UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2012
OR
For the transition period from to
Commission File Number 0-16668
WSFS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
Incorporation or organization)
(I.R.S. Employer
Identification Number)
WSFS Bank Center
500 Delaware Avenue, Wilmington, Delaware
(302) 792-6000
Registrant’s telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files), Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of August 3, 2012:
Common Stock, par value $.01 per share
8,705,604
INDEX
PART I. Financial Information
PART II. Other Information
Signatures
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands, Except Per Share Data)
Interest income:
Interest and fees on loans
Interest on mortgage-backed securities
Interest and dividends on investment securities
Other interest income
Interest expense:
Interest on deposits
Interest on Federal Home Loan Bank advances
Interest on trust preferred borrowings
Interest on other borrowings
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income:
Security gains, net
Credit/debit card and ATM income
Deposit service charges
Fiduciary & investment management income
Loan fee income
Mortgage banking activities, net
Bank owned life insurance income
Other income
Noninterest expenses:
Salaries, benefits and other compensation
Occupancy expense
Equipment expense
Loan workout and OREO expenses
Data processing and operations expenses
FDIC expenses
Professional Fees
Marketing Expense
Acquisition integration costs
Other operating expense
Income before taxes
Income tax provision
Net income
Dividends on preferred stock and accretion of discount
Net income allocable to common stockholders
Earnings per share:
Basic
Diluted
The accompanying notes are an integral part of these Consolidated Financial Statements.
1
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
Net Income
Other comprehensive income (loss):
Unrealized gains on securities available for sale
Tax expense
Net of tax amount
Reclassification adjustment for gains included in net income
Total other comprehensive (loss) income
Total comprehensive income
2
CONSOLIDATED STATEMENTS OF CONDITION
Assets
Cash and due from banks
Cash in non-owned ATMs
Interest-bearing deposits in other banks
Total cash and cash equivalents
Investment securities, available-for-sale
Investment securities, trading
Loans held-for-sale
Loans, net of allowance for loan losses of $46,429 at June 30, 2012 and $53,080 at December 31, 2011
Bank owned life insurance
Stock in Federal Home Loan Bank of Pittsburgh, at cost
Assets acquired through foreclosure
Premises and equipment
Goodwill
Intangible assets
Accrued Interest receivable
Other assets
Total assets
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand
Interest-bearing demand
Money market
Savings
Time
Jumbo certificates of deposit – customer
Total customer deposits
Brokered deposits
Total deposits
Federal funds purchased and securities sold under agreements to repurchase
Federal Home Loan Bank advances
Trust preferred borrowings
Other borrowed funds
Accrued interest payable
Other liabilities
Total liabilities
Stockholders’ Equity:
Serial preferred stock $.01 par value, 7,500,000 shares authorized; issued 52,625 at June 30, 2012 and December 31, 2011
Common stock $.01 par value, 20,000,000 shares authorized; issued 18,287,752 at June 30, 2012 and 18,258,714 at December 31, 2011
Capital in excess of par value
Accumulated other comprehensive income
Retained earnings
Treasury stock at cost, 9,580,569 shares at June 30, 2012 and December 31, 2011
Total stockholders’ equity
Total liabilities and stockholders’ equity
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, accretion and amortization
Decrease in accrued interest receivable
Decrease in other assets
Origination of loans held-for-sale
Proceeds from sales of loans held-for-sale
Loss on loan disposition
Gain on mortgage banking activities, net
Stock-based compensation expense
Excess tax benefits from share-based payment arrangements
Increase in accrued interest payable
Decrease in other liabilities
Loss on sale of assets acquired through foreclosure and valuation adjustments, net
Increase in value of bank-owned life insurance
(Increase) decrease in capitalized interest, net
Net cash provided by operating activities
Investing activities:
Maturities of investment securities
Sale of investment securities available for sale
Purchase of investment securities available-for-sale
Repayments of investment securities available-for-sale
Disbursements for reverse mortgages
Proceeds from loan disposition
Net increase in loans
Net decrease in stock of Federal Home Loan Bank of Pittsburgh
Sales of assets acquired through foreclosure, net
Investment in premises and equipment, net
Net cash provided by (used for) investing activities
Financing activities:
Net increase in demand and saving deposits
Net decrease in time deposits
Net decrease in brokered deposits
Receipts from FHLB advances
Repayments of FHLB advances
Receipts from federal funds purchased and securities sold under agreement to repurchase
Repayments of federal funds purchased and securities sold under agreement to repurchase
Repayment of unsecured debt
Dividends paid
Issuance of common stock and exercise of common stock options
Net cash (used for) provided by financing activities
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest during the period
Cash paid for income taxes, net
Loans transferred to assets acquired through foreclosure
Other comprehensive (loss) income
4
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(UNAUDITED)
1. BASIS OF PRESENTATION
Our Consolidated Financial Statements include the accounts of WSFS Financial Corporation (“the Company”, “our Company”, “we”, “our” or “us”), Wilmington Savings Fund Society, FSB (“WSFS Bank” or the “Bank”) and Montchanin Capital Management, Inc. (“Montchanin”). We also have one unconsolidated affiliate, WSFS Capital Trust III (“the Trust”). WSFS Bank has two fully-owned subsidiaries, WSFS Investment Group, Inc. (“WIG”) and Monarch Entity Services LLC (“Monarch”) and Montchanin has one wholly owned subsidiary, Cypress Capital Management, LLC (“Cypress”).
