SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549Form 10-KANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004Commission File number 0-7617Univest Corporation of Pennsylvania(Exact name of registrant as specified in its charter)
UNIVEST CORPORATION OF PENNSYLVANIATABLE OF CONTENTS
1
PART I The information contained in this report may contain forward-looking statements. When used or incorporated by reference in disclosure documents, the words “believe,” “anticipate,” “estimate,” “expect,” “project,” “target,” “goal” and similar expressions are intended to identify forward-looking statements within the meaning of section 27A of the Securities Act of 1933. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including those set forth below: • Operating, legal and regulatory risks • Economic, political and competitive forces impacting various lines of business • The risk that our analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful • Volatility in interest rates • Other risks and uncertainties Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. These forward-looking statements speak only as of the date of the report. The Corporation expressly disclaims any obligation to publicly release any updates or revisions to reflect any change in the Corporation’s expectations with regard to any change in events, conditions or circumstances on which any such statement is based.Item 1.BusinessGeneral Univest Corporation of Pennsylvania, (the “Corporation”), is a Pennsylvania corporation organized in 1973 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956. Univest elected to become a Financial Holding Company in 2000 as provided under Title I of the Gramm-Leach-Bliley Act. It owns all of the capital stock of Univest National Bank and Trust Co. (The “Bank”), Univest Realty Corporation, Univest Delaware, Inc., and Univest Reinsurance Corporation. The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, including the Bank. On January 18, 2003 Union National Bank and Trust Company of Souderton and Pennview Savings Bank combined to form Univest National Bank and Trust Co. The Bank is engaged in the general commercial banking business and provides a full range of banking services and trust services to its customers. Delview, Inc., a wholly owned subsidiary of the Bank, is a passive investment holding company located in Delaware. Delview provides various financial services including financial planning, investment management, insurance products and brokerage services to individuals and businesses through its subsidiaries Univest Investments, Inc. and Univest Insurance, Inc. Univest Realty Corporation was established to obtain, hold and operate properties for the holding company and its subsidiaries. Univest Reinsurance Corporation, as a reinsurer, offers life and disability insurance to individuals in connection with credit extended to them by the Bank. Univest Delaware, Inc. is a passive investment holding company located in Delaware. Univest Investments, Inc., Univest Insurance, Inc. and Univest Reinsurance Corporation were formed to enhance the traditional banking and trust services provided by the Bank. Univest2
2
Investments, Univest Insurance and Univest Reinsurance do not currently meet the quantitative thresholds for separate disclosure provided under SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” Therefore, the Corporation currently has one reportable segment, “Community Banking,” and strategically is how the Corporation operates and has positioned itself in the marketplace. The Corporation’s activities are interrelated, each activity is dependent, and performance is assessed based on how each of these activities supports the others. Accordingly, significant operating decisions are based upon analysis of the Corporation as one Community Banking operating segment.Employees As of December 31, 2004, the Corporation and its subsidiaries employed five hundred four (504) persons.Competition The Corporation’s service areas are characterized by intense competition for banking business among commercial banks, savings and loan associations, savings banks and other financial institutions. The Corporation’s subsidiary bank actively competes with such banks and financial institutions for local retail and commercial accounts, in Bucks and Montgomery counties, as well as other financial institutions outside its primary service area. In competing with other banks, savings and loan associations, and other financial institutions, the Bank seeks to provide personalized services through management’s knowledge and awareness of their service area, customers and borrowers. Other competitors, including credit unions, consumer finance companies, insurance companies and mutual funds, compete with certain lending and deposit gathering services offered by the Bank and its subsidiaries, Univest Investments, Inc. and Univest Insurance, Inc.Supervision and Regulation The Bank is subject to supervision and is regularly examined by the Office of the Comptroller of the Currency. Also, the Bank is subject to examination by the Federal Deposit Insurance Corporation and by the Board of Governors of the Federal Reserve System (the “Board”). The Corporation is subject to the provisions of the Bank Holding Company Act of 1956, as amended, and is registered pursuant to its provisions. The Corporation is subject to the reporting requirements of the Board, and the Corporation, together with its subsidiaries, is subject to examination by the Board. The Federal Reserve Act limits the amount of credit that a member bank may extend to its affiliates, and the amount of its funds that it may invest in or lend on the collateral of the securities of its affiliates. Under the Federal Deposit Insurance Act, insured banks are subject to the same limitations. The Corporation elected to become a Financial Holding Company in 2000 as provided under Title I of the Gramm-Leach-Bliley Act. The Act provides a new regulatory framework for regulation through the financial holding company, which has the Board as its umbrella regulator. The Gramm-Leach-Bliley Act requires “satisfactory” or higher Community Reinvestment Act compliance for insured depository institutions and their financial holding companies in order for them to engage in new financial activities. The Act provides a federal right to privacy of non-public personal information of individual customers. The Corporation is subject to the Sarbanes-Oxley Act of 2002 (“SOX”) that went into effect on July 30, 2002. The Act legislated reforms that are intended to address corporate and accounting fraud. SOX adopts new standards of corporate governance and imposes new requirements on the board and management of public companies. The bill also requires that the chief executive officer and chief financial officer certify the accuracy of periodic reports filed with the Securities and3
3
Exchange Commission (“SEC”). Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”), the Corporation is required to furnish a report by its management on internal controls over financial reporting, identify any material weaknesses in its internal controls over financial reporting and assert that such internal controls are effective. The Corporation has implemented and completed an exhaustive process to achieve compliance with SOX 404 during 2004. The Corporation must maintain effective internal controls over time which will require an on-going commitment by management and the Corporation’s Audit Committee. The process has and will continue to require substantial resources in both financial costs and human capital.Credit and Monetary Policies The Bank is affected by the fiscal and monetary policies of the federal government and its agencies, including the Board. An important function of the policies is to curb inflation and control recessions through control of the supply of money and credit. The Board uses its powers to regulate reserve requirements of member banks, the discount rate on member-bank borrowings, interest rates on time and savings deposits of member banks, and to conduct open-market operations in United States Government securities to exercise control over the supply of money and credit. The policies have a direct effect on the amount of bank loans and deposits and on the interest rates charged on loans and paid on deposits, with the result that the policies have a material effect on bank earnings. Future policies of the Board and other authorities cannot be predicted, nor can their effect on future bank earnings be predicted. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks, and is subject to supervision and regulation by the Federal Housing Finance Board. The Federal Home Loan Banks provide a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank of Pittsburgh, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount equal to 5% of outstanding loans plus 0.5% of the unused credit line from the Federal Home Loan Bank of Pittsburgh.Statistical Disclosure The Corporation was incorporated under Pennsylvania law in 1973 for the purpose of acquiring the stock of Union National Bank and subsequently to engage in other business activities permitted under the Bank Holding Company Act. On September 28, 1973, pursuant to an exchange offer, Univest acquired the outstanding stock of Union National Bank and Trust Company of Souderton and on August 1, 1990 acquired the stock of Pennview Savings Bank. Two new subsidiaries were incorporated on September 8, 1998 in the State of Delaware; Univest Delaware, Inc. and Delview, Inc. were formed as passive investment companies. Univest Delaware, Inc. is wholly owned by the Corporation; Delview, Inc. is wholly owned by Univest National Bank and Trust Co., the Bank. Univest Insurance, Inc. and Univest Investments, Inc. are wholly owned by Delview, Inc. Univest Insurance, Inc. acquired Gum Insurance on December 3, 2001 and Donald K. Martin & Company on December 13, 2004. On January 18, 2003, Union National Bank and Trust Company of Souderton and Pennview Savings Bank combined to form Univest National Bank and Trust Co. The Bank acquired First County Bank on May 17, 2003 and Suburban Community Bank on October 4, 2003. Both First County Bank and Suburban Community Bank were merged into the Bank.Item 2.Properties The Corporation and its subsidiaries occupy thirty-eight properties in Montgomery and Bucks counties in Pennsylvania, which are used principally as banking offices. Business locations and hours are available on the Corporation’s website at www.univest.net. The Corporation owns its corporate headquarters building, which is shared with the Bank and Univest Investments, Inc., in Souderton, Montgomery County. Univest Insurance, Inc. occupies an4
4
owned location in Montgomery County. The Bank serves the area through its twenty-nine traditional offices and seven supermarket branches that offer traditional community banking and trust services. Sixteen banking offices are located in Montgomery County, of which eleven are owned and five are leased; twenty banking offices are located in Bucks County, of which five are owned and fifteen are leased. Additionally, the Bank provides banking and trust services for the residents and employees of twelve retirement home communities, offers a payroll check cashing service at one work site office, offers merchants an express banking center located in the Montgomery Mall, and has five off-premise automated teller machines. The work site office and the express banking center are located in Montgomery County. Three off-premise automated teller machines are located in Montgomery County and two are located in Bucks County.Item 3.Legal Proceedings Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation. In addition, there are no material proceedings pending or known to be threatened or contemplated against the Corporation or the Bank by government authorities.Item 4.Submission of Matters to a Vote of Security Holders Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005.PART IIItem 5.Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities The Corporation’s common stock is listed on NASDAQ: UVSP. The Corporation’s shares were approved for NASDAQ listing and began trading on the NASDAQ National Market, effective August 15, 2003. At December 31, 2004, Univest had 2,321 stockholders. StockTrans, Inc. serves as the Corporation’s transfer agent to assist shareholders in managing their stock. StockTrans, Inc. is located at 44 East Lancaster Avenue, Ardmore, PA. Shareholders can contact a representative by calling 610-649-7300.Range of Market Prices The following table shows the range of market values of the Corporation’s stock. The prices shown on this page represent transactions between dealers and do not include retail markups, markdowns, or commissions.
