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, 2005
or
[
]
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
transition period from ____
to
____
.
Commission file Number
0-16667
(Exact
Name of registrant as specified in its charter)
|
Pennsylvania
|
23-2222567
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer Identification No.)
|
|
incorporation
or organization)
|
|
|
4
Brandywine Avenue, Downingtown, Pennsylvania
|
19335
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code:
(610)
269-1040
Securities
registered pursuant to Section 12 (b) of the Act: 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 is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act.
[
] Yes
[X] No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
[
] Yes
[X] No
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
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). [ ] Yes [X] No
As
of
March 2, 2006, $42.6 million of the Registrant’s Common Stock, $1 par value per
share, was held by non-affiliates of the Registrant.
As
of
March 2, 2006, the Registrant had outstanding 2,372,156 shares of Common Stock,
$1 par value per share.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Registrant’s definitive Proxy Statement relating to the Annual Meeting of
Shareholders are incorporated by reference into Parts III and IV of this
Form 10-K.
DNB
FINANCIAL CORPORATION
Table
of Contents
|
Part
I
|
|||
| 1 | |||
|
Item
1.
|
Business
|
|
|
|
Item
1A.
|
Risk
Factors
|
10
|
|
|
Item
1B.
|
Unresolved
Staff Comments
|
14
|
|
|
Item
2.
|
Properties
|
14 | |
|
Item
3.
|
Legal
Proceedings
|
15 | |
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
15 | |
|
Part
II
|
|||
|
Item
5.
|
Market
for Registrant’s Common Equity and Related Stockholder
Matters
|
||
|
and
Issuer Purchases of Equity Securities
|
15 | ||
|
Item
6.
|
Selected
Financial Data
|
17 | |
|
Item
7.
|
Management’s
Discussion and Analysis of Financial
|
||
|
Condition
and Results of Operations
|
18 | ||
|
Item
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
47 | |
|
Item
8.
|
Financial
Statements and Supplementary Data
|
48
|
|
|
Item
9.
|
Changes
in and Disagreements with Accountants
|
||
|
on
Accounting and Financial Disclosure
|
77 | ||
|
Item
9A.
|
Controls
and Procedures
|
77 | |
|
Item
9B.
|
Other
Information
|
77 | |
|
Part
III
|
|||
|
Item
10.
|
Directors
and Executive Officers of the Registrant
|
77 | |
|
Item
11.
|
Executive
Compensation
|
77 | |
|
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management
|
||
|
and
Related Stockholder Matters
|
78 | ||
|
|
|||
|
Item
13.
|
Certain
Relationships and Related Transactions
|
78 | |
|
Item
14.
|
Principal
Accounting Fees and Services
|
78 | |
|
Part
IV
|
|||
|
Item
15.
|
Exhibits,
Financial Statement Schedules
|
79
|
|
|
SIGNATURES
|
80 | ||
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.
(a)
General Description of Registrant’s Business and Its Development
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). The
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, now known as DNB First, National Association (the
“Bank”). Since commencing operations, DNB’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, 2005, DNB had total consolidated
assets, total liabilities and stockholders’ equity of $473.0 million, $442.9
million, and $30.2 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 the 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 ten full
service and two limited service branches and a full-service wealth management
group known as “DNB Advisors”. The Bank’s financial subsidiary, DNB Financial
Services, Inc., is a Pennsylvania licensed insurance agency, which, together
with the Bank, sells a broad variety of insurance and investment products.
The
Bank’s other 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.
(b)
Financial Information About Segments
In
accordance with generally accepted accounting principles in the United States,
the Registrant and the Bank operate as one segment, and therefore do not report
financial information for multiple segments of their business.
(c)
Narrative Description of Business
The
Bank’s legal headquarters is located at 4 Brandywine Avenue, Downingtown,
Pennsylvania. As of December 31, 2005, the Bank had total assets of $472.6
million, total deposits of $339.9 million and total stockholders’ equity of
$39.2 million. The Bank’s business is not seasonal in nature. The FDIC, to the
extent provided by law, insures its deposits. At December 31, 2005, the Bank
had
132 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 and investments.
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
substantial reporting and compliance obligations on management and boards of
directors, and new obligations and restrictions have been placed on auditors
and
audit committees that is 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 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 give 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
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.
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 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.
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 asset” 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 non-cumulative perpetual
preferred stock and related surplus. “Tier 2” or “qualifying supplementary”
capital is defined to include a bank’s allowance for credit 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.
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. The FDIC sets the Financing Corporation assessment
rate every quarter. Currently, the special assessment rate is 1.32 basis points
on all assessable deposits.
The
FDIC
sets deposit insurance assessment rates on a semiannual basis. The FDIC has
authority to impose or change the assessment rates within its discretion to
maintain the deposit insurance fund’s reserve ratio at the required levels.
While the required ratio was designated at 1.25% prior to 2006, the Deposit
Insurance Reform Act of 2005 (the “Reform Act”) changes the designated ratio to
a required range, giving the FDIC authority to establish the reserve level
within that range. For further information, please refer to “Deposit Insurance
Reform Act” on page 8.
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 deposit insurance fund. 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 assessment rates by capital group and
supervisory risk subgroup (with no minimum assessment amount):
|
Supervisory
subgroup
|
||||||
|
(in
basis points)
|
||||||
|
Capital
Group
|
A
|
B
|
C
|
|||
|
1
|
0
|
3
|
17
|
|||
|
2
|
3
|
10
|
24
|
|||
|
3
|
10
|
24
|
27
|
|||
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 and OFAC.
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. The Department of the Treasury's Office
of
Foreign Asset Control (“OFAC”) administers and enforces economic and trade
sanctions against targeted foreign countries, terrorism-sponsoring jurisdictions
and organizations, and international narcotics traffickers based on U.S. foreign
policy and national security goals. OFAC acts under presidential wartime and
national emergency powers and authority granted by specific legislation to
impose controls on transactions and freeze foreign assets under U.S.
jurisdiction. Acting under authority delegated from the Secretary of the
Treasury, OFAC promulgates, develops, and administers the sanctions under its
statutes and executive orders. OFAC requirements are separate and distinct
from
the BSA, but both OFAC requirements and the BSA share a common national security
goal. Because institutions and regulators view compliance with OFAC sanctions
as
related to BSA compliance obligations, supervisory examination for OFAC
compliance is typically connected to examination of an institution's BSA
compliance. Examiners focus on a banking organization's compliance processes
and
evaluate the sufficiency of a banking organization's implementation of policies,
procedures and systems to ensure compliance with OFAC regulations.
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 subsidiary 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.
The
Registrant has and will incur significant additional expense complying with
BSA,
OFAC and Patriot Act requirements. The Registrant’s management has identified
weaknesses in the Bank’s BSA, OFAC and Patriot Act compliance program (the “BSA
compliance program”) and is still assessing the impact of the identified
weaknesses. As a result, Registrant’s management cannot assure investors that
the Bank is compliant with BSA in all respects, but the Registrant’s management
has committed to a focused program in 2006 to strengthen its BSA compliance
program.
Deposit
Insurance Reform Act of 2005.
The
Deposit Insurance Reform Act of 2005 (the “Reform Act”) established a new
Deposit Insurance Fund (“DIF”) and merges the Bank Insurance Fund (“BIF”) and
the Savings Association Insurance Fund (“SAIF”) into it. The Reform Act replaced
the previous 1.25% “designated reserve ratio” for the BIF and SAIF with a
reserve ratio range of 1.15% to 1.4% of estimated insured deposits, subject
to
specified factors and annual redetermination by the FDIC. It requires the FDIC
to set assessments as it determines appropriate, including a maximum base rate
for assessments at one basis point for insured depository institutions in the
lowest-risk category. The FDIC is required to establish and implement a DIF
restoration plan whenever its reserve ratio is projected to fall, or actually
falls, below the minimum reserve ratio. The Reform Act prescribes requirements
for such plans, notably restoration to the minimum required reserve level within
ten years. Whenever the actual reserve ratio exceeds the prescribed range,
the
Reform Act requires the FDIC to refund assessments to assessed institutions.
In
addition, the Reform Act provides for a one-time credit to assessed institutions
based upon the December 31, 1996, assessment base of each eligible depository
institution, as compared to the combined aggregate assessment base of all such
institutions, but restricts the amount of such credit for depository
institutions that exhibit financial, operational, or compliance weakness,
including undercapitalization. For institutions that fail to pay assessments,
the Reform Act increases penalties from $100 to 1% of assessments per day for
the failure of a depository institution assessed more than $10,000 to make
timely assessment payments. The Reform Act also amended the Federal Deposit
Insurance Act to provide increased deposit insurance coverage for certain
retirement accounts, increasing the coverage from $100,000 to $250,000 on those
accounts. As of the date of this report, the BIF and SAIF have not yet been
merged into the DIF, but the FDIC had announced its intention to complete the
merger by March 31. The Reform Act requires the FDIC to adopt implementing
regulations for the other features of the Reform Act within 270 days after
the
Reform Act’s adoption.
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
hereunder. 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.
(d)
Financial Information About Geographical Areas
All
of
the Registrant’s revenues are attributable to customers located in the United
States, and primarily from customers located in Southeastern Pennsylvania.
All
of Registrant’s assets are located in the United States and in Southeastern
Pennsylvania. Registrant has no activities in foreign countries and hence no
risks attendant to foreign operations.
(e)
Available Information
Registrant
files reports with the Securities and Exchange Commission (“SEC”). The public
may read and copy any materials we file with the SEC at the SEC’s Public
Reference Room at 450 fifth Street, NW, Washington, DC 20549. The public may
obtain information on the operation of the Public Reference Room by calling
the
SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports,
proxy and information statements, and other information regarding issuers that
file electronically with the SEC. The SEC Internet site’s address is
http://www.sec.gov
.
The
Registrant maintains a corporate website at
www.dnbfirst.com
.
We will
provide printed copies of our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and any amendments to these
reports at no charge upon written request. Requests should be made to DNB
Financial Corporation, 4 Brandywine Avenue, Downingtown, PA 19335, Attention:
Bruce E. Moroney, Chief Financial Officer.
Item
1A.
Risk
Factors
Here
are
some of the risks that affect DNB’s business:
Our
Profitability is Affected by Interest Rate Changes
.
Our profitability depends largely on our net interest income. This is the
difference between our interest income on loans, investments and other assets,
and our interest expense on our deposits, borrowing and other liabilities.
We
try to identify and manage interest rate risk, which is the risk that we will
not be able to keep investing our money at a higher rate than we borrow it.
To
manage interest rate risks, we have to keep track of the interest we earn and
the interest we pay. When interest rates change, the relationship between our
interest income and our interest expense changes. Interest rate changes can
be
complex. For example, the relationship between short-term interest rates and
long-term interest rates can change. We try to limit the chances that these
changes may make us less profitable. The types of assets and liabilities we
have
can also affect our profitability when interest rates change.
For
example:
(a)
Our
assets and liabilities may change interest rates at different
times.
(b)
Our
assets and liabilities may not mature at the same time.
(c)
Some
types of assets and liabilities may be repayable sooner or later as interest
rates change.
Normally,
we expect our assets and liabilities not to have the same sensitivity to changes
in interest rates. This means that a change in interest rates will normally
either increase or decrease our net income. As of December 31, 2005, we were
in
an asset sensitive position, meaning that, when interest rates change, the
rates
we earn on our assets change more quickly than the rates we pay on our
liabilities. In this situation, a decline in interest rates could reduce our
net
income. In addition, as of December 31, 2005, our liabilities, on average were
scheduled to be repaid sooner than our assets. As a result, when short-term
interest rates rise
faster
than long-term interest rates, the interest we pay on our liabilities will
increase faster than the interest we receive on our assets, which can reduce
our
net income. We cannot predict interest rate changes or the relationships between
long-term interest rates and short-term interest rates.
Heavy
Competition
.
We now
face strong competition from many Pennsylvania and out-of-state banking and
thrift institutions, many of which have been in business for a number of years
and have established customer bases. We expect to continue to face this strong
competition in the future. Competition also comes from other businesses that
provide financial services, including consumer loan companies, credit unions,
mortgage brokers, insurance companies, securities
brokerage
firms, investment advisors, money market funds and other mutual funds, and
private lenders. Many of these competitors have resources greater than ours.
They have the advantages of an established market presence and customer base,
name recognition and a greater capital base. While our strategy is to attract
customers by providing personalized services and making use of the business
and
personal ties of our management, there is no assurance we will keep or increase
market acceptance and be able to operate profitably. Many financial service
providers believe our primary market area, Chester County, is an attractive
market because of its strong economic growth. As a result, we are experiencing
particularly intense competition in our primary marketplace. This includes
attempts at new entry into the market by established competitors that had not
previously done business in Chester County, as well as the formation of new
banks with management that are experienced in the Chester County market. All
of
these factors may adversely impact our ability to maintain or increase our
profitability.
Small
Size and Geographic Restrictions
.
We are
a community bank and do not have the capital resources or the number of people
that many of our competitors have. In addition, we cannot provide as many
products or services as some of our competitors, making it more difficult for
us
to compete. Our market territory is relatively small, which limits our ability
to diversify our credit risks and increase our business.
Real
Estate Loans.
Like
many community banks, many of our loans are commercial loans secured primarily
by commercial real estate. We are more vulnerable to losses on these loans
if
commercial real estate generally suffers a downturn in values. As a result,
if
commercial real estate values decline in the future, our profitability could
be
adversely affected.
Dependence
on Interest Income
.
Our
profitability depends heavily on net interest income. This means we can only
be
profitable if we lend money at higher interest rates than we borrow it through
deposits and other debt. Recently the margin between lending rates and borrowing
rates has gotten smaller, causing our net interest income to decline. While
we
are increasing fee-based income to make us less dependent on interest rates
for
profitability, we have not completed the implementation of strategies to
increase our fee-based income. If interest rate margins shrink further, or
if we
are unable to diversify our business to generate greater fee-based income,
our
profitability may be negatively impacted.
Dependence
on Key Personnel
.
As a
community bank, our success will depend greatly on the continued services of
our
executive officers. In order to be successful, we must attract, retain and
motivate key employees, and if we fail to do that, our profits could be hurt.
We
may not be successful in continuing to recruit experienced people for positions
with us, or in retaining necessary people. If we lose Mr. Latoff’s or Mr. Hieb’s
services or those of other key personnel, our future prospects could be
harmed.
Director
and Officer Liability Limitations.
Under
our articles of incorporation and Pennsylvania law, our directors and officers
may not be liable to us unless they breach a duty of loyalty, or they engage
in
intentional misconduct or violate the law, or if they gain an improper personal
benefit. Our bylaws permit us to indemnify our officers and directors to the
fullest extent permitted by law for all expenses incurred in settlement of
actions against them in connection with their service to us. Because we
indemnify our directors and officers, there is a risk they could make riskier
decisions than they would make if we did not offer them this protection.
Risks
Related to Balance Sheet Repositioning
.
We
announced a comprehensive plan designed to reposition our balance sheet and
improve core earnings. The plan calls for a substantial reduction in the size
of
the investment portfolio and expansion of the loan portfolio through new
originations, increased loan participations, as well as strategic loan and
lease
receivable purchases. We also announced plans to reduce debt borrowings with
cash flows from existing loans and investments and from new core deposit growth.
It is possible we will not be able to originate new loans or additional core
deposits as quickly as planned, or that changes in interest rates will make
this
strategy less effective in achieving our profitability goals. If we do not
achieve our balance sheet repositioning or revenue enhancement goals, our
profitability may be adversely affected.
Concentration
of Voting Control
.
As of
February 21, 2006, William S. Latoff, our Chairman and Chief Executive Officer,
owned 106,956 shares of our common stock, including 4,410 shares of restricted
stock that will vest on May 25, 2008. He can also obtain 50,352 additional
shares of common stock by exercising options he has previously been granted
by
the Company. Therefore, with the shares of common stock represented by options,
he potentially controls 6.73% of issued and outstanding voting stock. He has
expressed his intent to purchase additional shares of our common stock in the
future. We are likely to grant him additional stock options, restricted stock
or
other equity-based compensation that would increase his voting percentage
further. Our directors and officers as a group now own a total of 189,140 shares
of our common stock, including 16,569 shares of restricted stock that will
vest
in the future. They can also acquire 175,918 additional shares of common stock
by exercising options they have been granted. With the shares of common stock
represented by options granted to them, our directors and officers as a group
potentially control 14% of our issued and outstanding voting stock. Many of
our
directors and officers have indicated their intent to purchase additional shares
of common stock in the future. Further, it is likely they will be granted
additional stock options, restricted stock or other equity-based compensation
that would further increase the total voting percentage of our directors and
officers. We believe ownership of stock causes our directors and officers to
have the same interests as our shareholders, but it also gives them the ability
to vote as shareholders for matters that are in their personal
interest.
Possible
Future Capital Needs
.
There
is no assurance we will be able to generate sufficient capital through retained
earnings to achieve our operating and growth goals. We may require additional
capital in the future to support growth and expansion, to increase our legal
lending limit, and to accept increased deposits. If we are not able to raise
sufficient capital at an acceptable cost, we may not reach our profitability
goals and the value of a shareholder’s investment may be adversely
affected.
Possible
Dilution from Future Equity or Debt Offerings
.
We may
make additional offerings of equity or debt privately or publicly without
further approval by holders of our common stock. These offerings may include
senior debt, subordinated debt, additional trust preferred securities or common
or preferred stock, any of which we can issue without shareholder approval.
Additional debt or equity could be issued at prices that are greater or lower
than the market price of our shares. The offerings could dilute the book value,
voting control or market value of shares you purchase under the
Plan.
If
the Economy Gets Worse in Our Market, our Profits Could Be
Hurt
.
Recent
news reports indicate economists think the U.S. economy might not do well in
2006. Our profits can be hurt if the economy does not do well in areas where
we
do business, because we may not be able to find as many creditworthy borrowers,
or borrowers may decide to borrow less, or our losses on defaulted loans can
increase if borrowers have financial problems.
If
our Allowance for Credit Losses is Not Enough to Cover Future Credit Losses,
or
if We Do Not Manage our Credit Risks, our Earnings Could
Decrease
.
We make
assumptions and judgments about the collectibility of our loans, including
the
creditworthiness of our borrowers and the value of any collateral securing
our
loans. To determine our allowance for credit losses, we review our loans and
our
experience with loan losses and late loan payments, and we evaluate economic
conditions. If we make the wrong assumptions, our allowance for credit losses
may not be large enough to cover future losses on our loans. We also might
make
other mistakes in managing our credit risks. For example, we might not identify
credit risks in a loan or in our portfolio accurately. We might make mistakes
in
managing our loans or in trying to recover losses. These mistakes might reduce
our income, or require us to apply more of our income to add to the allowance
for credit losses, or both. Either of these results would hurt our profits.
Our
bank regulators also have to review our allowance for credit losses. If our
regulators decide we should increase it, we have to apply more of our income
to
do so, which might reduce our profits.
We
Have a Concentration of Exposure to Some Borrowers, Which Adds to our
Risks
.
The
total amount of loans we make to a group of related borrowers is called our
exposure to a borrowing relationship. As of December 31, 2005, the largest
exposure we had to a group of related borrowers was $4.8 million. This
equaled 8.0% of the total amount of our regulatory capital. For these purposes,
our regulatory capital includes our stated capital, our capital surplus, and
certain portions of our allowance for credit losses, with further adjustments,
as required by our banking regulators. The standard lending limit for national
banks is equal to 15% of this regulatory capital. As of December 31, 2005,
our total exposure to our 10 largest borrowing relationships was approximately
$35.2 million. This was approximately 60% of our regulatory capital for
these purposes. Because a default on a loan to one borrower in a group of
related borrowers can often result in defaults on the other loans to related
borrowers, and because larger loan amounts produce more losses to a bank when
they go into a default, if any of these loans goes into default and we cannot
recover all we have lent, there is a greater risk that a default on these loans
will produce a greater loss, and consequently a greater reduction in our
profitability. If the total exposure to a few borrowing relationships gets
too
big in relation to a bank’s capital, it increases the risk that loan defaults on
those borrowing relationships will reduce the bank’s capital. Without enough
capital, a bank cannot operate profitably and may be subject to regulatory
enforcement action.
Changes
in Regulations and Accounting Rules May Hurt our Revenue
.
Section
404 of the Sarbanes-Oxley Act requires many companies to spend a lot of money
to
strengthen their internal control. We do not know yet whether that requirement
will apply to us, but we have to make changes in our accounting and auditing
in
case it will. In addition, our auditors are charging us more because they have
to do more work in auditing our records. Other recent accounting changes, such
as the new rules for recognizing expenses associated with the value of stock
options we grant to employees, are changing our accounting and business
practices. The USA Patriot Act, OFAC and new regulations under the Bank Secrecy
Act are also costing us a lot of money and are expected to cost substantially
more during 2006 and succeeding years as we augment our BSA compliance program.
The Bank may not be in full compliance in these areas and, while management
is
actively assessing and working to strengthen the Bank’s BSA, OFAC and Patriot
Act compliance, there is a risk that the Bank could be exposed to enforcement
action, civil money penalties or other adverse actions in the future based
on
any shortcomings that may be identified in the Bank’s historic BSA compliance
program implementation. Other new bank regulations are also being adopted,
and
we must spend money to comply with them. In other cases, such as with our trust
preferred securities, Bank Owned Life Insurance and tax and accounting positions
we have taken, we depend upon Congress, regulatory agencies and accounting
rulemaking bodies not to make changes in their current positions on the proper
treatment of many of our activities. Any changes in these positions could hurt
our financial position and our profitability. We do not know what other rules
will be adopted in the future or whether new rules will be adopted. New rules
and changes in rules may increase our expenses in complying with them. This
may
hurt our future profits in ways we cannot predict now.
Unexpected
Events Affecting our Marketing Partners Could Hurt Our
Revenues
.
Over
recent years, we have sold more products and services jointly with other
organizations, and we have relied more on other organizations to provide
services to us to support our activities. We believe this trend will continue
and that we will be more dependent in the future on other organizations in
order
to run our business efficiently and profitably. If an unexpected loss or problem
affects one of these organizations, it could cost us money or hurt our ability
to be profitable. While we try to plan for these risks, we may not predict
some
of these types of events.
Our
Expansion Plans May Not be Successful
.
We have
been adding branches and offices, and we may add more in the future. We do
this
so that we can provide our products and services to more customers, which we
believe will make us more profitable. New offices cost us more money, but we
expect them to become profitable after a time. If new offices do not become
as
profitable as we hope or do not become profitable as quickly as we expect,
our
profits may be hurt.
Unexpected
Disasters May Hurt Our Profitability and Your Investment
.
Terrorist acts, conflicts, wars and natural disaster may seriously harm our
business and revenue, costs and expenses and financial condition and stock
price. While we try to make contingency plans to help continue our business
if a
disaster occurs, we might not anticipate every type of disaster, and our plans
might fail. In addition, some disasters might be so overwhelming that we would
not be able to recover from them. These situations could hurt our profitability
and in the worst case could destroy our business and wipe out your
investment.
Here
are
some risks that do not affect our business but could affect the value of an
investment in DNB Common Stock:
On
a Liquidation or in Certain Other Cases, Our Debt Holders May Hold Rights
Superior to Shareholders.
We have
issued trust preferred securities that constitute indebtedness. These securities
contain covenants requiring us to repay the debt with interest. If we fail
to do
so, the holders of that debt will have rights to seek repayment, and their
claims on our assets will have priority over your claim as a
shareholder.
Our
Governing Documents May Reduce the Influence of an Individual
Shareholder.
Our
articles of incorporation and bylaws give our directors substantial control
over
who sits on our board of directors and what proposals are presented to our
shareholder to consider. For example, the board is divided into three staggered
classes of directors. Only one class gets re-elected each year. As a result,
it
may take at least two years for a majority of directors to change. Second,
under
our articles of incorporation, a shareholder may not cumulate votes for the
election of directors. As a result, the same majority of shareholders may
control the election of each director position. Third, our bylaws impose time
limits and other requirements on a shareholder who wants to nominate a director
or make a proposal for new business at a shareholder meeting. As a result,
the
nomination or proposal may be delayed until the shareholder meets these
requirements. These provisions may also give our management more time to
evaluate and respond to a shareholder nomination or proposal and, if management
believes the nomination or proposal is not in the best interests of
shareholders, to advocate that it not be adopted.
Our
Governing Documents May Make it More Difficult for Another Company to Buy
DNB
.
Our
articles of incorporation and bylaws contain provisions that may make it harder
for another company to acquire control of DNB. For example, a change in control
of DNB cannot occur unless it has been approved by shareholders owning at least
75% of the shares of DNB common stock or by two-thirds of DNB’s directors. In
addition, the board of directors may oppose another company’s offer to buy DNB
from its shareholders and in doing so may consider many factors not directly
involving the current value of DNB stock. We believe these provisions help
DNB
become more profitable because they let our management concentrate on developing
the profitability of DNB’s business for the benefit of our shareholders. As a
result of these provisions, if another company tries to offer shareholders
a
higher price than shareholders can obtain by selling them in the open market,
our shareholders may not be able to sell their shares to the other company
without the approval of our board of directors.
Item
1B.
Unresolved
Staff Comments
Not
applicable.
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 leases its operations
center located at 104-106 Brandywine Avenue, Downingtown. With the exception
of
the West Goshen office, Exton office, West Chester office and limited service
offices in Newtown Square and 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 $3.9 million including leasehold improvements at December
31, 2005. The Bank’s trust department and wealth management unit, operating
under the name, “DNB Advisors,” have offices in the Bank’s Exton
Office.
The
bank
has twelve offices located in Chester and Delaware Counties, 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, Chester Springs
|
Owned
|
||
|
Tel
Hai Office
|
Tel
Hai Retirement Community, Honey Brook (Limited Service)
|
Leased
|
||
|
West
Goshen Office
|
1115
West Chester Pike, West Chester
|
Leased
|
||
|
West
Chester Office
|
2
North Church Street, West Chester
|
Leased
|
||
|
Newtown
Square Office
|
3409
West Chester Pike, Suite 102, Newtown Square (Limited
Service)
|
Leased
|
On
November 18, 2005, the Bank sold its operations center and an adjunct
administrative office at 104-106 Brandywine Avenue, to an unaffiliated buyer
for
$1,700,000 and leased the Property from the buyer for an initial term ending
December 1, 2010, on a triple net basis for an initial annual basic lease rental
of approximately $176,000. The Lease gives the Bank successive options to renew
its term for three additional terms of five years each at a basic rent to be
established at a fair market rental taking into account all of the terms and
conditions of this Lease, and an option to terminate the Lease at any time
on
120 days prior notice.
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
None.
Part
II
(a)
Market Price of and Dividends on Registrant’s Common Equity
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 1,250 stockholders who owned 2.4 million shares
of common stock outstanding at March 2, 2006.
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 Boenning &
Scattergood, Inc. and Ferris, Baker Watts, Inc. These over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. 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 to
reflect stock dividends.
|
2005
|
2004
|
|||
|
High
|
Low
|
High
|
Low
|
|
|
First
quarter
|
$28.10
|
$25.48
|
$27.21
|
$24.49
|
|
Second
quarter
|
26.95
|
25.29
|
25.35
|
22.68
|
|
Third
quarter
|
25.00
|
22.38
|
23.81
|
22.74
|
|
Fourth
quarter
|
22.14
|
18.95
|
25.48
|
22.95
|
The
information required with respect to the frequency and amount of the
Registrant’s cash dividends declared on each class of its common equity for the
two most recent fiscal years is set forth in the section of this report titled,
“Item 6 - Selected Financial Data” on page
.
