10-K 1 dnb10k.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 _______________ Form 10-K [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2003. OR [x] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _________ to _________ Commission file Number 0-16667 DNB Financial Corporation (Exact Name of registrant as specified in its charter) Pennsylvania 23-2222567 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 4 Brandywine Avenue Downingtown, Pennsylvania 19335 (Address of principal executive offices) (Zip Code) (610) 269-1040 Registrant's telephone number, including area code Securities registered pursuant to Section 12 (b) of the Act: N/A Title of each class Name of each exchange on which registered N/A N/A Securities registered pursuant to Section 12 (g) of the Act Common stock, par value $1.00 per share (Title of class) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. $49.8 million as of March 18, 2004 Indicate the number of shares outstanding of each class of the registrant's classes of common stock, as of the latest practicable date. 1,894,375 shares of Common Stock, $1 par value per share, were outstanding as of March 18, 2004 DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 2003 are incorporated by reference into Parts I, II and IV of this report. 2. Portions of the Registrant's Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held April 27, 2004 are incorporated by reference into Parts III and IV of this report. 2
DNB FINANCIAL CORPORATION Table of Contents Page Part I Item 1. Business 4 Item 2. Properties 13 Item 3. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Part II Item 5. Market for Registrant's Common Equity and Related 14 Stockholder Matters Item 6. Selected Financial Data 14 Item 7. Management's Discussion and Analysis of Financial 14 Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk 14 Item 8. Financial Statements and Supplementary Data 15 Item 9. Changes in and Disagreements with Accountants 15 on Accounting and Financial Disclosure Item 9A. Controls and Procedures 15 Part III Item 10. Directors and Executive Officers of the Registrant 16 Item 11. Executive Compensation 16 Item 12. Security Ownership of Certain Beneficial Owners and Management 16 Item 13. Certain Relationships and Related Transactions 16 Item 14. Principal Accounting Fees and Services 16 Part IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 16 SIGNATURES
3 DNB FINANCIAL CORPORATION FORM 10-K Forward-Looking Statements This report contains statements, that are not of historical facts and may pertain to future operating results or events or management's expectations regarding those results or events. These are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. These forward-looking statements may include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", or words of similar meaning, or future or conditional verbs, such as "will", "would", "should", "could", or "may" are generally intended to identify forward-looking statements. 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; (6) DNB may change one or more strategies described in this document; or (7) management's evaluation of certain facts, circumstances or trends and the appropriate responses to them may change. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are either beyond our control or not reasonably capable of predicting at this time. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements. Readers of this report are accordingly cautioned not to place undue reliance on forward-looking statements. DNB disclaims any intent or obligation to update publicly any of the forward-looking statements herein, whether in response to new information, future events or otherwise. With regard to DNB's balance sheet repositioning, the degree to which these steps can be accomplished will depend on a number of factors, including changes in the interest rate environment for loans, investments and deposits, loan prepayments, market opportunities for new loan and participation originations, and the availability of loan and lease receivables for purchase at attractive prices and yields, as well as management's assessment of the timing of each of these opportunities and steps in light of future, unknown developments affecting DNB's business generally. Part I Item 1. Business General DNB Financial Corporation (the "Registrant" or "DNB"), a Pennsylvania business corporation, is a bank holding company registered with and supervised by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Registrant was incorporated on October 28, 1982 and commenced operations on July 1, 1983 upon consummation of the acquisition of all of the outstanding stock of Downingtown National Bank (the "Bank"). Since commencing operations, Registrant's business has consisted primarily of managing and supervising the Bank, and its principal source of income has been dividends paid by the Bank. At December 31, 2003, Registrant had total consolidated assets, total liabilities 4 and stockholders' equity of $409.0 million, $383.6 million, and $25.4 million, respectively. The Bank was organized in 1861. The Bank is a national banking association that is a member of the Federal Reserve System, the deposits of which are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a full service commercial bank providing a wide range of services to individuals and small to medium sized businesses in its southeastern Pennsylvania market area, including accepting time, demand, and savings deposits and making secured and unsecured commercial, real estate and consumer loans. In addition, the Bank has one limited service branch and a full-service Wealth Management Group - DNB Advisors. The Bank's subsidiary, Downco, Inc. was incorporated in December, 1995 for the purpose of acquiring and holding other real estate owned acquired through foreclosure or deed in lieu of foreclosure and now owns certain Bank-occupied real estate. The Bank's financial subsidiary, DNB Financial Services, Inc., is a Pennsylvania licensed insurance agency. The Bank's legal headquarters are located at 4 Brandywine Avenue, Downingtown, Pennsylvania. As of December 31, 2003, the Bank had total assets of $407.7 million, total deposits of $292.5 million and total stockholders' equity of $29.0 million. The Bank's business is not seasonal in nature. The FDIC, to the extent provided by law, insures its deposits. At December 31, 2003, the Bank had 114 full-time employees and 20 part-time employees. The Bank derives its income principally from interest charged on loans and, to a lesser extent, interest earned on investments and fees received in connection with the origination of loans and for other services. The