5
6
The following table provides information on repurchases by the Corporation of its common stock during the year ended December 31, 2004.Issuer Purchases of Equity Securities
7
The Corporation’s filings are also available at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the hours of operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains the Corporation’s SEC filings electronically at www.sec.gov.Item 6.Selected Financial Data
8
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsResults of Operations (All dollar amounts presented within tables are in thousands, except per share data.) (Common stock data has been restated to give effect to a five-for-four stock split in the form of a dividend declared on January 22, 2003 to shareholders of record as of February 7, 2003, paid on February 28, 2003. All share and per share amounts have been retroactively adjusted to give effect to the stock split.) Univest Corporation of Pennsylvania (the “Corporation”) earns its revenues primarily, through its subsidiaries, from the margins and fees it generates from the loan and depository services it provides as well as from trust fees and insurance and investment commissions. The Corporation seeks to achieve adequate and reliable earnings by growing its business while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk to Board of Directors approved levels. Growth is pursued through expansion of current customer relationships and development of additional relationships with new offices and strategic related acquisitions. The Corporation has also taken steps in recent years to reduce its dependence on net interest income by intensifying its focus on fee based income from trust, insurance, and investment services to customers. The principal component of earnings for the Corporation is net interest income, which is the difference between the yield on interest-earning assets and the cost on interest-bearing liabilities. The net interest margin, which is the ratio of net interest income to average earning assets, is affected by several factors including market interest rates, economic conditions, loan demand, and deposit activity. The Board of Governors of the Federal Reserve System has begun to increase interest rates and is signaling that it will raise rates at a measured pace to a more neutral level. The Corporation maintains a relatively low interest rate risk profile and does not anticipate that an increase in interest rates would be adverse to its net interest margin. The Corporation seeks to maintain a steady net interest margin and consistent growth of net interest income. On May 17, 2003, the Corporation completed a merger of First County Bank with and into Univest National Bank and Trust Co. (the “Bank”) in a cash transaction for $29.5 million. On October 4, 2003, the Corporation completed a merger of Suburban Community Bank with and into the Bank in a cash transaction for $24.1 million. The impact of these mergers to the consolidated balance sheets and income statements is discussed in the Financial Condition section of this Management’s Discussion and Analysis. The Corporation’s consolidated net income and earnings per share for 2004, 2003, and 2002 were as follows:
9
• Total noninterest income decreased by $0.9 million or 3.7% due primarily to a decrease in gains on the sales of securities. • Total noninterest expense increased $2.9 million or 6.9% largely due to increases in salaries and benefits expense and increases in advertising, marketing and public relations.2003 versus 2002 The 2003 results compared to 2002 include the following significant pretax components: • Net interest income increased due to growth in average earning assets. The net interest margin declined from 4.0% to 3.8% due to the increase in long-term debt from new borrowed funds, Trust Preferred Securities and Subordinated Capital Notes. • Total noninterest income increased by $2.9 million or 14.1% due primarily to gains on the sales of securities. • Total noninterest expense increased $4.2 million or 11.1% largely due to increases in salaries and benefits expense. The mergers with First County Bank and Suburban Community Bank in May and October 2003, respectively, contributed to this increase.Net Interest Income Net interest income is the difference between interest earned on loans, investments and other interest-earning assets and interest paid on deposits and other interest-bearing liabilities. Net interest income is the principal source of the Corporation’s revenue. Table 1 presents a summary of the Corporation’s average balances, the yields earned on average assets, the cost of average liabilities, and shareholders’ equity for the years ended December 31, 2004, 2003, and 2002. Table 2 analyzes the changes in net interest income for the periods broken down by their rate and volume components. Sensitivities associated with the mix of assets and liabilities are numerous and complex. The Asset/ Liability Management and Investment Committees work to maintain an adequate and stable net interest margin for the Corporation. Net interest income increased $5.0 million in 2004 compared to 2003 and $3.6 million in 2003 compared to 2002 primarily due to increased volume of real estate-commercial and construction loans in both periods. The net interest margin, which is net interest income as a percentage of average interest-earning assets, declined from 4.0% at December 31, 2002 to 3.8% at both December 31, 2003 and 2004. The net interest spread, which represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities, was 3.5%, 3.4% and 3.5% at December 31, 2004, 2003 and 2002, respectively. However, the effect of net interest free funding sources of 0.3%, 0.4% and 0.5% for December 31, 2004, 2003 and 2002, respectively, has steadily declined; and represents the effect on the net interest margin of net funding provided by noninterest-earning assets, noninterest-bearing liabilities and shareholders’ equity.10
10
Table 1 — Distribution of Assets, Liabilities and Stockholders’ Equity;Interest Rates and Interest Differential
11
Table 2 — Analysis of Changes in Net Interest Income The rate-volume variance analysis set forth in the table below compares changes in net interest for the periods indicated by their rate and volume components. The change in interest income/expense due to both volume and rate has been allocated to change in volume.
12
Interest Income Interest and fees on loans increased 11.4% for the year ended December 31, 2004 compared to 2003 primarily due to a 38.7% increase in the average balance of real estate — commercial and construction loans. The average interest yield on the loan portfolio decreased from 5.8% in 2003 to 5.4% in 2004 as a result of market conditions. This decrease in yield however, was more than offset by an increase in average loan balances outstanding. The increase in average loan volume came in part from the First County Bank and Suburban Community Bank acquisitions during 2003 and in part from regular loan growth. Comparing 2003 to 2002, interest and fees on loans increased 1.6% primarily due to a 34.1% increase in average real estate — commercial and construction loans. The average interest yield on the loan portfolio decreased from 6.6% in 2002 to 5.8% in 2003. The average prime rate for the year ended December 31, 2003 was 4.12% compared to 4.68% for the year ended December 31, 2002. This decrease in yield, however, was more than offset by an increase in average loan balances outstanding. The increase in loan volume came in part from the First County Bank and Suburban Community Bank acquisitions during 2003 and in part from regular loan growth. Tax-exempt interest on loans increased 8.8% for the year ended December 31, 2004 compared to 2003 due to an 18.4% increase in volume which more than offset a 35 basis point decline in the rate. The decrease in rate is a result of market conditions. Comparing 2003 to 2002, tax-exempt interest on loans decreased 15.1% due to a 94 basis point decline in rates. Interest on U.S. Government obligations increased 5.0% for the year ended December 31, 2004 compared to 2003 primarily due to a 21.2% increase in volume which more than offset a 48 basis point decline in the rate. Comparing 2003 to 2002, interest on U.S. Government obligations decreased 4.4% primarily due to an 86 basis point decline in the rate which more than offset the 18.5% increase in volume. In 2003, the volume increase was offset by a decrease in the portfolio yield due to repricing through maturities, calls, and advantageous sales. Interest and dividends on state and political subdivisions continues to show an increasing trend from $2.8 million in 2002 to $3.4 million in 2003 and $3.6 million in 2004. The increase is a result of the Corporation’s decision to continue to grow its investments in tax-exempt securities during 2003. During 2003 and 2002, the Corporation acquired tax-exempt securities with a term of greater than ten years and at tax-equated yields substantially higher than other investment opportunities. The increase in volume more than offset the slight decline in yield for all three periods. The other securities category consists mainly of U.S. Government Agency mortgage-backed securities. Income on other securities declined 37.9% in 2004 compared to 2003 primarily due to the sale of approximately $50.3 million of primarily fixed-rate U.S. Government agency mortgage-backed securities and prepayments during 2004. Comparing 2003 to 2002, interest on other securities declined 18.4% primarily due to a 134 basis point decline in rate which more than offset the 4.2% net increase in volume, as higher yielding securities matured or were prepaid and were replaced with lower yielding securities. Interest on federal funds sold is income received from the daily investment of excess or unused funds. It can be volatile in both rate and volume. Interest on federal funds sold decreased in 2004 compared to 2003 due to volume decreases offsetting increases in federal funds rates. Interest on federal funds sold decreased in 2003 compared to 2002 due to declines in both average volume and the federal funds rate.Interest Expense The average rates paid on deposits declined significantly during 2003 throughout the banking industry; the effects of this decline continued during 2004 as some categories flattened during 2004. The Corporation’s average cost of deposits declined 87 basis points during 2003 compared to 2002 and 47 basis point during 2004 compared to 2003. Every major category of deposits grew in average13
13