The
information required with respect to securities authorized for issuance under
the Registrant’s equity compensation plans is set forth in “Item 12 - Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters” on page
.
(b)
Recent Sales of Unregistered Securities
The
following information relates to all securities of the registrant sold by the
registrant within the past three years which were not registered under the
Securities Act of 1933, including sales of reacquired securities, as well as
new
issues, securities issued in exchange for property, services or other
securities, and new securities resulting from the modification of outstanding
securities.
On
November 14, 2005, the registrant sold 265,730 shares of its common stock,
par
value $1.00 per share in a private, unregistered offering, at a cash sale price
of $21.00 per share. The registrant did not use any underwriters or placement
agents in the sale. Of the total offering, the registrant sold 204,877 shares
to
a total of 42 individuals and organizations not otherwise affiliated with the
registrant, and a total of 60,853 shares to certain of its directors and
officers as follows: William S. Latoff, 28,572 shares; William J. Hieb, 1,200
shares; Mildred C. Joyner, 1,000 shares; James J. Koegel, 19,048 shares; Eli
Silberman, 1,191 shares; Thomas M. Miller, 3,571 shares; Raymond Mincarelli,
1,500 shares; Richard M. Wright, 1,200 shares; J. Curtis Joyner (spouse of
Mildred C. Joyner, Director), 2,380 shares; and Janeice H. Silberman (spouse
of
Eli Silberman, Director), 1,191 shares. The aggregate offering price for the
securities sold was $5.6 million in cash. The registrant did not pay any
underwriting discounts or commissions, and did not pay the brokerage fees for
any purchasers of the shares. The registrant relies upon the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933 and Rule
506
of SEC Regulation D, in that: (a) the shares were sold only to individuals
and
organizations qualifying as “accredited investors” under Regulation D; (b) the
shares were sold without any general solicitation or public advertising; (c)
the
purchasers provided the registrant with representations customary for a private
placement of securities; and (d) certificates delivered to the purchasers bear
a
restrictive legend. The shares are not subject to any related agreements, rights
or conditions other than the transfer restrictions. The registrant has no
material relationships with any of the purchasers other than its purchasing
directors and officers, except the relationship established by their purchase
of
the shares as described above. The shares sold constitute 11.8% of the number
of
shares outstanding of the class of equity securities sold, as determined
immediately after the sale of the shares. The registrant is contributing the
net
proceeds of the offering to its wholly owned subsidiary, DNB First, National
Association (the “Bank”), for use for the Bank’s general corporate
purposes.
(c)
Purchases of Equity Securities by the Registrant and Affiliated
Purchasers
The
following table provides information on repurchases by or on behalf of DNB
or
any “affiliated purchaser” (as defined in Regulation 10b-18(a)(3)) of its common
stock in each month of the quarter ended December 31, 2005:
|
Period
|
|
Total Number
Of
Shares Purchased
|
|
Average
Price
Paid
Per
Share
|
|
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs (a)
|
|
|
October
1, 2005 - October 31, 2005
|
|
—
|
|
$
|
—
|
|
—
|
|
145,320
|
|
November
1, 2005 - November 30, 2005
|
|
—
|
|
—
|
|
—
|
|
145,320
|
|
|
December
1, 2005 - December 31, 2005
|
|
250
|
|
20.00
|
|
250
|
|
145,070
|
|
|
Total
|
|
250
|
|
$
|
20.00
|
|
250
|
|
145,070
|
|
(a)
|
On
July 25, 2001, DNB authorized the buyback of up to 183,750 shares
of its
common stock over an indefinite period. On August 27, 2004, DNB increased
the buyback from 183,750 to 358,313 shares of its common stock over
an
indefinite period. This number has been adjusted to reflect the 5%
stock
dividend issued in December 2005.
|
The
selected financial data set forth below is derived in part from, and should
be
read in conjunction with, the Consolidated Financial Statements and Notes
thereto, contained elsewhere herein.
|
At
or For the Year Ended December 31
|
||
|
(Dollars
in thousands, except share data)
|
|
2005
|
2004
|
2003
|
2002
|
2001
|
||||||
|
RESULTS
OF OPERATIONS
|
||||||||||
|
Interest
income
|
$23,427
|
$20,233
|
$18,894
|
$21,498
|
$24,389
|
|||||
|
Interest
expense
|
9,313
|
6,833
|
7,421
|
9,430
|
13,109
|
|||||
|
Net
interest income
|
14,114
|
13,400
|
11,473
|
12,068
|
11,280
|
|||||
|
Provision
for credit losses
|
—
|
—
|
—
|
—
|
—
|
|||||
|
Other
non-interest income
|
2,356
|
2,940
|
2,540
|
2,645
|
2,303
|
|||||
|
Other-than-temporary
charge
|
—
|
(2,349
|
)
|
—
|
—
|
—
|
||||
|
Total
non-interest income
|
2,356
|
591
|
2,540
|
2,645
|
2,303
|
|||||
|
Non-interest
expense
|
14,411
|
13,189
|
12,622
|
11,257
|
9,894
|
|||||
|
Income
before income taxes
|
2,059
|
802
|
1,391
|
3,456
|
3,689
|
|||||
|
Income
tax (benefit) expense
|
(89
|
)
|
504
|
(10
|
)
|
728
|
967
|
|||
|
Net
income
|
$
2,148
|
$
298
|
$
1,401
|
$
2,728
|
$
2,722
|
|||||
|
PER
SHARE DATA*
|
||||||||||
|
Basic
earnings
|
$1.02
|
$0.14
|
$0.67
|
$1.29
|
$1.26
|
|||||
|
Diluted
earnings
|
1.00
|
0.14
|
0.65
|
1.27
|
1.25
|
|||||
|
Cash
dividends
|
0.50
|
0.47
|
0.45
|
0.43
|
0.41
|
|||||
|
Book
value
|
13.07
|
11.98
|
12.10
|
12.38
|
11.71
|
|||||
|
Weighted
average
|
||||||||||
|
Common
shares outstanding - basic
|
2,115,693
|
2,079,341
|
2,094,993
|
2,116,809
|
2,158,841
|
|||||
|
FINANCIAL
CONDITION
|
||||||||||
|
Total
assets
|
$473,046
|
$441,059
|
$409,013
|
$384,368
|
$389,404
|
|||||
|
Loans
and leases
|
288,130
|
232,577
|
203,553
|
187,585
|
186,050
|
|||||
|
Allowance
for credit losses
|
4,420
|
4,436
|
4,559
|
4,546
|
4,809
|
|||||
|
Deposits
|
339,627
|
323,144
|
292,436
|
287,802
|
293,383
|
|||||
|
Stockholders’
equity
|
30,186
|
24,738
|
25,372
|
26,208
|
25,288
|
|||||
|
SELECTED
RATIOS
|
||||||||||
|
Return
on average stockholders’ equity
|
8.31
|
%
|
1.16
|
%
|
5.47
|
%
|
10.66
|
%
|
10.97
|
%
|
|
Return
on average assets
|
0.48
|
0.07
|
0.35
|
0.72
|
0.74
|
|||||
|
Average
equity to average assets
|
5.77
|
6.05
|
6.41
|
6.76
|
6.76
|
|||||
|
Loans
to deposits
|
84.84
|
71.97
|
69.61
|
65.18
|
63.42
|
|||||
|
Dividend
payout ratio
|
49.39
|
337.58
|
67.83
|
33.41
|
32.32
|
|
*
|
Per
share data and shares outstanding have been adjusted for the 5% stock
dividends in December of 2005, 2004, 2003, 2002 and
2001.
|
I.
Introductory
Overview
DNB
Financial Corporation is a bank holding company whose bank subsidiary, DNB
First, National Association (the “Bank”) is a nationally chartered commercial
bank with trust powers, and a member of the FDIC. DNB provides a broad range
of
banking services to individual and corporate customers through its twelve
community offices located throughout Chester and Delaware Counties,
Pennsylvania. DNB is a community banking organization that focuses its lending
and other services on businesses and consumers in the local market area. DNB
funds all these activities with retail and business deposits and borrowings.
Through its DNB Advisors division, the Bank provides wealth management and
trust
services to individuals and businesses. The Bank and its subsidiary, DNB
Financial Services, Inc. through the name “DNB Financial Services,” make
available certain non-depository products and services, such as securities
brokerage, mutual funds, life insurance and annuities.
DNB
earns
revenues and generates cash flows by lending funds to commercial and consumer
customers in its marketplace. DNB generates its largest source of interest
income through its lending function. Secondary sources of interest income are
DNB’s investment portfolio, which provide liquidity and cash flows for future
lending needs.
In
addition to interest earned on loans and investments, DNB earns revenues from
fees it charges customers for non-lending services. These services include
wealth management and trust services; brokerage and investment services; cash
management services; banking and ATM services; as well as safekeeping and other
depository services.
To
implement the culture changes necessary at DNB First to become an innovative
community bank capable of meeting challenges of the 21st century, we embarked
on
a strategy called "Loyalty, Bank On It." In recognizing the importance of
loyalty in our everyday lives, we have embraced this concept as the cornerstone
of DNB First's new culture in 2006. To that end, DNB continues to make
appropriate investments in all areas of our business, including people,
technology, facilities and marketing.
Highlights
of DNB’s results for the year-end December 31, 2005 include:
·
Strong
growth in annual operating earnings
·
Solid
loan growth - up 23.9%
·
Steady
growth in deposits - up 5.1%
Earnings
.
For the
year ended December 31, 2005, DNB reported net income of $2.1 million, an
increase of $1.8 million from the $298,000 reported for the year ended December
31, 2004, or $1.00 per share versus $0.14 per share, respectively, on a fully
diluted basis. During 2005, DNB reversed a portion of the previously recorded
valuation allowance for deferred tax assets and recognized a related income
tax
benefit of $308,000. A significant portion of the reversal was associated with
a
tax gain recognized on the sale of two operations buildings as well as an
additional reversal made in connection with the sale of agency preferred
securities which is discussed in detail on page 20 under the heading
“
Investment
Portfolio Restructure”
.
The
reduced earnings for 2004, was attributable to a $2.3 million
other-than-temporary impairment charge taken on Government Agency Securities
and
a $250,000 charge taken in connection with the retirement of DNB’s
former
President
and Chief Executive Officer, each of which was taken in the fourth quarter
of
2004.
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 paid in 2005 and 2004.
Quarterly
Financial Data
|
(Dollars
in thousands,
|
2005
|
2004
|
||||||||||||||
|
except
per share data)
|
Fourth
|
Third
|
Second
|
First
|
Fourth
|
Third
|
Second
|
First
|
||||||||
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
|||||||||
|
Interest
income
|
$
6,325
|
$
6,180
|
$
5,715
|
$
5,207
|
$
5,257
|
$
5,192
|
$
4,901
|
$
4,883
|
||||||||
|
Interest
expense
|
2,689
|
2,487
|
2,255
|
1,882
|
1,789
|
1,741
|
1,620
|
1,683
|
||||||||
|
Net
interest income
|
3,636
|
3,693
|
3,460
|
3,325
|
3,468
|
3,451
|
3,281
|
3,200
|
||||||||
|
Provision
for credit losses
|
(120
|
)
|
75
|
30
|
15
|
—
|
—
|
—
|
—
|
|||||||
|
Other
non-interest income
|
779
|
761
|
760
|
56
|
624
|
707
|
822
|
788
|
||||||||
|
Other-than-temporary
charge
|
—
|
—
|
—
|
—
|
(2,349
|
)
|
—
|
—
|
—
|
|||||||
|
Total
non-interest income
|
779
|
761
|
760
|
56
|
(1,725
|
)
|
707
|
822
|
788
|
|||||||
|
Non-interest
expense
|
3,754
|
3,678
|
3,538
|
3,441
|
3,542
|
3,273
|
3,209
|
3,165
|
||||||||
|
Income
(loss) before
income
taxes
|
781
|
701
|
652
|
(75
|
)
|
(1,799
|
)
|
885
|
894
|
823
|
||||||
|
Income
tax (benefit) expense
|
(64
|
)
|
114
|
15
|
(154
|
)
|
5
|
161
|
185
|
154
|
||||||
|
Net
income (loss)
|
845
|
587
|
637
|
79
|
(1,804
|
)
|
724
|
709
|
669
|
|||||||
|
Adjustment
(1)
|
—
|
—
|
—
|
—
|
2,534
|
—
|
—
|
—
|
||||||||
|
Operating
earnings
|
$
845
|
$
587
|
$
637
|
$
79
|
$
730
|
$
724
|
$
709
|
$
669
|
||||||||
|
Basic
earnings (loss) per share
|
$
0.39
|
$
0.28
|
$
0.31
|
$
0.04
|
$
(0.87
|
)
|
$
0.35
|
$
0.34
|
$
0.32
|
|||||||
|
Adjustment
(1)
|
—
|
—
|
—
|
—
|
1.23
|
—
|
—
|
—
|
||||||||
|
Operating
basic earnings
per
share
|
0.39
|
0.28
|
0.31
|
0.04
|
0.36
|
0.35
|
0.34
|
0.32
|
||||||||
|
Diluted
earnings (loss)
per
share
|
0.39
|
0.28
|
0.30
|
0.04
|
(0.85
|
)
|
0.34
|
0.33
|
0.32
|
|||||||
|
Adjustment
(1)
|
|
—
|
—
|
—
|
—
|
1.21
|
—
|
—
|
—
|
|||||||
|
Operating
diluted earnings
per
share
|
0.39
|
0.28
|
0.30
|
0.04
|
0.36
|
0.34
|
0.33
|
0.32
|
||||||||
|
Cash
dividends per share
|
$0.124
|
$0.124
|
$0.124
|
$0.124
|
$0.118
|
$0.118
|
$0.118
|
$0.118
|
||||||||
(1)
The
above
adjustments (after tax) relate to the $2,283,968 other-than-temporary impairment
write-down of preferred stock as well as the $250,000 charge associated with
the
retirement of DNB’s former President and CEO.
Asset
Quality.
Total
non-performing loans were $1.4 million at December 31, 2005 compared to $425,000
at December 31, 2004. Non-performing loans to total loans was .47% at December
31, 2005 compared to .18% at December 31, 2004. Despite increases in recent
levels of non-performing assets, DNB’s asset quality remains strong compared to
its peer group. The allowance for credit losses was $4.4 million at December
31,
2005 and 2004. The allowance to total loans was 1.53% at December 31, 2005
compared to 1.91% at December 31, 2004. This decrease was a result of strong
loan growth in 2005.
II.
Overview
of Financial Condition - Major Changes and Trends
At
December 31, 2005, DNB had consolidated assets of $473.0 million and a Tier
I/Leverage Capital -Ratio of 8.61%. Loans and leases comprise 63.0% of earning
assets, while investments and federal funds sold constitute the remainder.
During 2005, assets increased $32.0 million to $473.0 million at December 31,
2005, compared to $441.1 million at December 31, 2004. Investment securities
decreased $23.0 million to $146.7 million, while the loan and lease portfolio
grew $55.6 million, or 23.9%, to $288.1 million. Deposits increased $16.5
million to $339.6 million at December 31, 2005. DNB credit quality remained
strong, as did the allowance for credit losses, which was 1.53% of total loans
and leases. DNB’s delinquency ratio (total delinquent loans and leases to total
loans and leases) was .9% at December 31, 2005 down from 1.0% at December 31,
2004. DNB’s liabilities are comprised of a high level of core deposits with a
low cost of funds in addition to a moderate level of borrowings with costs
that
are more volatile than core deposits. During the last few years, a flat yield
curve and significant margin compression contributed to lower levels of
earnings.
During
2005, DNB completed a private placement sale of 265,730 shares of its common
stock to 53 accredited investors at a price of $21.00 per share, realizing
total
offering proceeds of $5.5 million. DNB’s management team and board of directors
organized the offering. There were not any brokerage or underwriting commissions
paid in relation to the private placement.
Comprehensive
5-Year Plan.
During
2003, management developed a strategic 5-year plan designed to reposition its
balance sheet and improve core earnings. As part of the plan, management
announced its intentions to substantially reduce the size of its investment
portfolio and expand its loan portfolio through new originations, increased
loan
participations, as well as strategic loan and lease receivable purchases.
Management also planned a reduction in the absolute level of borrowings with
cash flows from existing loans and investments as well as from new core deposit
growth. A detailed discussion on DNB’s progress follows below.
Investment
Portfolio Restructure.
As
part
of its previously announced balance sheet repositioning, DNB took advantage
of
the rate environment to restructure a significant portion of its investment
securities portfolio. In March 2005, DNB sold $73.3 million of structured
securities, government agency preferred stock, longer-term municipal securities,
as well as corporate securities, resulting in a net pre-tax loss of $699,000.
In
total, net pre-tax gains of $300,000 were recognized during 2005, on the sale
of
preferred stock. As such, the gains recognized on the sale of the preferred
stock (capital assets) resulted in a reversal of a portion of a previously
recorded valuation allowance for deferred tax assets of $102,000 for 2005.
This
amount contributed to a reduction in income tax expense for 2005.
The
majority of the proceeds received on the sale of these investments were
re-invested into higher yielding agency mortgage-backed securities, agency
bonds
and municipal securities. Management believed that the restructured portfolio
will result in more stable earnings and cash flow, as well as improved value
metrics.
Continued
Progress in Balance Sheet Repositioning.
DNB
decreased its investment portfolio, grew its loan portfolio, reduced its FHLB
borrowings and increased deposits in a continuing effort to strengthen its
balance sheet during 2005. During the year, the investment portfolio decreased
$23.0 million or by 13.6%, loans increased $55.6 million or by 23.9%, with
solid
growth in all sectors. Commercial loans and leases increased $25.3 million,
while residential and consumer loans increased $30.2 million. In addition,
DNB
increased its deposit base by $16.5 million and added $12.9 million in customer
repurchase agreements. FHLB borrowings declined $7.8 million or by 13% to $53.9
million.
DNB’s
financial objectives are focused on earnings per diluted share growth and return
on average equity. In order to achieve its financial objectives, DNB defined
the
following strategies as part of the 5-Year Plan:
•
Grow
loans and diversify the mix
•
Reduce
the size of the investment portfolio
•
Reduce
long-term borrowings
•
Enhance
the branch network and alternative delivery options
•
Focus
on
profitable customer segments
•
Grow
and
diversify non-interest income
Management’s
strategies are designed to direct DNB’s tactical investment decisions and
support financial objectives. DNB’s most significant revenue source continues to
be net interest income, defined as total interest income less interest expense,
which in 2005 accounted for approximately 86% of total revenue. To produce
net
interest income and consistent earnings growth over the long-term, DNB must
generate loan and deposit growth at acceptable economic spreads within its
market area. To generate and grow loans and deposits, DNB must focus on a number
of areas including, but not limited to, the economy, branch expansion, sales
practices, customer satisfaction and retention, competition, customer behavior,
technology, product innovation and credit performance of its customers.
Management
has made a concerted effort to improve the measurement and tracking of business
lines and overall corporate performance levels. Improved information systems
have increased DNB’s ability to track key indicators and enhance corporate
performance levels. Better measurement against goals and objectives and
increased accountability will be integral in attaining desired loan, deposit
and
fee income production.
III.
DNB’s
Principal Products and Services
Loans
and Lending Services.
DNB’s
primary source of earnings and cash flows is derived from its lending function.
Sixty-eight percent of DNB’s portfolio relates to commercial loans and lease
products. DNB focuses on providing these products to small to mid-size
businesses throughout Chester and Delaware Counties. In keeping with DNB’s goal
to match customer business initiatives with products designed to meet their
needs, DNB offers a wide variety of fixed and variable rate loans that are
priced competitively. DNB serves this market by providing funds for the purchase
of business property or ventures, working capital lines, lease financing for
equipment and for a variety of other purposes. Net loan and lease growth in
the
commercial loan and lease portfolios amounted to $25.3 million or 14.8% in
2005.
As
a
community bank, DNB also serves consumers by providing home equity and home
mortgages, as well as term loans for the purchase of consumer goods. During
the
current low interest rate environment, there has been a high demand for consumer
home equity loan products. DNB has successfully met this demand with a variety
of fixed and variable rate home equity loans and lines, secured by first or
second liens on the borrowers’ primary residence. At December 31, 2005, consumer
loans totaled $48.4 million, up 12.0% from 2004.
In
addition to providing funds to customers, DNB also provides a variety of
services to its commercial customers. These services, such as cash management,
commercial sweep accounts, internet banking, letters of credit and other lending
products, are designed to meet our customer needs and help them become
successful. DNB provides these -services to assist its customers in obtaining
financing, securing business opportunities, providing access to new resources
and managing cash flows.
Deposit
Products and Services
.
DNB’s
primary source of funds is derived from customer deposits, which are typically
generated by DNB’s twelve branch offices. DNB’s deposit base, while highly
concentrated in central Chester County, extends to southern Chester County
and
into parts of Delaware and Lancaster Counties. In addition, a growing amount
of
new deposits are being generated through expanded government service offerings
and as a part of comprehensive loan or wealth management
relationships.
The
majority of DNB’s deposit mix consists of low costing core deposits, (demand,
NOW and savings accounts). The remaining deposits are comprised of
rate-sensitive money market and time products. DNB offers tiered savings and
money market accounts, designed to attract high dollar, less volatile funds.
Certificates of deposit and IRAs are traditionally offered with interest rates
commensurate with their terms.
Non-Deposit
Products and Services.
DNB
offers non-deposit products and services through its subsidiaries under the
names “DNB Financial Services” (“DNBFS”) and “DNB Advisors.”
DNB
Financial Services.
Through
a
partnership with UVEST Financial Services, DNBFS offers a complete line of
investment and insurance products.
DNB
Advisors
.
DNB
Advisors offers a full line of products and services, which includes the
following.
|
•
|
Investment
Management
|
•
|
Investment
Advisory
|
|
•
|
Estate
Settlement
|
•
|
Trust
Services
|
|
•
|
Custody
Services
|
•
|
Retirement
Planning
|
|
•
|
Safekeeping
|
IV.
Material
Challenges, Risks and Opportunities
A.
Interest
Rate Risk Management
.
Interest
rate risk is the exposure to adverse changes in net interest income due to
changes in interest rates. DNB considers interest rate risk a predominant risk
in terms of its potential impact on earnings. Interest rate risk can occur
for
any one or more of the following reasons: (a) assets and liabilities may mature
or re-price at different times; (b) short-term or long-term market rates may
change by different amounts; or (c) the remaining maturity of various assets
or
liabilities may shorten or lengthen as interest rates change.
The
principal objective of the Bank’s interest rate risk management is to evaluate
the interest rate risk included in certain on and off balance sheet accounts,
determine the level of risk appropriate given the Bank’s business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. Through
such management, the Bank seeks to reduce the vulnerability of its operations
to
changes in interest rates. The Bank’s Asset Liability Committee (the “ALCO”) is
responsible for reviewing the Bank’s asset/liability policies and interest rate
risk position and making decisions involving asset liability considerations.
The
ALCO meets on a monthly basis and reports trends and the Bank’s interest rate
risk position to the Board of Directors. The extent of the movement of interest
rates is an uncertainty that could have a negative impact on the earnings of
the
Bank.
1.
Net
Interest Margin
DNB’s
net
interest margin is the ratio of net interest income to average interest-earning
assets. Unlike the interest rate spread, which measures the -difference between
the rates on earning assets and interest paying liabilities, the net interest
margin measures that spread plus the effect of net free funding sources. This
is
a more meaningful measure of profitability because a bank can have a narrow
spread but a high level of -equity and non-interest-bearing deposits, resulting
in a good net interest margin. One of the most critical challenges DNB faced
over the last several years was the impact of historically low interest rates
and a narrower spread between short-term rates and long-term rates as noted
in
the tables below.
|
December
31,
|
||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
2000
|
|
|
Prime
|
7.25%
|
5.25%
|
4.00%
|
4.25%
|
4.75%
|
9.00%
|
|
Federal
Funds Sold (“FFS”)
|
4.25%
|
2.25%
|
1.00%
|
1.25%
|
1.75%
|
6.00%
|
|
6
month Treasury
|
4.25%
|
2.56%
|
1.00%
|
1.21%
|
1.80%
|
5.06%
|
|
Historical
Yield Spread
|
||||||
|
December
31,
|
||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
||
|
FFS
to 5 Year U.S. Treasury
|
0.10%
|
1.38%
|
2.25%
|
1.53%
|
2.63%
|
|
|
FFS
to 10 Year U.S. Treasury
|
0.14%
|
1.99%
|
3.27%
|
2.58%
|
3.32%
|
|
In
late
2003, management and the Board of Directors of DNB reviewed the declines in
DNB’s net interest margin and in that connection evaluated DNB’s funds
management practices to assess the quantity and quality of risk management
over
interest rate risk and liquidity risk. Based on the review, they determined
that
the decline in DNB’s net interest margin and the relatively high level of
interest rate risk resulted from a number of factors. Those factors included
the
following: slow loan growth; a dependency on investment portfolio income and
a
reliance on wholesale borrowings to fund investments; and high levels of cash
flow coming from mortgage related products during a historically low interest
rate environment. Management and the Board of Directors decided to take the
following actions to address the decline in net interest income: improve DNB’s
Strategic Plan and related controls to address the net income contribution
of
the loan portfolio; complete a review of DNB’s Liquidity Policy, as well as its
Asset/Liability Management Policy and revise them where necessary; restructure
the investment portfolio to mitigate risks of future prepayments; increase
monitoring and assessment of leverage strategies; make greater use of available
outside resources for -monitoring and managing interest rate risk and
asset/liability risks; evaluate asset/liability policies to determine that
risk
limits are appropriate; and provide for independent periodic evaluation of
information and methods used in asset/liability and interest rate risk
management.
The
items
mentioned above were critical factors in management’s decision to reposition a
portion of its investment portfolio to improve earnings. Since 2003, management
has focused its efforts on positioning the balance sheet for increased rates.
In
anticipation of higher rates, management attempted to shorten the duration
of
its investment portfolio and lengthen the maturity of its deposit base. As
a
result, the size of the investment portfolio has decreased by $27.7 million
or
15.9% over the last two years. These funds have been used to pay-down FHLB
borrowings and to fund loan and lease growth. DNB’s investment portfolio was
31.0% of DNB’s balance sheet at December 31, 2005 compared 38.5% and 42.6% at
December 31, 2004 and 2003, respectively.
The
table
below 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. Non-accrual loan balances are included
in
total loans. Loan fees and costs are included in interest on total
loans.
