 13,805 4.00 17,256 5.00 ------------------------------------------------------------------------------------------------------------------------ Downingtown National Bank December 31, 2001: Total risk-based capital $29,137 11.21% $20,793 8.00% $25,992 10.00% Tier 1 capital 25,869 9.95 10,397 4.00 15,595 6.00 Tier 1 (leverage) capital 25,869 6.85 15,107 4.00 18,884 5.00 ------------------------------------------------------------------------------------------------------------------------ December 31, 2000: Total risk-based capital $26,975 10.78% $20,016 8.00% $25,020 10.00% Tier 1 capital 23,825 9.52 10,008 4.00 15,012 6.00 Tier 1 (leverage) capital 23,825 6.90 13,805 4.00 17,256 5.00 ------------------------------------------------------------------------------------------------------------------------
Downingtown National Bank [LOGO] 39 Independent Auditors' Report -------------------------------------------------------------------------------- KPMG 1600 Market Street Philadelphia, PA 19103-7212 The Board of Directors and Stockholders DNB Financial Corporation: We have audited the accompanying consolidated statements of financial condition of DNB Financial Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of DNB Financial Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP January 25, 2002 Philadelphia, PA KPMG LLP. KPMG LLP, a U.S. limited liability partnership, is a member of KPMG International, a Swiss association. Downingtown National Bank [LOGO] 40 DNB Financial Corporation and Subsidiaries Dnb Financial Corporation Directors Robert J. Charles Chairman Vernon J. Jameson Vice Chairman Thomas R. Greenleaf William S. Latoff Joseph G. Riper Louis N. Teti Henry F. Thorne James H. Thornton Directors Emeritus Ellis Y. Brown, III Paul F. DiMatteo I. Newton Evans, Jr. Ilario S. Polite Officers Henry F. Thorne President and CEO Ronald K. Dankanich Secretary Bruce E. Moroney Chief Financial Officer Downingtown National Bank Officers Henry F. Thorne President and CEO Richard L. Bergey Senior Vice President/ Senior Credit Officer Charles E. Bradford Senior Vice President Director - DNB Advisors Ronald K. Dankanich Senior Vice President/ Operations and Secretary Eileen M. Knott Senior Vice President/ Audit and Compliance Officer Kristen LaDow Senior Vice President/ Senior Loan Officer Bruce E. Moroney Senior Vice President and CFO Joseph M. Stauffer Senior Vice President/ Retail Banking and Marketing Departments Elizabeth B. Barr Vice President/Construction Lending David L. Binder Vice President/Commercial Lending William W. Brown Vice President/Data Processing Elizabeth A. Cook Asst. Vice President/Marketing Manager Lisa A. Donnon Asst. Vice President/Commercial Lending Dominick A. Frederick Vice President/Central Operations Charles H. Fulton Asst. Vice President/Consumer Lending Michelle L. Griffith Assistant Controller Marilyn K. Harris Asst. Vice President/Lending Timothy J. Mahan Asst. Vice President/ Loan Operations Manager Debora A. Micka Vice President/Commercial Lending Charles S. Moore Vice President/Commercial Lending Tracy E. Panati Asst. Vice President/Human Resources M. Esther Popjoy Vice President/Reconcilements Michael Rist Commercial Loan Officer Barry A. Schmidt Vice President/Commercial Lending and Cash Management Kimberly L. Schneider Asst. Vice President/Lending Jenn Vanwijk Commercial Loan Officer Charles E. Wuertz Vice President/Commercial Lending Downingtown National Bank [LOGO] 41 DNB Financial Corporation and Subsidiaries Corporate Headquarters 4 Brandywine Avenue Downingtown, PA 19335 Tel. 610-269-1040 Fax 610-873-5298 Internet http://www.dnb4you.com Financial Information Investors, brokers, security analysts and others desiring financial information should contact Bruce Moroney at 610-873-5253 or bmoroney@dnb4you.com Auditors KPMG LLP 1600 Market Street Philadelphia, PA 19103-7212 Counsel Stradley, Ronon, Stevens and Young, LLP 30 Valley Stream Parkway Malvern, PA 19355 Registrar and Stock Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 800-368-5948 Market Makers Boenning & Scattergood, Inc. 800-883-1212 Ferris, Baker Watts, Inc. 410-659-4616 F. J. Morrissey & Company, Inc. 800-842-8928 Herzog, Heine, Geduld, Inc. 215-972-0860 Janney Montgomery Scott, Inc. 800-526-6397 Ryan Beck & Company 800-223-8969 DNB Leasing 610-873-4025 Kenneth R. Kramer Vice President DNB Advisors 610-269-4657 Charles E. Bradford Sr.Vice President & Director Cheryl T. Burkey Vice President/Trust Officer Jennifer C. Calabro Financial Relationship Manager Jan L. Jandrlich Trust Officer Drew J. Mone Vice President, Financial Consultant Community Offices Main Office 610-269-1040 Wanda G. Mize Vice President and Manager Caln Office 610-383-7562 Robin M. DiMattei Manager East End Office 610-269-3800 Christine M. Yohn Assistant Vice President and Manager Kennett Square Office 610-444-4350 C. Ray Cornell Assistant Vice President and Manager Lionville Office 610-363-7590 Joseph J. Bucciaglia Vice President and Manager Little Washington Office 610-942-3666 John R. Rode Vice President and Manager Ludwig's Corner Office 610-458-5100 Dorothy A. Cook Manager West Goshen Office 610-429-5860 Sandra L. Mattern Assistant Vice President and Manager Exton Office 610-363-7098 Clifford S. Purse Assistant Vice President and Manager