volume, with the exception of time open and club accounts, during both 2003 and 2004. The impact on interest expense of this overall increase in volume was offset by the decrease in the average interest rate for that category for 2003. During 2004, the overall increase in volume was more than offset by the impact of a 97 basis point decline in the rate on certificates of deposit. Interest expense on demand deposits increased 3.3% during 2004 compared to 2003 as volume increased and rates flattened. Comparing 2003 to 2002, interest expense on demand deposits decreased 40.5% as a 57 basis point decline in rates more than offset the volume increases of 14.1%. Interest expense on regular savings deposits decreased 32.0% during 2004 compared to 2003 and 55.8% for 2003 compared to 2002 as interest rates continued to decline. Interest expense on certificates of deposit and other time accounts decreased 22.9% during 2004 compared to 2003 primarily due to a 97 basis point decline in the rate on certificates of deposit. Comparing 2003 to 2002, interest expense on certificates of deposit and other time accounts decreased 16.5% primarily due to a 97 basis point decline in the rate on certificates of deposit. Interest expense on short-term borrowings includes interest paid on federal funds purchased and repurchase agreements. In addition, the Bank offers an automated cash management checking account that sweeps funds daily into a repurchase agreement account. Interest expense increased 44.3% during 2004 compared to 2003 primarily due to volume increases in these cash management accounts of 39.3%. Comparing 2003 to 2002, interest expense on short-term borrowings decreased 35.8% primarily due to a 53 basis point rate decline. Interest on long-term debt increased 34.6% during 2004 compared to 2003 and 87.4% during 2003 compared to 2002 primarily due to respective volume increases of 40.1% and 121.3%. These increases represent interest on higher volumes of borrowings from the Federal Home Loan Bank of Pittsburgh, the issuance of $15.0 million in Subordinated Capital Notes in 2003 and the issuance of, $20.0 million in Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Junior Subordinated Debentures of the Corporation (“Trust Preferred Securities”) in 2003. At December 31, 2002, total long-term debt was borrowings from the Federal Home Loan Bank of Pittsburgh. Federal Home Loan Bank advances are available to expand lending.Provision For Loan Losses The reserve for loan losses is determined through a periodic evaluation that takes into consideration the growth of the loan portfolio, the status of past-due loans, current economic conditions, various types of lending activity, policies, real estate and other loan commitments, and significant changes in charge-off activity. Loans are also reviewed for impairment based on discounted cash flows using the loans’ initial effective interest rate or the fair value of the collateral for certain collateral dependent loans as provided for under SFAS No. 114. Any of the above criteria may cause the provision to fluctuate. The provision for the years ended December 31, 2004, 2003, and 2002 was $1.6 million, $1.0 million, and $1.3 million, respectively. Growing loan volumes and current economic conditions in addition to a $0.6 million increase in specific allowances for loan losses indicated the need for an increase to the reserve in 2004.Noninterest Income Noninterest income consists of trust department fee income, service charges on deposits income, commission income, net gains on sales of securities, and other miscellaneous types of income. It also includes various types of service fees, such as ATM fees, and life insurance income which primarily represents changes in the cash surrender value of bank-owned insurance. Total noninterest income decreased during 2004 compared to 2003 and increased during 2003 compared to 2002 primarily due to gains on the sales of securities in 2003.14
14
The following table presents noninterest income for the years ended December 31, 2004, 2003 and 2002:
15
Gains on Sales of Assets Sales of $8.1 million in mortgage loans during the year ended December 31, 2004 resulted in a gain of $0.1 million as compared to sales of $41.4 million during the year ended December 31, 2003 for a gain of $0.6 million. Sales of $12.3 million in mortgage loans during the year ended December 31, 2002 resulted in a gain of $0.2 million for the year ended December 31, 2002. Higher sales in 2003 were due to the large number of refinancings as a result of record low mortgage rates. Net gains on sales of fixed assets was $0.2 million for the year ended December 31, 2004 compared to net losses of $0.1 million in 2003 and net gains of $0.1 million in 2002. Net gains in 2004 were primarily the result of the sale of a branch office which was in close proximity to another more favorable Bank branch location. Net losses in 2003 were primarily due to the consolidation of a supermarket branch location into an existing stand-alone branch within the same shopping center. Net gains in 2002 were primarily due to the sale of a property adjacent to a branch used primarily for parking. During 2004, available for sale debt and equity securities, primarily fixed-rate U.S. Government Agency mortgage-backed securities, with an amortized cost of approximately $57.1 million were sold for a net gain of $1.1 million. During 2004, mortgage-backed securities were sold to position the portfolio for higher rates by reducing extension risk and price volatility. During 2003, debt and equity securities with an amortized cost of approximately $103.0 million were sold from the available-for-sale portfolio resulting in a net gain of $2.1 million. During 2003, short-term securities were sold and the funds were reinvested in medium-term securities to take advantage of a steep yield curve. In 2002, securities totaling approximately $27.0 million were sold from the available-for-sale portfolio or matured, resulting in a net gain of $0.9 million.Noninterest Expense The operating costs of the Corporation are known as noninterest expense, and include, but are not limited to, salaries and benefits, equipment expense, and occupancy costs. Expense control is very important to the management of the Corporation, and every effort is made to contain and minimize the growth of operating expenses, and to provide technological innovation whenever practical, as operations change or expand. The following table presents noninterest expense for the years ended December 31, 2004, 2003 and 2002:
16
relatively flat during 2004 in comparison to 2003. Comparing 2003 to 2002, equipment expense increased primarily due to an increase in software expense. Other expenses increased for the year ending December 31, 2004 in comparison to 2003 primarily due to increases of approximately $0.9 million in advertising, marketing and public relations expenses. The Corporation’s targeted market area and planned allocations were expanded in 2004 primarily due to the 2003 acquisitions. Legal, advisory and consulting fees increased approximately $0.5 million primarily due to legal costs associated with loan workout and foreclosure proceedings and tax advisory costs. Other expenses increased for the year ended December 31, 2003 as compared to 2002. Capital shares tax increased $0.5 million in 2003 compared to 2002 primarily due to an increase in bank and trust company shares tax resulting from the merging of Pennview Savings Bank into the Bank in January of 2003 and the acquisitions of First County Bank and Suburban Community Bank. Other increases were due to audit and regulatory examination fees, insurance expense and the core deposit intangible amortization expense and there was a one-time NASDAQ Stock Market application fee of $0.1 million. Advertising, marketing and public relations expenses for 2003 were less than 2002 expenses due to managed allocations. These allocations were increased for the 2004 year.Tax Provision The provision for income taxes was $8.3 million for the year ended December 31, 2004; $8.2 million for the year ended December 31, 2003; and $7.6 million for the year ended December 31, 2002. The provision for income taxes for 2004, 2003, and 2002 was at effective rates of 26.1%, 26.2% and 26.5%, respectively. The effective tax rates reflect the benefits of tax credits generated from investments in low-income housing projects, tax-exempt income from investments in municipal securities and loans, and bank-owned life insurance.Financial Condition During 2004, total assets increased primarily due to loan growth partially offset by maturities and sales of investment securities. Total liabilities decreased primarily due to a reduction in borrowings as funding for loan growth was supported by proceeds from maturities and sales of investments in excess of investment purchases, available cash and current earnings. Detailed explanations follow.ASSETS The following table presents assets at December 31, 2004 and December 31, 2003:
17
Acquisitions On December 13, 2004, the Corporation acquired Donald K. Martin & Company. The acquisition will expand Univest Insurance, Inc. into the West Chester area of Pennsylvania. Donald K. Martin & Company specializes in property and casualty insurance primarily for the non-profit sector, including churches, senior communities and life communities. Univest Insurance, Inc. made an initial payment $0.2 million in January 2005 for the acquisition.Investment Securities The investment portfolio is managed as part of the overall asset and liability management process to optimize income and market performance over an entire interest rate cycle while mitigating risk. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk and to take advantage of market conditions that create more economically attractive returns on these investments. The securities portfolio consists primarily of U.S. Government agency, mortgage-backed and municipal securities. Total investments decreased in 2004 compared to 2003 as proceeds from sales and maturities of $224.3 million were used to purchase $145.7 million in securities and to fund loan growth. During 2004, primarily fixed-rate mortgage-backed securities were sold to position the portfolio for higher rates by reducing extension risk and price volatility. In 2004, maturities of primarily U.S. government agency securities were replaced primarily with like securities.Table 3 — Investment Securities The following table shows the carrying amount of investment securities as of the dates indicated. Held-to-maturity and available-for-sale portfolios are combined.