Founded in 1832, the Bank is one of the ten oldest banks continuously operating under the same name in the United States. We provide residential and commercial real estate, commercial and consumer lending services, as well as retail deposit and cash management services. In addition, we offer a variety of wealth management and trust services to personal and corporate customers through our Trust and Wealth Management division. Lending activities are funded primarily with customer deposits and borrowings. The Federal Deposit Insurance Corporation (“FDIC”) insures our customers’ deposits to their legal maximums. We serve our customers primarily from our 52 offices located in Delaware (42), Pennsylvania (8), Virginia (1) and Nevada (1) and through our website at www.wsfsbank.com.
Amounts subject to significant estimates are items such as the allowance for loan losses and reserves for lending related commitments, goodwill, intangible assets, post-retirement benefit obligations, the fair value of financial instruments and other-than-temporary impairments. Among other effects, changes to such estimates could result in future reserves for impairments of investment securities, goodwill and intangible assets and increases of allowances for loan losses and lending related commitments as well as increased post-retirement benefits expense.
Our accounting and reporting policies conform with U.S. generally accepted accounting principles and prevailing practices within the banking industry for interim financial information and Rule 10-01 of the Securities and Exchange Commission (“SEC”) Regulation S-X. Rule 10-01 of Regulation S-X does not require us to include all information and notes for complete financial statements and prevailing practices within the banking industry. Operating results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for any future quarters or for the year ending December 31, 2012. For further information, refer to the consolidated financial statements and the accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.
Whenever necessary, reclassifications have been made to prior period Consolidated Financial Statements to conform to the current period’s presentation. All significant intercompany transactions were eliminated in consolidation.
Accounting for Stock-Based Compensation
Stock-based compensation is accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, Stock Compensation. After shareholder approval in 2005, the 1997 Stock Option Plan (“1997 Plan”) was replaced by the 2005 Incentive Plan (“2005 Plan”). No future awards may be granted under the 1997 Plan. The 2005 Plan will terminate on the tenth anniversary of its effective date, after which no awards may be granted. We have stock options outstanding under both plans (collectively, “Stock Incentive Plans”). The number of shares reserved for issuance under the 2005 Plan is 1,197,000. At June 30, 2012, there were 141,177 shares available for future grants under the 2005 Plan.
The Stock Incentive Plans provide for the granting of incentive stock options as defined in Section 422 of the Internal Revenue Code as well as non-incentive stock options (collectively, “Stock Options”). Additionally, the 2005 Plan provides for the granting of stock appreciation rights, performance awards, restricted stock and restricted stock unit awards, deferred stock units, dividend equivalents, other stock-based awards and cash awards. All Stock Options
5
are to be granted at not less than the market price of our Corporation’s common stock on the date of the grant. All Stock Options granted during 2012 and 2011 vest in 25% per annum increments, start to become exercisable one year from the grant date and expire five years from the grant date. Generally, all awards become immediately exercisable in the event of a change in control, as defined within the Stock Incentive Plans. In addition, the Black-Scholes option-pricing model is used to determine the grant date fair value of stock options.
Stock Options
The following table provides information about our stock options outstanding for the three months ended June 30, 2012 and 2011:
Stock Options:
Outstanding at beginning of period
Granted
Exercised
Forfeited
Outstanding at end of period
Exercisable at end of period
Weighted-average fair value of awards granted
The following table provides vesting information about our stock options outstanding for the three months ended June 30, 2012 and 2011:
Unvested at beginning of period
Vested
Unvested at end of period
6
The following table provides information about our stock options outstanding for the six months ended June 30, 2012 and 2011:
Granted (1)
The total amount of compensation cost to be recognized relating to non-vested stock options as of June 30, 2012 was $1.2 million. The weighted-average period over which it is expected to be recognized is 2.9 years. We issue new shares upon the exercise of options.
Restricted Stock
We did not issue any restricted stock units or awards during the second quarter of 2012. We issued 24,442 restricted stock units and awards during the first six months of 2012 compared to 39,422 during the first six months of 2011. These awards vest over a four year period. These stock awards were made to certain executive officers. The total amount of compensation cost to be recognized relating to non-vested restricted stock as of June 30, 2012, was $1.5 million. The weighted-average period over which it is expected to be recognized is 2.0 years.
Performance Stock Awards
The Board approved a plan in which Marvin N. Schoenhals, Chairman of the Board, was granted 22,250 shares of restricted stock effective January 3, 2011, with a five-year performance vesting schedule starting at the end of the second year. These shares are subject to vesting in whole or in part based on whether Mr. Schoenhals plays a meaningful role in establishing new business relationships that, over a two year period of time achieve at least a 50% return on the investment of restricted stock cost.
7
For the three months ended June 30, 2012, the effect of stock-based compensation, including stock options, restricted stock, stock awards, and performance stock, on salaries, benefits and other compensation was $767,000 pre-tax ($537,000 after tax) or $0.06 per share. This compares to $335,000 pre-tax ($251,000 after tax) or $0.03 per share during the three months ended June 30, 2011. The increase was mainly due to the timing of stock option awards granted in 2012 as well as additional expense in 2012 related to Performance Stock Awards. There was no expense for Performance Stock Awards recorded during 2011.