Average
Balances, Rates, and Interest Income and Expense
(Dollars
in thousands)
|
Year
Ended December 31
|
|||||||||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||||||||
|
Average
|
Yield/
|
Average
|
Yield/
|
Average
|
Yield/
|
||||||||||||||
|
Balance
|
Interest
|
Rate
|
Balance
|
Interest
|
Rate
|
Balance
|
Interest
|
Rate
|
|||||||||||
|
ASSETS
|
|||||||||||||||||||
|
Interest-earning
assets:
|
|||||||||||||||||||
|
Investment
securities:
|
|||||||||||||||||||
|
Taxable
|
$128,238
|
$
5,063
|
3.95
|
%
|
$150,179
|
$
4,949
|
3.30
|
%
|
$159,477
|
$
4,718
|
2.96
|
%
|
|||||||
|
Tax-exempt
|
28,380
|
1,664
|
5.86
|
24,422
|
1,529
|
6.26
|
14,696
|
863
|
5.87
|
||||||||||
|
Tax-preferred
DRD
|
2,199
|
77
|
3.50
|
10,991
|
362
|
3.29
|
13,499
|
567
|
4.20
|
||||||||||
|
Total
securities
|
158,817
|
6,804
|
4.28
|
185,592
|
6,840
|
3.69
|
187,672
|
6,148
|
3.28
|
||||||||||
|
Cash
and cash equivalents
|
13,085
|
218
|
1.66
|
4,812
|
64
|
1.33
|
4,012
|
48
|
1.20
|
||||||||||
|
Total
loans and leases
|
259,077
|
17,056
|
6.58
|
218,513
|
13,987
|
6.40
|
185,659
|
13,178
|
7.10
|
||||||||||
|
Total
interest-earning assets
|
430,979
|
24,078
|
5.59
|
408,917
|
20,891
|
5.11
|
377,343
|
19,374
|
5.13
|
||||||||||
|
Non-interest-earning
assets
|
16,965
|
15,837
|
22,012
|
||||||||||||||||
|
Total
assets
|
$447,944
|
$424,754
|
$399,355
|
||||||||||||||||
|
LIABILITIES
AND
|
|||||||||||||||||||
|
STOCKHOLDERS’
EQUITY
|
|||||||||||||||||||
|
Interest-bearing
liabilities:
|
|||||||||||||||||||
|
Savings
deposits
|
$193,205
|
$
2,438
|
1.26
|
%
|
$183,283
|
$
1,141
|
0.62
|
%
|
$155,562
|
$
1,001
|
0.64
|
%
|
|||||||
|
Time
deposits
|
74,549
|
2,096
|
2.81
|
68,631
|
1,534
|
2.24
|
80,916
|
2,201
|
2.72
|
||||||||||
|
Total
interest-bearing
Deposits
|
267,754
|
4,534
|
1.69
|
251,914
|
2,675
|
1.06
|
236,478
|
3,202
|
1.35
|
||||||||||
|
Federal
funds purchased
|
624
|
21
|
3.44
|
858
|
12
|
1.42
|
913
|
14
|
1.53
|
||||||||||
|
Repurchase
agreements
|
30,549
|
821
|
2.69
|
11,926
|
145
|
1.22
|
—
|
—
|
—
|
||||||||||
|
FHLB
advances
|
59,506
|
3,278
|
5.51
|
77,376
|
3,626
|
4.69
|
83,648
|
3,842
|
4.59
|
||||||||||
|
Other
borrowings
|
8,990
|
659
|
7.32
|
5,870
|
375
|
6.38
|
5,724
|
363
|
6.35
|
||||||||||
|
Total
interest-bearing
Liabilities
|
367,423
|
9,313
|
2.53
|
347,944
|
6,833
|
1.96
|
326,763
|
7,421
|
2.27
|
||||||||||
|
Demand
deposits
|
52,863
|
49,214
|
45,762
|
||||||||||||||||
|
Other
liabilities
|
1,803
|
1,886
|
1,214
|
||||||||||||||||
|
Stockholders’
equity
|
25,855
|
25,710
|
25,616
|
||||||||||||||||
|
Total
liabilities and
|
|||||||||||||||||||
|
stockholders’
equity
|
$447,944
|
$424,754
|
$399,355
|
||||||||||||||||
|
Net
interest income
|
$14,765
|
$14,058
|
$11,953
|
||||||||||||||||
|
Interest
rate spread
|
3.05
|
%
|
3.15
|
%
|
2.86
|
%
|
|||||||||||||
|
Net
interest margin
|
3.43
|
%
|
3.44
|
%
|
3.13
|
%
|
|||||||||||||
Although
DNB believes that the non-GAAP financial measures included in the Average
Balance table above enhance investor’s understanding of DNB’s business and
performance, and DNB management uses these non-GAAP financial measures in
evaluating DNB’s performance, these non-GAAP financial measures should not be
considered an alternative to GAAP. The reconciliation of these non-GAAP
financial measures to GAAP is presented below.
|
Reconciliation
of Non-GAAP Financial Measures
|
|||||||||||||
|
Year
Ended December 31
|
|||||||||||||
|
2005
|
2004
|
2003
|
|||||||||||
|
(Dollars
in thousands)
|
Interest
|
Yield/Rate
|
Interest
|
Yield/Rate
|
Interest
|
Yield/Rate
|
|||||||
|
Securities
- tax-exempt
|
$
1,101
|
3.88
|
%
|
$
1,009
|
4.13
|
%
|
$
587
|
4.00
|
%
|
||||
|
Tax
equivalent adjustments
|
563
|
520
|
276
|
||||||||||
|
Securities
- tax equivalent yield
|
1,664
|
5.86
|
1,529
|
6.26
|
863
|
5.87
|
|||||||
|
Securities
- tax-preferred DRD
|
57
|
2.57
|
266
|
2.42
|
417
|
3.09
|
|||||||
|
Tax
equivalent adjustments
|
20
|
96
|
150
|
||||||||||
|
Securities
- tax equivalent yield
|
77
|
3.50
|
362
|
3.29
|
567
|
4.20
|
|||||||
|
Loans
and leases - tax-exempt
|
16,988
|
6.56
|
13,945
|
6.38
|
13,124
|
7.07
|
|||||||
|
Tax
equivalent adjustments
|
68
|
|
42
|
|
54
|
||||||||
|
Loans
and leases - tax equivalent yield
|
17,056
|
6.58
|
13,987
|
6.40
|
13,178
|
7.10
|
|||||||
|
Net
interest income
|
14,114
|
|
13,400
|
|
11,473
|
||||||||
|
Tax
equivalent adjustments
|
651
|
658
|
480
|
||||||||||
|
Net
interest income tax equivalent
|
$14,765
|
$14,058
|
$11,953
|
||||||||||
|
Net
interest rate spread, no tax adjustment
|
2.90
|
%
|
2.98
|
%
|
2.74
|
%
|
|||||||
|
Net
interest margin, no tax adjustment
|
3.27
|
%
|
3.28
|
%
|
3.04
|
%
|
|||||||
2.
Rate
/ Volume Analysis
During
2005, net interest income increased $707,000 or 5.0% on a tax equivalent basis,
to $14.8 million, from $14.1 million in 2004. As shown in the Rate/Volume
Analysis below, $1.8 million was attributable to volume changes mostly
attributable to loan and lease growth, which accounted for $2.7 million, offset
by $942,000 related to investment portfolio run-off. The average balance on
loans and leases were $259.1 million in 2005 compared to $218.5 million in
2004,
representing an increase of $40.6 million, or 18.6%, year-over-year. The $1.8
million increase to net interest income was offset by a $1.1 million decrease
related to rate changes. Basically, the rates on DNB’s interest-bearing
liabilities increased at a faster pace than the rates on DNB’s interest-earning
assets, which had a negative impact on interest income and was mostly
attributable to DNB’s deposit base. The tax equivalent yield on loans and leases
increased to 6.58% for 2005 compared to 6.40% for 2004. The cost of
interest-bearing deposits increased to 1.69% for 2005 compared to 1.06% for
2004. DNB’s composite cost of funds increased to 2.53% in 2005 compared to 1.96%
in 2004.
During
2004, net interest income increased $2.2 million or 18.2% on a tax equivalent
basis, to $14.1 million, from $11.9 million in 2003. As shown in the Rate/Volume
Analysis below, $2.8 million was related to volume changes mostly attributable
to loan and lease growth, which accounted for $2.3 million of the increase.
The
average balance on loans and leases were $218.5 million at December 31, 2004
compared to $185.7 million at December 31, 2003, representing an increase of
$32.9 million, or 17.7%, year-over-year. The $2.8 million increase to net
interest income was offset by a $653,000 decrease related to rate changes.
Basically, the decline in the yield on interest-earnings assets outpaced the
decline in the rate paid on interest-bearing liabilities, which had a negative
impact on interest income and was also mostly attributable to the loan and
lease
portfolio. The tax equivalent yield on loans and leases decreased to 6.40 in
2004 compared to 7.10% in 2003. The cost of interest-bearing liabilities
decreased to 1.96% in 2004 compared to 2.27% in 2003, which had a positive
impact on net interest income by $300,000. This was largely attributable to
higher costing deposits, such as certificates of deposit, being replaced with
lower costing deposits as they matured. The cost on interest-bearing deposits
decreased to 1.06% in 2004 compared to 1.35% in 2003.
The
following tables 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
for
the periods noted (tax-exempt yields and yields on agency-preferred stock that
have a 70% dividend received deduction have been adjusted to a tax equivalent
basis using a 34% tax rate). For each category of interest-earning assets and
interest-bearing liabilities, information is provided with respect to changes
attributable to (i) changes in rate (change in rate multiplied by old volume)
and (ii) changes in volume (change in volume multiplied by old rate). The net
change attributable to the combined impact of rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
|
Rate
/ Volume Analysis
|
|||||||||||||
|
(Dollars
in thousands)
|
2005
Versus 2004
|
2004
Versus 2003
|
|||||||||||
|
Change
Due To
|
Change
Due To
|
||||||||||||
|
Rate
|
Volume
|
Total
|
Rate
|
Volume
|
Total
|
||||||||
|
Interest-earning
assets:
|
|||||||||||||
|
Loans
and leases
|
$
399
|
$2,671
|
$
3,070
|
$(1,458
|
)
|
$2,322
|
$
864
|
||||||
|
Investment
securities:
|
|||||||||||||
|
Taxable
|
979
|
(866
|
)
|
113
|
506
|
(275
|
)
|
231
|
|||||
|
Tax-exempt
|
(96
|
)
|
232
|
136
|
95
|
571
|
666
|
||||||
|
Tax-preferred
DRD
|
23
|
(308
|
)
|
(285
|
)
|
(101
|
)
|
(105
|
)
|
(206
|
)
|
||
|
Cash
and cash equivalents
|
16
|
138
|
154
|
6
|
10
|
16
|
|||||||
|
Total
|
1,321
|
1,867
|
3,188
|
(952
|
)
|
2,523
|
1,571
|
||||||
|
Interest-bearing
liabilities:
|
|||||||||||||
|
Savings
deposits
|
1,173
|
125
|
1,298
|
(38
|
)
|
178
|
140
|
||||||
|
Time
deposits
|
395
|
166
|
561
|
(333
|
)
|
(334
|
)
|
(667
|
)
|
||||
|
Federal
funds purchased
|
17
|
(8
|
)
|
9
|
(1
|
)
|
(1
|
)
|
(2)
|
||||
|
Repurchase
agreements
|
175
|
501
|
676
|
—
|
145
|
145
|
|||||||
|
FHLB
advances
|
637
|
(984
|
)
|
(347
|
)
|
71
|
(288
|
)
|
(217
|
)
|
|||
|
Other
borrowings
|
55
|
229
|
284
|
2
|
10
|
12
|
|||||||
|
Total
|
2,452
|
29
|
2,481
|
(299
|
)
|
(290
|
)
|
(589
|
)
|
||||
|
Net
interest income
|
$
(1,131
|
)
|
$
1,839
|
$
707
|
$
(653
|
)
|
$2,813
|
$2,160
|
|||||
The
tax-equivalent adjustments included in the Rate / Volume Analysis above are
presented in the table “Reconciliation of Non-GAAP Financial Measures” on page
25.
3.
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 comprised 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 re-pricing
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 in-terest rate-sensitive assets and
interest rate-sensitive -liabilities.
ALCO
continually evaluates interest rate risk management opportunities, including
the
use of derivative financial instruments. Management believes 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.
DNB
reports its callable agency, callable corporate notes and callable municipal
investments ($38 million at December 31, 2005) and callable FHLB advances ($47
million at December 31, 2005) 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 and advances 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.
B.
Liquidity
and Market Risk Management
Liquidity
is the ability to meet current and future financial obligations. The Bank
further defines liquidity as the ability to respond to deposit outflows as
well
as maintain flexibility to take advantage of lending and investment
opportunities. The Bank’s primary sources of funds are operating earnings,
deposits, principal and interest payments on loans, proceeds from loan sales,
sales and maturities of mortgage-backed and investment securities, and FHLB
advances. The Bank uses the funds generated to support its lending and
investment activities as well as any other demands for liquidity such as deposit
outflows. While maturities and scheduled amortization of loans and securities
are predictable sources of funds, deposit flows, mortgage prepayments, loan
and
security sales and the exercise of call features are greatly influenced by
general interest rates, economic conditions and competition.
The
objective of DNB’s asset/liability management function is to maintain consistent
growth in net interest income within DNB’s policy limits. This objective is
accomplished through the management of liquidity and interest rate risk, as
well
as customer offerings of various loan and deposit products. DNB maintains
adequate liquidity to meet daily funding requirements, anticipated deposit
withdrawals, or asset opportunities in a timely manner. Liquidity is also
necessary to meet obligations during unusual, extraordinary or adverse operating
circumstances, while avoiding a significant loss or cost. DNB’s foundation for
liquidity is a stable deposit base as well as a marketable investment portfolio
that provides cash flow through regular maturities or that can be used for
collateral to secure funding in an emergency. As part of its liquidity
management, DNB maintains assets, which comprise its primary liquidity (Federal
funds sold, investments and interest-bearing cash balances, less pledged
securities), which totaled $106.1 million and $129.8 million as of December
31,
2004 and 2003, respectively. DNB’s primary liquidity ratio (primary liquidity as
a percent of assets) was 24% and 32% for the same respective dates.
C.
Credit
Risk Management
DNB
defines credit risk as the risk of default by a customer or counter-party.
The
objective of DNB’s credit risk management strategy is to quantify and manage
credit risk on an aggregate portfolio basis as well as to limit the risk of
loss
resulting from an individual customer default. Credit risk is managed through
a
combination of underwriting, documentation and collection standards. DNB’s
credit risk management strategy calls for regular credit examinations and
quarterly management reviews of large credit exposures and credits experiencing
credit quality deterioration. DNB’s loan review procedures provide objective
assessments of the quality of underwriting, documentation, risk grading and
charge-off procedures, as well as an assessment of the allowance for credit
loss
reserve analysis process.
D.
Management
of Others Risks
As
a
financial institution, DNB’s earnings are significantly affected by general
business and economic conditions. These conditions include short-term and
long-term interest rates, inflation, monetary supply, fluctuations in both
debt
and equity capital markets, and the strength of the United States economy and
local economics in which we operate. For example, an economic downturn, increase
in unemployment, or other events that negatively impact household and/or
corporate incomes could decrease the demand for DNB’s loan and non-loan products
and services and increase the number of customers who fail to pay interest
or
principal on their loans. Geopolitical conditions can also affect DNB’s
earnings. Acts or threats of terrorism, actions taken by the United States
or
other governments in response to acts or threats of terrorism and our military
conflicts including the aftermath of the war with Iraq, could impact business
conditions in the United States.
E.
Competition
In
addition to the challenges related to the interest rate environment, community
banks in Chester County have been experiencing increased competition from large
regional and international banks entering DNB’s marketplace through mergers and
acquisitions. Competition for loans and deposits has negatively affected DNB’s
net interest margin. To compensate for the increased competition, DNB, along
with other area community banks, has aggressively sought and marketed customers
who have been disenfranchised by these mergers. To attract these customers,
DNB
has introduced new deposit products, such as the Partnership banking program,
the “Platinum” account, the Executive and employee package as well as the
Business package. In addition, DNB has introduced Market Managers and Personal
Bankers to serve the special banking needs of its clients.
F.
Bank
Secrecy Act/OFAC/Patriot Act Implementation
Management
of the Bank has determined that its BSA compliance program needs strengthening
in a number of important ways. For example, management has determined that
the
Bank may have failed to review a number of transactions during the last 5 years
to verify that non-customer parties are not listed under OFAC as “blocked
persons.” Management has concluded that the Bank’s BSA compliance program needs
to be improved to a level commensurate with BSA, OFAC and Patriot Act related
risks to which the Bank is exposed. While a methodology has been put in place
to
identify high-risk customers, assessment of the customer base is incomplete
and
management has determined to accelerate this process with the goal of completing
it by the end of the third quarter of 2006. Management also intends to expand
and augment its policies and procedures to establish protocols with respect
to
identification, evaluation and compliance responses to certain types of
potentially high-risk individuals. The Bank plans to strengthen training and
further involve its front-line personnel in this process. The Bank’s management
is increasing the frequency with which it reports BSA compliance program
activity to its board of directors and intends to focus its board of directors
more frequently and more thoroughly on BSA compliance program requirements,
including the identification of high risk customers and the processes the Bank
uses to evaluate and monitor them. The Bank will be formalizing, structuring
and
documenting compliance in a more disciplined way, including more stringent
policies and formal periodic review. The Bank is taking a more aggressive
posture in identifying customers and transactions that are potentially subject
to the filing of Suspicious Activity Reports (“SARs”) and in appropriate cases
expects to file SARs. The Bank will be improving its management information
systems to improve identification, evaluation and reporting of certain types
of
high risk or suspicious transactions and activities. The Bank will be augmenting
its BSA compliance staff, and management intends to strengthen its day-to-day
audit processes to more effectively validate and test the Bank’s BSA compliance
program procedures and records. It is management’s goal that the planned
improvements to the BSA compliance program will be completed in 2006 and will
address the Bank’s BSA compliance needs, in order to establish the Bank as an
institution that will not pose a target to those who would use the U.S.
financial system to further criminal or terroristic ends.
V.
Material
Trends and Uncertainties
The
industry is experiencing an on-going and widespread trend of consolidation
in
response to shrinking margins, as well as competitive and economic challenges.
In an effort to broaden market share by capitalizing on operational
efficiencies, larger institutions have been acquiring smaller regional and
community banks and thrifts. Chester County has witnessed many recent mergers
due to attractive demographics, commercial expansion and other growth
indicators. As a result of these factors, the operating environment is very
competitive as Chester County hosts over 45 banks, thrifts and credit unions.
In
addition, brokerage firms, mutual fund companies and boutique investment firms
are prevalent, given the county’s attractive demographics. This intense
competition continually puts pressures on DNB’s margins and operating results as
competitors offer a full range of loan, deposit and investment products and
services. In addition, many of these competitors are much larger than DNB and
consistently outspend the Bank in marketing to attract new customers and buy
market share. DNB anticipates these pressures will continue to adversely affect
operating results.
VI.
Recent
Developments
A.
Economic
Developments
1.
National
Trends
.
The
performance of the U.S. economy and banking industry remains strong. U.S.
economic expansion continues to support strong loan performance and mortgage-led
loan growth. Banks, in general, have reported four consecutive years of record
earnings, and have recently enjoyed earnings growth derived from securities
gains, reduced loan loss provision expenses, and improved overhead efficiency.
There has been overall continued strength in credit quality. Weaknesses in
net
interest margins (NIMs) have been a result of a flattening yield curve. After
the U.S. economic expansion began producing consistent growth in jobs and
business investment in early 2004, the Federal Reserve undertook a program
of
gradually raising short-term interest rates. Since June 2004, the federal funds
rate target has been raised 12 times, by a total of 300 basis points. However,
in part because of continued strong demand for U.S. Treasury and agency debt
by
foreign investors, long-term U.S. interest rates have been slower to rise.
The
result has been a significant flattening of the Treasury yield curve. The
average spread between 10-year U.S. Treasury yields and the federal funds rate
shrunk from 3.72 percent as recently as May 2004 to just 0.14 percent in
December 2005. The flattening yield curve, along with heightened competition
for
loans and deposits, has put downward pressure on the average net interest margin
for banking institutions.
Overall,
the industry remains healthy, with strong credit quality, stable earnings and
capital ratios at historic highs. Despite this robust financial performance,
emerging risks in banking could lead to deteriorating financial performance
in
future quarters. Recent hurricanes pose challenges for some banks. The most
immediate identifiable sources of concern at this time are the intermediate-term
effects of Hurricanes Rita and, especially, Katrina. The large-scale destruction
of property and business activity in the Gulf Coast region, along with the
displacement of hundreds of thousands of people, have created stresses for
some
financial institutions.
2.
Local
Trends
.
Business
activity in the Philadelphia region and the Chester County market areas expanded
in December 2005. Banks have reported overall lending continued on an upward
trend. Bankers believe overall lending will continue to rise. Commercial and
industrial loans have been growing, with new borrowing being done by firms
in a
wide range of industries. Banks also reported increases in consumer lending,
including credit cards and home equity lines. Banks generally indicated that
growth in home mortgage lending has slowed. Local trends have been similar
to
the national level. Locally, there has been overall continued strength in credit
quality. Institutions have also experienced a weakness in NIMs as a result
of a
flattening yield curve. Recent hurricanes have not had an impact on most local
banks.
B.
Regulatory
Developments
As
a
national bank and a publicly traded corporation, DNB has a wide-range of
regulatory supervision. Over the past few years the regulatory environment
has
significantly changed, as bank regulators act to monitor economic pressures
while the Federal government acts to monitor corporate activities. Bank
regulators have increased their scrutiny of asset/liability management,
underwriting and capital policies, while Federal regulators have increased
their
scrutiny on employee compensation arrangements, stock activity, and insider
transactions. To help monitor insider transactions and other areas of concern,
Congress enacted the Sarbanes-Oxley Act of 2002, which requires members of
the
Board of Directors to be more knowledgeable and involved with the Bank, imposes
more stringent corporate governance standards on publicly held companies, and
prompts more transparent disclosure to investors. Fundamentally, the
Sarbanes-Oxley Act of 2002 requires more ownership of, and accountability for,
financial -information by the Board and oversight committees. It also
requires increased documentation reporting and review by management in all
areas
of the Bank and the Corporation.
C.
Accounting
Developments Affecting DNB
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement No. 123 (revised 2004), “Share-Based Payment - An Amendment of
Statements No. 123 and 95” (“SFAS 123(R)”), that addresses the accounting for
equity-based compensation arrangements, including employee stock options. Upon
implementation of the changes proposed in this statements, entities would no
longer be able to account for equity-based compensation using the intrinsic
value method under Opinion 25. Entities would be required to measure the cost
of
employees service received in exchange for awards of equity instruments at
the
grant date of the award using a fair value based method. The comment period
for
this proposed statement ended on September 30, 2004. In October 2004, FASB
announced that for public entities, this proposed statement would apply
prospectively for reporting periods beginning after June 15, 2005 as if all
equity-based compensation awards granted, modified or settled after December
15,
1994 had been accounted for using a fair value based method of accounting.
On
April 14, 2005 the Securities and Exchange Commission amended the compliance
dates for SFAS 123 (R). Under the amended compliance dates, SFAS 123 (R) becomes
effective for public entities that do not file as small business issuers, as
of
the beginning of the first fiscal reporting period that begins after June 15,
2005. For the Bank, this will become effective on January 1, 2006. The adoption
of Statement No. 123 (R), will not have a negative impact on earnings for any
option issued prior to December 31, 2005 due to all stock options being fully
vested. Effective January 1, 2006, DNB does not anticipate recording expense
significantly different than what is presented in Note 1 to the financial
statements.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” -
a replacement of APB Opinion No. 20 and FASB Statement No. 3 that requires
retrospective application to prior periods financial statements of voluntary
changes in accounting principle and changes required by new accounting standards
when the standard does not include specific transition provisions unless it
is
impracticable to do so. SFAS 154 becomes effective for accounting changes and
corrections of errors in fiscal years beginning after December 15, 2005. For
DNB, this will become effective on January 1, 2006.
D.
Internal
Developments Affecting DNB
1.
Changes
in Key Management Positions
In
January 2006, DNB entered into a severance and cooperation agreement with
Richard M. Wright in connection with his resignation as the Company’s Executive
Vice President of Retail Banking. In the past 2 years, Mr. Wright was involved
with DNB’s name change, development of a competitive product lineup, addition of
key staff, a new West Chester branch and a call center.
Consequently,
in January 2006, Richard J. Hartmann was named Executive Vice President of
Retail Banking. Mr. Hartmann has served as Senior Vice President of the Bank
since June 29, 2005. Mr. Hartman is a 25-year veteran of the banking industry
with relevant experience in larger regional banks.
In
October 2005, C. Tomlinson Kline, III, SVP Commercial Real Estate Lending,
assumed the position of Chief Credit Officer for the Bank. In this role, Mr.
Kline is responsible for the Credit Administration and Loan Operations
functions. Mr. Kline will also be streamlining DNB’s internal processes to
support DNB’s goal of establishing a unique competitive market advantage in
commercial and consumer lending. Mr. Kline has over 30 years in lending and
credit administration experience in both large institutions and in community
banks.
In
October 2005, Raymond M. Mincarelli, SVP of Commercial Real Estate Lending,
agreed to manage and lead DNB’s commercial real estate and construction lending
activities. Mr. Mincarelli has over 30 years of lending and marketing experience
and has successfully led the commercial and construction lending units at a
multi-billion dollar regional bank.
DNB’s
management believes that it is essential to assemble and grow a real estate
lending staff that is proven, talented and knowledgeable of local markets as
DNB
grows and expands geographically.
In
addition to these important changes, management is in the process of expanding
its lending and support staff to facilitate loan growth as part of its balance
sheet restructuring plan. DNB believes that these changes will be integral
to
achieving its long-term strategic goals.
2.
DNB’s
Retail Bank
In
order
to support the Bank’s five-year strategic plan, which calls for strong growth in
deposits, loans and fee income, a new position was created in each branch,
a
Personal Banker. A majority of DNB’s Personal Bankers are licensed in life and
health insurance. Some are also Series 6 and 63 securities license holders.
With
these licenses and the knowledge that goes with them, these staff members are
better equipped to discuss the broad range of their clients’ needs and can
provide them more tailored financial solutions. DNB also added a full-service
branch in West Chester and a loan production office in Newtown Square, which
has
deposit-gathering capabilities, during 2005.
VII.
Critical
Accounting Policies and Estimates
The
following discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have
been
prepared in accordance with accounting principals generally accepted in the
United States of America. Generally accepted accounting principles are complex
and require management to apply significant judgment to various accounting,
reporting and disclosure matters. Management must use assumptions and estimates
to apply these principles where actual measurement is not possible or practical.
Actual results may differ from these estimates under different assumptions
or
conditions.
In
management’s opinion, the most critical accounting policies and estimates
impacting DNB’s consolidated financial statements are listed below. These
policies are critical because they are highly dependent upon subjective or
complex judgments, assumptions and estimates. Changes in such estimates may
have
a significant impact on the financial statements. For a complete discussion
of DNB’s significant accounting policies, see the footnotes to the Consolidated
Financial Statements and discussion throughout this financial review
document.
1.
Determination
of the allowance for credit losses
.
Credit
loss allowance policies involve significant judgments and assumptions by
management which may have a material impact on the carrying value of net loans
and, potentially, on the net income recognized by DNB from period to period.
The
allowance for credit losses is based on management’s ongoing evaluation of the
loan and lease portfolio and reflects an amount considered by management to
be
its best estimate of the amount necessary to absorb known and inherent losses
in
the portfolio. Management considers a variety of factors when establishing
the
allowance, such as the impact of current economic conditions, diversification
of
the portfolios, delinquency statistics, results of loan review and related
classifications, and historic loss rates. In addition, certain individual loans
which management has identified as problematic are specifically provided for,
based upon an evaluation of the borrower’s perceived ability to pay, the
estimated adequacy of the underlying collateral and other relevant factors.