Bank's principal expenses are interest expense on deposits and borrowings and operating expenses. Funds for activities are provided principally by operating revenues, deposit growth and the repayment of outstanding loans. Competition - Bank The Bank encounters vigorous competition from a number of sources, including other commercial banks, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, Federal and state savings and loan associations, savings banks, credit unions and industrial savings banks actively compete in the Bank's market area to provide a wide variety of banking services. Mortgage banking firms, real estate investment trusts, finance companies, insurance companies, leasing companies and brokerage companies, financial affiliates of industrial companies and certain government agencies provide additional competition for loans and for certain financial services. The Bank also competes for interest-bearing funds with a number of other financial intermediaries which offer a diverse range of investment alternatives, including brokerage firms and mutual fund companies. Supervision and Regulation - Registrant Sarbanes-Oxley Act of 2002 - On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") which imposed significant additional requirements and restrictions on publicly-held companies, such as the Registrant. These provisions include new requirements governing the composition and responsibilities of audit committees, financial disclosures and reporting and restrictions on personal loans to directors and officers. Sarbanes-Oxley, inter alia, now mandates chief executive and chief financial officer certifications of periodic financial reports, additional financial disclosures concerning off-balance sheet items, and speedier transaction reporting requirements for executive officers, directors and 10% shareholders. Rules promulgated and to be promulgated by the SEC pursuant to Sarbanes-Oxley impose 5 substantial reporting and compliance obligations on management and boards of directors, and new obligations and restrictions on auditors, audit committees intended to enhance their independence from management. In addition, penalties for non-compliance with the federal securities laws are heightened. While the Registrant has and will incur significant additional expense complying with Sarbanes Oxley requirements, the Registrant does not anticipate this legislation to have any other material adverse impact on the Registrant. Federal Banking Laws The Registrant is subject to a number of complex Federal banking laws --- most notably the provisions of the Bank Holding Company Act of 1956, as amended ("Bank Holding Company Act") and the Change in Bank Control Act of 1978 ("Change in Control Act"), and to supervision by the Federal Reserve Board. Bank Holding Company Act - Financial Holding Companies The Bank Holding Company Act requires a "company" (including the Registrant) to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than five percent (5%) of the voting shares or substantially all of the assets of any bank. It also prohibits acquisition by any "company" (including the Registrant) of more than five percent (5%) of the voting shares of, or interest in, or all or substantially all of the assets of, any bank located outside of the state in which a current bank subsidiary is located unless such acquisition is specifically authorized by laws of the state in which such bank is located. A "bank holding company" (including the Registrant) is prohibited from engaging in or acquiring direct or indirect control of more than five percent (5%) of the voting shares of any company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects. Applications under the Bank Holding Company Act and the Change in Control Act are subject to review, based upon the record of compliance of the applicant with the Community Reinvestment Act of 1977 ("CRA"). See further discussion below. The Registrant is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may also make examinations of the Registrant and any or all of its subsidiaries. Further, under Section 106 of the 1970 amendments to the Bank Holding Company Act and the Federal Reserve Board's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of credit or provision of any property or services. The so-called "anti-tie-in" provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer provide additional credit or service to the bank, to its bank holding company or to any other subsidiary of its bank holding company or on the condition that the customer not obtain other credit or service from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. Permitted Non-Banking Activities. The Federal Reserve Board permits bank holding companies to engage in non-banking activities so closely related to banking or managing or controlling banks as to be a proper incident thereto. A number of activities are authorized by Federal Reserve Board regulation, while 6 other activities require prior Federal Reserve Board approval. The types of permissible activities are subject to change by the Federal Reserve Board. Recent revisions to the Bank Holding Company Act contained in the Federal Gramm-Leach Bliley Act of 1999 permit certain eligible bank holding companies to qualify as "financial holding companies" and thereupon engage in a wider variety of financial services such as securities and insurance activities. Gramm-Leach Bliley Act of 1999 ("GLB") - This law repeals certain restrictions on bank and securities firm affiliations, and allows bank holding companies to elect to be treated as a "financial holding company" that can engage in approved "financial activities," including insurance, securities underwriting and merchant banking. Banks without holding companies can engage in many of these new financial activities through a "financial subsidiary." The law also mandates functional regulation of bank securities activities. Banks' exemption from broker-dealer regulation would be limited to, for example, trust, safekeeping, custodian, shareholder and employee benefit plans, sweep accounts, private placements (under certain conditions), self-directed IRAs, third party networking arrangements to offer brokerage services to bank customers, and the like. It also requires banks that advise mutual funds to register as investment advisers. The legislation provides for state regulation of insurance, subject to certain specified state preemption standards. It establishes which insurance products banks and bank subsidiaries may provide as principal or underwriter, and prohibits bank underwriting of title insurance, but also preempts state laws interfering with affiliations. GLB prohibits approval of