For the six months ended June 30, 2012, the effect of stock-based compensation, including stock options, restricted stock, stock awards, and performance stock, on salaries, benefits and other compensation was $1.5 million pre-tax ($1.1 million after tax) or $0.12 per share. This compares to $860,000 pre-tax ($688,000 after tax) or $0.08 per share during the three months ended June 30, 2011. Similar to the quarterly discussion, the increase was mainly due to the timing and amount of stock option awards granted in 2012 and the expense related to Performance Stock Awards.
2. EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per share:
Numerator:
Denominator:
Denominator for basic earnings per share—weighted average shares
Effect of dilutive employee stock options and warrants
Denominator for diluted earnings per share—adjusted weighted average shares and assumed exercise
Basic:
Net income allocable to common shareholders
Diluted:
Outstanding common stock equivalents having no dilutive effect
8
3. INVESTMENT SECURITIES
The following tables detail the amortized cost and the estimated fair value of the Company’s investment securities held-to-maturity and securities available-for-sale (which include reverse mortgages):
Available-for-sale securities:
June 30, 2012:
Reverse mortgages
U.S. Government and government sponsored enterprises (“GSE”)
State and political subdivisions
Collateralized Mortgage Obligation (“CMO”) (1)
Federal National Mortgage Association (“FNMA”) Mortgage-Backed Securities (“MBS”)
Federal Home Loan Mortgage Corporation (“FHLMC”) MBS
Government National Mortgage Association (“GNMA”) MBS
December 31, 2011:
GSE
CMO (1)
FNMA
FHLMC
GNMA
Trading securities
CMO
9
The scheduled maturities of investment securities available-for-sale at June 30, 2012 and December 31, 2011 were as follows:
June 30, 2012
Within one year (1)
After one year but within five years
After five years but within ten years
After ten years
December 31, 2011
The portfolio of available-for-sale mortgage-backed securities (“MBS”) includes 151 securities with an amortized cost of $740.8 million comprised of all GSE securities. All securities were AAA-rated at the time of purchase. All securities were re-evaluated for OTTI at June 30, 2012. The result of this evaluation showed no OTTI for the second quarter of 2012. The weighted average duration of the mortgage-backed securities was 4.5 years at June 30, 2012.
At June 30, 2012, investment securities with market values aggregating $364.0 million were pledged as collateral for retail customer repurchase agreements, municipal deposits, and other obligations. From time to time, investment securities are also pledged as collateral for FHLB borrowings. There were no FHLB pledged investment securities at June 30, 2012.
In conjunction with the asset disposition strategies discussed in the Company’s Current Report on Form 8-K filed on May 10, 2012 (“the Asset Strategies”), during the first six months of 2012, we sold $504.2 million of investment securities categorized as available-for-sale for net gains of $15.4 million. In the first six months of 2011, proceeds from the sale of investment securities available-for-sale were $123.0 million and resulted in net gains of $1.0 million. These sales were the result of ongoing portfolio management aimed at minimizing credit risk and decreasing prepayment/premium risk due to faster prepayments caused by declining mortgage interest rates in this historically-low rate environment. The cost basis of all investment securities sales are based on the specific identification method.
MBS have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty.
At June 30, 2012, we owned investment securities totaling $107.9 million in which the amortized cost basis exceeded fair value. Total unrealized losses on those securities were $322,000 at June 30, 2012. The temporary impairment is the result of changes in market interest rates subsequent to the purchase of the securities. Our investment portfolio is reviewed each quarter for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market. We evaluate our intent and ability to hold debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy and interest rate risk position. In addition, we do not have the intent to sell, nor is it more likely-than-not we will be required to sell these securities before we are able to recover the amortized cost basis.
10
The table below shows our investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012.
Available-for-sale
U.S Government and agencies
Total temporarily impaired investments
The table below shows our investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities were in a continuous unrealized loss position at December 31, 2011.
We own $12.5 million par value of SASCO RM-1 2002 class B securities which are classified as trading, of which, $1.5 million is interest paid in kind. We expect to recover all principal and interest due to seasoning and excess collateral. Based on FASB ASC 320, Investments – Debt and Equity Securities (“ASC 320”) when these securities were acquired they were classified as trading because it was our intent to sell them in the near term. We use the guidance under ASC 320 to provide a reasonable estimate of fair value. We estimated the value of these securities based on the pricing of BBB+ securities that have an active market through a technique which estimates the fair value of this asset using the income approach as of June 30, 2012.
During 2011, we purchased 100% of SASCO 2002-RM1 Class O certificates for $2.5 million. As of June 30, 2012, the market value of the SASCO 2002-RM1 O securities was determined in accordance with FASB ASC 820-10, Fair Value Measurement (“ASC 820”), to be $4.3 million. These securities have been included in our CMO portfolio since their purchase.
11
4. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION
Allowance for Loan Losses
We maintain an allowance for loan losses and charge losses to this allowance when such losses are realized. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of impairment related to specifically identified loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios.