In
addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for credit losses. They may require additions
to the allowance based upon their judgments about information available to
them
at the time of examination. Although provisions have been established and
segmented by type of loan, based upon management’s assessment of their differing
inherent loss characteristics, the entire allowance for credit losses is
available to absorb further losses in any category.
Management
uses significant estimates to determine the allowance for credit losses. Because
the allowance for credit losses is dependent, to a great extent, on conditions
that may be beyond DNB’s control, management’s estimate of the amount necessary
to absorb allowance for credit losses and actual credit losses could differ.
DNB’s current judgment is that the valuation of the allowance for credit losses
remains appropriate at December 31, 2005.
2.
Realization
of deferred income tax items
.
Estimates of deferred tax assets and deferred tax liabilities make up the asset
category titled “net deferred taxes”. These estimates involve significant
judgments and assumptions by management, which may have a material impact on
the
carrying value of net deferred tax assets for financial reporting purposes.
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
basis, as well as operating loss carry forwards. 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. A valuation allowance would be established against deferred
tax
assets when in the judgment of management, it is more likely than not that
such
deferred tax assets will not become available. For a more detailed description
of these items, refer to Footnote 11 (Federal Income Taxes) to DNB’s audited
consolidated financial statements for the fiscal year ended December 31, 2005.
3.
Other-than temporary impairment of investment securities
.
FASB
Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities states, in part: for individual securities classified as either
available-for-sale or held-to-maturity, an enterprise shall determine whether
a
decline in fair value below the amortized cost basis is other than temporary.
For example, if it is probable that the investor will be unable to collect
all
amounts due according to the contractual terms of a debt security not impaired
at acquisition, an other-than-temporary impairment shall be considered to have
occurred. If the decline in fair value is judged to be other than temporary,
the
cost basis of the individual security shall be written down to fair value as
a
new cost basis and the amount of the write-down shall be included in earnings
(that is, accounted for as a realized loss). While FASB Statement No. 115 uses
a
debt security as an example, similar considerations exist for investments in
marketable equity securities. Accordingly, judgment is required in determining
whether factors exist that indicate that an impairment loss has been incurred
at
the end of the reporting period. These judgments are based on subjective as
well
as objective factors, including knowledge and experience about past and current
events and assumptions about future events. The following are examples of such
factors.
| • |
Fair
value is significantly below cost and the decline is
attributable to adverse conditions specifically related to the security
or
to specific conditions in an industry or in a geographic area, the
decline
has existed for an extended period of time or Management does not
possess
both the intent and the ability to hold the security for a period
of time
sufficient to allow for any anticipated recovery in fair
value.
|
|
|
•
|
The
security has been downgraded by a rating agency.
|
|
|
•
|
The
financial condition of the issuer has deteriorated.
|
|
|
•
|
Dividends
have been reduced or eliminated, or scheduled interest payments have
not
been made.
|
|
|
•
|
The
entity recorded losses from the security subsequent to the end of
the
reporting period.
|
VIII.
2005
Financial Results
A.
Liquidity
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, cash and cash equivalents, 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. As part of its liquidity management, DNB maintains assets that comprise
its primary liquidity, which totaled $71.2 million at December 31, 2005. Primary
liquidity includes investments, Federal funds sold, and interest-bearing cash
balances, less pledged securities. DNB also anticipates scheduled payments
and
prepayments on its loan and mortgage-backed securities portfolios. In addition,
DNB maintains borrowing arrangements with various correspondent banks, the
Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of
Philadelphia to meet short-term liquidity needs. Through these relationships,
DNB has available credit of approximately $142.7 million. Management believes
that DNB has adequate resources to meet its short-term and long-term funding
requirements.
As
of
December 31, 2005, deposits totaled $339.6 million, up $16.5 million from $323.1
million at December 31, 2004. There were approximately $55.5 million in
certificates of deposit scheduled to mature during the next twelve months.
At
December 31, 2005, DNB had $50.1 million in un-funded loan commitments. In
addition, there were $7.0 million in un-funded letters of credit. Management
anticipates the majority of these commitments will be funded by means of normal
cash flows.
The
following table sets forth the composition of DNB’s deposits at the dates
indicated.
|
Deposits
By Major Classification
|
|||||||||||
|
(Dollars
in thousands)
|
December
31
|
||||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||
|
Non-interest-bearing
deposits
|
$
51,407
|
$
53,402
|
$
52,788
|
$
45,117
|
$
40,355
|
||||||
|
Interest-bearing
deposits:
|
|||||||||||
|
NOW
|
78,664
|
79,527
|
67,158
|
50,400
|
46,346
|
||||||
|
Money
market
|
45,390
|
42,199
|
55,412
|
59,457
|
64,491
|
||||||
|
Savings
|
77,216
|
77,897
|
46,630
|
39,569
|
34,480
|
||||||
|
Certificates
|
70,621
|
53,558
|
52,611
|
74,560
|
90,387
|
||||||
|
IRA
|
16,329
|
16,561
|
17,837
|
18,699
|
17,324
|
||||||
|
Total
deposits
|
$339,627
|
$323,144
|
$292,436
|
$287,802
|
$293,383
|
||||||
B.
Capital
Resources and Adequacy
Stockholders’
equity was $30.2 million at December 31, 2005 compared to $24.7 million at
December 31, 2004. The increase was primarily the result of $5.5 million, net
of
expenses, raised in a private stock offering during the year.
Management
believes that the Corporation and the Bank have each met the definition of
“well
capitalized” for regulatory purposes on December 31, 2005. 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 lever-age ratio requirements for
bank holding companies (see additional discussion in Regulatory Matters -
Footnote 17 to DNB’s consolidated financial statements).
Under
federal banking laws and regulations, DNB and the Bank are required to maintain
minimum capital as determined by certain regulatory ratios. Capital adequacy
for
regulatory purposes, and the capital category assigned to an institution by
its
regulators, may be determinative of an institution’s overall financial
condition.
In
addition, the Federal Reserve Bank (the “FRB”) leverage ratio rules require bank
holding companies to maintain a minimum level of “primary capital” to total
assets of 5.5% and a minimum level of “total capital” to total assets of 6%. For
this purpose, (i) “primary capital” includes, among other items, common stock,
certain perpetual debt instruments such as eligible Trust Preferred Securities,
contingency and other capital reserves, and the allowance for credit losses,
(ii) “total capital” includes, among other things, certain subordinated debt,
and “total assets” is increased by the allowance for credit losses. DNB’s
primary capital ratio and its total capital ratio are both 8.6%. Based on the
foregoing, as of December 31, 2005, both DNB and the Bank would be deemed to
be
“well capitalized” for regulatory purposes.
C.
Results
of Operations
1.
Summary
of Performance
(a)
Summary
of Results
For
the
year ended December 31, 2005, DNB reported net income of $2.1 million, an
increase of $1.8 million from the $298,000 reported for the year ended December
31, 2004, or $1.00 per share versus $0.14 per share, respectively, on a fully
diluted basis. During 2005, DNB reversed a portion of the previously recorded
valuation allowance for deferred tax assets and recognized a related income
tax
benefit of $308,000. A significant portion of the reversal was associated with
a
tax gain recognized on the sale of two operations buildings as well as an
additional reversal made in connection with the sale of agency preferred
securities which is discussed in detail on page 20 under the heading
“
Investment
Portfolio Restructure”
.
The
reduced earnings for 2004 was attributable to a $2.3 million
other-than-temporary impairment charge taken on Government Agency Securities
and
a $250,000 charge taken in connection with the retirement of DNB’s former
President and Chief Executive Officer, each of which was taken in the fourth
quarter of 2004.
(b)
Significant
Events, Transactions and Economic Changes Affecting
Results
With
both
a new image and the addition of key personnel, 2005 was a rebuilding year for
DNB. DNB made progress in implementing its long-term strategic plan. One of
DNB’s achievements was putting in place a seasoned, well-qualified lending team,
which produced a 24% growth in the loan portfolio. DNB also added a full-service
branch in West Chester, a loan production office in Newtown Square, which has
deposit-gathering capabilities, and made great strides in the retail delivery
and wealth management areas.
Additionally,
DNB completed a private placement sale of 265,730 shares of its common stock
to
53 accredited investors at a price of $21.00 per share, realizing total offering
proceeds of $5.5 million. DNB’s management team and board of directors organized
the offering. There were no brokerage or underwriting commissions paid in
relation to the private placement.
During
2005, DNB sold all of its agency preferred stocks and recognized a $300,000
gain. A $2.3 million other-than-temporary impairment charge was taken on these
securities in 2004, which is discussed below in more detail.
The
decline in 2004 annual results from 2003 was related to two after-tax charges
to
earnings. The first of these events relates to a $250,000 after-tax charge
taken
in connection with the retirement of DNB’s former President and Chief Executive
Officer. The second relates to a $2.3 million other-than-temporary impairment
charge taken on Government Agency Securities. At December 31, 2004, DNB owned
four agency preferred stock issues totaling $9.98 million and recognized pre-tax
adjustments totaling $2.3 million or 24% of the book value of these securities.
The other-than-temporary impairment charges were recognized due to the negative
impact on the market value of these securities caused by the ongoing accounting,
management, and regulatory oversight issues confronting Fannie Mae (FNMA) and
Freddie Mac (FHLMC). DNB is required to recognize other-than-temporary
impairment under guidance provided by the Financial Accounting Standards Board
(FASB115) and the Securities and Exchange Commission (SEC). Much of the book
value adjustment for this impairment charge had been recognized through the
ongoing mark-to-market of these securities as a reduction in other comprehensive
income.
(c)
Trends
and Uncertainties
Since
June 2004, the federal funds rate target has been raised 12 times, by a total
of
300 basis points. However, in part because of continued strong demand for U.S.
Treasury and agency debt by foreign investors, long-term U.S. interest rates
have been slower to rise. The result has been a significant flattening of the
Treasury yield curve. The average spread between 10-year U.S. Treasury yields
and the federal funds rate has declined from 3.72% as recently as May 2004
to
just 0.14% in December 2005. The flattening yield curve, along with heightened
competition for loans and deposits, has put downward pressure on the average
net
interest margin of most financial institutions. DNB’s profitability depends
largely on our net interest margin. Continued downward pressure could have
a
significant impact on the future earnings of DNB.
(d)
Material
Changes in Results
Please
refer to the discussion above in the section titled “Significant Events,
Transactions and Economic Changes Affecting Results”.
(e)
Effect
of Inflation and Changing Rates
For
detailed discussion of the effects of inflation and changes in rates on DNB’s
results, refer to the discussion below on Net Interest Income.
2.
Net
Interest Income
DNB’s
earnings performance is primarily dependent upon its level of net interest
income, which is the excess of interest income over interest expense. Interest
income includes interest earned on loans and leases (net of interest reversals
on non-performing loans), investments and Federal funds sold, as well as net
loan fee amortization and dividend income. Interest expense includes the
interest cost for deposits, FHLB advances, repurchase agreements, corporate
debentures, Federal funds purchased and other borrowings.
2005
Results Compared to 2004 Results
In
2005,
DNB continued its progress to reposition its balance sheet as net interest
income increased year-over-year by $714,000 to $14.1 million. This increase
was
primarily due to a higher volume of interest-earning assets with higher yields
offset by an increased cost of funds on interest-bearing liabilities. The higher
volume of interest-earning assets was attributable to strong loan growth offset
by investment portfolio run-off. The higher yield on the interest-earning assets
as well as the increased cost of funds on interest-bearing liabilities was
a
result of a rising interest rate environment as the Fed funds rate increased
by
300 basis points since June 2004. The Fed funds rate was 4.25% at December
31,
2005.
Interest
on loans and leases was $17.0 million for 2005 compared to $13.9 million for
2004. The average balance on loans and leases was $259.1 million with an average
yield of 6.58% compared to an average balance of $218.5 million with an average
yield of 6.40%. The increase in the average balance was the result of
implementing DNB’s strategic plan to aggressively grow the balance sheet through
loan originations, participations and purchases. This has been accomplished
with
the addition of key revenue producing personnel as well as by adding a loan
production office in Newtown Square. The increase in yield was the result of
the
rising interest rate environment mentioned above.
Interest
and dividends on investment securities was $6.2 million for both 2005 and 2004.
The average balance on investment securities was $158.8 million with an average
yield of 4.28% in 2005 compared to $185.6 million with an average yield of
3.69%
in 2004. The decrease in balance was the result of investment portfolio run-off,
which was part of DNB’s strategic plan. The increase in yield was the result of
DNB taking advantage of the interest rate environment to restructure a
significant portion of its investment securities portfolio. In March 2005,
DNB
sold $73.3 million of structured securities, government agency preferred stock,
longer-term municipal securities, as well as corporate securities. The majority
of the proceeds received on the sale of these investments were re-invested
into
higher yielding agency mortgage-backed securities, agency bonds and municipal
securities. Management believes that the restructured portfolio will result
in
more stable earnings and cash flow, as well as improved value metrics.
Interest
on deposits was $4.5 million for 2005 compared to $2.7 million for 2004. The
average balance of interest-bearing deposits was $267.8 million with an average
rate of 1.69% for 2005 compared to $251.9 million with an average rate of 1.06%
for 2004. The increase in average balance was primarily the result of aggressive
marketing of deposit relationships in an effort to fund loan and lease growth.
The increase in rate was primarily the result of an increase in the cost of
funds resulting from the rising interest rate environment.
Interest
on FHLB advances was $3.3 million for 2005 compared to $3.6 million for 2004.
The average balance on FHLB advances was $59.5 million with an average rate
of
5.51% for 2005 compared to $77.4 million with an average rate of 4.69% for
2004.
The decrease in the average balance was the result of FHLB borrowings that
matured and were repaid. The increased average rate in 2005 resulted from lower
levels of overnight FHLB borrowings in 2005, compared to 2004.
2004
Results Compared to 2003 Results
For
the
period ending December 31, 2004, DNB’s net interest income increased
year-over-year by $1.9 million or 16.8% to $13.4 million. The increase was
primarily due to increased levels of interest-earning assets, primarily loans
and leases, offset by slightly lower yields. Additionally, DNB’s cost of funds
declined to 1.96% in 2004 from 2.27% in 2003, which was primarily due to the
interest rate environment and also contributed to the increase in net interest
income.
Interest
on loans and leases was $13.9 million for 2004 compared to $13.1 million for
2003. The average balance on loans and leases in 2004 was $218.5 million with
an
average yield of 6.40% compared to an average balance of $185.7 million with
an
average yield of 7.07% in 2003. The increase in the average balance is the
result of an aggressive calling and marketing effort for commercial and consumer
loans. The decrease in yield is primarily the result of the lower interest
rate
environment.
Interest
and dividends on investment securities was $6.2 million for 2004 compared to
$5.7 million for 2003. The average balance on investment securities was $185.6
million with an average yield of 3.69%, compared to $187.7 million with an
average yield of 3.28% in 2003. The decrease in the average balance was part
of
DNB’s strategic plan to reduce the size of its investment portfolio. The
increase in yield was primarily due to slower prepayment speeds on mortgage
related products, which led to lower levels of premium amortization on such
securities.
Interest
on deposits was $2.7 million for 2004 compared to $3.2 million for 2003. The
average balance on interest-bearing deposits was $251.9 million with an average
rate of 1.06% for 2004 compared to $236.4 million with an average rate of 1.35%
for 2003. The increase in average balance was primarily the result of aggressive
marketing of deposit relationships in an effort to fund loan and lease growth.
The decrease in rate was primarily the result of higher costing time deposits
being replaced with lower costing deposits as the time deposits
matured.
Interest
on FHLB advances was $3.6 million for 2004 compared to $3.8 million for 2003.
The average balance on FHLB advances was $77.4 million with an average rate
of
4.69% for 2004 compared to $83.6 million with an average rate of 4.59% for
2003.
The decrease in the average balance occurred when these FHLB borrowings were
replaced with repurchase agreements, which had an average balance of $11.9
million and an average rate of 1.22% in 2004.
3.
Provision
for Credit Losses
To
provide for known and inherent losses in the loan and lease portfolio, DNB
maintains an allowance for credit losses. There were no provisions for credit
losses made during the periods ended December 31, 2005, 2004 and 2003, since
management determined the allowance for credit losses was adequate based on
its
analysis.
During
2005, DNB provided $120,000 to the allowance for credit losses through the
three
quarterly periods ended September 30, 2005. This provision was based on the
deterioration of three loans to one borrower during this nine-month period.
However, during the fourth quarter, DNB received a large pay down and signed
a
forbearance agreement in connection with these loans. As a result of this
triggering event, the $120,000 provision that was previously booked to the
allowance was reversed. For a detailed discussion on DNB’s reserving
methodology, refer to “Item 1 - Determination of the allowance for credit
losses” which can be found under “Critical Accounting Policies and
Estimates”.
4.
Non-Interest
Income
Non-interest
income includes service charges on deposit products; fees received in connection
with the sale of non-depository products and services, including fiduciary
and
investment advisory services offered through DNB Advisors; securities brokerage
products and services and insurance 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 (“BOLI”), net gains on sales of
investment securities and other real estate owned (“OREO”) properties. In
addition, DNB receives fees for cash management, merchant services, debit cards,
safe deposit box rentals, check cashing and similar activities.
2005
Results Compared to 2004 Results
Non-interest
income was $2.4 million for 2005 compared to $591,000 for 2004. This increase
was primarily due to the $2.35 million impairment recognized in the fourth
quarter of 2004. In addition, DNB restructured its investment portfolio in
the
first quarter of 2005 and reported a $699,000 pre-tax loss on the sale of
securities. The increase in non-interest income was also partly due to higher
levels of commissions earned on the sales of annuities, coupled with additional
service charges on deposit accounts.
Service
charges on deposit accounts were $1.4 million for 2005 compared to $1.3 million
for 2004. This increase was primarily attributable to non-sufficient funds
(“NSF”) fees, which increased $74,000 year-over-year.
Wealth
management fees were $712,000 for 2005 compared to $633,000 for 2004. This
increase was primarily the result of growth in fee income derived on the sale
of
annuities through DNB’s subsidiary, DNB Financial Services.
2004
Results Compared to 2003 Results
For
the
period ended December 31, 2004, total non-interest income was $591,000, compared
to $2.5 million for 2003. The decrease in non-interest income during 2004 was
primarily due to the $2.3 million other-than-temporary impairment charge taken
on Government Agency Securities, offset by fewer losses recognized on the sale
of securities. There was $16,000 of losses in 2004 versus $362,000 of losses
in
2003.
Service
charges on deposit accounts increased $80,000 or 6.4% to $1.3 million in 2004
from $1.2 million in 2003. This increase was primarily attributable to
non-sufficient funds (“NSF”) fees, which increased $105,000, and was a result of
an -increase in the volume of accounts. This increase was offset by a $16,000
decrease in business analysis charges due to higher earnings credit rates in
2004.
Income
from DNB’s Wealth Management Group in 2004 was $633,000, which was relatively
consistent to 2003, which was $658,000.
DNB
earns
income on its investments in BOLI policies, which DNB maintains on 22 of its
officers. During 2004, income from these policies amounted to $208,000 versus
$299,000 in 2003. The decrease in 2004 was due to a one-time taxable stock
dividend of $90,000 received from the issuer of a BOLI policy in 2003.
Losses
taken on the sale on investment securities totaled $16,000 for 2004 compared
to
$362,000 for 2003. The losses in 2004 and 2003 are the result of sales as part
of DNB’s strategic initiative to restructure its balance sheet.
Other
non-interest-income consists of fees from services, such as debit cards, safe
deposit box rental income and cash management fees. The income generated from
these sources was relatively consistent year over year. Other non-interest
income increased $90,000 or 12.8% to $792,000 for 2004 compared to $702,000
for
2003. This increase was primarily due to a $259,000 gain recognized on the
sale
of land offset by an $86,000 loss taken on the disposal of fixed assets relating
to DNB’s name change.
5.
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 significant expense items.
2005
Results Compared to 2004 Results
Non-interest
expense was $14.4 million for 2005 compared to $13.2 million for 2004.
Salary
and employee benefits
.
Salary
and employee benefits was $8.2 million for 2005 compared to $7.3 million for
2004. The increase was largely attributable to the substantial investment in
key
staff, principally revenue producing personnel. DNB continued to make
significant progress by adding seasoned individuals who will provide DNB with
additional leadership serving the Private Banking, Credit and Retail needs
of
our customers.
Professional
and consulting.
Professional and consulting expenses were $1.1 million for 2005 compared to
$823,000 for 2004. The primary reason for the increase was due to the following.
First, a marketing firm was engaged to assist DNB with several marketing
initiatives which includes (a) Providing a comprehensive analysis of DNB's
product and service offerings, competitive position and customer profiles,
including interviews with selected samples of customers of DNB and other
financial institutions; (b) Consulting with and assisting DNB's management
in
establishing strategies for branding based on the foregoing analysis and
research; (c) Assisting DNB with marketing, public relations and customer
relations strategies to implement the new branding strategies. Second, DNB
hired
a third-party to assist in its efforts to comply with the provisions of the
Sarbanes-Oxley Act. Third, fees associated with a third-party providing network
support increased as a result of the growth in the Bank’s overall staff and
other initiatives such as the opening DNB’s Newtown Square Loan Production
Office and West Chester branch facilities as well as upgrading DNB’s network.
Lastly, audit and legal expenses increased as the result of several initiatives
designed to increase share ownership in the Company by management and employees.
These initiatives included the implementation of DNB’s new Incentive Equity and
Deferred Compensation Plan and incorporating the Company’s stock into the DNB
First 401-k Retirement Plan
2004
Results Compared to 2003 Results
For
2004,
non-interest expenses increased by $567,000 to $13.2 million, compared to $12.6
million for 2003. This increase was primarily due to a $432,000 increase in
compensation costs and a $333,000 increase in marketing costs offset by a
$297,000 decrease in furniture and equipment costs. The increase in compensation
was related to an increase in full-time equivalent employees, normal merit
increases, contributions to DNB’s new Profit Sharing Plan as well as a $317,000
charge taken in connection with the retirement of DNB’s former President and
Chief Executive Officer. The increase in full-time equivalents is part of DNB’s
strategic plan associated with expanding its lending and support staff to
facilitate loan growth as part of its balance sheet restructuring plan. DNB
believes that these changes will be integral to achieving its long-term
strategic goals. The increase in marketing costs was for promoting its new
corporate identity as well as substantial expenses for promoting new loan and
deposit products. The decrease in furniture and equipment costs was primarily
due to a decrease in depreciation expense.
6.
Income
Taxes
2005
Results Compared to 2004 Results
Income
tax (benefit) expense was ($89,000) for 2005 compared to $504,000 for 2004.
Income tax (benefit) expense for each period differs from the amount determined
at the statutory rate of 34% due to tax-exempt income on loans and investment
securities, DNB's ownership of BOLI policies and tax credits recognized on
a
low-income housing limited partnership. During 2005, DNB reversed a portion
of
the previously recorded valuation allowance for deferred tax assets and
recognized a related income tax benefit of $308,000. Most of the reversal was
associated with a tax gain recognized on the sale of two operations buildings
as
well as an additional reversal that was made in connection with the sale of
agency preferred securities both of which are “Capital Assets” as defined under
Internal Revenue Code Section 221.
With
regard to the previously recorded valuation allowance, DNB recognized a pre-tax
other-than-temporary impairment charge during 2004 totaling $2.3 million or
24%
of the book value on four agency preferred stock issues totaling $9.98 million.
The other-than-temporary impairment charges were recognized due to the negative
impact on the market value of these securities caused by the ongoing accounting,
management, and regulatory oversight issues confronting Fannie Mae and Freddie
Mac.
DNB
was
required to recognize other-than-temporary impairment under guidance provided
by
the Financial Accounting Standards Board (FASB115) and the Securities and
Exchange Commission (SEC). The perpetual preferred agency securities that DNB
owned at December 31, 2004 (preferred stock) were “Capital Assets” as defined
under Internal Revenue Code (IRC) Section 1221. In general, when the preferred
stock securities would be sold or disposed of, any net gain or loss on such
securities would generate a capital gain or capital loss. It was anticipated
that the sale of the preferred stock securities would give rise to a realized
capital loss for income tax purposes. Realized capital losses can only be used
to offset capital gain income and not ordinary taxable income from operations
(IRC Section 1211(a)). To the extent a corporate taxpayer is unable to utilize
a
net realized capital loss, such losses can be carried forward to each of the
5
taxable years succeeding such loss year (IRC Section 1212(a)(1)(B)). If
unutilized after 5 taxable years, such capital losses will expire unused.
Neither DNB, nor its wholly owned subsidiary DNB First, National Association,
had a history of generating such capital gains within the past 3 tax years,
nor
did the management of DNB anticipate that it would generate such capital gains
within five (5) years of the anticipated sale of these securities. When the
impairment charge was recognized, DNB contemplated selling some or all of these
securities during 2005. The 5 year period to recover the capital loss would
start when these securities were sold. At December 31, 2004, DNB did not
anticipate recognizing gains from the sale of any capital assets that it may
have held as of this date (including these preferred stock securities) during
the next 5 - 6 years. As a result, management determined that it was more likely
than not that the income tax benefits associated with the above impairment
write
down would not be realizable and accordingly recorded a valuation allowance
for
deferred tax asset in the amount of $733,000.
2004
Results Compared to 2003 Results
Income
tax expense was $504,000 for 2004, compared to a benefit of $10,000 in 2003.
DNB’s effective tax rate was 63% and (1%) for the two years, respectively. The
effective tax rate of 63% in 2004 was higher than the statutory rate because
no
tax benefit was recognized on the $2.3 million other-than-temporary impairment
charge taken on Government Agency Securities as discussed above, partially
offset by the effect of tax-exempt income. The effective tax rate for 2003
was
less than the statutory rate due to the effect of tax-exempt income, DNB’s
ownership of BOLI policies, and tax credits recognized on a low-income housing
limited partnership.
Financial
Condition Analysis
1.
Investment
Securities
DNB’s
investment portfolio consists of US agency securities, mortgage-backed
securities issued by US Government agencies, collateralized mortgage
obligations, state and municipal securities, bank stocks, 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
normally expects to realize all of its investment upon the maturity of such
instruments. 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.
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 $146.7 million at December
31, 2005, down 14% from $169.8 million at December 31, 2004.
The
following tables set forth information regarding the composition, stated
maturity and average yield of DNB’s investment security portfolio as of the
dates indicated (tax-exempt yields have been adjusted to a tax equivalent basis
using a 34% tax rate). The first two tables do not include amortization or
anticipated prepayments on mortgage-backed securities. Callable securities
are
included at their stated maturity dates.