new de novo thrift charter applications by commercial entities and limits sales of existing so-called "unitary" thrifts to commercial entities. The law bars banks, savings and loans, credit unions, securities firms and insurance companies, as well as other "financial institutions," from disclosing customer account numbers or access codes to unaffiliated third parties for telemarketing or other direct marketing purposes, and enables customers of financial institutions to "opt out" of having their personal financial information shared with unaffiliated third parties, subject to exceptions related to the processing of customer transactions and joint financial services marketing arrangements with third parties, as long as the institution discloses the activity to its customers and requires the third party to keep the information confidential. It requires policies on privacy and disclosure of information to be disclosed annually, requires federal regulators to adopt comprehensive regulations for ensuring the security and confidentiality of consumers' personal information, and allows state laws to five consumers greater privacy protections. The GLB is likely to increase the competition the Bank faces, and this increased competition is likely to come from a wider variety of non-banking competitors as well as banks. Change in Bank Control Act Under the Change in Control Act, no person, acting directly or indirectly or through or in concert with one or more other persons, may acquire "control" of any Federally insured depository institution unless the appropriate Federal banking agency has been given 60 days prior written notice of the proposed acquisition and within that period has not issued a notice disapproving of the proposed acquisition or has issued written notice of its intent not to disapprove the action. The period for the agency's disapproval may be extended by the agency. Upon receiving such notice, the Federal agency is required to provide a copy to the appropriate state regulatory agency, if the institution of which control is to be acquired is state chartered, and the Federal agency is obligated to give due consideration to the views and recommendations of the state agency. Upon receiving a notice, the Federal agency is also required to conduct an investigation of each person involved in the proposed acquisition. Notice of such proposal is to be published and public comment solicited thereon. A proposal may be disapproved by the Federal agency if the proposal would have anticompetitive effects, if the proposal would jeopardize the financial stability of the institution to be acquired or prejudice the interests of its depositors, if the competence, experience or integrity of any acquiring person or proposed management personnel indicates that it would not be in the interest of depositors or the public to permit such person to control the institution, if 7 any acquiring person fails to furnish the Federal agency with all information required by the agency, or if the Federal agency determines that the proposed transaction would result in an adverse effect on a deposit insurance fund. In addition, the Change in Control Act requires that, whenever any Federally insured depository institution makes a loan or loans secured, or to be secured, by 25% or more of the outstanding voting stock of a Federally insured depository institution, the president or chief executive officer of the lending bank must promptly report such fact to the appropriate Federal banking agency regulating the institution whose stock secures the loan or loans. Pennsylvania Banking Laws Under the Pennsylvania Banking Code of 1965, as amended ("PA Code"), the Registrant is permitted to control an unlimited number of banks, subject to prior approval of the Federal Reserve Board as more fully described above. The PA Code authorizes reciprocal interstate banking without any geographic limitation. Reciprocity between states exists when a foreign state's law authorizes Pennsylvania bank holding companies to acquire banks or bank holding companies located in that state on terms and conditions substantially no more restrictive than those applicable to such an acquisition by a bank holding company located in that state. Interstate ownership of banks in Pennsylvania with banks in Delaware, Maryland, New Jersey, Ohio, New York and other states, is currently authorized. However, state laws still restrict de novo formations of branches in other states. Pennsylvania law also provides Pennsylvania state chartered institutions elective parity with the power of national banks, federal thrifts, and state-chartered institutions in other states as authorized by the Federal Deposit Insurance Corporation ("Competing Institutions"). In some cases, this may give state chartered institutions broader powers than national banks such as the Bank, and may increase competition the Bank faces from other banking institutions. Environmental Laws The Registrant, the Bank and the Bank's customers are subject in the course of their activities to a growing number of Federal, state and local environmental laws and regulations. Neither the Registrant nor the Bank anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on its competitive positions. Supervision and Regulation - Bank The operations of the Bank are subject to Federal and State statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System and to banks whose deposits are insured by the FDIC. Bank operations are also subject to regulations of the Office of the Comptroller of the Currency ("OCC"), the Federal Reserve Board and the FDIC. The primary supervisory authority of the Bank is the OCC, who regularly examines the Bank. The OCC has the authority to prevent a national bank from engaging in an unsafe or unsound practice in conducting its business. Federal and state banking laws and regulations govern, among other things, the scope of a bank's business, the investments a bank may make, the reserves against deposits a bank must maintain, loans a bank makes and collateral it takes, the activities of a bank with respect to mergers and consolidations and the establishment of branches. All nationally and state-chartered banks in Pennsylvania are permitted to maintain branch offices in any county of the state. National bank branches may be established only after approval by the OCC. 8 It is the general policy of the OCC to approve applications to establish and operate domestic branches, including ATMs and other automated devices that take deposits, provided that approval would not violate applicable Federal or state laws regarding the establishment of such branches. The OCC reserves the right to deny an application