We established our loan loss allowance in accordance with guidance provided in the Securities and Exchange Commission’s Staff Accounting Bulletin 102 (“SAB 102”). Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula allowances for commercial and commercial real estate loans; and allowances for pooled homogenous loans.
Specific reserves are established for certain impaired loans in cases where we have identified significant conditions or circumstances related to a specific credit that indicate the probability that a loss has been incurred.
The formula allowances for commercial, commercial real estate and construction loans are calculated by applying estimates of default and loss severity to outstanding loans based on the risk grade of loans. Default rates are determined through a past twelve quarter migration analysis. Loss severity is based on a three year historical analysis. As a result, changes in risk grades affect the amount of the formula allowance.
Pooled loans are usually smaller, not-individually-graded and homogenous in nature, such as consumer installment loans and residential mortgages. Loan loss allowances for pooled loans are first based on a five-year net charge-off history. The average loss allowance per homogenous pool is based on the product of average annual historical loss rate and the homogeneous pool balances. These separate risk pools are then assigned a reserve for losses based upon this historical loss information.
Qualitative and environmental adjustment factors are taken into consideration when determining above reserve estimates. These adjustment factors are based upon our evaluation of various current conditions, including those listed below.
General economic and business conditions affecting the Bank’s key lending areas,
Credit quality trends,
Recent loss experience in particular segments of the portfolio,
Collateral values and loan-to-value ratios,
Loan volumes and concentrations, including changes in mix,
Seasoning of the loan portfolio,
Specific industry conditions within portfolio segments,
Bank regulatory examination results, and
Other factors, including changes in quality of the loan origination, servicing and risk management processes.
Our loan officers and risk managers meet at least quarterly to discuss and review these conditions and risks associated with individual problem loans. In addition, various regulatory agencies and loan review consultants periodically review our loan ratings and allowance for loan losses.
During the first quarter of 2012, we made certain improvements to the method in which we determine the allowance for loan loss. These improvements include:
Used a three year loss migration analysis to determine the probability of default
Segregated the commercial loan segment to more specifically analyze the risks associated with business, owner-occupied CRE, investor CRE and Construction loan portfolios
Improved the data used to determine qualitative adjustment factors
Established a portion of the allowance for loan losses related to model and complexity risk
Revised our loan risk rating system based on recommendations from industry experts
12
The following table provides the activity of the allowance for loan losses and loan balances for the three and six months ended June 30, 2012:
Three months ended June 30, 2012
Allowance for loan losses
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Six months ended June 30, 2012
Period-end allowance allocated to:
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
Period-end loan balances evaluated for:
The following table provides the activity of the allowance for loan losses and loan balances for the three and six months ended June 30, 2011:
Three months ended June 30, 2011
Six months ended June 30, 2011
13
Non-Accrual and Past Due Loans
The following tables show our nonaccrual and past due loans at the dates indicated:
Commercial
Owner occupied commercial (1)
Commercial mortgages
Construction
Residential
Consumer
Total
% of Total Loans
Impaired Loans
The following tables provide an analysis of our impaired loans at June 30, 2012 and December 31, 2011:
Owner-Occupied Commercial (2)
14
Interest income of $235,000 and $328,000 was recognized on impaired loans during the three and six months ended June 30, 2012, respectively.
Credit Quality Indicators
Below is a description of each of our risk ratings for all commercial loans:
Pass. These borrowers presently show no current or potential problems and their loans are considered fully collectible.
Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, e.g.; declining revenues or margins, high leverage, tight liquidity, or increasing inventory without increasing sales. These adverse trends can have a potential negative effect on the borrower’s repayment capacity. These assets are not adversely classified and do not expose the Bank to significant risk that would warrant a more severe rating. Borrowers in this category may also be experiencing significant management problems, pending litigation, or other structural credit weaknesses.
Substandard. Borrowers have well-defined weaknesses that require extensive oversight by management. Borrowers in this category may exhibit one or more of the following: inadequate debt service coverage, unprofitable operations, insufficient liquidity, high leverage, and weak or inadequate capitalization. Relationships in this category are not adequately protected by the sound financial worth and paying capacity of the obligor or the collateral pledged on the loan, if any. The distinct possibility exists that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful. Borrowers have well-defined weaknesses inherent in the Substandard category with the added characteristic that the possibility of loss is extremely high. Current circumstances in the credit relationship make collection or liquidation in full highly questionable. A doubtful asset has some pending event that may strengthen the asset that defers the loss classification. Such impending events include: perfecting liens on additional collateral, obtaining collateral valuations, an acquisition or liquidation preceding, proposed merger, or refinancing plan.
Loss. Borrowers are uncollectible or of such negligible value that continuance as a bankable asset is not supportable. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical to defer writing off this asset even though partial recovery may be recognized sometime in the future.
Residential and Consumer Loans
The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed in nonaccrual status.
15
The following tables provide an analysis of problem loans as of June 30, 2012 and December 31, 2011:
Commercial credit exposure credit risk profile by internally assigned risk rating (in thousands):
Risk Rating:
Special mention
Substandard:
Accrual
Nonaccrual
Doubtful/Nonaccrual
Total Special Mention and Substandard
Pass
Total Commercial Loans
Consumer credit exposure credit risk profile based on payment activity (in thousands):
Nonperforming
Performing
16
Troubled Debt Restructurings (TDR)
Effective July 1, 2011, we adopted the provisions of Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. In doing so, we reassessed all loan modifications occurring since January 1, 2011 for identification as TDRs, resulting in no newly identified TDRs.