Investment
Maturity Schedule, Including Weighted Average Yield
|
(Dollars
in thousands)
|
December
31, 2005
|
|||||||||||||||||||||
|
Held
to Maturity
|
Less
than
1
Year
|
1-5
Years
|
5-10
Years
|
Over
10
Years
|
No
Stated
Maturity
|
Total
|
Yield
|
|||||||||||||||
|
US
Government agency obligations
|
$
|
—
|
$
|
4,724
|
$
|
2,871
|
$
|
2,991
|
$
|
—
|
$
|
10,586
|
4.72
|
%
|
||||||||
|
US
agency mortgage-backed
securities
|
8
|
440
|
885
|
253
|
—
|
1,586
|
4.61
|
|||||||||||||||
|
Collateralized
mortgage obligations
|
—
|
—
|
—
|
8,623
|
—
|
8,623
|
3.51
|
|||||||||||||||
|
State
and municipal tax-exempt
|
—
|
—
|
1,491
|
4,646
|
—
|
6,137
|
5.22
|
|||||||||||||||
|
Equity
securities
|
—
|
—
|
—
|
373
|
3,368
|
3,741
|
3.19
|
|||||||||||||||
|
Total
|
$
|
8
|
$
|
5,164
|
$
|
5,247
|
$
|
16,886
|
$
|
3,368
|
$
|
30,673
|
4.29
|
%
|
||||||||
|
Percent
of portfolio
|
—
|
%
|
17
|
%
|
17
|
%
|
55
|
%
|
11
|
%
|
100
|
%
|
||||||||||
|
Weighted
average yield
|
4.6
|
%
|
4.7
|
%
|
4.8
|
%
|
4.2
|
%
|
3.2
|
%
|
4.3
|
%
|
||||||||||
|
Available
for Sale
|
Less
Than
1
Year
|
|
|
1-5
Years
|
|
|
5-10
Years
|
|
|
Over
10
Years
|
|
|
No
Stated
Maturity
|
|
|
Total
|
|
|
Yield
|
|||
|
US
Government agency obligations
|
$
|
—
|
$
|
34,794
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
34,794
|
4.20
|
%
|
||||||||
|
US
agency mortgage-backed securities
|
—
|
—
|
4,350
|
51,831
|
—
|
56,181
|
4.36
|
|||||||||||||||
|
State
and municipal tax-exempt
|
—
|
2,064
|
1,978
|
21,020
|
—
|
25,062
|
5.89
|
|||||||||||||||
|
Equity
securities
|
—
|
—
|
—
|
—
|
37
|
37
|
3.10
|
|||||||||||||||
|
Total
|
$
|
—
|
$
|
36,858
|
$
|
6,328
|
$
|
72,851
|
$
|
37
|
$
|
116,074
|
4.64
|
%
|
||||||||
|
Percent
of portfolio
|
—
|
%
|
32
|
%
|
5
|
%
|
63
|
%
|
—
|
%
|
100
|
%
|
||||||||||
|
Weighted
average yield
|
—
|
%
|
4.3
|
%
|
4.8
|
%
|
4.8
|
%
|
3.1
|
%
|
4.6
|
%
|
||||||||||
|
Composition
of Investment Securities
|
|||||||||
|
(Dollars
in thousands)
|
|||||||||
|
December
31
|
|||||||||
|
2005
|
2004
|
||||||||
|
Held
to
|
Available
|
Held
to
|
Available
|
||||||
|
Maturity
|
for
Sale
|
Maturity
|
for
Sale
|
||||||
|
US
Government agency obligations
|
$10,586
|
$
34,794
|
$10,581
|
$
32,557
|
|||||
|
US
agency mortgage-backed securities
|
1,586
|
56,181
|
3,457
|
38,368
|
|||||
|
Corporate
bonds
|
—
|
—
|
—
|
15,754
|
|||||
|
Collateralized
mortgage obligations
|
8,623
|
—
|
12,753
|
19,553
|
|||||
|
State
and municipal tax-exempt
|
6,137
|
25,062
|
6,195
|
18,403
|
|||||
|
DRD
agency preferred stock
|
—
|
—
|
—
|
7,653
|
|||||
|
Equity
securities
|
3,741
|
37
|
4,489
|
—
|
|||||
|
Total
|
$30,673
|
$116,074
|
$37,475
|
$132,288
|
|||||
In
2004,
DNB recorded a $2.3 million other-than-temporary impairment charge taken on
Government Agency Securities. DNB owned four agency preferred stock issues
totaling $9.98 million and recognized pre-tax other-than-temporary impairment
charges totaling $2.3 million or 24% of the book value. The other-than-temporary
impairment charges were recognized due to the negative impact on the market
value of these securities caused by the ongoing accounting, management, and
regulatory oversight issues confronting Fannie Mae (FNMA) and Freddie Mac
(FHLMC). DNB is required to recognize other-than-temporary impairment under
guidance provided by the Financial Accounting Standards Board (FASB115) and
the
Securities and Exchange Commission (SEC).
In
2005,
all of the agency preferred stock was sold and a $300,000 gain was
recognized.
2.
Loans
and Lease Portfolio
DNB’s
loan and lease portfolio consists primarily of commercial and residential real
estate loans, commercial loans and lines of credit (including commercial
construction), commercial leases and consumer loans. The portfolio provides
a
stable source of interest income, monthly amortization of principal and, in
the
case of adjustable rate loans, re-pricing opportunities.
Net
loans
and leases were $283.7 million at December 31, 2005, up $55.6 million or 24.4%
from 2004. Commercial loans increased $19.6 million or 30.8% to $83.2 million,
commercial leases increased $4.6 million or 24.0% to $23.9 million, residential
mortgage loans increased $25.1 million or 134.2% to $43.7 million, consumer
loans increased $5.2 million or 12.0% to $48.4 million and commercial mortgage
loans increased of $1.1 million or 1.3% to $88.9 million. The increase in the
commercial loans and leases continues to reflect DNB’s commitment to commercial
and residential development in Chester and Delaware counties as well as northern
Delaware.
The
following table sets forth information concerning the composition of total
loans
outstanding, net of the allowance for credit losses, as of the dates
indicated.
Total
Loan and Lease Outstanding, Net of Allowance for Credit
Losses
|
(Dollars
in thousands)
|
December
31
|
|||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
||||||
|
Residential
mortgages
|
$43,738
|
$18,677
|
$16,048
|
$26,120
|
$39,298
|
|||||
|
Commercial
mortgages
|
88,921
|
87,795
|
89,027
|
83,322
|
70,282
|
|||||
|
Commercial
loans
|
83,156
|
63,595
|
54,587
|
48,151
|
42,081
|
|||||
|
Commercial
leases
|
23,934
|
19,300
|
8,434
|
1,285
|
65
|
|||||
|
Consumer
|
48,381
|
43,210
|
35,457
|
28,707
|
34,324
|
|||||
|
Total
loans and leases
|
288,130
|
232,577
|
203,553
|
187,585
|
186,050
|
|||||
|
Less
allowance for credit losses
|
(4,420
|
)
|
(4,436
|
)
|
(4,559
|
)
|
(4,546
|
)
|
(4,809
|
)
|
|
Net
loans and leases
|
$283,710
|
$228,141
|
$198,994
|
$183,039
|
$181,241
|
|||||
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
and Lease Maturities
|
December
31, 2005
|
||||||||
|
(Dollars
in thousands)
|
Less
than
1
Year
|
1-5
Years
|
Over
5
Years
|
Total
|
|||||
|
Residential
mortgages
|
$
3,296
|
$
22,850
|
$17,592
|
$
43,738
|
|||||
|
Commercial
mortgages
|
1,680
|
27,458
|
59,783
|
88,921
|
|||||
|
Commercial
term loans
|
32,944
|
35,734
|
14,478
|
83,156
|
|||||
|
Commercial
leases
|
1,127
|
22,540
|
267
|
29,934
|
|||||
|
Consumer
loans
|
2,220
|
24,201
|
21,960
|
48,381
|
|||||
|
Total
loans and leases
|
41,267
|
132,783
|
114,080
|
288,130
|
|||||
|
Loans
and leases with fixed interest rates
|
3,301
|
72,414
|
38,556
|
114,271
|
|||||
|
Loans
and leases with variable interest rates
|
37,966
|
60,369
|
75,524
|
173,859
|
|||||
|
Total
loans and leases
|
$41,267
|
$132,783
|
$114,080
|
$288,130
|
|||||
3
.
Non-Performing
Assets
Total
non-performing assets increased $926,000 to $1.4 million at December 31, 2005,
compared to $425,000 at December 31, 2004. The increase in 2005 was primarily
attributable to two loans associated with one customer totaling $882,000. The
two loans were placed on non-accrual in accordance with DNB’s policy, as set
forth below. As a result of the increase in non-performing loans, the
non-performing loans to total loans ratio increased to .47% at December 31,
2005
from .18% at December 31, 2004. Despite an increase in the absolute level of
non-performing loans, DNB’s asset quality remains strong. DNB has a significant
level of commercial and commercial real estate loans and 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 non-accrual loans, loans delinquent over ninety days
and
still accruing, troubled debt restructurings (“TDRs”) and other real estate
owned (“OREO”). Non-accrual 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 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
Credit Policy Committee monitors the performance of the loan and lease 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. As of December 31, 2005, DNB
had
$3.7 million of loans, which, although performing at that date, 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, 2004 was $3.6 million. The majority
of
the loans are secured by commercial real estate, with lesser amounts being
secured by residential real estate, inventory and receivables.
The
following table sets forth those assets that are: (i) placed on non-accrual
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.
|
Non-Performing
Assets
|
|||||||||||
|
(Dollars
in thousands)
|
|||||||||||
|
December
31
|
|||||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||
|
Non-accrual
loans:
|
|||||||||||
|
Residential
mortgage
|
$
—
|
$117
|
$
165
|
$
285
|
$
224
|
||||||
|
Commercial
mortgage
|
5
|
25
|
2,142
|
1,057
|
567
|
||||||
|
Commercial
|
1,017
|
231
|
233
|
1,758
|
1,964
|
||||||
|
Leases
|
83
|
—
|
—
|
—
|
—
|
||||||
|
Consumer
|
—
|
16
|
16
|
254
|
301
|
||||||
|
Total
non-accrual loans
|
1,105
|
389
|
2,556
|
3,354
|
3,056
|
||||||
|
Loans
90 days past due and still accruing
|
245
|
36
|
472
|
514
|
155
|
||||||
|
Troubled
debt restructurings
|
—
|
—
|
—
|
—
|
—
|
||||||
|
Total
non-performing loans
|
1,350
|
425
|
3,028
|
3,868
|
3,211
|
||||||
|
Other
real estate owned
|
—
|
—
|
—
|
—
|
—
|
||||||
|
Total
non-performing assets
|
$1,350
|
$425
|
$3,028
|
$3,868
|
$3,211
|
||||||
|
Asset
quality ratios:
|
|||||||||||
|
Non-performing
loans to total loans
|
0.5
|
%
|
0.2
|
%
|
1.5
|
%
|
2.1
|
%
|
1.7
|
%
|
|
|
Non-performing
assets to total assets
|
0.3
|
0.1
|
0.7
|
1.0
|
0.8
|
||||||
|
Allowance
for credit losses to:
|
|||||||||||
|
Total
loans and leases
|
1.5
|
1.9
|
2.2
|
2.4
|
2.6
|
||||||
|
Non-performing
loans and leases
|
327.3
|
1,043.8
|
150.5
|
117.5
|
149.8
|
||||||
4.
Allowance
for Credit Losses
To
provide for known and inherent losses in the loan and lease portfolios, DNB
maintains an allowance for credit losses. Provisions for credit losses are
charged against income to increase the allowance when necessary. Loan and lease
losses are charged directly against the allowance and recoveries on previously
charged-off loans and leases are added to the allowance. In establishing its
allowance for credit losses, management considers the size and risk exposure
of
each segment of the loan and lease portfolio, past loss experience, present
indicators of risk such as delinquency rates, levels of non-accruals, the
potential for losses in future periods, and other relevant factors. Management’s
evaluation of the loan and lease portfolio generally includes 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
establishing and reviewing the allowance for adequacy, Management establishes
the allowance for credit losses in accordance with generally accepted accounting
principles in the United States and the guidance provided in the Securities
and
Exchange Commission’s Staff Accounting Bulletin 102 (SAB 102). Its methodology
for assessing the appropriateness of the allowance consists of several key
elements which include: specific allowances for identified problem loans;
formula allowances for commercial and commercial real estate loans; and
allowances for pooled homogenous loans. As a result, management has taken into
consideration factors and variables which may influence the risk of loss within
the loan portfolio, including: (i) trends in delinquency and non-accrual 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; (v) quality of loan review; (vi) national and local economic trends
and conditions; (vii) concentrations of credit; and (viii) effect of external
factors on estimated credit losses. The unallocated portion of the allowance
is
intended to provide for probable likelihood that the bank would advance funds
into a known troubled situation, and then sustain a loss on the newly advanced
funds. The risk of loss factors are then applied against the percentage of
un-funded commitments in each category of loans. In addition, DNB reviews
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.
DNB’s
percentage of allowance for credit losses to total loans and leases was 1.53%
at
December 31, 2005 compared to 1.91% and 2.24% for the years ended December
31,
2004 and 2003, respectively. There were no provisions made during these years
since management determined the allowance for credit losses was adequate and
provided for known and inherent credit losses.
During
2005, DNB provided $120,000 to the allowance for credit losses through the
three
quarterly periods ended September 30, 2005. This provision was based on the
deterioration of three loans to one borrower during this nine-month period.
However, during the fourth quarter, DNB received a large pay down and signed
a
forbearance agreement in connection with these loans. As a result of this
triggering event, the $120,000 provision that was previously booked to the
allowance was reversed. For a detailed discussion on DNB’s reserving
methodology, refer to “Item 1 - Determination of the allowance for credit losses
which can be found under Critical Accounting Policies and
Estimates”.
Net
charge-offs were $16,000 in 2005 compared to $123,000 and net recoveries of
$13,000 in 2004 and 2003, respectively. The percentage of net charge-offs
(recoveries) to total average loans and leases was .01%, .06% and (0.1%) during
the same respective periods.
|
Analysis
of Allowance for Credit Losses
|
|||||||||||
|
(Dollars
in thousands)
|
|||||||||||
|
Year
Ended December 31
|
|||||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||
|
Beginning
balance
|
$4,436
|
$4,559
|
$4,546
|
$4,809
|
$4,917
|
||||||
|
Provisions
|
—
|
—
|
—
|
—
|
—
|
||||||
|
Loans
charged off:
|
|||||||||||
|
Real
estate
|
—
|
—
|
(10
|
)
|
—
|
(209
|
)
|
||||
|
Commercial
|
(31
|
)
|
(8
|
)
|
(302
|
)
|
(221
|
)
|
(66
|
)
|
|
|
Leases
|
—
|
(75
|
)
|
—
|
—
|
—
|
|||||
|
Consumer
|
(15
|
)
|
(105
|
)
|
(14
|
)
|
(89
|
)
|
(9
|
)
|
|
|
Total
charged off
|
(46
|
)
|
(188
|
)
|
(326
|
)
|
(310
|
)
|
(284
|
)
|
|
|
Recoveries:
|
|||||||||||
|
Real
estate
|
6
|
16
|
111
|
18
|
132
|
||||||
|
Commercial
|
20
|
14
|
220
|
18
|
36
|
||||||
|
Leases
|
—
|
—
|
—
|
—
|
—
|
||||||
|
Consumer
|
4
|
35
|
8
|
11
|
8
|
||||||
|
Total
recoveries
|
30
|
65
|
339
|
47
|
176
|
||||||
|
Ending
balance
|
$4,420
|
$4,436
|
$4,559
|
$4,546
|
$4,809
|
||||||
The
following table sets forth the composition of DNB’s allowance for credit losses
at the dates indicated.
|
Composition
of Allowance for Credit Losses
|
|||||||||||||||||||||
|
(Dollars
in thousands)
|
|||||||||||||||||||||
|
December
31
|
|||||||||||||||||||||
|
2005
|
2004
|
2003
|
2002
|
2001
|
|||||||||||||||||
|
Amount
|
Percent
of Loan Type to Total Loans
|
Amount
|
Percent
of Loan Type to Total Loans
|
Amount
|
Percent
of Loan Type to Total Loans
|
Amount
|
Percent
of Loan Type to Total Loans
|
Amount
|
Percent
of Loan Type to Total Loans
|
||||||||||||
|
Real
estate
|
$
927
|
46
|
%
|
$1,033
|
46
|
%
|
$1,495
|
51
|
%
|
$1,598
|
58
|
%
|
$1,685
|
59
|
%
|
||||||
|
Commercial*
|
1,220
|
29
|
1,640
|
27
|
1,752
|
27
|
1,943
|
26
|
1,609
|
23
|
|||||||||||
|
Leases
|
1,132
|
8
|
952
|
8
|
450
|
4
|
77
|
1
|
—
|
—
|
|||||||||||
|
Consumer
|
305
|
17
|
310
|
19
|
288
|
18
|
331
|
15
|
145
|
18
|
|||||||||||
|
Unallocated
|
836
|
—
|
501
|
—
|
574
|
—
|
597
|
—
|
1,370
|
—
|
|||||||||||
|
Total
|
$4,420
|
100
|
%
|
$4,436
|
100
|
%
|
$4,559
|
100
|
%
|
$4,546
|
100
|
%
|
$4,809
|
100
|
%
|
||||||
*Includes
commercial construction
5.
Certain
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. The sum of these items amounted to $1.8 million
for the year ended December 31, 2005.
The
FDIC
has authority to assess and change federal deposit insurance assessment rates
on
assessable deposits of the Bank. For further information, please refer to the
discussion of FDIC deposit insurance assessments under Part I, Item 1
(“Business”), section (c) (“Narrative Description of Business”) - “Supervision
and Regulation - Bank” under the heading “Deposit Insurance Assessments” on page
7 of this report. If additional deposit insurance premiums were assessed in
future years, they would reduce the earnings and profitability of DNB. Bank
management cannot predict whether the deposit insurance fund reserve level
will
remain above the Designated Reserve Ratio of 1.25%, or, if it does not, what
assessment rate the FDIC might impose in future periods.
Please
refer to Footnote 17 to DNB’s Consolidated Financial Statements on page 75 of
this report for a table that summarizes required capital ratios and the
corresponding regulatory capital positions of DNB and the Bank at December
31,
2005.
6.
Off
Balance Sheet Arrangements
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 stand-by letters of credit totaling $7.0 million and unfunded loan
and lines of credit commitments totaling $50.1 million at December 31, 2005.
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 stand-by 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.
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 the
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.
Stand-by
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.
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 credit of approximately $142.7 million.
Approximately
$88.0 million in 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.
The
following table sets forth DNB’s known contractual obligations as of December
31, 2005. The amounts presented below do not include interest.
|
Payments
Due by Period
|
||||||||||
|
Less
than
|
1-3
|
3-5
|
More
than
|
|||||||
|
(Dollars
in thousands)
|
Total
|
1
Year
|
Years
|
Years
|
5
Years
|
|||||
|
Contractual
Obligations
|
||||||||||
|
FHLB
advances
|
$
53,850
|
$
6,400
|
$7,450
|
$20,000
|
$20,000
|
|||||
|
Repurchase
agreements
|
36,050
|
36,050
|
—
|
—
|
—
|
|||||
|
Capital
lease obligations
|
701
|
12
|
29
|
39
|
621
|
|||||
|
Operating
lease obligations
|
1,662
|
369
|
705
|
572
|
17
|
|||||
|
Junior
subordinated debentures
|
9,279
|
—
|
—
|
—
|
9,279
|
|||||
|
Total
|
$101,542
|
$42,831
|
$8,184
|
$20,611
|
$29,917
|
|||||
|
Expiration
by Period
|
||||||||||
|
Less
than
|
1-3
|
3-5
|
More
than
|
|||||||
|
(Dollars
in thousands)
|
Total
|
1
Year
|
Years
|
Years
|
5
Years
|
|||||
|
Off
Balance Sheet Obligations
|
||||||||||
|
Commitments
to extend credit
|
$50,052
|
$16,423
|
$17,812
|
$6,487
|
$9,330
|
|||||
|
Letters
of credit
|
7,026
|
3,941
|
199
|
2,886
|
—
|
|||||
|
Total
|
$57,078
|
$20,364
|
$18,011
|
$9,373
|
$9,330
|
|||||
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 Equity
("EVE") 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 EVE analysis is also used to dynamically model
the
present value of asset and liability cash flows, with rates ranging up or down
200 basis points. The economic value of equity is likely to be different if
rates change. Results falling outside prescribed ranges require action by
management. At December 31, 2005 and December 31, 2004, 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 table below. The change as a percentage of the
present value of equity with a 200 basis point increase or decrease at December
31, 2005 and December 31, 2004, was within DNB's negative 25%
guideline.
|
December
31, 2005
|
December
31, 2004
|
|||||||||||
|
Change
in rates
|
Flat
|
|
-200bp
|
|
+200bp
|
|
Flat
|
|
-200bp
|
|
+200bp
|
|
|
EVE
|
$60,579
|
$55,559
|
$54,967
|
$40,712
|
$33,327
|
$36,297
|
||||||
|
Change
|
(5,020
|
)
|
(5,612
|
)
|
(7,385
|
)
|
(4,415
|
)
|
||||
|
Change
as a % of assets
|
(1.1%
|
)
|
(1.2%
|
)
|
(1.7%
|
)
|
(1.0%
|
)
|
||||
|
Change
as a % of PV equity
|
(8.3%
|
)
|
(9.3%
|
)
|
(18.1%
|
)
|
(10.9%
|
)
|
||||
Item
8.
Financial
Statements and Supplementary Data
DNB
Financial Corporation and Subsidiary
Consolidated
Statements of Financial Condition
|
(Dollars
in thousands)
|
||||
|
December
31
|
||||
|
2005
|
2004
|
|||
|
Assets
|
||||
|
Cash
and due from banks
|
$
14,421
|
$
9,535
|
||
|
Federal
funds sold
|
7,762
|
14,586
|
||
|
Cash
and cash equivalents
|
22,183
|
24,121
|
||
|
AFS
Investment securities, at market value
|
116,074
|
132,288
|
||
|
HTM
Investment securities (market value $29,954 in 2005
|
||||
|
and
$37,095 in 2004)
|
30,673
|
37,475
|
||
|
Loans
and leases
|
288,130
|
232,577
|
||
|
Allowance
for credit losses
|
(4,420
|
)
|
(4,436
|
)
|
|
Net
loans and leases
|
283,710
|
228,141
|
||
|
Office
property and equipment
|
6,733
|
7,186
|
||
|
Accrued
interest receivable
|
2,134
|
1,772
|
||
|
Bank
owned life insurance
|
6,642
|
6,295
|
||
|
Net
deferred taxes
|
2,326
|
950
|
||
|
Other
assets
|
2,571
|
2,831
|
||
|
Total
assets
|
$473,046
|
$441,059
|
||
|
Liabilities
and Stockholders’ Equity
|
||||
|
Liabilities
|
||||
|
Non-interest-bearing
deposits
|
$
51,407
|
$
53,402
|
||
|
Interest-bearing
deposits:
|
||||
|
NOW
|
78,664
|
79,527
|
||
|
Money
market
|
45,390
|
42,199
|
||
|
Savings
|
77,216
|
77,897
|
||
|
Time
|
86,950
|
70,119
|
||
|
Total
deposits
|
339,627
|
323,144
|
||
|
FHLB
advances
|
53,850
|
61,650
|
||
|
Repurchase
agreements
|
36,050
|
23,127
|
||
|
Junior
subordinated debentures
|
9,279
|
5,155
|
||
|
Other
borrowings
|
701
|
711
|
||
|
Total
borrowings
|
99,880
|
90,643
|
||
|
Accrued
interest payable
|
939
|
923
|
||
|
Other
liabilities
|
2,414
|
1,611
|
||
|
Total
liabilities
|
442,860
|
416,321
|
||
|
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; 2,572,419 and
|
||||
|
2,278,749
issued, respectively
|
2,572
|
2,170
|
||
|
Treasury
stock, at cost; 201,865 and 212,995 shares, respectively
|
(4,253
|
)
|
(4,488
|
)
|
|
Surplus
|
34,802
|
29,388
|
||
|
Accumulated
deficit
|
(1,196
|
)
|
(2,273
|
)
|
|
Accumulated
other comprehensive loss, net
|
(1,739
|
)
|
(59
|
)
|
|
Total
stockholders’ equity
|
30,186
|
24,738
|
||
|
Total
liabilities and stockholders’ equity
|
$473,046
|
$441,059
|
||
|
See
accompanying notes to consolidated financial statements.
|
||||
DNB
Financial Corporation and Subsidiary
Consolidated
Statements of Operations
|
(Dollars
in thousands)
|
|||||||
|
Year
Ended December 31
|
|||||||
|
2005
|
2004
|
2003
|
|||||
|
Interest
Income:
|
|||||||
|
Interest
and fees on loans
|
$16,988
|
$
13,945
|
$
13,124
|
||||
|
Interest
and dividends on investment securities:
|
|||||||
|
Taxable
|
5,063
|
4,949
|
4,718
|
||||
|
Exempt
from federal taxes
|
1,101
|
1,009
|
587
|
||||
|
Tax-preferred
DRD
|
57
|
266
|
417
|
||||
|
Interest
on cash and cash equivalents
|
218
|
64
|
48
|
||||
|
Total
interest income
|
23,427
|
20,233
|
18,894
|
||||
|
Interest
Expense:
|
|||||||
|
Interest
on NOW, money market and savings
|
2,438
|
1,141
|
1,001
|
||||
|
Interest
on time deposits
|
2,096
|
1,534
|
2,201
|
||||
|
Interest
on FHLB advances
|
3,278
|
3,626
|
3,842
|
||||
|
Interest
on repurchase agreements
|
821
|
145
|
—
|
||||
|
Interest
on junior subordinated debentures
|
562
|
277
|
263
|
||||
|
Interest
on other borrowings
|
118
|
110
|
114
|
||||
|
Total
interest expense
|
9,313
|
6,833
|
7,421
|
||||
|
Net
interest income
|
14,114
|
13,400
|
11,473
|
||||
|
Provision
for credit losses
|
—
|
—
|
—
|
||||
|
Net
interest income after provision for credit losses
|
14,114
|
13,400
|
11,473
|
||||
|
Non-interest
Income:
|
|||||||
|
Service
charges
|
1,362
|
1,323
|
1,243
|
||||
|
Wealth
management
|
712
|
633
|
658
|
||||
|
Increase
in cash surrender value of BOLI
|
214
|
208
|
299
|
||||
|
Other-than-temporary
impairment charge
|
—
|
(2,349
|
)
|
—
|
|||
|
Net
losses on sales of available for sale securities
|
(662
|
)
|
(16
|
)
|
(362
|
)
|
|
|
Gain
on sale of land
|
—
|
259
|
—
|
||||
|
Other
fees
|
730
|
533
|
702
|
||||
|
Total
non-interest income
|
2,356
|
591
|
2,540
|
||||
|
Non-interest
Expense:
|
|||||||
|
Salaries
and employee benefits
|
8,161
|
7,320
|
6,888
|
||||
|
Furniture
and equipment
|
1,248
|
1,204
|
1,501
|
||||
|
Occupancy
|
968
|
868
|
856
|
||||
|
Professional
and consulting
|
1,117
|
823
|
819
|
||||
|
Marketing
|
519
|
638
|
305
|
||||
|
Printing
and supplies
|
305
|
342
|
325
|
||||
|
Other
expenses
|
2,093
|
1,994
|
1,928
|
||||
|
Total
non-interest expense
|
14,411
|
13,189
|
12,622
|
||||
|
Income
before income taxes
|
2,059
|
802
|
1,391
|
||||
|
Income
tax (benefit) expense
|
(89
|
)
|
504
|
(10
|
)
|
||
|
Net
Income
|
$
2,148
|
$
298
|
$
1,401
|
||||
|
Earnings
per share:
|
|||||||
|
Basic
|
$1.02
|
$0.14
|
$0.67
|
||||
|
Diluted
|
1.00
|
0.14
|
0.65
|
||||
|
Cash
dividends per share
|
$0.50
|
$0.47
|
$0.45
|
||||
|
Weighted
average common shares outstanding:
|
|||||||
|
Basic
|
2,115,693
|
2,079,341
|
2,094,993
|
||||
|
Diluted
|
2,142,009
|
2,112,403
|
2,146,770
|
||||
|
See
accompanying notes to consolidated financial
statements.