or grant approval subject to conditions if (1) there are significant supervisory concerns with respect to the applicant or affiliated organizations, (2) in accordance with CRA, the applicant's record of helping meet the credit needs of its entire community, including low and moderate income neighborhoods, consistent with safe and sound operation, is less than satisfactory, or (3) any financial or other business arrangement, direct or indirect, involving the proposed branch or device and bank "insiders" (directors, officers, employees and 10%-or-greater shareholders) involves terms and conditions more favorable to the insiders than would be available in a comparable transaction with unrelated parties. The Bank, as a subsidiary of a bank holding company, is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries and on taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Prompt Corrective Action - Federal banking law mandates certain "prompt corrective actions" which Federal banking agencies are required to take, and certain actions which they have discretion to take, based upon the capital category into which a Federally regulated depository institution falls. Regulations have been adopted by the Federal bank regulatory agencies setting forth detailed procedures and criteria for implementing prompt corrective action in the case of any institution which is not adequately capitalized. Under the rules, an institution will be deemed to be "adequately capitalized" or better if it exceeds the minimum Federal regulatory capital requirements. However, it will be deemed "undercapitalized" if it fails to meet the minimum capital requirements, "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%, and "critically undercapitalized" if the institution has a ratio of tangible equity to total assets that is equal to or less than 2.0%. The rules require an undercapitalized institution to file a written capital restoration plan, along with a performance guaranty by its holding company or a third party. In addition, an undercapitalized institution becomes subject to certain automatic restrictions including a prohibition on the payment of dividends, a limitation on asset growth and expansion, and in certain cases, a limitation on the payment of bonuses or raises to senior executive officers, and a prohibition on the payment of certain "management fees" to any "controlling person". Institutions that are classified as undercapitalized are also subject to certain additional supervisory actions, including increased reporting burdens and regulatory monitoring, a limitation on the institution's ability to make acquisitions, open new branch offices, or engage in new lines of business, obligations to raise additional capital, restrictions on transactions with affiliates, and restrictions on interest rates paid by the institution on deposits. In certain cases, bank regulatory agencies may require replacement of senior executive officers or directors, or sale of the institution to a willing purchaser. If an institution is deemed to be "critically undercapitalized" and continues in that category for four quarters, the statute requires, with certain narrowly limited exceptions, that the institution be placed in receivership. 9 Under the Federal Deposit Insurance Act, the OCC possesses the power to prohibit institutions regulated by it, such as the Bank, from engaging in any activity that would be an unsafe and unsound banking practice and in violation of the law. Moreover, Federal law enactments have expanded the circumstances under which officers or directors of a bank may be removed by the institution's Federal supervisory agency; restricted and further regulated lending by a bank to its executive officers, directors, principal shareholders or related interests thereof; and restricted management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area; and restricted management personnel from borrowing from another institution that has a correspondent relationship with their bank. Capital Rules - Pursuant to The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the laws it amended, the Federal banking agencies have issued certain "risk-based capital" guidelines, which supplemented existing capital requirements. In addition, the OCC imposes certain "leverage" requirements on national banks such as the Bank. Banking regulators have authority to require higher minimum capital ratios for an individual bank or bank holding company in view of its circumstances. The risk-based guidelines require all banks and bank holding companies to maintain two "risk-weighted assets" ratios. The first is a minimum ratio of total capital ("Tier 1" and "Tier 2" capital) to risk-weighted assets equal to 8.00%; the second is a minimum ratio of "Tier 1" capital to risk-weighted assets equal to 4.00%. Assets are assigned to five risk categories, with higher levels of capital being required for the categories perceived as representing greater risk. In making the calculation, certain intangible assets must be deducted from the capital base. The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets. The risk-based capital rules also account for interest rate risk. Institutions with interest rate risk exposure above a normal level, would be required to hold extra capital in proportion to that risk. A bank's exposure to declines in the economic value of its capital due to changes in interest rates is a factor that the banking agencies will consider in evaluating a bank's capital adequacy. The rule does not codify an explicit minimum capital charge for interest rate risk. The Bank currently monitors and manages its assets and liabilities for interest rate risk, and management believes that the interest rate risk rules which have been implemented and proposed will not materially adversely affect the Bank's operations. The OCC's "leverage" ratio rules require national banks which are rated the highest by the OCC in the composite areas of capital, asset quality, management, earnings and liquidity to maintain a ratio of "Tier 1" capital to "adjusted total assets" (equal to the bank's average total assets as stated in its most recent quarterly Call Report filed with the OCC, minus end-of-quarter intangible assets that are deducted from Tier 1 capital) of not less than 3.00%. For banks which are not the most highly rated, the minimum "leverage" ratio will range from 4.00% to 5.00%, or higher at the discretion of the OCC, and is required to be at a level commensurate with the nature of the riskiness of the bank's condition and activities. For purposes of the capital requirements, "Tier 1" or "core" capital is defined to include common stockholders' equity and certain noncumulative perpetual preferred stock and related surplus. "Tier 2" or "qualifying supplementary" capital is defined to include a bank's allowance for loan and lease losses up to 1.25% of risk-weighted assets, plus certain types of preferred stock and related surplus, certain "hybrid capital instruments" and certain term subordinated debt instruments. 