The book balance of TDRs at June 30, 2012 and December 31, 2011 was $17.9 million and $27.7 million, respectively. The balances at June 30, 2012 include approximately $7.4 million of TDRs in nonaccrual status and $10.5 million of TDRs in accrual status compared to $18.8 million of TDRs in nonaccrual status and $8.9 million of TDRs in accrual status at December 31, 2011. Approximately $927,000 and $1.3 million in specific reserves have been established for these loans as of June 30, 2012 and December 31, 2011, respectively.
During the six months ending June 30, 2012, the terms of nine loans were modified in troubled debt restructurings, of which two were related to commercial loans that were already placed on nonaccrual. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance for a reasonable period, usually six months. The remaining seven loans represented residential loans. Our concessions on restructured loans consisted mainly of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven by us when a loan is modified as a TDR.
The following table presents loans identified as TDRs during the three and six months ended June 30, 2012:
The troubled debt restructurings described above increased the allowance for loan losses by $130,000 through allocation of a specific reserve, and resulted in charge offs of $5.3 million during the six months ending June 30, 2012.
There were no TDRs which defaulted (defined as past due 90 days) during the three and six months ended June 30, 2012 that were restructured within the last twelve months prior to December 31, 2011.
5. TAXES ON INCOME
We account for income taxes in accordance with FASB ASC 740, Income Taxes (“ASC 740”) (Formerly SFAS No. 109, Accounting for Income Taxes and FASB Interpretation No. 48,Accounting for Uncertainty In Income Taxes, an Interpretation of FASB Statement 109). ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. No valuation allowance has been recorded on our deferred tax assets due to our history of prior earnings along with our expectations of future income. ASC 740 prescribes a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. We recognize, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the financial statements. Assessment of uncertain tax positions under ASC 740 requires careful consideration of the technical merits of a position based on our analysis of tax regulations and interpretations.
17
The total amount of unrecognized tax benefits as of June 30, 2012 and December 31, 2011 were $3,000 and $88,000, respectively, all of which would affect our June 30, 2012 effective tax rate if recognized. As of June 30, 2012 and December 31, 2011, the total amount of accrued interest included in such unrecognized tax benefits were $3,000 and $15,000, respectively. Penalties of $6,000 were included in such unrecognized tax benefits at December 31, 2011, but none are included at June 30, 2012. We record interest and penalties on potential income tax deficiencies as income tax expense. Our Federal and state tax returns for the 2008 through 2011 tax years are subject to examination as of June 30, 2012. We were recently notified of the IRS intention to audit our 2010 tax return. There are currently no other income tax audits in process.
6. SEGMENT INFORMATION
Under the definition of FASB ASC 280, Segment Reporting (“ASC 280”) (Formerly SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information) we discuss our business in three segments. There is one segment for each of WSFS Bank, Cash Connect, (the ATM division of WSFS Bank), and Trust and Wealth Management. Trust and Wealth Management is comprised of Montchanin, Christiana Trust, Monarch Entity Services LLC, Private Banking and WSFS Investment Group, Inc. in a single reportable segment because each has similar economic characteristics, products, customers and distribution methods. As required by ASC 280, all prior years’ information has been updated to reflect this presentation.
The WSFS Bank segment provides financial products to commercial and retail customers through its 52 offices located in Delaware (42), Pennsylvania (8) and Virginia (1) and Nevada (1). Retail and Commercial Banking, Commercial Real Estate Lending and other banking business units are operating departments of WSFS. These departments share the same regulator, the same market, many of the same customers and provide similar products and services through the general infrastructure of the Bank. Because of these and other reasons, these departments are not considered discrete segments and are appropriately aggregated within the WSFS Bank segment in accordance with ASC 280.
Cash Connect provides turnkey ATM services through strategic partnerships with several of the largest networks, manufacturers and service providers in the ATM industry. The balance sheet category “Cash in non-owned ATMs” includes cash from which fee income is earned through bailment arrangements with customers of Cash Connect.
The Trust and Wealth Management segment is comprised of Christiana Trust, Monarch Entity Services LLC, Montchanin, Private Banking and WSFS Investment Group, Inc. Christiana Trust was acquired in December 2010 and WSFS’ Trust and Wealth Management business was consolidated into Christiana Trust. Christiana Trust provides investment, fiduciary, and agency services from locations in Delaware and Nevada. These services are provided to individuals and families as well as corporations and institutions. Monarch Entity Services LLC provides commercial domicile services from locations in Delaware and Nevada. Montchanin has one consolidated wholly owned subsidiary, Cypress Capital Management, LLC (Cypress). Cypress is a Wilmington-based investment advisory firm serving high net-worth individuals and institutions. WSFS Investment Group, Inc. markets various third-party insurance products and securities and Private Banking specializes in meeting the needs of professionals and their practices, including deposit services and credit needs of existing and start-up practices.