|
|||||||
Consolidated
Statements of Stockholders’ Equity and Comprehensive
Income
|
(Dollars
in thousands)
|
||||||||||||||||||||||
|
Accumulated
Other
|
||||||||||||||||||||||
|
Compre-
hensive
Income
|
Common
Stock
|
Treasury
Stock
|
Surplus
|
Retained
Earnings
|
Compre-
hensive
Income (Loss)
|
Total
|
||||||||||||||||
|
Balance
at January 1, 2003
|
$
|
1,902
|
$
|
(1,687
|
)
|
$
|
23,402
|
$
|
3,184
|
$
|
(593
|
)
|
$
|
26,208
|
||||||||
|
Comprehensive
Income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
1,401
|
—
|
—
|
—
|
1,401
|
—
|
1,401
|
||||||||||||||
|
Other
comprehensive income,
|
||||||||||||||||||||||
|
net
of tax, relating to net
|
||||||||||||||||||||||
|
unrealized
losses on investments
|
(444
|
)
|
—
|
—
|
—
|
—
|
(444
|
)
|
(444
|
)
|
||||||||||||
|
Total
comprehensive income
|
$
|
957
|
||||||||||||||||||||
|
Cash
dividends
|
—
|
—
|
—
|
(941
|
) |
—
|
(941
|
)
|
||||||||||||||
|
Issuance
of stock dividends
|
97
|
(195
|
)
|
2,642
|
(2,544
|
) |
—
|
—
|
||||||||||||||
|
Purchase
of treasury shares
|
—
|
(1,215
|
)
|
—
|
—
|
—
|
(1,215
|
)
|
||||||||||||||
|
Cash
payment for fractional shares
|
—
|
—
|
—
|
(8
|
) |
—
|
(8
|
)
|
||||||||||||||
|
Exercise
of stock options
|
42
|
—
|
329
|
—
|
—
|
371
|
||||||||||||||||
|
Balance
at December 31, 2003
|
2,041
|
(3,097
|
)
|
26,373
|
1,092
|
(1,037
|
)
|
25,372
|
||||||||||||||
|
Comprehensive
Income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
298
|
—
|
—
|
—
|
298
|
—
|
298
|
||||||||||||||
|
Other
comprehensive income,
|
||||||||||||||||||||||
|
net
of tax, relating to net
|
||||||||||||||||||||||
|
unrealized
gains on investments
|
89
|
—
|
—
|
—
|
—
|
89
|
89
|
|||||||||||||||
|
Reclass
for other-than-temporary
|
||||||||||||||||||||||
|
impairment
charge
|
—
|
—
|
—
|
—
|
889
|
889
|
||||||||||||||||
|
Total
comprehensive income
|
$
|
387
|
||||||||||||||||||||
|
Cash
dividends
|
—
|
—
|
—
|
(981
|
) |
—
|
(981
|
)
|
||||||||||||||
|
Issuance
of stock dividends
|
103
|
—
|
2,570
|
(2,673
|
) |
—
|
—
|
|||||||||||||||
|
Purchase
of treasury shares
|
—
|
(1,391
|
)
|
—
|
—
|
—
|
(1,391
|
)
|
||||||||||||||
|
Cash
payment for fractional shares
|
—
|
—
|
—
|
(9
|
) |
—
|
(9
|
)
|
||||||||||||||
|
Exercise
of stock options
|
26
|
—
|
445
|
—
|
—
|
471
|
||||||||||||||||
|
Balance
at December 31, 2004
|
2,170
|
(4,488
|
)
|
29,388
|
(2,273
|
(59
|
)
|
24,738
|
||||||||||||||
|
Comprehensive
Income:
|
||||||||||||||||||||||
|
Net
income
|
$
|
2,148
|
—
|
—
|
—
|
2,148
|
—
|
2,148
|
||||||||||||||
|
Other
comprehensive loss, net of tax:
|
||||||||||||||||||||||
|
Unrealized
losses on investments
|
(935
|
)
|
—
|
—
|
—
|
—
|
(935
|
)
|
(935
|
)
|
||||||||||||
|
Unrealized
actuarial losses - pension
|
(745
|
)
|
—
|
—
|
—
|
—
|
(745
|
)
|
(745
|
)
|
||||||||||||
|
Release
of restricted stock
|
3
|
—
|
88
|
—
|
—
|
91
|
||||||||||||||||
|
Common
stock issued
|
266
|
—
|
5,259
|
—
|
—
|
5,525
|
||||||||||||||||
|
Total
comprehensive income
|
$
|
468
|
||||||||||||||||||||
|
Cash
dividends
|
—
|
—
|
—
|
(1,064
|
) |
—
|
(1,064
|
)
|
||||||||||||||
|
Issuance
of stock dividends
|
122
|
—
|
(122
|
)
|
—
|
—
|
—
|
|||||||||||||||
|
Purchase
of treasury shares
|
—
|
(5
|
)
|
—
|
—
|
—
|
(5
|
)
|
||||||||||||||
|
Sale
of treasury shares to 401-K plan
|
—
|
240
|
9
|
—
|
—
|
249
|
||||||||||||||||
|
Cash
payment for fractional shares
|
—
|
—
|
—
|
(7
|
) |
—
|
(7
|
)
|
||||||||||||||
|
Exercise
of stock options
|
11
|
—
|
180
|
—
|
—
|
191
|
||||||||||||||||
|
Balance
at December 31, 2005
|
$
|
2,572
|
$
|
(4,253
|
)
|
$
|
34,802
|
$
|
(1,196
|
$(1,739
|
)
|
$
|
30,186
|
|||||||||
|
See
accompanying notes to consolidated financial
statements.
|
||||||||||||||||||||||
Consolidated
Statements of Cash Flows
|
(Dollars
in thousands)
|
||||||||||
|
Year
Ended December 31
|
||||||||||
|
2005
|
2004
|
2003
|
||||||||
|
Cash
Flows From Operating Activities:
|
||||||||||
|
Net
income
|
$
|
2,148
|
$
|
298
|
$
|
1,401
|
||||
|
Adjustments
to reconcile net income to net cash
|
||||||||||
|
provided
(used) by operating activities:
|
||||||||||
|
Depreciation,
amortization and accretion
|
1,315
|
1,498
|
3,162
|
|||||||
|
Restricted
stock amortization
|
91
|
—
|
—
|
|||||||
|
Net
loss on sale of investment securities
|
662
|
16
|
362
|
|||||||
|
Gain
on sale of land
|
—
|
259
|
—
|
|||||||
|
Deferred
gain on sale of buildings
|
(812
|
)
|
—
|
—
|
||||||
|
Loss
on other-than-temporary impairment
|
—
|
2,349
|
—
|
|||||||
|
(Increase)
decrease in accrued interest receivable
|
(362
|
)
|
(28
|
)
|
146
|
|||||
|
Decrease
(increase) in other assets
|
260
|
760
|
(410
|
)
|
||||||
|
Increase
in investment in BOLI
|
(347
|
)
|
(358
|
)
|
(360
|
)
|
||||
|
Increase
(decrease) in interest payable
|
16
|
23
|
(264
|
)
|
||||||
|
(Increase)
in deferred tax benefit
|
(518
|
)
|
(131
|
)
|
(114
|
)
|
||||
|
(Decrease)
increase in other liabilities
|
(326
|
)
|
25
|
1,119
|
||||||
|
Net
Cash Provided By Operating Activities
|
2,127
|
4,711
|
5,042
|
|||||||
|
Cash
Flows From Investing Activities:
|
||||||||||
|
Proceeds
from maturities and paydowns - AFS securities
|
23,161
|
49,245
|
69,813
|
|||||||
|
Proceeds
from maturities and paydowns - HTM securities
|
6,999
|
12,625
|
20,793
|
|||||||
|
Purchase
of AFS securities
|
(105,443
|
)
|
(68,251
|
)
|
(107,315
|
)
|
||||
|
Purchase
of HTM securities
|
—
|
—
|
(49,122
|
)
|
||||||
|
Proceeds
from sale of AFS - securities
|
95,780
|
9,469
|
48,066
|
|||||||
|
Net
increase in loans and leases
|
(55,569
|
)
|
(29,147
|
)
|
(15,955
|
)
|
||||
|
Proceeds
from the sale of property and equipment
|
1,683
|
518
|
—
|
|||||||
|
Purchase
of property and equipment
|
(1,285
|
)
|
(1,197
|
)
|
(543
|
)
|
||||
|
Net
Cash Used By Investing Activities
|
(34,674
|
)
|
(26,738
|
)
|
(34,263
|
)
|
||||
|
Cash
Flows From Financing Activities:
|
||||||||||
|
Net
increase in deposits
|
16,483
|
30,708
|
4,634
|
|||||||
|
(Decrease)
increase in FHLB advances
|
(7,800
|
)
|
(21,350
|
)
|
20,000
|
|||||
|
Proceeds
from short term repurchase agreements
|
12,923
|
23,127
|
—
|
|||||||
|
Increase
in junior subordinated debentures
|
4,124
|
—
|
—
|
|||||||
|
Decrease
in lease obligations
|
(10
|
)
|
(9
|
)
|
(8
|
)
|
||||
|
Dividends
paid
|
(1,071
|
)
|
(990
|
)
|
(949
|
)
|
||||
|
Proceeds
from the issuance of common stock
|
5,525
|
—
|
—
|
|||||||
|
Proceeds
from issuance of stock under stock option plan
|
191
|
471
|
317
|
|||||||
|
Sale
(purchase) of treasury stock, net
|
244
|
(1,391
|
)
|
(1,215
|
)
|
|||||
|
Net
Cash Provided By Financing Activities
|
30,609
|
30,566
|
22,779
|
|||||||
|
Net
Change in Cash and Cash Equivalents
|
(1,938
|
)
|
8,539
|
(6,442
|
)
|
|||||
|
Cash
and Cash Equivalents at Beginning of Period
|
24,121
|
15,582
|
22,024
|
|||||||
|
Cash
and Cash Equivalents at End of Period
|
$
|
22,183
|
$
|
24,121
|
$
|
15,582
|
||||
|
Supplemental
Disclosure of Cash Flow Information:
|
||||||||||
|
Cash
paid during the period for:
|
||||||||||
|
Interest
|
$
|
9,297
|
$
|
6,810
|
$
|
7,685
|
||||
|
Income
taxes
|
101
|
458
|
166
|
|||||||
|
Supplemental
Disclosure of Non-cash Flow Information:
|
||||||||||
|
Change
in unrealized losses on AFS securities
|
$
|
1,409
|
$
|
1,482
|
$
|
(672
|
)
|
|||
|
Change
in deferred taxes due to change in unrealized
|
||||||||||
|
losses
on AFS securities
|
(474
|
)
|
(504
|
)
|
(228
|
)
|
||||
|
Tax
benefit of exercised stock options
|
31
|
64
|
56
|
|||||||
|
Increase
in junior subordinated debentures
|
¾
|
155
|
—
|
|||||||
|
See
accompanying notes to consolidated financial
statements.
|
||||||||||
Notes
to Consolidated Financial Statements
(1)
SUMMARY
OF SIGNIFICANT - ACCOUNTING POLICIES
DNB
Financial Corporation (the “Corporation” or “DNB”) through its wholly owned
subsidiary, DNB First, National Association (the “Bank”) formerly Downingtown
National Bank, has been serving individuals and small to medium sized businesses
of Chester County, Pennsylvania since 1861. DNB Capital Trust I and II are
special purpose Delaware business trusts (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 twelve 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
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
inter-company 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, 2005 and 2004 was
approximately $391,000 and $207,000, 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 that 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
2005, 2004, or 2003.
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
and Leases
—
Loans
and leases are stated net of unearned discounts, unamortized net loan
origination fees and the allowance for credit losses. Interest income is
recognized on an accrual basis. The accrual of interest on loans and leases
is
generally discontinued when loans become 90 days past due or earlier when,
in
management’s judgment, it is determined that a reasonable doubt exists as to its
collectibility. When a loan or lease is placed on non-accrual, interest accruals
cease and uncollected accrued interest is reversed and charged against current
income. Additional interest payments on such loans or leases are applied to
principal or recognized to income on a cash basis. A non-accrual loan or lease
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 and Costs
—
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 non-accrual 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 Credit Losses
—
Credit
loss allowance policies involve significant judgments and assumptions by
management which may have a material impact on the carrying value of net loans
and, potentially, on the net income recognized by DNB from period to period.
The
allowance for credit losses is based on management’s ongoing evaluation of the
loan and lease portfolio and reflects an amount considered by management to
be
its best estimate of the amount necessary to absorb known and inherent losses
in
the portfolio. Management considers a variety of factors when establishing
the
allowance, such as the impact of current economic conditions, diversification
of
the portfolios, delinquency statistics, results of loan review and related
classifications, and historic loss rates. In addition, certain individual loans
which management has identified as problematic are specifically provided for,
based upon an evaluation of the borrower’s perceived ability to pay, the
estimated adequacy of the underlying collateral and other relevant factors.
In
addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for credit losses. They may require additions
to the allowance based upon their judgments about information available to
them
at the time of examination. Although provisions have been established and
segmented by type of loan, based upon management’s assessment of their differing
inherent loss characteristics, the entire allowance for credit losses is
available to absorb further losses in any category.
Management
uses significant estimates to determine the allowance for credit losses. Because
the allowance for credit losses is dependent, to a great extent, on conditions
that may be beyond DNB’s control, management’s estimate of the amount necessary
to absorb allowance for credit losses and actual credit losses could differ.
DNB’s current judgment is that the valuation of the allowance for credit losses
remains appropriate at December 31, 2005.
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. DNB did not have
any
OREO at December 31, 2005 or December 31, 2004.
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 to sell. Gains or losses on disposition of premises and
equipment are reflected in operations.
Other
Assets
—
Financing costs related to the issuance of the 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 from
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 (see Note 14 - Benefit Plans).
Stock
Option Plan
—
SFAS
No. 123,
Accounting
for Stock-Based Compensation
(“SFAS
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
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 proforma 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 123 had
been
applied. DNB has elected to continue to apply the provisions of APB Opinion
No.
25 and provide the proforma disclosure provisions of SFAS 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. During 2005, 2004
and
2003, there was no expense recorded as all options granted were at the then
current market price.
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 proforma amounts indicated below:
|
(Dollars
in thousands,
|
Year
Ended December 31
|
|||||
|
except
per share data)
|
2005
|
2004
|
2003
|
|||
|
Net
income - as reported
|
$2,148
|
$298
|
$1,401
|
|||
|
Less:
Stock option expense
|
572
|
344
|
68
|
|||
|
Proforma
net income (loss)
|
$1,576
|
$(46
|
)
|
$1,333
|
||
|
EPS
- diluted - as reported
|
$
1.00
|
$
0.15
|
$
0.69
|
|||
|
Less:
Stock option expense
|
.26
|
.17
|
.04
|
|||
|
Proforma
earnings (loss) per share - diluted
|
$
0.74
|
$(0.02
|
)
|
$
0.65
|
||
Earnings
Per Share (EPS)
—
Basic
EPS is computed based on the weighted average number of common shares
outstanding during the year. Diluted EPS reflects the potential dilution that
could occur from the conversion of common stock equivalents and is computed
using the treasury stock method. Stock options and awards for which the exercise
price exceeds the average market price over the period have an anti-dilutive
effect on EPS and, accordingly, are excluded from the EPS calculation.
Earnings
per share, dividends per share and weighted average shares outstanding have
been
adjusted to reflect the effects of the 5% stock dividend paid in December 2005,
2004 and 2003.
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
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement No. 123 (revised 2004), “Share-Based Payment - An Amendment of
Statements No. 123 and 95” (“SFAS 123(R)”), that addresses the accounting for
equity-based compensation arrangements, including employee stock options. Upon
implementation of the changes proposed in this statements, entities would no
longer be able to account for equity-based compensation using the intrinsic
value method under Opinion 25. Entities would be required to measure the cost
of
employees service received in exchange for awards of equity instruments at
the
grant date of the award using a fair value based method. The comment period
for
this proposed statement ended on September 30, 2004. In October 2004, FASB
announced that for public entities, this proposed statement would apply
prospectively for reporting periods beginning after June 15, 2005 as if all
equity-based compensation awards granted, modified or settled after December
15,
1994 had been accounted for using a fair value based method of accounting.
On
April 14, 2005 the Securities and Exchange Commission amended the compliance
dates for SFAS 123 (R). Under the amended compliance dates, SFAS 123 (R) becomes
effective for public entities that do not file as small business issuers, as
of
the beginning of the first fiscal reporting period that begins after June 15,
2005. For the Bank, this will become effective on January 1, 2006. The adoption
of Statement No. 123 (R), will not have a negative impact on earnings for any
option issued prior to December 31, 2005 due to all stock options being fully
vested. Effective January 1, 2006, DNB does not anticipate recording expense
significantly different than what is presented above in the stock option plan
discussion.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” -
a replacement of APB Opinion No. 20 and FASB Statement No. 3 that requires
retrospective application to prior periods financial statements of voluntary
changes in accounting principle and changes required by new accounting standards
when the standard does not include specific transition provisions unless it
is
impracticable to do so. SFAS 154 becomes effective for accounting changes and
corrections of errors in fiscal years beginning after December 15, 2005. For
DNB, this will become effective on January 1, 2006.
(2)
INVESTMENT
SECURITIES
During
2004, DNB recognized pre-tax other-than-temporary impairment charges totaling
$2.3 million or 24% of the book value on four agency preferred stock issues
totaling $9.98 million. The other-than-temporary impairment charges were
recognized due to the negative impact on the market value of these securities
caused by the ongoing accounting, management, and regulatory oversight issues
confronting Fannie Mae (FNMA) and Freddie Mac (FHLMC). DNB is required to
recognize other-than-temporary impairment under guidance provided by the
Financial Accounting Standards Board (FASB115) and the Securities and Exchange
Commission (SEC). In 2005, all of the agency preferred stock was sold and a
$300,000 gain was recognized.
The
amortized cost and estimated fair values of investment securities, as of the
dates indicated, are summarized as follows:
|
Available
For Sale
|
|||||||||||||
|
US
government agency obligations
|
35,229
|
¾
|
(435
|
)
|
34,794
|
||||||||
|
US
agency mortgage-backed securities
|
57,187
|
10
|
(1,016
|
)
|
56,181
|
||||||||
|
State
and municipal tax-exempt
|
25,127
|
72
|
(137
|
)
|
25,062
|
||||||||
|
Equity
securities
|
37
|
—
|
—
|
37
|
|||||||||
|
Total
|
$
|
117,580
|
$
|
82
|
$
|
(1,588
|
)
|
$
|
116,074
|
|
December
31, 2004
|
|||||||||||||
|
Amortized
|
Unrealized
|
Unrealized
|
Estimated
|
||||||||||
|
(Dollars
in thousands)
|
Cost
|
Gains
|
Losses
|
Fair
Value
|
|||||||||
|
Held
To Maturity
|
|||||||||||||
|
US
government agency obligations
|
$
|
10,581
|
$
|
—
|
$
|
(99
|
)
|
$
|
10,482
|
||||
|
US
agency mortgage-backed securities
|
3,457
|
72
|
(3
|
)
|
3,526
|
||||||||
|
Collateralized
mortgage obligations
|
12,753
|
—
|
(369
|
)
|
12,384
|
||||||||
|
State
and municipal tax-exempt
|
6,195
|
34
|
(15
|
)
|
6,214
|
||||||||
|
Equity
securities
|
4,489
|
—
|
—
|
4,489
|
|||||||||
|
Total
|
$
|
37,475
|
$
|
106
|
$
|
(486
|
)
|
$
|
37,095
|
||||
|
Available
For Sale
|
|||||||||||||
|
US
government agency obligations
|
$
|
32,833
|
$
|
18
|
$
|
(294
|
)
|
$
|
32,557
|
||||
|
US
agency mortgage-backed securities
|
38,523
|
68
|
(223
|
)
|
38,368
|
||||||||
|
Corporate
bonds
|
15,659
|
143
|
(48
|
)
|
15,754
|
||||||||
|
Collateralized
mortgage obligations
|
19,706
|
48
|
(201
|
)
|
19,553
|
||||||||
|
State
and municipal tax-exempt
|
18,011
|
392
|
—
|
18,403
|
|||||||||
|
DRD
agency preferred stock
|
7,653
|
—
|
—
|
7,653
|
|||||||||
|
Total
|
$
|
132,385
|
$
|
669
|
$
|
(766
|
)
|
$
|
132,288
|
Included
in unrealized losses are market losses on securities that have been in a
continuously unrealized loss position for twelve months or more and those
securities that have been in a continuous unrealized loss position for less
than
twelve months. The table below details the aggregate unrealized losses and
aggregate fair value of the underlying securities whose fair values are below
their values at December 31, 2005 and 2004.
|
December
31, 2005
|
|||||||||||||||||||
|
Fair
value
|
Unrealized
|
Fair
value
|
Unrealized
|
||||||||||||||||
|
Total
|
Impaired
|
Loss
|
Impaired
|
Loss
|
|||||||||||||||
|
Total
|
Unrealized
|
Less
Than
|
Less
Than
|
More
Than
|
More
Than
|
||||||||||||||
|
(Dollars
in thousands)
|
Fair
Value
|
Loss
|
12
Months
|
12
Months
|
12
Months
|
12
Months
|
|||||||||||||
|
Held
To Maturity
|
|||||||||||||||||||
|
US
Government agency obligations
|
$
|
10,405
|
$
|
(181
|
)
|
$
|
¾
|
$
|
¾
|
$
|
10,405
|
$
|
(181
|
)
|
|||||
|
Collateralized
mortgage obligations
|
8,104
|
(519
|
)
|
¾
|
¾
|
8,104
|
(519
|
)
|
|||||||||||
|
State
and municipal tax-exempt
|
785
|
(27
|
)
|
785
|
(27
|
)
|
¾
|
¾
|
|||||||||||
|
US
agency mortgage-backed securities
|
425
|
(10
|
)
|
¾
|
¾
|
425
|
(10
|
)
|
|||||||||||
|
Total
|
$
|
19,719
|
$
|
(737
|
)
|
$
|
785
|
$
|
(27
|
)
|
$
|
18,934
|
$
|
(710
|
)
|
||||
|
Available
For Sale
|
|||||||||||||||||||
|
US
Government agency obligations
|
$
|
34,794
|
$
|
(435
|
)
|
$
|
34,794
|
$
|
(435
|
)
|
$
|
¾
|
$
|
¾
|
|||||
|
State
and municipal tax-exempt
|
13,200
|
(137
|
)
|
13,200
|
(137
|
)
|
¾
|
¾
|
|||||||||||
|
US
agency mortgage-backed securities
|
53,969
|
(1,016
|
)
|
37,918
|
(532
|
)
|
16,051
|
(484
|
)
|
||||||||||
|
Total
|
$
|
101,963
|
$
|
(1,588
|
)
|
$
|
85,912
|
$
|
(1,104
|
)
|
$
|
16,051
|
$
|
(484
|
)
|
||||
|
December
31, 2004
|
|||||||||||||||||||
|
Fair
value
|
Unrealized
|
Fair
value
|
Unrealized
|
||||||||||||||||
|
Total
|
Impaired
|
Loss
|
Impaired
|
Loss
|
|||||||||||||||
|
Total
|
Unrealized
|
Less
Than
|
Less
Than
|
More
Than
|
More
|
||||||||||||||
|
(Dollars
in thousands)
|
Fair
Value
|
Loss
|
12
Months
|
12
Months
|
12
Months
|
12
Months
|
|||||||||||||
|
Held
To Maturity
|
|||||||||||||||||||
|
US
Government agency obligations
|
$
|
14,481
|
$
|
(99
|
)
|
$
|
14,481
|
$
|
(99
|
)
|
$
|
—
|
$
|
—
|
|||||
|
Collateralized
mortgage obligations
|
12,384
|
(369
|
)
|
2,362
|
(23
|
)
|
10,022
|
(346
|
)
|
||||||||||
|
State
and municipal tax-exempt
|
1,605
|
(15
|
)
|
1,068
|
(14
|
)
|
537
|
(1
|
)
|
||||||||||
|
US
agency mortgage-backed securities
|
712
|
(3
|
)
|
695
|
(3
|
)
|
17
|
—
|
|||||||||||
|
Total
|
$
|
29,182
|
$
|
(486
|
)
|
$
|
18,606
|
$
|
(139
|
)
|
$
|
10,576
|
$
|
(347
|
)
|
||||
|
Available
For Sale
|
|||||||||||||||||||
|
US
Government agency obligations
|
$
|
21,679
|
$
|
(294
|
)
|
$
|
21,679
|
$
|
(294
|
)
|
$
|
—
|
$
|
—
|
|||||
|
Corporate
bonds
|
3,033
|
(48
|
)
|
2,044
|
(27
|
)
|
989
|
(21
|
)
|
||||||||||
|
Collateralized
mortgage obligations
|
12,605
|
(201
|
)
|
9,342
|
(143
|
)
|
3,263
|
(58
|
)
|
||||||||||
|
State
and municipal tax-exempt
|
348
|
—
|
348
|
—
|
—
|
—
|
|||||||||||||
|
US
agency mortgage-backed securities
|
28,220
|
(223
|
)
|
26,855
|
(212
|
)
|
1,365
|
(11
|
)
|
||||||||||
|
Total
|
$
|
65,885
|
$
|
(766
|
)
|
$
|
60,268
|
$
|
(676
|
)
|
$
|
5,617
|
$
|
(90
|
)
|
||||
DNB
has
$16 million in securities available for sale, which have had fair values below
book value for at least twelve continuous months at December 31, 2005. The
total
unrealized loss of these securities was $484,000. The impaired securities
consist of fixed and variable rate government agency MBS securities. The
unrealized losses on the mortgage-related securities are attributed to extension
risk resulting from slower prepayment speeds in a rising rate environment.
Management believes that the impairment associated with these and all other
securities, where fair value is below book value at December 31, 2005, is only
temporary.
The
amortized cost and estimated fair value of investment securities as of December
31, 2005, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because certain securities may be called or prepaid
without penalties.
|
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
|
$
|
8
|
$
|
8
|
$
|
¾
|
$
|
¾
|
|||||
|
Due
after one year through five years
|
5,164
|
5,009
|
37,315
|
36,858
|
|||||||||
|
Due
after five years through ten years
|
5,247
|
5,228
|
6,485
|
6,328
|
|||||||||
|
Due
after ten years
|
16,886
|
16,341
|
73,743
|
72,851
|
|||||||||
|
No
stated maturity
|
3,368
|
3,368
|
37
|
37
|
|||||||||
|
Total
investment securities
|
$
|
30,673
|
$
|
29,954
|
$
|
117,580
|
$
|
116,074
|
|||||
DNB
sold
$95.8 million, $9.4 million and $48.1 million of securities from the AFS
portfolio during 2005, 2004 and 2003. Gains and losses from sales of investment
securities were as follows:
|
Year
Ended December 31
|
||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||||||
|
Gross
realized gains
|
$
|
509
|
$
|
71
|
$
|
423
|
||||
|
Gross
realized losses
|
1,171
|
87
|
785
|
|||||||
|
Net
realized loss
|
$
|
(662
|
)
|
$
|
(16
|
)
|
$
|
(362
|
)
|
|
At
December 31, 2005 and 2004, investment securities with a carrying value of
approximately $83.2 million and $80.3 million, respectively, were pledged to
secure public funds, repurchase agreements and for other purposes as required
by
law. See Footnote 7 regarding the use of certain securities as
collateral.