18
Loans Total loans increased at December 31, 2004 compared to December 31, 2003 primarily due to a $42.6 million increase in commercial loans, a $32.4 million increase real estate-construction loans and a $23.9 million increase in real estate-commercial loans. Also contributing to the increase was growth in consumer loans of $11.1 million. Real estate-residential loans, which are loans secured by one- to four-family properties, were relatively flat with net growth of $1.8 million.Table 5 — Loan Portfolio The following table presents the composition of the loan portfolio as of the dates indicated:
19
Asset Quality Performance of the entire loan portfolio is reviewed on a regular basis by bank management and loan officers. A number of factors regarding the borrower, such as overall financial strength, collateral values and repayment ability, are considered in deciding what actions should be taken when determining the collectibility of interest for accrual purposes. When a loan, including a loan impaired under SFAS No. 114, is classified as nonaccrual, the accrual of interest on such a loan is discontinued. A loan is classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against other expense. Interest received on nonaccrual loans is either applied against principal or reported as interest income, according to management’s judgment as to the collectibility of principal. Loans are usually restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Total cash basis, restructured and nonaccrual loans totaled $10.1 million at December 31, 2004, $8.6 million at December 31, 2003 and $2.6 million at December 31, 2002 and consist mainly of commercial loans and real estate-commercial loans. For the years ended December 31, 2004, 2003 and 2002, nonaccrual loans resulted in lost interest income of $0.6 million, $0.4 million and $0.2 million respectively. The Corporation’s ratio of nonperforming assets to total loans and other real estate owned was 0.99% as of December 31, 2004 and 0.89% as of December 31, 2003. At December 31, 2004, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $10.1 million, all of which were on a nonaccrual basis. The related reserve for loan losses for those loans was $2.7 million. Nonaccruing loans increased during 2004 due to $2.9 million in real estate-commercial loans and $1.6 million in commercial loans placed on nonaccrual status. Specific reserves of $1.1 million have been established for these loans based on current facts and management’s judgments about the ultimate outcome of these credits. The amount of the specific reserve needed for these credits could change in future periods subject to changes in facts and judgments related to these credits. Increases in nonaccruing loans in 2004 were offset by $0.8 million in charge-offs, approximately $1.0 million in paydowns, $0.6 million in loans returned to accruing status and $0.6 million in foreclosed loans carried in other real estate owned. At December 31, 2004 nonaccruing loans consisted of: $6.7 million in real estate-commercial loans and $3.3 million in commercial loans. At December 31, 2003, the recorded investment in loans considered to be impaired under SFAS No. 114 was $8.6 million, all of which were on a nonaccrual basis. The related reserve for loan losses for those loans was $1.9 million. At December 31, 2003 nonaccruing loans consisted of $4.4 in commercial loans, $3.1 million in real estate-commercial loans and $1.1 million in real estate-residential loans, secured by 1-4 family dwellings. At December 31, 2004, management is not aware of other potential problem loans that cause serious doubts as to the ability of the borrowers to comply with the present loan repayment terms. In management’s evaluation of the loan portfolio risks, any significant future increases in nonperforming loans are dependent to a large extent on the economic environment, or specific industry problems. At December 31, 2004 there were no concentrations of loans exceeding 10% of total loans other than disclosed in Table 5.20
20
Table 7 — Nonaccrual, Past Due and Restructured Loans The following table details the aggregate principal balance of loans classified as nonaccrual, past due and restructured:
21
The reserve for loan losses consists of an allocated reserve and an unallocated reserve. The allocated reserve is comprised of reserves established on specific loans, and class reserves based on historical loan loss experience, current trends, and management assessments. The unallocated reserve is based on both general economic conditions and other risk factors in the Corporation’s individual markets and portfolios. The specific reserve element is based on a regular analysis of impaired commercial and real estate loans. For these loans, the specific reserve established is based on an analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class reserve element is determined by an internal loan grading process in conjunction with associated allowance factors. The Corporation revises the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. The Corporation maintains a reserve in other liabilities for off-balance sheet credit exposures that currently are unfunded.Table 8 — Allocated, Unallocated Loan Loss Reserves The reserve for loan losses is made up of the allocated reserve and the unallocated portion. The following table summarizes the two categories for the periods indicated.
22
Table 9 — Summary of Loan Loss Experience The following table presents average loans and summarizes loan loss experience for the years ended December 31, 2004, 2003, 2002, 2001 and 2000:
23
Corporation has completed the annual impairment tests and no impairment was noted. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings. The Corporation has intangible assets due to bank and branch acquisitions, core deposit intangibles, covenants not to compete (in favor of the Corporation) and mortgage servicing rights, which are not deemed to have an indefinite life and therefore will continue to be amortized over their useful life. The amortization for these intangible assets was $0.6 million for the year ended December 31, 2004, $0.4 million for the year ended December 31, 2003, and $0.3 million for the year ended December 31, 2002. The Corporation also has goodwill of $40.8 million, which is deemed to be an indefinite intangible asset and will not be amortized. In connection with the 2003 acquisitions of First County Bank and Suburban Community Bank, the Corporation initially recorded $34.9 million of goodwill which was adjusted for unrecorded deferred taxes during 2004 to $34.6 million.LIABILITIES The following table presents liabilities at December 31, 2004 and December 31, 2003:
24
The following table summarizes the maturities of certificates of deposit and other time deposits with balances of $100 thousand or more at December 31, 2004:
25
Accumulated other comprehensive income related to debt securities is primarily the difference between the book value and market value of the available-for-sale investment portfolio. The year-to-year decrease in accumulated other comprehensive income was caused by the decline in the portfolio yield as a result of debt securities maturing, being called, or sold. As these securities were replaced with new securities purchased at market rates, the difference between the book value and market value of this portfolio declined. Additionally during 2004, available for sale debt and equity securities, primarily fixed-rate U.S. Government Agency mortgage-backed securities, totaling approximately $57.1 million were sold for a net gain of $1.1 million. The accumulated other comprehensive income related to interest-rate swaps, net of taxes, included in shareholders’ equity at December 31, 2003 was $3.0 thousand. Accumulated other comprehensive income related to interest-rate swaps reflects the current market value of the swap net of taxes. The interest-rate swap matured on January 7, 2004.Capital Adequacy Capital guidelines which banking regulators have adopted assign minimum capital requirements for categories of assets depending on their assigned risks. The components of risk-based capital for the Corporation are Tier 1 and Tier 2. Minimum required total risk-based capital is 8.0%. The Corporation had a Tier 1 capital ratio of 10.6% and total risk-based capital ratio of 12.4% at December 31, 2004. At December 31, 2003, the Corporation had a Tier 1 capital ratio of 10.0% and total risked-based capital ratio of 12.0%. These ratios declined during the year as a result of the bank acquisitions, yet continue to place the Corporation in the “well-capitalized” category under regulatory standards. Details on the capital ratios can be found in Note 17 “Regulatory Matters” of this Form 10-K along with a discussion on dividend and other restrictions. In April 2003 the Corporation secured $15.0 million in subordinated capital notes that qualifies for Tier 2 capital status. In August 2003 the Corporation issued $20.0 million of trust preferred securities that qualify for Tier 1 capital status.Critical Accounting Policies Management, in order to prepare the Corporation’s financial statements in conformity with generally accepted accounting principles, is required to make estimates and assumptions that effect the amounts reported in the Corporation’s financial statements. There are uncertainties inherent in making these estimates and assumptions. Certain critical accounting policies, discussed below, could materially affect the results of operations and financial position of the Corporation should changes in circumstances require a change in related estimates or assumptions. The Corporation has identified the reserve for loan losses, intangible assets, investment securities, mortgage servicing rights, income taxes and benefit plans as its critical accounting policies. Reserve for loan losses are provided using techniques that specifically identify losses on impaired loans, estimate losses on pools of homogeneous loans, and estimate the amount of unallocated reserve necessary to account for losses that are present in the loan portfolio but not yet currently identifiable. The adequacies of these reserves are sensitive to changes in current economic conditions that may affect the ability of borrowers to make contractual payments as well as the value of the collateral committed to secure such payments. Rapid or sustained downturns in the economy may require increases in reserves that may negatively impact the Corporation’s results of operation and statements of financial condition in the periods requiring additional reserves. Intangible assets have been recorded on the books of the Corporation in connection with its acquisitions of First County Bank, Pennview Savings Bank, Suburban Community Bank, Univest Investments, Inc. and Univest Insurance, Inc. These assets, both identifiable and unidentifiable, are subject to tests for impairment. Changes in the useful life or economic value of acquired assets may require a reduction in the asset value carried on the financial statements of the Corporation and a related charge in the statement of operations. Such changes in asset value could result from a26
26
change in market demand for the products or services offered by an acquired business or by reductions in the expected profit margins that can be obtained through the future delivery of the acquired product or service line. SFAS No. 142, which took effect January 1, 2002, defines the methods that are acceptable for determining whether intangible asset values are sustainable. The Corporation designates its investment securities as held-to-maturity, available-for-sale or trading in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Each of these designations affords different treatment in the statement of operations and statement of financial condition for market value changes effecting securities that are otherwise identical. Should evidence emerge that indicates that management’s intent or ability to manage the securities as originally asserted is not supportable, securities in the held-to-maturity or available-for-sale designations may be re-categorized so that either statement of financial position or statement of operations adjustments may be required. The Corporation accounts for mortgage servicing rights for mortgages it originated but subsequently sold in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities — a replacement of FAS No. 125.” As such, the value of the rights is booked as income when the corresponding mortgages are sold. The income booked at sale is the estimated present value of the cash flows that will be received from servicing the loans over the entire future term. The term of a servicing right can be reasonably estimated using prepayment assumptions of comparable assets priced in the secondary market. As mortgage rates being offered to the public decrease, the life of loan servicing rights tends to shorten, as borrowers have increased incentive to refinance. Shortened loan servicing lives require a change in the value of the servicing rights that have already been recorded to be marked down in the statement of operations of the servicing company. This may cause a material change in reported operations for the Corporation depending on the size of the servicing portfolio and the degree of change in the prepayment speed of the type and coupon of loans being serviced. The Corporation recognizes deferred tax assets and liabilities under the liability method of FAS 109. Enacted tax rates are applied to cumulative temporary differences based on expected taxable income in the periods in which the deferred tax asset or liability is anticipated to be realized. Future tax rate changes could occur that would require the recognition of income or expense in the statement of operations in the period in which they are enacted. Deferred tax assets must be reduced by a valuation allowance if in management’s judgment it is “more likely than not” that some portion of the asset will not be realized. Management may need to modify their judgments in this regard from one period to another should a material change occur in, the business environment, tax legislation, or in any other business factor that could impair the Corporation’s ability to benefit from the asset in the future. The Corporation has a retirement plan that it provides as a benefit to employees and former employees and supplemental retirement plans that it provides as a benefit to certain current and former executives. Determining the adequacy of the funding of these plans may require estimates of future salary rate increases, of long-term rates of investment return, and the use of an appropriate discount rate for the obligation. Changes in these estimates and assumptions due to changes in the economic environment or financial markets may result in material changes in the Corporation’s report of operation or statement of financial condition. Readers of the Corporation’s financial statements should be aware that the estimates and assumptions used in the Corporation’s current financial statements may need to be updated in future financial presentations for changes in circumstances, business or economic conditions in order to fairly represent the condition of the Corporation at that time.Asset/ Liability Management The primary functions of Asset/Liability Management are to assure adequate earnings, capital and liquidity while maintaining an appropriate balance between interest-earning assets and interest-27