An operating segment is a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. We evaluate performance based on pretax ordinary income relative to resources used, and allocate resources based on these results. The accounting policies applicable to our segments are those that apply to our preparation of the accompanying Consolidated Financial Statements. Segment information for the three and six months ended June 30, 2012 and 2011 follows:
18
For the three months ended June 30, 2012
External customer revenues:
Interest income
Noninterest income
Total external customer revenues
Inter-segment revenues:
Total inter-segment revenues
Total revenue
External customer expenses:
Interest expense
Noninterest expenses
Provision for loan loss
Total external customer expenses
Inter-segment expenses
Total inter-segment expenses
Total expenses
Provision for income taxes
Consolidated net income
Capital expenditures
As of June 30, 2012
Cash and cash equivalents
Other segment assets
Total segment assets
19
For the three months ended June 30, 2011
Income (loss) before taxes
As of December 31, 2011
20
For the six months ended June 30, 2012
21
For the six months ended June 30, 2011
22
7. FAIR VALUE DISCLOSURES OF FINANCIAL ASSETS
FAIR VALUE OF FINANCIAL ASSETS
ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820-10 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:
Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.
Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
The table below presents the balances of assets measured at fair value as of June 30, 2012 (there are no material liabilities measured at fair value):
Description
Assets Measured at Fair Value on a Recurring Basis
Collateralized mortgage obligations
U.S. Government and agencies
Trading Securities
Total assets measured at fair value on a recurring basis
Assets Measured at Fair Value on a Nonrecurring Basis
Other real estate owned
Total assets measured at fair value on a nonrecurring basis
23
The table below presents the balances of assets measured at fair value as of December 31, 2011 (there are no material liabilities measured at fair value):
Quoted
Prices inActiveMarkets forIdenticalAsset
Fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include unobservable parameters. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While we believe our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Available- for-sale securities. As of June 30, 2012, securities classified as available for sale are reported at fair value using both Level 2 and Level 3 inputs. Included in the Level 2 total are approximately $48.0 million in Federal Agency debentures, $751.9 million in Federal Agency MBS, and $3.7 million in municipal bonds. Agency and MBS securities are predominately AAA-rated. We believe that this Level 2 designation is appropriate for these securities under ASC 820-10 as, with almost all fixed income securities, none are exchange traded, and all are priced by correlation to observed market data. For these securities we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. Included in the Level 3 total is a small equity traunche of a reverse mortgage security purchased on July 15, 2011. This security is Level 3 because there is no active market for this security and no observable inputs that reflect quoted prices for identical assets in active markets (Level 1) or inputs other than quoted prices that are observable for the asset through corroboration with observable market data (Level 2). In order to establish the fair value for a Level 3 asset a “mark-to-model” has been developed using the income approach described in ASC 820-10-35-32 and is similar to the methodology used to value our trading securities described below.
24
Trading securities. The amount included in the trading securities category represents the fair value of a BBB-rated traunche of a reverse mortgage security. There has never been an active market for these securities. As such, we classify these trading securities as Level 3 under ASC 820-10. As prescribed by ASC 820-10 management used various observable and unobservable inputs to develop a range of likely fair value prices where this security would be exchanged in an orderly transaction between market participants at the measurement date. The unobservable inputs reflect management’s assumptions about the assumptions that market participants would use in pricing this asset. Included in these inputs were the median of a selection of other BBB-rated securities as well as quoted market prices from higher rated traunches of this asset class. The unobservable inputs consist of prepayments, house price appreciation and interest rates. Management has completed a sensitivity analysis at June 30, 2012, which showed any increase or decrease in these inputs would not have a significant impact on the fair value of these assets. As a result, the value assigned to this security is determined primarily through a discounted cash flow analysis. All of these assumptions require a significant degree of management judgment.
Reverse Mortgages. The amount of our investment in reverse mortgages represents the estimated value of future cash flows of the reverse mortgages at a rate deemed appropriate for these mortgages, based on the market rate for similar collateral. The projected cash flows depend on assumptions about life expectancy of the mortgagor and the future changes in collateral values. Due to the significant amount of management judgment and the unobservable input calculations, these reverse mortgages have been classified as Level 3.
The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows:
Balance at December 31, 2010
Total net income (losses) for the period included in net income
Purchases, sales, issuances, and settlements, net
Mark-to-market adjustment
Balance at December 31, 2011
Balance at March 31, 2012
Balance at June 30, 2012
Other real estate owned. Other real estate owned consists of loan collateral which has been repossessed through foreclosure or other measures. Initially, foreclosed assets are recorded as held for sale at the lower of the loan balance or fair value of the collateral less estimated selling costs. Subsequent to foreclosure, valuations are updated periodically and the assets may be marked down further, reflecting a new cost basis. The fair value of our real estate owned was estimated using Level 3 inputs based on appraisals obtained from third parties.
Impaired loans. We evaluate and value impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral has a unique appraisal and management’s discount of the value is based on the factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which range from 10%—50%. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on the appraisals by qualified licensed appraisers hired by us. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net amount of $51.0 million and $75.3 million at June 30, 2012 and December 31, 2011, respectively. The valuation allowance on impaired loans was $2.0 million as of June 30, 2012 and $4.7 million as of December 31, 2011.