(3)
LOANS
AND LEASES
|
December
31
|
|||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
|||||
|
Residential
mortgage
|
$
|
43,738
|
$
|
18,677
|
|||
|
Commercial
mortgage
|
88,921
|
87,795
|
|||||
|
Commercial
|
83,156
|
63,595
|
|||||
|
Leases
|
23,934
|
19,300
|
|||||
|
Consumer
|
48,381
|
43,210
|
|||||
|
Total
loans and leases
|
$
|
288,130
|
$
|
232,577
|
|||
|
Less
allowance for credit losses
|
(4,420
|
)
|
(4,436
|
)
|
|||
|
Net
loans and leases
|
$
|
283,710
|
$
|
228,141
|
|||
Included
in the loan portfolio are loans for which DNB has ceased the accrual of
interest. Loans of approximately $1.1 million, $389,000, and $2.6 million as
of
December 31, 2005, 2004 and 2003, respectively, were on a non-accrual basis.
DNB
also had loans of approximately $46,000, $36,000 and $472,000 that were more
than 90 days delinquent, but still accruing as of December 31, 2005, 2004 and
2003, respectively. If contractual interest income had been recorded on
non-accrual loans, interest would have been increased as shown in the following
table:
|
Year
Ended December 31
|
||||||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||||||
|
Interest
income which would have been recorded
|
||||||||||
|
under
original terms
|
$
|
87
|
$
|
31
|
$
|
191
|
||||
|
Interest
income recorded during the year
|
(8
|
)
|
(5
|
)
|
(169
|
)
|
||||
|
Net
impact on interest income
|
$
|
79
|
$
|
26
|
$
|
22
|
||||
DNB
had
$3.7 million of loans, which, although performing at December 31, 2005, 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 $3.6 million of such loans at December 31, 2004. The majority
of these loans are secured by commercial real estate with lesser amounts being
secured by residential real estate, inventory and receivables.
DNB
has a
significant concentration of residential and commercial mortgage loans
collateralized by first mortgage liens on properties located in Chester County.
DNB did not have any concentration of loans to borrowers engaged in similar
activities that exceed 10% of total loans at December 31, 2005, except for
loans
of approximately $43.1 million relating to commercial real-estate buildings.
See
Footnote 7 regarding the use of certain loans as collateral.
(4)
ALLOWANCE
FOR CREDIT LOSSES
Changes
in the allowance for credit losses, for the years indicated, are as
follows:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Beginning
balance
|
$4,436
|
$4,559
|
$4,546
|
|||
|
Provisions
|
—
|
—
|
—
|
|||
|
Loans
charged off
|
(46
|
)
|
(113
|
)
|
(326
|
)
|
|
Leases
charged off
|
—
|
(75
|
)
|
—
|
||
|
Recoveries
|
30
|
65
|
339
|
|||
|
Net
(charge-offs) recoveries
|
(16
|
)
|
(123
|
)
|
13
|
|
|
Ending
balance
|
$4,420
|
$4,436
|
$4,559
|
|||
There
were no provisions for credit losses made during the periods ended December
31,
2005, 2004 and 2003, since management determined the allowance for credit losses
was adequate based on its analysis.
During
2005, DNB provided $120,000 to the allowance for credit losses through the
three
quarterly periods ended September 30, 2005. This provision was based on the
deterioration of three loans to one borrower during this nine-month period.
However, during the fourth quarter, DNB received a large pay down and signed
a
forbearance agreement in connection with these loans. As a result, the $120,000
provision that was previously booked to the allowance was reversed. For a
detailed discussion on DNB’s reserving methodology, refer to “Item 1 -
Determination of the allowance for credit losses which can be found under
Critical Accounting Policies and Estimates”.
Information
regarding impaired loans is as follows:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Total
recorded investment
|
$
916
|
$
216
|
$
2,147
|
|||
|
Average
recorded investment
|
1,118
|
1,083
|
2,074
|
|||
|
Specific
allowance allocation
|
442
|
—
|
—
|
|||
|
Total
cash collected
|
564
|
2,249
|
42
|
|||
|
Interest
income recorded
|
18
|
133
|
37
|
|||
(5)
OFFICE
PROPERTY AND EQUIPMENT
|
Estimated
|
December
31
|
|||||||||
|
(Dollars
in thousands)
|
Useful
Lives
|
2005
|
|
2004
|
||||||
|
Land
|
$
|
611
|
$
|
862
|
||||||
|
Buildings
|
5-31.5
years
|
5,927
|
6,983
|
|||||||
|
Furniture,
fixtures and equipment
|
2-20
years
|
10,675
|
9,403
|
|||||||
|
Total
cost
|
17,213
|
17,248
|
||||||||
|
Less
accumulated depreciation
|
(10,480
|
)
|
(10,062
|
)
|
||||||
|
Office
property and equipment, net
|
$
|
6,733
|
$
|
7,186
|
||||||
Amounts
charged to operating expense for depreciation for the years ended December
31,
2005, 2004 and 2003 amounted to $867,000, $838,000, and $1.0 million,
respectively.
On
November 18, 2005, the Bank sold its operations center and an adjunct
administrative office at 104-106 Brandywine Avenue, to an unaffiliated buyer
for
$1,700,000 and leased the Property from the buyer for an initial term ending
December 1, 2010, on a triple net basis for an initial annual basic lease rental
of approximately $176,000. The Lease gives the Bank successive options to renew
its term for three additional terms of five years each at a basic rent to be
established at a fair market rental taking into account all of the terms and
conditions of this Lease, and an option to terminate the Lease at any time
on
120 days prior notice.
(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)
|
2005
|
2004
|
||
|
Three
months or less
|
$
7,082
|
$
8,794
|
||
|
Over
three through six months
|
4,539
|
5,566
|
||
|
Over
six through twelve months
|
7,760
|
3,559
|
||
|
Over
one year through two years
|
5,832
|
1,158
|
||
|
Over
two years
|
3,666
|
2,056
|
||
|
Total
|
$28,879
|
$21,133
|
||
(7)
FHLB
ADVANCES AND SHORT-TERM BORROWED FUNDS
DNB’s
short-term borrowed funds consist of borrowings at the Federal Home Loan Bank
(FHLB) of Pittsburgh, repurchase agreements and Federal funds purchased.
Repurchase agreements and Federal funds purchased generally represent one-day
borrowings. Borrowings at the FHLB consist of overnight and 90 day borrowings.
DNB had $36.1 million with an average rate of 3.52% in repurchase agreements
at
December 31, 2005. DNB did not have any overnight FHLB borrowings or Federal
funds purchased at December 31, 2005.
In
addition to short-term borrowings, DNB maintains other borrowing arrangements
with the FHLB. DNB has a maximum borrowing capacity at the FHLB of approximately
$132.7 million. At December 31, 2005, DNB had $53.9 million of outstanding
advances, which mature at various dates through the year-ended December 31,
2015, as shown in the table below. The $47 million of advances maturing in
2008
and thereafter are convertible term advances and are callable, at the FHLB’s
option, at various dates starting on January 25, 2006. If an advance is called
by the FHLB, DNB has the option of repaying the borrowing, or continue to borrow
at three month Libor plus 10-14 basis points, depending on the advance. FHLB
advances may be collateralized by a pledge of unencumbered investment
securities, certain mortgage loans or a lien on the Bank’s FHLB
stock.
|
December
31, 2005
|
|||||||
|
Weighted
|
|||||||
|
(Dollars
in thousands)
|
Average
Rate
|
Amount
|
|||||
|
Due
by December 31, 2006
|
3.96
|
%
|
$
|
6,400
|
|||
|
Due
by December 31, 2008
|
5.09
|
7,450
|
|||||
|
Due
by December 31, 2010
|
5.95
|
20,000
|
|||||
|
Thereafter
|
5.42
|
20,000
|
|||||
|
Total
|
5.40
|
%
|
$
|
53,850
|
|||
(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, 2005 the branch has a carrying
amount of $535,000, net of accumulated depreciation of $215,000, 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, 2005:
|
(Dollars
in thousands)
|
||
|
Year
ended December 31
|
Amount
|
|
|
2006
|
$
106
|
|
|
2007
|
106
|
|
|
2008
|
106
|
|
|
2009
|
106
|
|
|
2010
|
106
|
|
|
Thereafter
|
1,243
|
|
|
Total
minimum lease payments
|
1,773
|
|
|
Less
amount representing interest
|
(1,072
|
)
|
|
Present
value of net minimum lease payments
|
$
701
|
(9)
JUNIOR
SUBORDINATED DEBENTURES
DNB
has
two issuances of junior subordinated debentures (the "debentures") as follows.
The majority of the proceeds of each issuance were invested in DNB’s subsidiary,
DNB First, National Association, to increase the Bank's capital levels. The
junior subordinated debentures issued in each case qualify as a component of
capital for regulatory purposes.
DNB
Capital Trust I
DNB’s
first issuance of junior subordinated debentures was on July 20, 2001. This
issuance of debentures are floating rate and were issued to DNB Capital Trust
I,
a Delaware business trust in which DNB owns all of the common equity. DNB
Capital Trust I issued $5.0 million of floating rate (6 month Libor plus 3.75%,
with a cap of 12%) capital preferred securities ("TruPS") to a qualified
institutional buyer. The proceeds of these securities were used by the Trust,
along with DNB's capital contribution, to purchase $5,155,000 principal amount
of DNB's floating rate junior subordinated debentures. 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.
Effective
March 31, 2004, as a result of the adoption of FIN 46, DNB deconsolidated the
Trust, resulting in a change in the characterization of the underlying
consolidated debt obligations from the previous trust preferred securities
to
junior subordinated debentures. The result was an increase in junior
subordinated debentures of $155,000.
DNB
Capital Trust II
DNB’s
second issuance of junior subordinated debentures was on March 30, 2005. This
issuance of debentures are floating rate and were issued to DNB Capital Trust
II, a Delaware business trust in which DNB owns all of the common equity. DNB
Capital Trust II issued $4 million of floating rate (the rate is fixed at 6.56%
for the first 5 years and will adjust at a rate of 3-month LIBOR plus 1.77%
thereafter) capital preferred securities. The proceeds of these securities
were
used by the Trust, along with DNB's capital contribution, to purchase $4.1
million principal amount of DNB's floating rate junior subordinated debentures.
The preferred securities are redeemable by DNB on or after May 23, 2010, 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 May
23,
2035.
(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, Investment Securities, Accrued Interest Receivable and
Accrued Interest Payable
The
carrying amounts for short-term investments (cash and Federal funds sold) and
accrued interest receivable and payable 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.
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 non-accrual
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 non-accrual 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 non-accrual 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 at December 31, 2005 and 2004. The fair values of time deposits 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 stand-by 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, 2005 and 2004,
un-funded loan commitments totaled $50.1 million and $30.9 million,
respectively. Stand-by letters of credit totaled $7.0 million and $6.5 million
at December 31, 2005 and 2004, respectively.
The
following tables summarize information for all on-balance-sheet financial
instruments.
|
December
31
|
||||
|
2005
|
2004
|
|||
|
Estimated
|
Estimated
|
|||
|
Carrying
|
Fair
|
Carrying
|
Fair
|
|
|
(Dollars
in thousands)
|
Amount
|
Value
|
Amount
|
Value
|
|
Financial
assets
|
||||
|
Cash
and Federal funds sold
|
$
22,183
|
$
22,183
|
$
24,121
|
$
24,121
|
|
Investment
securities - AFS
|
116,074
|
116,074
|
132,288
|
132,288
|
|
Investment
securities - HTM
|
30,673
|
29,954
|
37,475
|
37,095
|
|
Net
loans and leases
|
283,710
|
288,379
|
228,141
|
229,667
|
|
Accrued
interest receivable
|
2,134
|
2,134
|
1,772
|
1,772
|
|
Financial
liabilities
|
||||
|
Deposits
|
339,627
|
312,607
|
323,144
|
302,049
|
|
Borrowings
|
99,880
|
102,125
|
90,643
|
95,222
|
|
Accrued
interest payable
|
939
|
939
|
923
|
923
|
(11)
FEDERAL
INCOME TAXES
Income
tax expense was comprised of the following:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Current
tax expense:
|
||||||
|
Federal
|
$
429
|
$
635
|
$
97
|
|||
|
State
|
—
|
—
|
7
|
|||
|
Deferred
income tax (benefit) expense:
|
||||||
|
Federal
|
(518
|
)
|
(131
|
)
|
(114
|
)
|
|
State
|
—
|
—
|
—
|
|||
|
Income
tax expense (benefit)
|
$
(89
|
)
|
$
504
|
$
(10
|
)
|
|
The
effective income tax rates of (4%) for 2005, 63% for 2004 and (1%) for 2003
were
different than the applicable statutory Federal income tax rate of 34%. The
reason for these differences follows:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Federal
income taxes at statutory rate
|
$
700
|
$
273
|
$
473
|
|||
|
Decrease
resulting from:
|
||||||
|
Low
income housing credits
|
(36
|
)
|
(36
|
)
|
(55
|
)
|
|
Tax-exempt
interest and dividend preference
|
(394
|
)
|
(419
|
)
|
(316
|
)
|
|
Change
in valuation allowance
|
(308
|
)
|
733
|
—
|
||
|
Bank
owned life insurance
|
(73
|
)
|
(71
|
)
|
(71
|
)
|
|
Other,
net increase (decrease)
|
22
|
24
|
(41
|
)
|
||
|
Income
tax (benefit) expense
|
$
(89
|
)
|
$
504
|
$
(10
|
)
|
|
The
tax
effects of temporary differences that give rise to significant portions of
the
deferred tax assets and deferred tax liabilities are presented
below:
|
December
31
|
||||
|
(Dollars
in thousands)
|
2005
|
2004
|
||
|
Deferred
tax assets:
|
||||
|
Allowance
for credit losses
|
$
1,503
|
$
1,508
|
||
|
Unrealized
losses on securities available for sale
|
512
|
38
|
||
|
Unrealized
loss on pension obiligation
|
384
|
—
|
||
|
AMT
credit carryforward
|
239
|
127
|
||
|
Low
income housing credit carryforward
|
314
|
221
|
||
|
Capital
loss disallowance
|
425
|
—
|
||
|
Other-than-temporary
impairment
|
—
|
799
|
||
|
Restricted
stock awards
|
31
|
—
|
||
|
Deferred
gain on sale / leaseback on buildings
|
270
|
—
|
||
|
Non
accrued interest
|
87
|
98
|
||
|
Joint
venture difference
|
43
|
30
|
||
|
Total
gross deferred tax assets
|
3,808
|
2,821
|
||
|
Deferred
tax liabilities:
|
||||
|
Depreciation
|
(333
|
)
|
(415
|
)
|
|
Pension
expense
|
(327
|
)
|
(360
|
)
|
|
Tax
bad debt reserve
|
(142
|
)
|
(142
|
)
|
|
Bank
shares tax credit
|
(68
|
)
|
—
|
|
|
Prepaid
expenses
|
(187
|
)
|
(170
|
)
|
|
Bond
accretion
|
—
|
(51
|
)
|
|
|
Total
gross deferred tax liabilities
|
(1,057
|
)
|
(1,138
|
)
|
|
Valuation
allowance
|
(425
|
)
|
(733
|
)
|
|
Net
deferred tax asset
|
$
2,326
|
$
950
|
||
In
2004,
DNB recorded a valuation allowance of $733,000. The valuation allowance relates
to the $2,283,968 other-than-temporary impairment write-down of preferred stock,
which DNB believed was not more likely than not to be realized. Based upon
DNB’s
current tax history and the anticipated level of future taxable income,
management believed the remaining net deferred tax asset would, more likely
than
not, be realized.
With
regards to the previously recorded valuation allowance, DNB recognized a pre-tax
other-than-temporary impairment charge during 2004 totaling $2.3 million or
24%
of the book value on four agency preferred stock issues totaling $9.98 million.
The other-than-temporary impairment charges were recognized due to the negative
impact on the market value of these securities caused by the ongoing accounting,
management, and regulatory oversight issues confronting Fannie Mae and Freddie
Mac.
DNB
was
required to recognize other-than-temporary impairment under guidance provided
by
the Financial Accounting Standards Board (FASB115) and the Securities and
Exchange Commission (SEC). The perpetual preferred agency securities that DNB
owned at December 31, 2004 (preferred stock) were “Capital Assets” as defined
under Internal Revenue Code (IRC) Section 1221. In general, when the preferred
stock securities would be sold or disposed of, any net gain or loss on such
securities would generate a capital gain or capital loss. It was anticipated
that the sale of the preferred stock securities would give rise to a realized
capital loss for income tax purposes. Realized capital losses can only be used
to offset capital gain income and not ordinary taxable income from operations
(IRC Section 1211(a). To the extent a corporate taxpayer is unable to utilize
a
net realized capital loss, such losses can be carried forward to each of the
5
taxable years succeeding such loss year (IRC Section 1212(a)(1)(B)). If
unutilized after 5 taxable years, such capital losses will expire unused.
Neither DNB, nor its wholly owned subsidiary DNB First, National Association,
had a history of generating such capital gains within the past 3 tax years,
nor
did the management of DNB anticipate that it would generate such capital gains
within five (5) years of the anticipated sale of these securities. When the
impairment charge was recognized, DNB contemplated selling some or all of these
securities during 2005. The 5 year period to recover the capital loss would
start when these securities were sold. At December 31, 2004, DNB did not
anticipate recognizing gains from the sale of any capital assets that it may
have held as of this date (including these preferred stock securities) during
the next 5 - 6 years. As a result, management determined that it was more likely
than not that the income tax benefits associated with the above impairment
write
down would not be realizable and accordingly recorded a valuation allowance
for
deferred tax asset in the amount of $733,000.
During
2005, DNB reversed a portion of the previously recorded valuation allowance
for
deferred tax assets and recognized a related income tax benefit of $308,000.
A
significant portion of the reversal was associated with a tax capital gain
recognized on the sale of two operations buildings, as well as an additional
reversal made in connection with the sale of agency preferred securities, both
of which are considered “Capital Assets” as defined under Internal Revenue Code
(IRC) Section 1221. Additionally, DNB recorded an income tax benefit of $31,000
relating to the exercise of stock options by employees and directors. This
benefit was credited to surplus. In addition, DNB had AMT and low-income
housing credit (LIHC) carryforwards, as of December 31, 2005, of $239,000 and
$314,000, respectively. The AMT credit carryforward has an indefinite life.
The
LIHC carryforward has a life of twenty years and will expire in the year 2023,
if not used.
(12)
EARNINGS
PER SHARE
Basic
earnings per share (“EPS”) is computed based on the weighted average number of
common shares outstanding during the period. Diluted EPS reflects the potential
dilution that could occur from the conversion of common stock equivalents and
is
computed using the treasury stock method. The difference between basic and
diluted EPS, for DNB, is attributable to stock options and restricted stock.
Stock options and restricted stock awards for which the exercise price exceeds
the average market price over the period have an anti-dilutive effect on EPS
and, accordingly, are excluded from the calculation. At December 31, 2005,
there
were 90,000 anti-dilutive stock options outstanding as well as 16,884
anti-dilutive stock awards. DNB had 41,500 anti-dilutive stock options
outstanding at December 31, 2004 and 39,237 anti-dilutive stock options
outstanding at December 31, 2003. EPS, dividends per share, and weighted average
shares outstanding have been adjusted to reflect the effect of the 5% stock
dividend paid in December 2005. The dilutive effect of stock options on basic
earnings per share is presented below.
(13)
OTHER
COMPREHENSIVE (LOSS) -INCOME
The
tax
effects allocated to each component of “Other Comprehensive (Loss) Income” are
as follows:
|
Tax
|
||||||
|
Before-Tax
|
Benefit
|
Net-of-Tax
|
||||
|
(Dollars
in thousands)
|
Amount
|
(Expense)
|
Amount
|
|||
|
Year
Ended December 31, 2005:
|
||||||
|
Unrealized
losses on securities:
|
||||||
|
Unrealized
holding losses
|
||||||
|
arising
during the period
|
$(2,071
|
)
|
$699
|
$(1,372
|
)
|
|
|
Less
reclassification for losses
|
||||||
|
included
in net income
|
662
|
(225
|
)
|
437
|
||
|
Unrealized
actuarial losses - pension
|
(1,129
|
)
|
384
|
(745
|
)
|
|
|
Other
Comprehensive Loss
|
$(2,538
|
)
|
$858
|
$(1,680
|
)
|
|
|
Year
Ended December 31, 2004:
|
||||||
|
Unrealized
losses on securities:
|
||||||
|
Unrealized
holding gains
|
||||||
|
arising
during the period
|
$1,497
|
$(508
|
)
|
$989
|
||
|
Reclass
for other-than-temporary
|
||||||
|
Impairment
charge
|
(1,347
|
)
|
458
|
(889
|
)
|
|
|
Less
reclassification for losses
|
||||||
|
included
in net income
|
16
|
(5
|
)
|
11
|
||
|
Other
Comprehensive Income
|
$
134
|
$
(45
|
)
|
$
89
|
||
|
Year
Ended December 31, 2003:
|
||||||
|
Unrealized
gains on securities:
|
||||||
|
Unrealized
holding losses
|
||||||
|
arising
during the period
|
$(1,034
|
)
|
$
351
|
$(683
|
)
|
|
|
Less
reclassification for losses
|
||||||
|
included
in net income
|
362
|
(123
|
)
|
239
|
||
|
Other
Comprehensive Loss
|
$
(672
|
)
|
$
228
|
$(444
|
)
|
(14)
BENEFIT
PLANS
Pension
Plan
The
Bank
maintains a 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. The Plan generally covers only full-time
employees.
Effective
December 31, 2003, DNB amended its Retirement Plan so that no participants
will
earn additional benefits under the Plan after December 31, 2003. As a result
of
this amendment, no further service or compensation will be credited under the
Plan after December 31, 2003. The Plan, although frozen, will continue to
provide benefit payments and employees can still earn vesting credits until
retirement.
The
following table sets forth the Plan’s funded status, as of the measurement dates
of December 31, 2005 and 2004 and amounts recognized in DNB’s consolidated
financial statements at December 31, 2005 and 2004:
|
December
31
|
||||
|
(Dollars
in thousands)
|
2005
|
2004
|
||
|
Projected
Benefit obligation
|
$(6,641
|
)
|
$(6,362
|
)
|
|
Accumulated
benefit obligation
|
(6,641
|
)
|
(6,362
|
)
|
|
Fair
value of plan assets
|
6,475
|
6,552
|
||
|
Reconciliation
of funded status:
|
||||
|
Funded
Status
|
(166
|
)
|
190
|
|
|
Unrecognized
net actuarial loss
|
1,129
|
869
|
||
|
Unrecognized
transition asset
|
—
|
(1
|
)
|
|
|
Prepaid
benefit cost
|
$
963
|
$1,058
|
||
The
amounts and changes in DNB’s pension benefit obligation and fair value of plan
assets for the year ended December 31, 2005 are as follows:
|
Year
ended December 31
|
||||
|
(Dollars
in thousands)
|
2005
|
2004
|
||
|
Change
in benefit obligation
|
||||
|
Benefit
obligation at beginning of year
|
$6,362
|
$5,823
|
||
|
Service
cost
|
—
|
—
|
||
|
Interest
cost
|
391
|
371
|
||
|
Actuarial
loss
|
349
|
433
|
||
|
Curtailment
|
—
|
—
|
||
|
Benefits
paid
|
(461
|
)
|
(265
|
)
|
|
Benefit
obligation at end of year
|
$6,641
|
$6,362
|
||
|
Change
in plan assets
|
||||
|
Fair
value of assets at beginning of year
|
$6,552
|
$6,307
|
||
|
Actual
return on plan assets
|
395
|
520
|
||
|
Employer
contribution
|
—
|
—
|
||
|
Benefits
paid
|
(461
|
)
|
(265
|
)
|
|
Actual
expenses paid during year
|
(11
|
)
|
(10
|
)
|
|
Fair
value of assets at end of year
|
$6,475
|
$6,552
|
||
The
Pension Plan’s assets are invested using an asset allocation strategy in units
of certain equity, bond, real estate and money market funds.
Net
periodic pension costs for the years indicated include the following
components:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Service
cost
|
$
21
|
$
21
|
$
343
|
|||
|
Interest
cost
|
391
|
372
|
424
|
|||
|
Expected
return on plan assets
|
(414
|
)
|
(402
|
)
|
(436
|
)
|
|
Amortization
of transition asset
|
(1
|
)
|
(19
|
)
|
(19
|
)
|
|
Recognized
net actuarial loss
|
98
|
47
|
122
|
|||
|
Net
periodic cost
|
$
95
|
$
19
|
$
434
|
|||
|
Assumptions
used:
|
||||||
|
Discount
rate
|
6.00
|
%
|
6.00
|
%
|
6.50
|
%
|
|
Rate
of increase in compensation level
|
N/A
|
N/A
|
3.00
|
|||
|
Expected
long-term rate of return on assets
|
6.50
|
7.00
|
8.50
|
|||
DNB’s
estimated future benefit payments are as follows:
|
(Dollars
in thousands)
|
Benefits
|
|
|
2006
|
$
348
|
|
|
2007
|
366
|
|
|
2008
|
397
|
|
|
2009
|
413
|
|
|
2010
|
415
|
|
|
2011-2015
|
2,061
|
|
On
November 24, 1999, the Bank and Henry F. Thorne, its then current Chief
Executive Officer (the “Executive”), entered into a Death Benefit Agreement
providing for supplemental death and retirement benefits for him (the
“Supplemental Plan”). The Supplemental Plan provided 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 “Policy”) and provided for additional
compensation to the Executive, equal to any income tax consequences related
to
the Supplemental Plan until retirement. The 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 Policy. In addition, the Policy is intended to provide the Executive
with a
projected death benefit of $750,000. Neither the insurance company nor the
Bank
guaranteed any minimum cash value under the Supplemental Plan.
On
December 23, 2003, the Supplemental Plan was replaced by a Retirement and
Death
Benefit Agreement (the “Replacement Plan”). Pursuant to the Replacement Plan,
ownership of the Policy was transferred to the Bank to comply with certain
Federal income tax law changes, and the Bank may establish a trust for the
purpose of funding the benefits to be provided under the Replacement Plan,
or
the Bank’s obligations under the Replacement Plan and similar agreements or
plans which it may enter into or establish for the benefit of the Executive,
other employees of the Bank, or both.
The
Replacement Plan provides that if the Executive remains employed continuously
by
the Bank until age 65, he shall, upon his termination of employment for any
reason other than Cause, receive an annual retirement benefit of $34,915,
payable monthly, from the date of his termination of employment until his
death.