10 Management does not anticipate that the foregoing capital rules will have a material effect on the Registrant's business and capital plans. Deposit Insurance Assessments - All Federally insured depository institutions pay special assessments toward the funding of interest payments on FICO bonds which were issued in 1989 to fund the savings and loan bailout. The special assessments are calculated on a deposit-by-deposit basis and differs depending upon whether a deposit is insured by SAIF or BIF. Currently, the special assessment rates are 6.1 basis points on all SAIF-assessable deposits, and 20% of that rate, or approximately 1.2 basis points, on all BIF-assessable deposits, regardless of whether an institution is a "bank", a "savings association". All assessable deposits at all institutions are assessed at the same rates in order to pay FICO bond interest. The FDIC sets deposit insurance assessment rates on a semiannual basis. The FDIC has authority to reduce the assessment rates whenever the ratio of its reserves to insured deposits is equal to or greater than 1.25%, and to increase deposit insurance assessments whenever that ratio is less than 1.25%. An institution's semiannual deposit insurance assessment is computed primarily by multiplying its "average assessment base" (generally, total insurable domestic deposits) for the prior semiannual period by one-half the annual assessment rate applicable to that institution depending upon its risk category, which is based principally on two measures of risk. These measures involve capital and supervisory factors. For the capital measure, institutions are assigned semiannually to one of three capital groups according to their levels of supervisory capital as reported on their Call Reports: "well capitalized" (group 1), "adequately capitalized" (group 2) and "undercapitalized" (group 3). The capital ratio standards for classifying an institution in one of these three groups are total risk-based capital ratio (10 percent or greater for group 1, and between 8 and 10 percent for group 2), the Tier 1 risk-based capital ratio (6 percent or greater for group 1, and between 4 and 6 percent for group 2), and the leverage capital ratio (5 percent or greater for group 1, between 4 and 5 percent for group 2). Management believes that the Bank has met the definition of "well capitalized" for regulatory purposes on December 31, 1999 and thereafter. Within each capital group, institutions are assigned to one of three supervisory risk subgroups --subgroup A, B, or C, depending upon an assessment of the institution's perceived risk based upon the results of its most recent examination and other information available to regulators. Subgroup A will consist of financially sound institutions with only a few minor weaknesses. Subgroup B will consist of institutions that demonstrate weaknesses, which, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the BIF. Subgroup C will consist of institutions that pose a substantial probability of loss to the deposit insurance fund unless effective corrective action is taken. Thus, there are nine possible classifications to which varying assessment rates are applicable. The regulation generally prohibits institutions from disclosing their subgroup assignments or assessment risk classifications without FDIC authorization. The following table sets forth the current BIF assessment rates by capital group and supervisory risk subgroup (with no minimum assessment amount): 11 Supervisory subgroup Capital Group A B C ------------- ------------------------- 1 0 3 17 2 3 10 24 3 10 24 27 In addition to deposit insurance assessments, banks are subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. The FDIC sets the Financing Corporation assessment rate every quarter. Interstate Banking - Federal law permits interstate bank mergers and acquisitions. Limited branch purchases are still subject to state laws. Pennsylvania law permits out-of-state banking institutions to establish branches in Pennsylvania with the approval of the Pennsylvania Banking Department, provided the law of the state where the banking institution is located would permit a Pennsylvania banking institution to establish and maintain a branch in that state on substantially similar terms and conditions. It also permits Pennsylvania banking institutions to maintain branches in other states. Bank management anticipates that interstate banking will continue to increase competitive pressures in the Bank's market by permitting entry of additional competitors, but management is of the opinion that this will not have a material impact upon the anticipated results of operations of the Bank. Bank Secrecy Act - Under the Bank Secrecy Act ("BSA"), the Bank is required to report to the Internal Revenue Service, currency transactions of more than $10,000 or multiple transactions of which the Bank is aware in any one day that aggregate in excess of $10,000. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report. USA PATRIOT Act - The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (together with its implementing regulations, the "Patriot Act"), designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for banks and other financial institutions. It requires the Registrant and its subsidiaries to implement new policies and procedures or amend existing policies and procedures with respect to, anti-money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers, as well as related matters. The Patriot Act permits and in some cases requires information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, and it requires federal banking agencies to evaluate the effectiveness of an institution in combating money laundering activities, both in ongoing examinations and in connection with applications for regulatory approval. While the Registrant has and will incur significant additional expense complying with Patriot Act requirements, the Registrant does not anticipate this legislation to have any other material adverse impact on the Registrant. Community Reinvestment Act - Under the Community Reinvestment Act of 1977 ("CRA"), the record of a bank holding company and its subsidiary banks must be considered by the appropriate Federal banking agencies, including the Federal Reserve and the OCC, in reviewing and approving or disapproving a variety of regulatory applications including approval of a branch or other deposit facility, office relocation, a merger and certain acquisitions of bank shares. Federal banking agencies have recently demonstrated an increased readiness to deny applications based on unsatisfactory CRA performance. The OCC is required to assess the record of the Bank to determine if it is meeting the credit needs of the community (including low and moderate neighborhoods) which it serves. 