25
In light of the continuing slow-down in the real estate market, management is required to utilize a more significant level of unobservable inputs and, as such, we have reclassified the hierarchical levels of both Other Real Estate Owned and Impaired Loans to Level 3 as of March 31, 2012.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The reported fair values of financial instruments are based on a variety of factors. In certain cases, fair values represent quoted market prices for identical or comparable instruments. In other cases, fair values have been estimated based on assumptions regarding the amount and timing of estimated future cash flows that are discounted to reflect current market rates and varying degrees of risk. Accordingly, the fair values may not represent actual values of the financial instruments that could have been realized as of period-end or that will be realized in the future.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Short-Term Investments:For cash and short-term investments, including due from banks, federal funds sold, securities purchased under agreements to resell and interest-bearing deposits with other banks, the carrying amount is a reasonable estimate of fair value.
Investments and Mortgage-Backed Securities: Since quoted market prices are not available, fair value is estimated using quoted prices for similar securities, which we obtain from a third party vendor. We utilize one of the largest providers of securities pricing to the industry and management periodically assesses the inputs used by this vendor to price the various types of securities owned by us to validate the vendor’s methodology. The fair value of our investment in reverse mortgages is based on the net present value of estimated cash flows, which have been updated to reflect recent external appraisals of the underlying collateral. For additional discussion of our mortgage-backed securities-trading or our internally developed models, see Fair Value of Financial Assets, to the Consolidated Financial Statements.
Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type: commercial, commercial mortgages, construction, residential mortgages and consumer. For loans that reprice frequently, the book value approximates fair value. The fair values of other types of loans are estimated by discounting expected cash flows using the current rates at which similar loans would be made to borrowers with comparable credit ratings and for similar remaining maturities. The fair value of nonperforming loans is based on recent external appraisals of the underlying collateral. Estimated cash flows, discounted using a rate commensurate with current rates and the risk associated with the estimated cash flows, are utilized if appraisals are not available. This technique does not contemplate an exit price.
Bank-Owned Life Insurance: The estimated fair value approximates the book value for this investment.
Stock in the Federal Home Loan Bank of Pittsburgh: The fair value of FHLB stock is assumed to be essentially equal to its cost. We carry FHLB stock at cost, or par value, and evaluate FHLB stock for impairment based on the ultimate recoverability of par value rather than by recognizing temporary declines in value. As part of the impairment assessment of FHLB stock, management considers, among other things, (i) the significance and length of time of any declines in net assets of the FHLB compared to its capital stock, (ii) commitments by the FHLB to make payments required by law or regulations and the level of such payments in relation to its operating performance, (iii) the impact of legislative and regulatory changes on FHLB, the FHLB has access to the U.S. Government-Sponsored Enterprise Credit Facility, a secured lending facility that serves as a liquidity backstop, substantially reducing the likelihood that the FHLB would need to sell securities to raise liquidity and, thereby, cause the realization of large economic losses. On August 8, 2011, Standard & Poors (“S&P”) downgraded the FHLB from AAA to AA+, similar to their downgrade of the U.S. sovereign rating. The reduction in the FHLB credit rating was due to the belief, by S&P, that the FHLB system is certain to receive U.S. government support, if necessary, resulting from the important role the FHLB system plays as primary liquidity providers to U.S. mortgage and housing-market participants. Despite the downgrade, the FHLB continues to have a very high degree of government support and was in compliance with all regulatory capital requirements as of June 30, 2012. As a result, we have determined there was no other-than-temporary impairment related to our FHLB stock investment as of June 30, 2012.
Demand Deposits, Savings Deposits and Time Deposits: The fair value of demand deposits and savings deposits is determined by projecting future cash flows using an estimated economic life based on account characteristics. The resulting cash flow is discounted using rates available on alternative funding sources. The fair value of time deposits is estimated using the rate and maturity characteristics of the deposits to estimate their cash flow. The cash flow is discounted at rates for similar term wholesale funding.
26
Borrowed Funds: Rates currently available to us for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Off-Balance Sheet Instruments: The fair value of off-balance sheet instruments, including commitments to extend credit and standby letters of credit, is estimated using the fees currently charged to enter into similar agreements with comparable remaining terms and reflects the present creditworthiness of the counterparties.
The book value and estimated fair value of our financial instruments are as follows:
Financial assets:
Investment securities
Loans held for sale
Loans, net
Stock in Federal Home Loan Bank of Pittsburgh
Accrued interest receivable
Financial liabilities:
Deposits
Borrowed funds
Standby letters of credit
The estimated fair value of our off-balance sheet financial instruments is as follows:
Off-balance sheet instruments:
Commitments to extend credit
8. INDEMNIFICATIONS AND GUARANTEES
Secondary Market Loan Sales. We generally do not sell loans with recourse except to the extent arising from standard loan sale contract provisions covering violations of representations and warranties and, under certain circumstances first payment defaults by borrowers. These are customary repurchase provisions in the secondary market for conforming mortgage loan sales. These indemnifications may include our repurchase of the loans. Repurchases and losses are rare, and no provision is made for the losses at the time of sale. During the three and six months ended June 30, 2012, we had no repurchases under these indemnifications.