27
bearing liabilities. Liquidity management involves the ability to meet cash flow requirements of customers and corporate needs. Interest-rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing rates. The Corporation uses both an interest-sensitivity gap analysis and a simulation model to quantify its exposure to interest rate risk. The Corporation uses the gap analysis to identify and monitor long-term rate exposure and uses a simulation model to measure the short-term rate exposures. The Corporation runs various earnings simulation scenarios to quantify the effect of declining or rising interest rates on the net interest margin over a one-year horizon. The simulation uses existing portfolio rate and repricing information, combined with assumptions regarding future loan and deposit growth, future spreads, prepayments on residential mortgages, and the discretionary pricing of non-maturity assets and liabilities. The Corporation had used interest-rate swap agreements that convert a portion of its floating rate commercial loans to a fixed rate basis. In these swaps, the Corporation agrees to exchange, at specified intervals, the difference between fixed and floating-interest rates calculated on an agreed upon notional principal amount. Interest-rate swaps in which the Corporation pays a floating rate and receives a fixed rate are used to reduce the impact of changes in interest rates on the Corporation’s net interest income. At December 31, 2004 the Corporation had no swaps outstanding. At December 31, 2003, the total notional amount of “Pay Floating, Receive Fixed” swaps outstanding was $10.0 million. The net payable or receivable from interest-rate swap agreements is accrued as an adjustment to interest income. The $10.0 million in notional amount of interest-rate swaps outstanding at December 31, 2003 expired on January 7, 2004. There was no material impact of interest-rate swaps on net interest income for the year ended December 31, 2004. The impact of the interest-rate swaps on net interest income for the year ended December 31, 2003 was a positive $0.5 million. The Corporation’s credit exposure on swaps is limited to the value of interest-rate swaps that have become favorable to the Corporation. As of December 31, 2003, the market value of interest-rate swaps in a favorable position was $5 thousand and there were no interest-rate swaps with a market value in an unfavorable position. Credit risk exists because the counterparty to a derivative contract with an unrealized gain might fail to perform according to the terms of the agreement.Credit Risk Extending credit exposes the Corporation to credit risk, which is the risk that the principal balance of a loan and any related interest will not be collected due to the inability of the borrower to repay the loan. The Corporation manages credit risk in the loan portfolio through adherence to consistent standards, guidelines and limitations established by the Board of Directors. Written loan policies establish underwriting standards, lending limits and other standards or limits as deemed necessary and prudent. The loan review department conducts ongoing, independent reviews of the lending process to ensure adherence to established policies and procedures, monitors compliance with applicable laws and regulations, provides objective measurement of the risk inherent in the loan portfolio, and ensures that proper documentation exists. The Corporation focuses on both assessing the borrower’s capacity and willingness to repay and on obtaining sufficient collateral. Commercial and industrial loans are generally secured by the borrower’s assets and by personal guarantees. Commercial real estate loans are originated primarily within the Eastern Pennsylvania market area and are secured by developed real estate at conservative loan-to-value ratios and often by a guarantee of the borrowers. Management closely28
28
monitors the composition and quality of the total commercial loan portfolio to ensure that significant credit concentrations by borrower or industry do not exist. Credit risk in the direct consumer loan portfolio is controlled by strict adherence to conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values. In the home equity loan portfolio, combined loan-to-value ratios are generally limited to 80%. Other credit considerations may warrant higher combined loan-to-value ratios for approved loans. The Corporation originates fixed-rate and adjustable-rate residential mortgage loans that are secured by the underlying 1- to 4-family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-equity ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance. The Corporation closely monitors delinquencies as another means of maintaining high asset quality. Collection efforts begin after a loan payment is missed, by attempting to contact all borrowers. If collection attempts fail, the Corporation will proceed to gain control of any and all collateral in a timely manner in order to minimize losses. While liquidation and recovery efforts continue, officers continue to work with the borrowers, if appropriate, to recover all monies owed to the Corporation. The Corporation monitors delinquency trends and past due reports are submitted to the Board of Directors.Liquidity The Corporation, in its role as a financial intermediary, is exposed to certain liquidity risks. Liquidity refers to the Corporation’s ability to ensure that sufficient cash flow and liquid assets are available to satisfy demand for loans and deposit withdrawals. The Corporation manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. The Corporation has a contingency funding plan in place to address liquidity needs in the event of an institution-specific or a systemic financial crisis.Sources of Funds Core deposits and cash management repurchase agreements (“Repos”) have historically been the most significant funding sources for the Corporation. These deposits and Repos are generated from a base of consumer, business and public customers primarily located in Bucks and Montgomery counties, Pennsylvania. The Corporation faces increased competition for these deposits from a large array of financial market participants, including banks, thrifts, mutual funds, security dealers and others. The Corporation supplements its core funding with money market funds it holds for the benefit of various trust accounts. These funds are fully collateralized by the Bank’s investment portfolio and are at current money market mutual fund rates. This funding source is subject to changes in the asset allocations of the trust accounts. The Corporation, through the Bank, has short-term and long-term credit facilities with the Federal Home Loan Bank of Pittsburgh (“FHLB”) with a maximum borrowing capacity of approximately $373.9 million. At December 31, 2004, outstanding borrowings under the FHLB credit facilities totaled $54.6 million. The maximum borrowing capacity changes as a function of qualifying collateral assets and the amount of funds received may be reduced by additional required purchases of FHLB stock. The Corporation maintains federal fund lines with several correspondent banks totaling $70.0 million. At December 31, 2004, there was $17.5 million in outstanding borrowings under these29
29
lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn. The Corporation, through the Bank, has an available line of credit at the Federal Reserve Bank of Philadelphia, the amount of which is dependent upon the balance of loans and securities pledged as collateral. At December 31, 2004, the Corporation had no outstanding borrowings under this line.Cash Requirements The Corporation has cash requirements including various financial obligations, including contractual obligations and commitments that require cash payments. The contractual obligations and commitments table that follows presents, as of December 31, 2004, significant fixed and determinable contractual obligations to third parties. The most significant obligation, in both the under and over one year time period, is for the Bank to repay its certificates of deposit. Securities sold under agreement to repurchase constitute the next largest payment obligation and it is short term in nature. The Bank anticipates meeting these obligations by continuing to provide convenient depository and cash management services through its branch network, thereby replacing these contractual obligations with similar fund sources at rates that are competitive in our market. The table also shows the amounts and expected maturities of significant commitments as of December 31, 2004. These commitments do not necessarily represent future cash requirements in that these commitments often expire without being drawn upon. Commitments to extend credit are the Banks most significant commitment in both the under and over one year time periods. In 2003, the Corporation made investments in bank acquisitions requiring cash outlays of $51.6 million. These cash outlays to invest in income producing businesses are discretionary and may not be typical of the Corporation’s regular cash requirements.Contractual Obligations and Commitments The Corporation enters into contractual obligations in the normal course of business as a source of funds for its asset growth and its asset/ liability management, to fund acquisitions and to meet required capital needs. These obligations require the Corporation to make cash payments over time as detailed in the table below. The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to manage the Corporation’s exposure to fluctuation in interest rates. These financial instruments include commitments to extend credit, standby and commercial letters of credit and forward contracts. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of these financial instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby and commercial letters of credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Corporation does not require and is not required to pledge collateral or other security to support financial instruments with credit risk. These commitments expire over time as detailed in Table 12. Forward contracts represent agreements for delayed delivery of financial instruments or commodities in which the buyer agrees to purchase and the seller agrees to deliver, at a specified future date, a specified instrument or commodity at a specified price or yield. Forward contracts are not traded on organized exchanges and their contractual terms are not standardized. The Corporation’s forward contracts are commitments to sell loans secured by 1-to-4 family residential properties whose predominant risk characteristic is interest rate risk.30
30
For further information regarding the Corporation’s commitments, refer to Footnote 14 of the Consolidated Financial Statements, herein.Table 12 — Contractual Obligations The following table sets forth contractual obligations and other commitments representing required and potential cash outflows, including interest payable, as of December 31, 2004:
31
Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards Board revised Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 (the “Interpretation”). The Interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. Application of this Interpretation is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of entities is required in financial statements for periods ending after March 15, 2004. As a result of the adoption of FIN 46, the Corporation deconsolidated its Capital Trust in the first quarter of 2004. The result was an increase in the junior debt of $619 thousand. In December 2004, the Financial Accounting Standards Board revised Statement No. 123, “Accounting for Stock Based Compensation” (“SFAS 123r”). SFAS 123r required that the fair-value-based method of accounting for stock options be used for all public entities and eliminates alternative accounting methods; consequently, similar economic transactions will be accounted for similarly. Entities are required to estimate the number of instruments for which the requisite service is expected to be rendered as compared to the original statement which permitted entities to account for forfeitures as they occur. In addition, SFAS 123r amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. Incremental compensation cost for a modification of the terms or conditions of an award is measured by comparing the fair value of the modified award with the fair value of the award immediately before the modification. SFAS 123r becomes effective for public entities that do not file as small business issuers, as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. SFAS 123r applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. As of the required effective date, all public entities that used the fair-value-based method for either recognition or disclosure under the original statement will apply SFAS 123r using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under the original statement for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by the original statement. Pro forma disclosures under the original statement are presented in Footnote 1 of the Consolidated Financial Statements, herein. The Corporation does not anticipate recording expense significantly different than what is presented in Footnote 1; although actual expense recorded in 2005 under the transition method will be approximately $185 thousand which equates to six months of stock-based compensation expense, net of allowable tax benefits. Future grants and unvested forfeitures of prior grants may alter this projected number.Item 7A.Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. In the course of its lending and deposit taking activities, the Corporation is subject to changes in the economic value and/or earnings potential of these assets and liabilities due to changes in interest rates. The Corporation’s Asset/ Liability Management Committee (“ALMC”) manages interest rate risk in a manner so as to provide adequate and reliable earnings. This is accomplished through the32
32
establishment of policy limits on maximum risk exposures, as well as the regular and timely monitoring of reports designed to quantify risk and return levels. The Corporation uses both an interest-rate sensitivity gap analysis and a simulation model to quantify its exposure to interest rate risk. The Corporation uses the gap analysis to identify and monitor long-term rate exposure and uses a simulation model to measure the short-term rate exposures. The Corporation runs various earnings simulation scenarios to quantify the effect of declining or rising interest rates on the net interest margin over a one-year horizon. The simulation uses existing portfolio rate and repricing information, combined with assumptions regarding future loan and deposit growth, future spreads, prepayments on residential mortgages, and the discretionary pricing of non-maturity assets and liabilities. The Corporation is permitted to use interest-rate swaps and interest-rate caps/ floors with indices that correlate to on-balance sheet instruments, to modify its indicated net interest sensitivity to levels deemed to be appropriate based on the Corporation’s current economic outlook. The effect of the interest-rate swaps that the Bank uses to reduce its earnings volatility due to rate risk is also included in the results of the simulation. At December 31, 2004, the simulation, based upon forward-looking assumptions, projects that the Corporation’s greatest interest margin exposure to interest-rate risk would occur if interest rates decline from present levels. Given the assumptions, a 200 basis point parallel shift in the yield curve applied on a ramp-down basis would cause the Corporation’s net interest margin, over a 1-year horizon, to be approximately 1.8% less than it would be if market rates would remain unchanged. At December 31, 2003, the simulation, based upon forward-looking assumptions, projects that the Corporation’s greatest interest margin exposure to interest-rate risk would occur if interest rates decline from present levels. Given the assumptions, a 200 basis point parallel shift in the yield curve applied on a ramp-down basis would cause the Corporation’s net interest margin, over a 1-year horizon, to be approximately 2.1% less than it would be if market rates would remain unchanged. Policy limits have been established which allow a tolerance for no more than approximately a 2.8% negative impact to the interest margin resulting from a 200 basis point parallel yield curve shift over a forward looking 12-month period. See Management’s Discussion and Analysis of Financial Condition and Results of Operations — “Net Interest Income” and “Asset/ Liability Management, Liquidity” and Table 13.33
33
Table 13 — Interest Sensitivity Analysis Interest Sensitivity Analysis at December 31, 2004:
34
Report of Independent Registered Public Accounting FirmThe Board of Directors Univest Corporation of Pennsylvania: We have audited the accompanying consolidated balance sheet of Univest Corporation of Pennsylvania and subsidiaries (the “Company”) as of December 31, 2004, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The accompanying consolidated financial statements of the Company as of December 31, 2003 and for the years ended December 31, 2003 and 2002, were audited by other auditors whose report thereon dated February 23, 2004, expressed an unqualified opinion on those statements. We conducted our audit in accordance with the auditing 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 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 audit provides 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 the Company as of December 31, 2004, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLPMarch 2, 2005Philadelphia, Pennsylvania35
35
UNIVEST CORPORATION OF PENNSYLVANIACONSOLIDATED BALANCE SHEETS
36
UNIVEST CORPORATION OF PENNSYLVANIACONSOLIDATED STATEMENTS OF INCOME
37
UNIVEST CORPORATION OF PENNSYLVANIACONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
38
UNIVEST CORPORATION OF PENNSYLVANIACONSOLIDATED STATEMENTS OF CASH FLOWS
39
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements(All dollar amounts presented are in thousands, except per share data)Note 1.Summary of Significant Accounting PoliciesOrganization Univest Corporation of Pennsylvania (the “Corporation”) through its wholly owned subsidiary, Univest National Bank and Trust Co. (the “Bank”), is engaged in domestic commercial and retail banking services and provides a full range of community banking and trust services to its customers. The Bank wholly owns Delview, Inc., who through its subsidiaries, Univest Investments, Inc. and Univest Insurance, Inc., provides financial planning, investment management, insurance products and brokerage services. Univest Investments, Univest Insurance and Univest Reinsurance Corporation, a wholly owned subsidiary of the Corporation, were formed to enhance the traditional banking and trust services provided by the Bank. Univest Investments, Univest Insurance and Univest Reinsurance do not currently meet the quantitative thresholds for separate disclosure provided under SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” Therefore, the Corporation currently has one reportable segment, “Community Banking,” and strategically is how the Corporation operates and has positioned itself in the marketplace. The Corporation’s activities are interrelated, each activity is dependent, and performance is assessed based on how each of these activities supports the others. Accordingly, significant operating decisions are based upon analysis of the Corporation as one Community Banking operating segment. The Bank serves the Montgomery and Bucks counties of Pennsylvania through 36 banking offices and provides banking and trust services to the residents and employees of 12 retirement communities, a work site office which performs a payroll check cashing service and an express banking center located in the Montgomery Mall.Principles of Consolidation The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, the Bank, Univest Realty Corporation, Univest Delaware, Inc. and Univest Reinsurance Company. All significant intercompany balances and transactions have been eliminated in consolidation.Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.Interest-bearing Deposits with Other Banks Interest-bearing deposits with other banks consist of deposit accounts with other financial institutions generally having maturities of three months or less.Investment Securities Securities are classified as investment securities held-to-maturity and carried at amortized cost if management has the positive intent and ability to hold the securities to maturity. Securities purchased with the intention of recognizing short-term profits are placed in the trading account and are carried at market value. Securities not classified as held-to-maturity or trading are designated securities available-for-sale and carried at fair value with unrealized gains and losses reflected in accumulated other comprehensive income, net of estimated income taxes. The net unrealized gain40
40
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)on available-for-sale securities included in accumulated other comprehensive income was $2,187 and $3,494 at December 31, 2004 and December 31, 2003, respectively. Gains and losses on sales of securities are computed on a specific security basis.Loans Loans are stated at the principal amount less net deferred loan fees and unearned discount. Interest income on commercial, consumer, and mortgage loans is recorded on the outstanding balance method, using actual interest rates applied to daily principal balances. Accrual of interest income on loans ceases when collectibility of interest and/or principal is questionable. If it is determined that the collection of interest previously accrued is uncertain, such accrual is reversed and charged to current earnings. Thereafter, income is only recognized as payments are received for loans on which there is no uncertainty as to the collectibility of principal. Loans are considered past due based upon failure to comply with contractual terms. When a loan, including a loan impaired under Statement of Financial Accounting Standard (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” is classified as nonaccrual, the accrual of interest on such a loan is discontinued. A loan is classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against other expense. Interest received on nonaccrual loans is either applied against principal or reported as interest income, according to management’s judgment as to the collectibility of principal. Loans are usually restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.Loan Fees Fees collected upon loan origination and certain direct costs of originating loans are deferred and recognized over the contractual lives of the related loans as yield adjustments. Upon prepayment or other disposition of the underlying loans before their contractual maturities, any associated unamortized fees or costs are recognized.Derivative Financial Instruments The Corporation may use interest-rate swap agreements to manage the interest-rate risk of its floating-rate loan portfolio. The Corporation accounts for its interest-rate swap contracts in compliance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” by establishing and documenting the effectiveness of the instrument in offsetting the change in cash flows of certain prime-rate-based loans held by the Bank. When the effectiveness of the hedge can be established and adequately documented at the inception of the derivative contract, the change in market value of the swap is recorded on the balance sheet of the Corporation but only the accrued payments due under the contract for the current period are passed through the statement of operations. To ensure effectiveness, the Corporation performs an analysis to ensure that changes in fair value or cash flow of the derivative correlates to the equivalent changes in the loans being hedged. Related fees, if any, are deferred and amortized on a straight-line basis over the life of the41
41