12 FIRREA amended the CRA to require, among other things, that the OCC make publicly available an evaluation of the Bank's record of meeting the credit needs of its entire community including low- and moderate-income neighborhoods. This evaluation includes a descriptive rating (outstanding, satisfactory, needs to improve, or substantial noncompliance) and a statement describing the basis for the rating. Other Laws and Regulations - The Bank is subject to a variety of consumer protection laws, including the Truth in Lending Act, the Truth in Savings Act adopted as part of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Electronic Funds Transfer Act, the Real Estate Settlement Procedures Act and the regulations adopted thereunder. In the aggregate, compliance with these consumer protection laws and regulations involves substantial expense and administrative time on the part of the Bank and the Registrant. Legislation and Regulatory Changes - From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities and/or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, and before various bank regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the Registrant and its subsidiary Bank. Effect of Government Monetary Policies - The earnings of the Registrant are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States Government and its agencies (particularly the Federal Reserve Board). The monetary policies of the Federal Reserve Board have had and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve Board has a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States Government securities and through its regulation of, among other things, the discount rate on borrowing of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies. Additional information regarding the Registrant's business is included in Management's Discussion and Analysis of Financial Condition and Results of Operations (pages 3 through 26) in the Registrant's 2003 Annual Report to Shareholders and is incorporated herein by reference and attached to this filing as Exhibit 13. Item 2. Properties The main office of the Bank is located at 4 Brandywine Avenue, Downingtown, Pennsylvania 19335. The Registrant's registered office is also at this location. The Registrant pays no rent or other form of consideration for the use of the Bank's main office as its principal executive office. The Bank also has an operations center located at 104-106 Brandywine Avenue, Downingtown. With the exception of the West Goshen office, Exton office and a limited service office at Tel Hai Retirement Community, all of which are leased, the Bank owns all of its existing branches as described below which had a net book value of $5.4 million including leasehold improvements at December 31, 2003. 13 The bank has nine full service offices located in Chester County, Pennsylvania. In addition to the Main Office discussed above, they are:
Office Office Location Owned/Leased ------------------ --------------------------------------------------- ----------- Caln Office 1835 East Lincoln Highway, Coatesville Owned East End Office 701 East Lancaster Avenue, Downingtown Owned Exton Office 410 Exton Square Parkway, Exton Leased Kennett Square Office 215 E. Cypress St., Kennett Square Owned Lionville Office Intersection of Route 100 and Welsh Pool Road, Exton Owned Little Washington Office Route 322 and Culbertson Run Road, Downingtown Owned Ludwig's Corner Office Intersection of Routes 100 and 401, Uwchland Owned Tel Hai Office Tel Hai Retirement Community, Honey Brook (Limited Service) Leased West Goshen Office 1115 West Chester Pike, West Chester Leased
Item 3. Legal Proceedings 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. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted during the fourth quarter of 2003 to a vote of holders of the Corporation's common stock. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information required herein is incorporated by reference to the Registrant's Annual Report to Shareholders ("Annual Report") for the year ended December 31, 2003 at page 25, filed as Exhibit 13. Item 6. Selected Financial Data The information required herein is incorporated by reference to the Registrant's Annual Report for the year ended December 31, 2003 at page 2, filed as Exhibit 13. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required herein is incorporated by reference to the Registrant's Annual Report for the year ended December 31, 2003 from pages 4 to 27, filed as Exhibit 13. Item 7a. Quantitative and Qualitative Disclosures About Market Risk To measure the impacts of longer-term asset and liability mismatches beyond two years, DNB utilizes Modified Duration of Equity and Economic Value of Portfolio Equity ("EVPE") models. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rates ranging up or down 200 basis points. The economic value of equity is likely to be different if rates change. Results falling outside prescribed 14 ranges require action by management. At December 31, 2003 and 2002, DNB's variance in the economic value of equity as a percentage of assets with an instantaneous and sustained parallel shift of 200 basis points was within its negative 3% guideline, as shown in the tables below. However, the change as a percentage of the present value of equity with a 200 basis point decline at December 31, 2002, was negative 35.1% and outside of DNB's negative 25% policy. This occurred as the duration of DNB's assets shortened more quickly than the duration of DNB's liabilities. Subsequent to December 31, 2002, management has taken the necessary steps to move this ratio within policy guidelines, including but not limited to reducing the level of Federal funds sold, purchasing municipal securities with positive convexity, promoting five year fixed rate lending and attempting to shorten the overall duration of deposits through pricing. In addition management reduced the amount of its short-term borrowings and duration of its investment portfolio. At December 31, 2003 DNB's change as a percentage of the present value of equity with a 200 basis point rise was negative 19.3% and a 200 basis point decline was negative 11.7%; both well within policy guidelines.