If Executive’s employment with the Bank terminates prior to age 65 for any
reason other than Cause, he will be entitled to an annual retirement benefit
payable monthly commencing the month after he reaches age 65 until his death,
but in this event his annual retirement benefit will be equal to that proportion
of the $34,915 annual benefit his actual years of service with the Bank bears
to
the years of service he would have completed had he remained employed
continuously by the Bank until age 65. In either case, he will also be entitled
to receive monthly a tax allowance calculated, subject to certain assumptions,
to substantially compensate him for his federal and state income, employment
and
excise tax liabilities attributable to the retirement benefit and the tax
allowance.
401(k)
Retirement Savings Plan
During
the fourth quarter of 1994, the Bank adopted a retirement savings plan intended
to comply with Section 40l(k) of the Internal Revenue Code of 1986. Prior to
January 1, 2004, employees became eligible to participate after 6 months of
service, and would thereafter participate in the 401(k) plan for any year in
which they have been employed by the Bank for at least 501 hours. Effective
January 1, 2004, employees were eligible to participate in the plan immediately
after hire and regardless of the hours they were employed in any year. Effective
July 1, 2005 all employees, with the exception of on-call employees, were
eligible to participate in the plan immediately after hire and regardless of
the
hours they were employed in any year. In general, amounts held in a
participant’s account are not distributable until the participant terminates
employment with the Bank, reaches age 59½, dies or becomes permanently
disabled.
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 Corporation’s matching contributions
to the 40l(k) plan was $81,000, $66,000 and $55,000 in 2005, 2004 and 2003,
respectively.
Profit
Sharing Plan
The
Bank
initiated a Profit Sharing Plan for eligible employees in 2004. Under the plan,
employees are immediately eligible for benefits and will be 100% vested after
3
years of service. In order to receive the profit sharing contribution an
employee must be employed on the last day of each plan year to participate
in
benefits. The plan provides that the Bank will make contributions beginning
in
2005 for the 2004 plan year equal to 3% of the eligible participant’s W-2 wages.
Safe
Harbor Contribution
-
Beginning
January 1, 2005, the Bank adopted a safe harbor plan, which requires a 3%
qualified non-elective contribution to be made to any employee with wages in
the
current year. Vesting is 100% at all times.
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 583,554 shares of DNB’s
common stock could be issued to employees and directors.
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 82,406, 200,376 and 21,732 shares available for grant at December
31,
2005, 2004 and 2003, respectively.
The
per
share weighted-average fair value of stock options granted during 2005, 2004
and
2003 was $7.22, $8.29 and $6.27 on the date of grant using the Black-Scholes
option valuation model with the following weighted-average assumptions used
for
grants for the three years ended December 31:
|
Year
Ended December 31
|
||||||
|
(Dollars
in thousands)
|
2005
|
2004
|
2003
|
|||
|
Dividend
yield
|
1.99
|
%
|
2.05
|
%
|
1.29
|
%
|
|
Expected
volatility
|
25.05
|
|
25.13
|
20.85
|
||
|
Risk-free
interest rate
|
4.45
|
4.21
|
3.61
|
|||
|
Expected
lives (in years)
|
10.00
|
10.00
|
9.50
|
|||
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.
Stock
option activity is indicated below. Stock options have been adjusted for the
5%
stock dividends in December of 2005, 2004 and 2003.
|
Number
|
Weighted
Average
|
|||
|
|
Outstanding
|
Exercise
Price
|
||
|
Outstanding
January 1, 2003
|
237,060
|
$15.75
|
||
|
Granted
|
11,952
|
20.58
|
||
|
Exercised
|
(76,767
|
)
|
12.51
|
|
|
Outstanding
December 31, 2003
|
172,245
|
17.53
|
||
|
Granted
|
43,575
|
25.11
|
||
|
Exercised
|
(31,502
|
)
|
14.87
|
|
|
Forfeited
|
(1,719
|
)
|
23.81
|
|
|
Outstanding
December 31, 2004
|
182,599
|
19.74
|
||
|
Granted
|
120,075
|
22.22
|
||
|
Exercised
|
(11,524
|
)
|
13.90
|
|
|
Forfeited
|
(2,104
|
)
|
25.09
|
|
|
Outstanding
December 31, 2005
|
289,046
|
$20.96
|
||
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, 2005
|
|||||
| Range of |
Number
|
Weighted
Average
|
||||
| Exercise Prices |
Outstanding
|
Exercise
Price
|
Remaining
Contractual Life
|
|||
| $ |
6.65-
8.99
|
4,887
|
$
8.98
|
.50
years
|
||
|
9.00-10.99
|
10,252
|
|
10.17
|
4.50
years
|
||
|
11.00-13.99
|
17,394
|
12.61
|
3.85
years
|
|||
|
14.00-19.99
|
123,217
|
19.12
|
7.88
years
|
|||
|
20.00-23.99
|
42,996
|
23.29
|
3.36
years
|
|||
|
24.00-26.76
|
90,300
|
|
25.85
|
9.17
years
|
||
| Total |
289,046
|
$20.96
|
7.12
years
|
|||
Stock-Based
Compensation
DNB
maintains an Incentive Equity and Deferred Compensation Plan. The plan provides
that up to 220,500 (as adjusted for subsequent stock dividends) shares of common
stock may be granted, at the discretion of the Board, to individuals of the
Company. During 2005, DNB granted 17,514 shares of restricted stock, issuable
on
the earlier of three years after the date of the grant or a change in control
of
DNB if the recipients are then employed by DNB (“Vest Date”). Upon issuance of
the shares, resale of the shares is restricted for an additional two years,
during which the shares may not be sold, pledged or otherwise disposed of.
Prior
to the Vest Date and in the event the recipient terminates association with
DNB
for reasons other than death, disability or change in control, the recipient
forfeits all rights to the shares that would otherwise be issued under the
grant. Share awards granted by the plan were recorded at the date of award
based
on the market value of shares. Awards are being amortized to expense over the
three-year cliff-vesting period. During this three-year period, DNB records
compensation expense equal to the value of the shares being amortized. For
the
year ended December 31, 2005, $92,000 was amortized to expense. At December
31,
2005, 203,616 shares were reserved for future grants under the plan. There
were
not any shares granted prior to 2005.
The
table below summarizes the activity for the year-ended December 31,
2005:
|
Shares
|
||
|
Outstanding
- January 1, 2005
|
—
|
|
|
Granted
|
17,514
|
|
|
Forfeited
|
(630
|
) |
|
Outstanding
- December 31, 2005
|
16,884
|
|
(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.
On
November 18, 2005, the Bank sold its operations center and an adjunct
administrative office at 104-106 Brandywine Avenue, to an unaffiliated buyer
for
$1,700,000 and leased the Property from the buyer for an initial term ending
December 1, 2010, on a triple net basis for an initial annual basic lease rental
of approximately $176,000. The Lease gives the Bank successive options to renew
its term for three additional terms of five years each at a basic rent to be
established at a fair market rental taking into account all of the terms and
conditions of this Lease, and an option to terminate the Lease at any time
on
120 days prior notice.
DNB
had
outstanding stand-by letters of credit in the amount of approximately $7.0
million and un-funded loan and lines of credit totaling $50.1 million at
December 31, 2005, of which, $53.9 million was variable rate and $3.2 million
was fixed rate.
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 nonperformance by the party to the financial
instrument for commitments to extend credit and stand-by 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.
Stand-by
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 credit of approximately $142.7 million.
Approximately
$88.0 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.
(16)
PARENT
COMPANY FINANCIAL INFORMATION
Condensed
financial information of DNB Financial Corporation (parent company only)
follows:
Condensed
Statements of Financial Condition
|
(Dollars
in thousands)
|
December
31
|
||||||
|
2005
|
|
2004
|
|||||
|
Assets
|
|||||||
|
Cash
|
$
|
299
|
$
|
315
|
|||
|
Investment
securities
|
37
|
—
|
|||||
|
Investment
in subsidiary
|
39,489
|
29,868
|
|||||
|
Other
assets
|
156
|
162
|
|||||
|
Total
assets
|
$
|
39,981
|
$
|
30,345
|
|||
|
Liabilities
and Stockholders’ Equity
|
|||||||
|
Liabilities
|
|||||||
|
Junior
subordinated debentures
|
$
|
9,279
|
$
|
5,155
|
|||
|
Other
liabilities
|
516
|
452
|
|||||
|
Total
liabilities
|
9,795
|
5,607
|
|||||
|
Stockholders’
Equity
|
30,186
|
24,738
|
|||||
|
Total
liabilities and stockholders’ equity
|
$
|
39,981
|
$
|
30,345
|
|||
Condensed
Statements of Operations
|
(Dollars
in thousands)
|
Year
Ended December 31
|
|||||||||
|
2005
|
|
2004
|
|
2003
|
||||||
|
Income:
|
||||||||||
|
Equity
in undistributed income of subsidiary
|
$
|
1,638
|
$
|
(412
|
)
|
$
|
718
|
|||
|
Dividends
from subsidiary
|
1,071
|
990
|
949
|
|||||||
|
Interest
income
|
—
|
—
|
—
|
|||||||
|
Total
Income
|
2,709
|
578
|
1,667
|
|||||||
|
Expenses:
|
||||||||||
|
Interest
expense
|
561
|
277
|
263
|
|||||||
|
Other
expenses
|
—
|
3
|
3
|
|||||||
|
Total
expense
|
561
|
280
|
266
|
|||||||
|
Net
income
|
$
|
2,148
|
$
|
(298
|
)
|
$
|
1,401
|
|||
Condensed
Statements of Cash Flows
|
(Dollars
in thousands)
|
Year
Ended December 31
|
|||||
|
2005
|
2004
|
2003
|
||||
|
Cash
Flows From Operating Activities:
|
||||||
|
Net
income
|
$
2,148
|
$
298
|
$1,401
|
|||
|
Adjustments
to reconcile net income to net cash
|
||||||
|
provided
by operating activities:
|
||||||
|
Equity
in undistributed income of subsidiary
|
(1,638
|
)
|
412
|
(718
|
)
|
|
|
Restricted
stock amortization
|
91
|
—
|
—
|
|||
|
Net
change in other liabilities
|
40
|
307
|
(11
|
)
|
||
|
Net
change in other assets
|
6
|
9
|
4
|
|||
|
Net
Cash Provided by Operating Activities
|
647
|
1,026
|
676
|
|||
|
Cash
Flows From Investing Activities:
|
||||||
|
Payments
for investments in and advances to subsidiaries
|
(9,672
|
)
|
—
|
—
|
||
|
Sale
or repayment of investments in and advances to
subsidiaries
|
33
|
—
|
—
|
|||
|
Purchase
of available for sale security
|
(
37
|
)
|
—
|
(1,225
|
)
|
|
|
Sales
and maturities of available for sale security
|
—
|
1,225
|
2,810
|
|||
|
Net
Cash (Used) Provided by Investing Activities
|
(9,676
|
)
|
1,225
|
1,585
|
||
|
Cash
Flows From Financing Activities:
|
||||||
|
Proceeds
from advances from subsidiaries
|
4,124
|
—
|
—
|
|||
|
Proceeds
from issuance of common stock
|
5,965
|
346
|
—
|
|||
|
Purchase
of treasury stock
|
(5
|
)
|
(1,391
|
)
|
(1,215
|
)
|
|
Dividends
paid
|
(1,071
|
)
|
(990
|
)
|
(949
|
)
|
|
Net
Cash Provided by Financing Activities
|
9,013
|
(2,035
|
)
|
(2,164
|
)
|
|
|
Net
Change in Cash and Cash Equivalents
|
(16
|
)
|
216
|
97
|
||
|
Cash
at Beginning of Period
|
315
|
99
|
2
|
|||
|
Cash
at End of Period
|
$
299
|
$
315
|
$
99
|
|||
(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 $1.8 million for the year ended
December 31, 2005.
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 the most recent regulatory notification that
management believes would have changed the Bank’s category. Actual capital
amounts and ratios are presented below.
|
For
Capital
|
To
Be Well Capitalized Under Prompt Corrective
|
|||||||||||
|
Actual
|
Adequacy
Purposes
|
Action
Provisions
|
||||||||||
|
(Dollars
in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||
|
DNB
Financial Corporation
|
||||||||||||
|
December
31, 2005:
|
||||||||||||
|
Total
risk-based capital
|
$43,752
|
13.77
|
%
|
$25,422
|
8.00
|
%
|
$31,778
|
10.00
|
%
|
|||
|
Tier
1 capital
|
39,773
|
12.52
|
12,711
|
4.00
|
19,067
|
6.00
|
||||||
|
Tier
1 (leverage) capital
|
39,773
|
8.61
|
18,468
|
4.00
|
23,085
|
5.00
|
||||||
|
December
31, 2004:
|
||||||||||||
|
Total
risk-based capital
|
$32,778
|
11.96
|
%
|
$21,917
|
8.00
|
%
|
$27,396
|
10.00
|
%
|
|||
|
Tier
1 capital
|
29,341
|
10.71
|
10,959
|
4.00
|
16,438
|
6.00
|
||||||
|
Tier
1 (leverage) capital
|
29,341
|
6.75
|
17,389
|
4.00
|
21,737
|
5.00
|
||||||
|
DNB
First, N.A.
|
||||||||||||
|
December
31, 2005:
|
||||||||||||
|
Total
risk-based capital
|
$43,770
|
13.79
|
%
|
$25,389
|
8.00
|
%
|
$31,736
|
10.00
|
%
|
|||
|
Tier
1 capital
|
39,797
|
12.54
|
12,695
|
4.00
|
19,042
|
6.00
|
||||||
|
Tier
1 (leverage) capital
|
39,797
|
8.63
|
18,450
|
4.00
|
23,063
|
5.00
|
||||||
|
December
31, 2004:
|
||||||||||||
|
Total
risk-based capital
|
$32,750
|
11.97
|
%
|
$21,894
|
8.00
|
%
|
$27,368
|
10.00
|
%
|
|||
|
Tier
1 capital
|
29,316
|
10.71
|
10,947
|
4.00
|
16,421
|
6.00
|
||||||
|
Tier
1 (leverage) capital
|
29,316
|
6.75
|
17,366
|
4.00
|
21,707
|
5.00
|
||||||
Report
of Independent Registered Public Accounting Firm
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, 2005 and 2004, 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, 2005. 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration
of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose
of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. 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 subsidiary as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
KPMG
LLP
Philadelphia,
Pennsylvania
March
10,
2006
None
DNB’s
Chief Executive Officer and Chief Financial Officer have reviewed and evaluated
the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a-15(e)) as of December 31, 2005, the end of the period
covered by this report, in accordance with the requirements of Exchange Act
Rule
240.13a-15(b). Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer have concluded that DNB’s current disclosure controls
and procedures are effective and timely, providing them with material
information relating to DNB and its subsidiaries required to be disclosed in
the
report DNB files under the Exchange Act.
Management
of DNB is responsible for establishing and maintaining adequate internal control
over financial reporting for DNB, as such term is defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934.
DNB’s
management, including the principal executive officer and principal financial
officer, has assessed the effectiveness of DNB’s internal control over financial
reporting as of December 31, 2005. In making this assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission in Internal Control—Integrated Framework. Based upon such
assessment, management believes that, as of December 31, 2005, the Corporation’s
internal control over financial reporting is effective based upon those
criteria.
There
was
no change in the DNB’s “internal control over financial reporting” (as such term
is defined in Rule 13a-15(f) under the Exchange Act) that occurred during the
quarter ended December 31, 2005, that has materially affected, or is reasonably
likely to materially affect, DNB’s internal control over financial
reporting.
None
Part
III
The
information required herein with respect to Registrant’s directors and officers
is incorporated by reference to pages 4-7 of the Registrant’s Proxy Statement
for the 2006 Annual Meeting of Stockholders, and the information required herein
with respect to compliance with Section 16(a) of the Securities Exchange Act
of
1934 is incorporated by reference to page 6 of the Registrant’s Proxy Statement
for the Annual Meeting of Stockholders. The Registrant has adopted a Code of
Ethics that applies to the Registrant’s principal executive officer, principal
financial officer, principal accounting officer or controller or persons
performing similar functions. The Registrant’s current Code of Ethics is
incorporated herein by reference as Exhibit 14 to this report.
The
information required herein is incorporated by reference to pages 8-13 and
16-18
of the Registrant’s Proxy Statement for the 2006 Annual Meeting of
Stockholders.
Matters
(a)
Information Regarding Equity Compensation Plans
The
following table summarizes certain information relating to equity compensation
plans maintained by the Registrant as of December 31, 2005:
|
Plan
category
|
Number
of securities
to
be issued upon
exercise
of outstanding
options,
warrants
and
rights
|
Weighted-average
price
of outstanding
options,
warrants
and
rights
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in
first
column)
|
|||
|
Equity
compensation plans
|
||||||
|
approved
by security holders:
|
||||||
|
1995
Stock Option Plan
|
289,046
|
$20.96
|
82,406
|
|||
|
2004
Incentive Equity and
|
||||||
|
Deferred
Compensation Plan
|
16,884
|
N/A
|
203,616
|
|||
|
Equity
compensation plans
|
||||||
|
not
approved by security holders
|
—
|
—
|
—
|
|||
|
Total
|
305,930
|
N/A
|
286,022
|
(b)
The
balance of the information required herein is incorporated by reference to
page
2 of the Registrant’s Proxy Statement for the 2006 Annual Meeting of
Stockholders.
The
information required herein is incorporated by reference to pages 15-16 of
the
Registrant’s Proxy Statement for the 2006 Annual Meeting of
Stockholders.
The
information required herein is incorporated by reference to page 20 of the
Registrant’s Proxy Statement for the 2006 Annual Meeting of
Stockholders.
Part
IV
(a)(1) Financial
Statements.
The
consolidated financial statements listed below, together with an opinion of
KPMG
LLP dated March 10, 2006 with respect thereto, are set forth beginning at
page 48 of this report under Item 8, “Financial Statements and
Supplementary Data.”
DNB
Financial Corporation and Subsidiaries:
Report
of
Independent Registered Public Accounting Firm
Consolidated
Statements of Income
Consolidated
Balance Sheets
Consolidated
Statements of Cash Flows
Consolidated
Statements of Changes in Preferred Stock and Common
Shareholders’
Equity
Notes
to
Consolidated Financial Statements
Selected
Quarterly Financial Data (Unaudited)
(a)(2) Not
applicable
(a)(3)
Exhibits, pursuant to Item 601 of Regulation S-K.
The
exhibits listed on the Index to Exhibits on pages
-
of this
report are incorporated by reference or filed or furnished herewith in response
to this Item.
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
23, 2006
|
||
|
BY:
|
/s/
William S. Latoff
|
|
|
William
S. Latoff, Chairman of the
Board
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 on behalf of the Registrant and in the
capacities and on the dates indicated.
|
/s/
William J. Hieb
|
March
23, 2006
|
|
William
Hieb, President and
|
|
|
Chief
Operating Officer
|
|
|
/s/
Bruce E. Moroney
|
March
23, 2006
|
|
Bruce
E. Moroney
|
|
|
Chief
Financial Officer
|
|
|
(Principal
Accounting Officer)
|
|
|
/s/
Thomas A. Fillippo
|
March
23, 2006
|
|
Thomas
A. Fillippo
|
|
|
Director
|
|
|
/s/
Mildred C. Joyner
|
March
23, 2006
|
|
Mildred
C. Joyner
|
|
|
Director
|
|
|
/s/
James J. Koegel
|
March
23, 2006
|
|
James
J. Koegel
|
|
|
Director
|
|
|
/s/
Eli Silberman
|
March
23, 2006
|
|
Eli
Silberman
|
|
|
Director
|
|
|
/s/
James H. Thornton
|
March
23, 2006
|
|
James
H. Thornton
|
|
|
Vice-Chairman
of the Board
|
|
|
Exhibit
No. Under Item
601
of Regulation S-K
|
Description
of Exhibit and Filing
Information
|
|
|
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.
|
|
|
4
|
Registrant
has certain debt obligations outstanding, for none of which do the
instruments defining holders rights authorize an amount of securities
in
excess of 10% of the total assets of the Registrant and its subsidiaries
on a consolidated basis. Registrant agrees to furnish copies of such
agreements to the Commission on request.
|
|
|
10
|
(a)*
|
Employment
Agreement between DNB First, N.A. 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)*
|
Change
of Control Agreements between DNB Financial Corporation and DNB First,
N.A. and the following executive officers each in the form filed
on March
29, 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: (i) dated
May 5,
1998 with Ronald K. Dankanich; and Bruce E. Moroney, (ii) dated April
28,
2003 with William J. Hieb, and (iii) dated October 18, 2004 with
C.
Tomlinson Kline III, (iv) dated December 3, 2004 with Thomas M. Miller,
(v) dated January 26, 2006 with Richard J. Hartmann.
|
|
|
(c)**
|
1995
Stock Option Plan of DNB Financial Corporation (as amended and restated,
effective as of April 27, 2004), filed on March 29, 2004 as Appendix
A to
Registrant’s Proxy Statement for its Annual Meeting of Stockholders held
April 27, 2004, and incorporated herein by reference.
|
|
|
(d)*
|
Death
Benefit Agreement between DNB First, N.A. 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.
|
|
|
(e)*
|
Form
of Change of Control Agreements, as amended November 10, 2003, filed
on
November 14, 2003 as Item 10(e) to Form 8-K (No. 0-16667) and incorporated
herein by reference between DNB Financial Corporation and DNB First,
N.A.
and each of the following Directors: (i) dated November 10, 2005
with
James H. Thornton, James J. Koegel and Eli Silberman, and (ii) dated
February 23, 2005 with Mildred C. Joyner, and dated February 22,
2006 with
Thomas Fillippo.
|
|
|
(f)*
|
Retirement
and Change of Control Agreement dated as of February 27, 2002, between
DNB
Financial Corporation and DNB First, N.A. 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 filed March 29, 2004 as Item 10(g) to Form 10-K for the fiscal
year
ended December 31, 2003 (No. 0-16667) and incorporated herein by
reference.
|
|
|
(h)*
|
Retirement
and Death Benefit Agreement between DNB First, N.A. and Henry F.
Thorne
dated December 23, 2003 filed March 29, 2004 as Item 10(h) to Form
10-K
for the fiscal year ended December 31, 2003 (No. 0-16667) and incorporated
herein by reference.
|
|
|
(i)***
|
DNB
Financial Corp. Incentive Equity and Deferred Compensation Plan,
filed
March 10, 2005 as item 10(i) to Form 10-K for the fiscal year-ended
December 31, 2004 (No. 0-16667) and incorporated herein by
reference.
|
|
|
(j)*
|
Retirement
Agreement among DNB Financial Corporation, DNB First, N.A. and Henry
F.
Thorne, dated December 17, 2004, filed March 10, 2005 as Item 10(i)
to
Form 10-K for the fiscal year ended December 31, 2004 (No. 0-16667)
and
incorporated herein by reference.
|
|
|
(k)*
|
Change
of Control Agreement among DNB Financial Corporation, DNB First,
N.A. and
William S. Latoff, dated December 17, 2004, filed March 10, 2005
as Item
10(i) to Form 10-K for the fiscal year ended December 31, 2004 (No.
0-16667) and incorporated herein by reference.
|
|
|
(l)
|
Agreement
of Lease dated February 10, 2005 between Headwaters Associates, a
Pennsylvania general partnership, as Lessor, and DNB First, National
Association as Lessee for a portion of premises at 2 North Church
Street,
West Chester, Pennsylvania, filed March 10, 2005 as Item 10(l) to
Form
10-K for the fiscal year ended December 31, 2004 (No. 0-16667) and
incorporated herein by reference, as amended by Addendum to Agreement
of
Lease dated as of November 15, 2005, filed herewith.
|
|
|
(m)
|
Marketing
Services Agreement between TSG, INC., a Pennsylvania business corporation
(the "Service Provider") for which Eli Silberman, a Director of
Registrant, is the President and owner dated April 11, 2005, filed
May 11,
2005 as Item 10(m) to Form 10-Q for the fiscal quarter ended March
31,
2005 (No. 0-16667) and incorporated herein by
reference.
|
|
|
(n)**
|
Form
of Stock Option Agreement for grants prior to 2005 under the Registrant’s
Stock Option Plan, filed May 11, 2005 as Item 10(n) to Form 10-Q
for the
fiscal quarter ended March 31, 2005 (No. 0-16667) and incorporated
herein
by reference.
|
|
|
(o)**
|
Form
of Nonqualified Stock Option Agreement for April 18, 2005 and subsequent
grants under the Stock Option Plan, filed May 11, 2005 as Item 10(o)
to
Form 10-Q for the fiscal quarter ended March 31, 2005 (No. 0-16667)
and
incorporated herein by reference.
|
|
|
(p)
|
Agreement
of Sale dated June 1, 2005 between DNB First, National Association
(the
“Bank”), as seller, and Papermill Brandywine Company, LLC, a Pennsylvania
limited liability company, as buyer (“Buyer”) with respect to the sale of
the Bank’s operations center and an adjunct administrative office (the
“Property”) and accompanying (i) Agreement of Lease between the Buyer as
landlord and the Bank as tenant, pursuant to which the Property will
be
leased back to the Bank, and (ii) Parking Easement Agreement to provide
cross easements with respect to the Property, the Buyer’s other adjoining
property and the Bank’s other adjoining property, filed August 15, 2005 as
Item 10(p) to Form 10-Q for the fiscal quarter ended June 30, 2005
(No.
0-16667) and incorporated herein by
reference.
|
| DNB FINANCIAL CORPORATION |
DIRECTORS
|
EXECUTIVE
OFFICERS
|
|
CORPORATE
HEADQUARTERS
4
Brandywine Avenue
Downingtown,
PA 19335
Tel.
610-269-1040 Fax 484-359-3176
Internet
http://www.dnbfirst.com
FINANCIAL
INFORMATION
Investors,
brokers, security analysts and others desiring financial information
should contact
Bruce
Moroney at 484-359-3153 or
bmoroney@dnbfirst.com
AUDITORS
KPMG
LLP
1601
Market Street
Philadelphia,
PA 19103-2499
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.
800-842-8928
Ferris,
Baker Watts, Inc.
800-638-7411
Janney
Montgomery Scott, Inc.
800-526-6397
Ryan
Beck & Company
800-223-8969
|
William
S. Latoff
Chairman
and Chief Executive Officer
James
H. Thornton
Vice
Chairman
Thomas
A. Fillippo
William
J. Hieb
Mildred
C. Joyner
James
J. Koegel
Eli
Silberman
DIRECTORS
EMERITUS
Ellis
Y. Brown III
Robert
J. Charles
I.
Newton Evans, Jr.
Thomas
R. Greenleaf
Vernon
J. Jameson
Ilario
S. Polite
Henry
F. Thorne
DNB
FIRST, N.A.
DIRECTORS
William
S. Latoff
Chairman
and Chief Executive Officer
William
J. Hieb
President
and Chief Operating Officer
Thomas
A. Fillippo
Mildred
C. Joyner
James
J. Koegel
Eli
Silberman
James
H. Thornton
|
William
S. Latoff
Chairman
and Chief Executive Officer
William
J. Hieb
President
and Chief Operating Officer
Thomas
M. Miller
First
Executive Vice President
Chief
Lending Officer
Ronald
K. Dankanich
Executive
Vice President
Operations,
IT and HR
Richard
J. Hartmann
Executive
Vice President
Retail
Banking and Marketing
Bruce
E. Moroney
Executive
Vice President
Chief
Financial Officer
|