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)swap, which corresponds to the estimated life of the asset being hedged. Interest-rate differentials to be paid or received as a result of interest-rate swap agreements are accrued and recognized as an adjustment of interest income related to the designated floating-rate loans. Recorded amounts related to interest-rate swaps are included in other assets or liabilities. Should the Corporation be unable to document the effectiveness of all or part of the cash flow hedge, the change in market value of the ineffective part of the instrument will need to be marked-to-market through the statement of operations, potentially causing material fluctuations in reported earnings in the period of the change relative to comparable periods. At December 31, 2004, the Corporation had no swaps.Reserve for Loan Losses The reserve for loan losses is based on management’s evaluation of the loan portfolio under current economic conditions and such other factors, which deserve recognition in estimating loan losses. This evaluation is inherently subjective, as it requires estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Additions to the reserve arise from the provision for loan losses charged to operations or from the recovery of amounts previously charged off. Loan charge-offs reduce the reserve. Loans are charged off when there has been permanent impairment or when in the opinion of management the full amount of the loan, in the case of non-collateral dependent borrowings, will not be realized. Certain impaired loans are reported at the present value of expected future cash flows using the loan’s initial effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The reserve for loan losses consists of an allocated reserve and an unallocated reserve. The allocated reserve is comprised of reserves established on specific loans, and class reserves based on historical loan loss experience, current trends, and management assessments. The unallocated reserve is based on both general economic conditions and other risk factors in the Corporation’s individual markets and portfolios, and is to account for a level of imprecision in management’s estimation process. The specific reserve element is based on a regular analysis of impaired commercial and real estate loans. The specific reserve established for these loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class reserve element is determined by an internal loan grading process in conjunction with associated allowance factors. The Corporation revises the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. The Corporation maintains an unallocated reserve to recognize the existence of credit exposures that are within the loan portfolio although currently are undetected. There are many factors considered such as the inherent delay in obtaining information regarding a customer’s financial condition or changes in their business condition, the judgmental nature of loan evaluations, the delay in the interpretation of economic trends and the judgmental nature of collateral assessments. The Corporation maintains a reserve in other liabilities for off-balance sheet credit exposures that currently are unfunded.Premises and Equipment Land is stated at cost, and bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method and charged to operating expenses over the estimated useful lives of the assets (bank premises and improvements —42
42
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)average life 25 years; furniture — average life 10 years; and equipment — average life of 3 to 5 years).Other Real Estate Owned Other real estate owned represents properties acquired through customers’ loan defaults and is included in accrued interest and other assets. The real estate is stated at an amount equal to the loan balance prior to foreclosure, plus costs incurred for improvements to the property, but no more than the fair market value of the property, less estimated costs to sell.Stock Options The Corporation grants stock options to employees with an exercise price equal to the fair value of the shares at the date of grant. The Corporation has elected to follow the intrinsic value method of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations in accounting for its employee stock options. The Corporation originally choose not adopt SFAS No. 123, “Accounting for Stock-Based-Compensation” (“FAS No. 123”, which was revised in December 2004 and will require mandatory adoption during the third quarter of 2005 as discussed under “Recent Accounting Pronouncement” of this footnote. The Corporation has adopted SFAS No. 148, “Accounting for Stock-Based-Compensation — Transition and Disclosure” (“SFAS No. 148”). The following table provides a pro forma presentation of the effects that such an election would have on income and earnings per share. Under APB 25, no compensation expense is recognized because the exercise price of the Corporation’s employee stock options equals the market price of the underlying stock on the date of grant. Had compensation expense for stock option awards been determined consistent with SFAS No. 123, net income and earnings per share would be reduced to the pro forma amounts indicated as follows:
43
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) Significant assumptions used to calculate the above and the resulting fair values are as follows:
44
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Intangible Assets On July 20, 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, “Accounting for Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), which changed the initial measurement and subsequent recording of goodwill and intangible assets. The Corporation acquired intangible assets in connection with the acquisitions of Pennview Savings Bank, Univest Investments, Inc., Univest Insurance, Inc., First County Bank and Suburban Community Bank that include goodwill, a covenant not to compete and core deposit intangibles. In accordance with the adoption of SFAS No. 142, goodwill is no longer amortized. Core deposit intangibles are being amortized over their average estimated useful lives of eight years. The covenant not to compete is being amortized over the five year contractual life. Mortgage servicing rights are recognized as separate assets when mortgage loans are sold and the rights are retained. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing period of the underlying mortgage loans. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance, to the extent that fair value is less than the capitalized amount.Retirement Plan, Supplemental Plans and Other Postretirement Benefit Plans Substantially all employees are covered by a noncontributory retirement plan. The plan provides benefits based on a formula of each participant’s final average pay. The Corporation also provides supplemental executive retirement benefits, a portion of which is in excess of limits imposed on qualified plans by federal tax law. These plans are nonqualified benefit plans. The Corporation sponsors a 401(k) deferred salary savings plan, which is a qualified defined contribution plan, and which covers all employees of the Corporation and its subsidiaries, and provides that the Corporation make matching contributions as defined by the plan. The Corporation provides certain postretirement healthcare and life insurance benefits for retired employees. The Corporation accrues the costs associated with providing these benefits during the active service periods of employees in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (“SFAS No. 106”).Statement of Cash Flows The Corporation has defined those items included in the caption “Cash and due from banks” as cash and cash equivalents.Trust Assets Assets held by the Corporation in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Corporation.Stock Split On January 22, 2003, the Corporation’s board of directors declared a five-for-four stock split in the form of a dividend distributed on February 28, 2003 to all shareholders of record as of February 7, 2003. All share and per share amounts have been retroactively adjusted to give effect to the stock split.45
45
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Earnings Per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if option common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method.Comprehensive Income Unrealized gains or losses on the Corporation’s available-for-sale securities and cash flow hedges are included in comprehensive income. The following shows the accumulated comprehensive income, net of income taxes, for the periods presented:
46
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)as a reduction of taxes paid. Incremental compensation cost for a modification of the terms or conditions of an award is measured by comparing the fair value of the modified award with the fair value of the award immediately before the modification. SFAS 123r becomes effective for public entities that do not file as small business issuers, as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. SFAS 123r applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. As of the required effective date, all public entities that used the fair-value-based method for either recognition or disclosure under the original statement will apply SFAS 123r using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under the original statement for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by the original statement. Pro forma disclosures under the original statement are presented in this footnote under “Stock Options.” The Corporation does not anticipate recording expense significantly different than what is presented within this footnote; although actual expense recorded in 2005 under the transition method will be approximately $185 thousand which equates to six months of stock-based compensation expense, net of allowable tax benefits. Future grants and unvested forfeitures of prior grants may alter this projected number.Note 2. Restrictions on Cash and Due from Bank Accounts The Bank maintains reserve balances under Federal Reserve Bank requirements. The reserve requirement at December 31, 2004 was $5,548 and was satisfied by vault cash held at the Bank’s branches. No additional reserves were required to be maintained at the Federal Reserve Bank of Philadelphia in excess of the required $25 clearing balance requirement. The average balances at the Federal Reserve Bank of Philadelphia were $858 at December 31, 2004 and $1,028 at December 31, 2003.47
47
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Note 3. Investment Securities The following table shows the amortized cost and the approximate market value of the held-to-maturity securities and available-for-sale securities at December 31, 2004 and 2003, by maturity within each type:
48
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)
49
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The following table shows the amount of securities that were in an unrealized loss position at December 31, 2004:
50
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) At December 31, 2004, loans to directors and executive officers of the Corporation and companies in which directors have an interest aggregated $24,600. These loans have been made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with customers and did not involve more than the normal risk of collectibility or present other unfavorable terms. The summary of activity for the past year is as follows:
51
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The following is an analysis of interest on nonaccrual and restructured loans at December 31 as follows:
52
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The following table reflects the components of intangible assets:
53
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Note 8.Income Taxes The provision for federal and state income taxes included in the accompanying consolidated statements of income consists of the following:
54
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) Assets and liabilities giving rise to the Corporation’s deferred tax assets and liabilities are as follows:
55
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) Information with respect to the Retirement and Supplemental Retirement Plans and Other Postretirement Benefits follows:
56
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The retirement benefit cost includes the following components:
57
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The Corporation’s pension plan asset allocation at December 31, 2004 and 2003, by asset category are as follows:
58
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) Transactions involving the plans are summarized as follows:
59
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) At December 31, 2004, the scheduled maturities of time deposits in denominations of $100 or more are as follows:
60