December 31, 2002 December 31, 2003 Change in rates Flat -200bp +200bp Flat -200bp +200 bp EVPE $33,915 $29,953 $27,357 $27,381 $17,760 28,553 Change (3,691) (6,557) (9,621) 1,172 Change as a % of assets (1.0%) (1.6%) (2.5%) 0.3% Change as a % of PV equity (11.7%) (19.3%) (35.1%) 4.3%
Item 8. Financial Statements and Supplementary Data The information required herein is incorporated by reference to the Registrant's Annual Report for the year ended December 31, 2003 from pages 28 to 49, filed as Exhibit 13. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None Item 9a. Controls and Procedures The Registrant's Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of disclosure controls and procedures (as defined in Exchange Act Rule 15d-14(c)) as of December 31, 2003 in accordance with the requirements of Exchange Act Rule 240.15d-15(b). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Registrant's current disclosure controls and procedures are effective and timely, providing them with material information relating to the Registrant and its subsidiaries required to be disclosed in the reports the Registrant files under the Exchange Act. The Registrant conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the quarter ended December 31, 2003, that have materially affected, or are reasonably likely to materially affect, the Registrant's internal control over financial reporting. Based on this evaluation, there has been no such change during the quarter that ended December 31, 2003. 15 Part III Item 10. Directors and Executive Officers of the Registrant The information required herein is incorporated by reference to the Registrant's Proxy Statement from pages 3 to 7. The Registrant's Code of Ethics is attached as Exhibit 14. Item 11. Executive Compensation The information required herein is incorporated by reference to the Registrant's Proxy Statement from pages 8 to 11. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required herein is incorporated by reference to the Registrant's Proxy Statement at page 2. Item 13. Certain Relationships and Related Transactions The information required herein is incorporated by reference to the Registrant's Proxy Statement at page 13. Item 14. Principal Accountant Fees and Services The information required herein is incorporated by reference to the Registrant's Proxy Statement at page 27. Part IV Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as part of this report: (1.) Financial statements.
Page Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001 * Consolidated Balance Sheets as of December 31, 2003 and 2002 * Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2003, 2002 and 2001 * Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 * Notes to Consolidated Financial Statements * Report of Independent Auditors -- KPMG LLP * * Incorporated by reference to pages 28 through 50 of the Registrant's 2003 Annual Report to Shareholders attached to this filing as Exhibit 13.
(2.) Those financial statement schedules required to be filed by Item 8 of this form, and by paragraph (d) below. All schedules normally required by Form 10-K are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto contained in the Annual Report filed as part of this report. (3.) Exhibits, pursuant to Item 601 of Regulation S-K. 16
Exhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit 3 (i) Amended and Restated Articles of Incorporation, as amended effective June 15, 2001, filed on August 14, 2001, as Item 6(a) to Form 10Q (No. 0-16667) and incorporated herein by reference. (ii) By-laws of the Registrant as amended December 19, 2001, filed on March 24, 2002 at Item 3b to Form 10-K for the fiscal year ended December 31, 2001 (No. 0-16667) and incorporated herein by reference. 10 (a) Employment Agreement between Downingtown National Bank and Henry F. Thorne dated December 31, 1996 filed on March 26, 1999 at Item 10.1 to Form 10-K for the fiscal year ended December 31, 1998 (No. 0-16667) and incorporated herein by reference. (b) Form of Change of Control Agreements (i) dated May 5, 1998 between DNB Financial Corporation and Downingtown National Bank and the following executive officers: Ronald K. Dankanich; Eileen M. Knott and Bruce E. Moroney and (ii) dated July 18, 2000, April 28, 2003 and September 22, 2003 between DNB Financial Corporation and Downingtown National Bank and Kristen J. LaDow, William J. Hieb and Richard M. Wright, respectively, each in the form filed on March 26, 1999 at Item 10.2 to Form 10-K for the fiscal year ended December 31, 1998 (No. 0-16667), and incorporated herein by reference. (c) 1995 Stock Option Plan of DNB Financial Corporation (as amended and restated, effective as of April 27, 1999), filed on May 20, 1999 as Exhibit 4 to Registration Statement No. 33-93272, and incorporated herein by reference. (d) Death Benefit Agreement between Downingtown National Bank and Henry F. Thorne dated November 24, 1999, filed March 20, 2002 as Item 10(d) to Form 10-K for the fiscal year ended December 31, 2001 (No. 0-16667) and incorporated herein by reference. 