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)2004, the Bank’s outstanding borrowings under the FHLB credit facilities totaled $54,575. The maximum borrowing capacity changes as a function of the Bank’s qualifying collateral assets and the amount of funds received may be reduced by additional required purchases of FHLB stock. Included in the $54,575 of outstanding, FHLB borrowings are $54,500 of convertible advances whereby the Federal Home Loan Bank of Pittsburgh has the option at a pre-determined time to convert the fixed interest rate to an adjustable rate tied to three-month LIBOR. The Bank has the option to prepay these advances without penalty if the rate on these borrowings is converted and on each quarterly reset date thereafter. Management does not believe that conversion is likely unless short-term interest rates increase several hundred basis points. The Corporation secured two subordinated term loan notes during the second quarter of 2003. The first note was issued for $5,000 at the fixed rate of 5.5% per annum. This note converts to a floating rate in second quarter 2008 based upon the one-month LIBOR plus 1.40% per annum. Quarterly principal and interest payments are made on this note. The second note was issued for $10,000 at a floating rate based upon the one-month LIBOR plus 1.40% per annum. Quarterly principal and interest payments are made on this note. Both of these notes mature in second quarter 2013. On August 27, 2003, the Corporation issued $20,000 of Capital Securities of Univest Capital Trust I, a Delaware statutory trust formed by the Corporation. This issuance constitutes Trust Preferred Securities, which were completed through a placement in Junior Subordinated Debentures of the Corporation. The 30-year term securities were issued on a variable rate based upon the published Libor rate plus 3.05% per annum. The initial interest rate of the securities is 4.19% and is callable by Univest at par in whole or in part after five years. Quarterly interest payments are made on this note. At December 31, 2004, the $20,619 in capital securities qualified as Tier 1 capital under capital guidelines of the Federal Reserve. In December 2003, the Financial Accounting Standards Board (FASB) revised Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 (the “Interpretation”). The Interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Previously, entities were generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. Application of this Interpretation is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of entities is required in financial statements for periods ending after March 15, 2004. As a result of the adoption of FIN 46, the Corporation deconsolidated Univest Capital Trust I, which maintains the Trust Preferred Securities, in the first quarter of 2004. The result was an increase in the junior debt of $619 on the balance sheet. The proceeds from the Trust Preferred Securities are being used to support the future growth of the Corporation and its banking subsidiary, the Bank. The Bank maintains federal fund credit lines with several correspondent banks totaling $70,000. At December 31, 2004, there was $17,500 in outstanding borrowings under these lines. Future availability under these lines is subject to the prerogatives of the granting banks and may be withdrawn at will. The Corporation, through the Bank, has an available line of credit at the Federal Reserve Bank of Philadelphia, the amount of which is dependent upon the balance of loans and securities pledged as collateral. At December 31, 2004, the Corporation had no outstanding borrowings from this line.61
61
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The following table details key information pertaining to securities sold under agreement to repurchase on an overnight basis for the periods indicated:
62
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The maximum potential amount of future payments under the guarantee is $58,368. The current carrying amount of the contingent obligation is $53. This arrangement has credit risk essentially the same as that involved in extending loans to customers and is subject to the Bank’s normal credit policies. Collateral is obtained based on management’s credit assessment of the customer. The Bank also controls their credit risk by limiting the amount of credit to any business, institution, or individual. As of December 31, 2004, the Bank has identified the due from banks’ balance of $21,444 as a significant concentration of credit risk because it contains a balance due from a single depository institution that is unsecured. Management evaluates the creditworthiness of the institution on at least a quarterly basis in an effort to monitor its credit risk associated with this concentration. The following schedule summarizes the Corporation’s off-balance sheet financial instruments:
63
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)year ended December 31, 2003 was a positive $524. The ineffective portion of the swaps’ change in fair value is to be immediately recognized in earnings. The Corporation’s current credit exposure on swaps is limited to the value of interest-rate swaps that have become favorable to the Corporation. There were no interest-rate swaps in an unfavorable position. At December 31, 2003, the market value of interest-rate swaps in a favorable position was $5 and there were no interest-rate swaps in an unfavorable position. Credit risk also exists when the counterparty to a derivative contract with an unrealized gain fails to perform according to the terms of the agreement.Note 16. Fair Values of Financial Instruments Statement of Financial Accounting Standard No. 107, “Disclosures about Fair Value of Financial Instruments” (SFAS No. 107), requires all entities to disclose the estimated fair value of its financial instruments whether or not recognized in the balance sheet. For the Corporation, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. Many of the Corporation’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Corporation’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities other than residential mortgage loans held-for-sale and those investment securities classified as available-for-sale. Significant estimations and present value calculations, which are affected by the assumptions used, including the discount rate and estimate of future cash flows, were used by the Corporation for the purposes of this disclosure. The Corporation, using the best available data and an estimation methodology suitable for each category of financial instruments, has determined estimated fair values. For certain loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the recorded book balances. Various methodologies are described in the accompanying notes. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. Management is concerned that reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of readily available active secondary market valuations for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Certain estimated fair values cannot be substantiated by comparison to independent valuation sources and, in many cases, might not be realized in immediate settlement of the instrument.64
64
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) The following table represents the estimates of fair value of financial instruments:
65
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Note 17.Regulatory Matters The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s and Bank’s financial statements. Capital adequacy guidelines, and additionally for the Bank prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).
66
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued) Management believes, as of December 31, 2004, that the Corporation and the Bank met all capital adequacy requirements to which it is subject. The Corporation, like other bank holding companies, currently is required to maintain Tier 1 Capital and Total Capital (the sum of Tier 1, Tier 2 and Tier 3 capital) equal to at least 4.0% and 8.0%, respectively, of its total risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit). The Bank, like other depository institutions, is required to maintain similar capital levels under capital adequacy guidelines. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 and Total Capital ratios must be at least 6.0% and 10.0% on a risk-adjusted basis, respectively. As of December 31, 2004, the most recent notification from the Office of Comptroller of the Currency and Federal Deposit Insurance Corporation (“FDIC”) categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.Dividend and Other Restrictions The primary source of the Corporation’s dividends paid to its shareholders is from the earnings of its subsidiaries paid to the Corporation in the form of dividends. The approval of the Office of Comptroller of the Currency is required for a national bank to pay dividends if the total of all dividends declared in any calendar year exceeds the Bank’s net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, the Bank can declare dividends in 2005 without approval of the Office of Comptroller of the Currency of approximately $23,967 plus an additional amount equal to the Bank’s net profits for 2005 up to the date of any such dividend declaration. The Federal Reserve Act requires that extension of credit by the Bank to certain affiliates, including Univest Corporation (parent), be secured by readily marketable securities, that extension of credit to any one affiliate be limited to 10% of the Bank’s capital and surplus (as defined), and that extensions of credit to all such affiliates be limited to 20% of the Bank’s capital and surplus.67
67
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Note 18.Parent Company Financial Information Condensed financial statements of Univest, parent company only, follow:
68
69
UNIVEST CORPORATION OF PENNSYLVANIANotes to Consolidated Financial Statements — (Continued)Note 19. Quarterly Data (Unaudited) The unaudited results of operations for the quarters for the years ended December 31, 2004 and 2003 were as follows:
70
Item 9.Change in and Disagreements with Accountants on Accounting and Financial Disclosures None.Item 9AControls and ProceduresDisclosure Controls and Procedures Management is responsible for the disclosure control and procedures of Univest Corporation of Pennsylvania (“Univest”). Disclosure controls and procedures are in place to assure that all material information is collected and disclosed in accordance with Rule 13a — 15(e) and 15d-15(c) under the Securities Exchange Act of 1934. Based on their evaluation Management believes that the financial information required to be disclosed in accordance with the Securities Exchange Act of 1934 is presented fairly, recorded summarized and reported within the required time periods.Management’s Report on Internal Control over Financial Reporting Internal controls over financial reporting are the responsibility of the Management of Univest. Based on their assessment, Management believes the internal control process is effective as of December 31, 2004, although no evaluation of controls can provide absolute assurance that control weaknesses or fraud activity does not exist at Univest. Management is required to base its assessment of the effectiveness of internal control over financial reporting on a suitable, recognized control framework. Our assessment was based on the “Internal Control-Integrated Framework,” which was developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Univest’s financial information as shown in the Annual Report Form 10-K for the year 2004 has received an attestation report on Management’s assessment of the Corporation’s internal control over financial reporting from KPMG LLP, independent registered public accounting firm. Ernst & Young LLP audited prior years, and consent for their opinion is a part of the Annual Report Form 10-K. Both firms, for their respective audit years, presented Univest with clean unqualified opinions.71
71
Report of Independent Registered Public Accounting FirmThe Board of Directors and Shareholders Univest Corporation of Pennsylvania: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, that Univest Corporation of Pennsylvania and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Company management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Univest Corporation of Pennsylvania and subsidiaries as of December 31, 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year ended December 31, 2004, and our report dated March 2, 2005 expressed an unqualified opinion on those consolidated financial statements.72
72
The accompanying consolidated financial statements of the Company as of December 31, 2003 and for the years ended December 31, 2003 and 2002, were audited by other auditors whose report thereon dated February 23, 2004, expressed an unqualified opinion on those statements. /s/ KPMG LLPPhiladelphia, PennsylvaniaMarch 2, 200573
73
PART IIIItem 10.Directors and Executive Officers of the Registrant Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005. The Corporation has adopted a Code of Conduct for Directors and a Code of Conduct for all officers and employees, which includes the CEO and senior financial officers. The waiver reporting requirement process was established in 2003 and there have been no waivers. The codes of conduct are available on the Corporation’s website at www.univest.net and are also available to any person without charge by sending a request to the Corporate Secretary at Univest Corporation, P.O. Box 64197, Souderton, PA 18964.Item 11.Executive Compensation Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005.Item 12.Security Ownership of Certain Beneficial Owners and Management Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005.Item 13.Certain Relationships and Related Transactions Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005.Item 14.Principal Accountant Fees and Services Incorporated herein by reference from the registrant’s definitive proxy statement on Schedule 14A for the annual meeting of shareholders on April 12, 2005.Part IVItem 15.Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. & 2. Financial Statements and Schedules The financial statements listed in the accompanying index to financial statements are filed as part of this annual report. 3. Listing of Exhibits The exhibits listed on the accompanying index to exhibits are filed as part of this annual report. (b) Reports on Form 8-K during the fourth quarter of 2004.
74
UNIVEST CORPORATION OF PENNSYLVANIA AND SUBSIDIARIESINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES[Item 15(a)]
75
UNIVEST CORPORATION OF PENNSYLVANIA AND SUBSIDIARIESINDEX TO EXHIBITS[Item 15(a)]
76
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. UNIVEST CORPORATION OF PENNSYLVANIA Registrant By: /s/ Wallace H. Bieler Wallace H. Bieler Chief Operation Officer and Chief Financial Officer February 23, 2005 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:
77