17 (e) Form of Change of Control Agreements, as amended November 10, 2003, between DNB Financial Corporation and Downingtown National Bank and each of the following Directors: William S. Latoff, James H. Thornton, Louis N. Teti, Joseph G. Riper, James J. Koegel, Eli Silberman and Henry F. Thorne, filed on November 14, 2003 as Item 10(e) to Form 8-K (No. 0-16667) and incorporated herein by reference. (f) Retirement and Change of Control Agreement dated as of February 27, 2002, between DNB Financial Corporation and Downingtown National Bank and Thomas R. Greenleaf, a Director, filed on November 14, 2003 as Item 10(f) to Form 8-K (No. 0-16667) and incorporated herein by reference. (g) First Amendment to Employment Agreement of Henry F. Thorne dated December 23, 2003. (h) Retirement and Death Benefit Agreement between Downingtown National Bank and Henry F. Thorne dated December 23, 2003. 11 Statement of Computation of earnings per share, see footnote #1 in Annual Report of the Registrant for the year ended December 31, 2003, attached hereto as Exhibit 13 and incorporated herein by reference. 13 Annual Report to Stockholders for the year ended December 31, 2003. 14 Code of Ethics. 21 List of Subsidiaries. 23 Consent of KPMG LLP. 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Chief Executive Officer. 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Chief Financial Officer. 32.1 Certification of Chief Executive Officer pursuant to Section 906. 32.2 Certification of Chief Financial Officer pursuant to Section 906.
(b) Reports on Form 8-K The Registrant filed the following Current Reports on Form 8-K during the quarter ended December 31, 2003: 18 Date Item Reported October 17, 2003 Items 7 and 9 - Press Release announcing hiring of Richard M. Wright as SVP of Retail Banking and Marketing October 27, 2003 Items 7, 9 and 12 - Third quarter earning release with summary financial information. November 14, 2003 Items 5, 7 and 9 - Announcements of changes in the following: 10(e) Form of Change of Control Agreements, as amended November 10, 2003, between DNB Financial Corporation and Downingtown National Bank and each of the following Directors: William S. Latoff, James H. Thornton, Louis N. Teti, Joseph G. Riper, James J. Koegel, Eli Silberman and Henry F. Thorne 10(f) Retirement and Change of Control Agreement dated as of February 27, 2002, between DNB Financial Corporation and Downingtown National Bank and Thomas R. Greenleaf, a Director 99.1 A copy of the Bank's Notice of Cessation of Future Benefit Accruals under the Bank's Retirement Plan, Effective as of December 31, 2003 99.2 A copy of the November 14, 2003 cover letter to employees from Henry F. Thorne, the Bank's President and Chief Executive Officer, providing the notice and explaining certain facts and circumstances relating to the Bank's decision to amend its Retirement Plan and to implement a defined contribution plan. November 28, 2003 Items 7 and 9 - Announcement of cash dividend and stock dividend. (c) Exhibits required by Item 601 of Regulation S-K. The exhibits required to be filed pursuant to this item are listed above under (a)(3) of this Item. (d) Financial statements required by Regulation S-X which are excluded from the annual report. Not Applicable. 19 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DNB FINANCIAL CORPORATION March 26, 2004 BY: /s/ Henry F. Thorne ------------------------ Henry F. Thorne, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons and on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Henry F. Thorne March 26, 2004 ---------------------------- Henry F. Thorne, President, Chief Executive Officer and Director /s/ Bruce E. Moroney March 26, 2004 ---------------------------- Bruce E. Moroney Chief Financial Officer (Principal Accounting Officer) /s/ William S. Latoff March 26, 2004 ---------------------------- William S. Latoff Chairman of the Board /s/ James H. Thornton March 26, 2004 ---------------------------- James H. Thornton Vice-Chairman of the Board /s/ Thomas R. Greenleaf March 26, 2004 ---------------------------- Thomas R. Greenleaf Director /s/ James J. Koegel March 26, 2004 ---------------------------- James J. Koegel Director /s/ Joseph G. Riper March 26, 2004 ---------------------------- Joseph G. Riper Director /s/ Eli Silberman March 26, 2004 ---------------------------- Eli Silberman Director /s/ Louis N. Teti March 26, 2004 ---------------------------- Louis N. Teti Director 20