We typically sell fixed-rate, conforming first mortgage loans (including reverse mortgages) in the secondary market as part of our ongoing asset/liability management program. Loans held-for-sale are carried at the lower of cost or market of the aggregate or in some cases individual loans. Gains and losses on sales of loans are recognized at the time of the sale.
27
Swap Guarantees. We entered into agreements with three unrelated financial institutions whereby those financial institutions entered into interest rate derivative contracts (interest rate swap transactions) with customers referred to them by us. By the terms of the agreements, those financial institutions have recourse to us for any exposure created under each swap transaction in the event the customer defaults on the swap agreement and the agreement is in a paying position to the third-party financial institution. This is a customary arrangement that allows smaller financial institutions like us to provide access to interest rate swap transactions for our customers without creating the swap ourselves.
At June 30, 2012 there were 96 variable-rate swap transactions between the third party financial institutions and our customers, compared to 79 at December 31, 2011. The initial notional amount aggregated approximately $394.3 million at June 30, 2012 compared with $318.1 million at December 31, 2011. At June 30, 2012 maturities ranged from approximately 1 month to 13 years. The aggregate market value of these swaps to the customers was a liability of $37.8 million at June 30, 2012 and $32.8 million at December 31, 2011.
9. ASSOCIATE (EMPLOYEE) BENEFIT PLANS
Postretirement Benefits
We share certain costs of providing health and life insurance benefits to retired Associates (and their eligible dependents). Substantially all Associates may become eligible for these benefits if they reach normal retirement age while working for us.
We account for our obligations under the provisions of FASB ASC 715,Compensation – Retirement Benefits (“ASC 715”) (Formerly SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions). ASC 715 requires that the costs of these benefits be recognized over an Associate’s active working career. Disclosures are in accordance with ASC 715.
The following disclosures of the net periodic benefit cost components of postretirement benefits were measured at January 1, 2012 and 2011:
Service cost
Interest cost
Amortization of transition obligation
Net loss recognition
Net periodic benefit cost
10. STOCK AND COMMON STOCK WARRANTS
In August 2010, we completed an underwritten public offering of 1,370,000 shares of common stock. The offering was priced at $36.50 per share, a slight premium to the prior day’s closing price, and raised $47.1 million net of $2.9 million of costs.
On September 24, 2009 we completed a private placement of stock to Peninsula Investment Partners, L.P. (Peninsula), pursuant to which we issued and sold 862,069 shares of common stock for a total purchase price of $25.0 million, and a 10-year warrant to purchase 129,310 shares of common stock at an exercise price of $29.00 per share. The warrant is immediately exercisable. During 2011 all shares were distributed on a pro-rata basis to the fund holders of Peninsula with the warrants being transferred to Peninsula’s managing partner.
Total proceeds of $25.0 million were allocated, based on the relative fair value of common stock and common stock warrants, to common stock for $23.5 million and common stock warrants for $1.5 million on September 24, 2009.
28
On January 23, 2009, we entered into a purchase agreement with the U.S. Treasury pursuant to which we issued and sold 52,625 shares of our fixed-rate cumulative perpetual preferred stock for a total purchase price of $52.6 million, and a 10-year warrant to purchase 175,105 shares of common stock at an exercise price of $45.08 per share. On March 28, 2012, the U.S. Department of the Treasury held a public auction where it sold all 52,625 shares, which represented the Treasury’s entire preferred stock holding in WSFS. Under the terms of the agreement, WSFS will continue to pay a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed. The cumulative dividend for the preferred stock is accrued for and payable on February 15, May 15, August 15 and November 15 of each year. We have declared and paid $1.3 million preferred stock dividends during the six months ended June 30, 2012.
Total proceeds of $52.6 million were allocated, based on the relative fair value of the preferred stock and common stock warrants, to preferred stock for $51.9 million and common stock warrants for $693,000 respectively, on January 23, 2009. The preferred stock discount is being accreted, on an effective yield method, to preferred stock over five years. We have accreted $69,000 during the six months ended June 30, 2012, relating to the discount on preferred stock.
The preferred stock is nonvoting, except for class voting rights on certain matters that could adversely affect the shares. They may be redeemed by us for the liquidation preference ($1,000 per share), plus accrued but unpaid dividends. The warrant is exercisable immediately and subject to certain anti-dilution and other adjustments.
11. GOODWILL AND INTANGIBLES
In accordance with FASB ASC 805, Business Combinations, and FASB ASC 350, Intangibles—Goodwill and Other, all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles and other intangibles are recorded at fair value. We consider our accounting policies related to goodwill and other intangible assets to be critical because the assumptions and judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions and judgment could have a significant impact on our financial condition or results of operations.
The fair value of acquired assets and liabilities, including the resulting goodwill, was based either on quoted market prices or provided by other third-party sources, when available. When third-party information was not available we made good-faith estimates primarily through the use of internal cash flow modeling techniques. The assumptions used in the cash flow modeling are subjective and susceptible to significant changes.
Goodwill and other intangible assets with indefinite useful lives are tested for impairment at least annually and charged to results of operations in periods in which the recorded value is more than the estimated fair value. Intangible assets that have finite useful lives will continue to be amortized over their useful lives and are periodically evaluated for impairment. Goodwill totaled $28.1 million at both June 30, 2012 and December 31, 2011. The majority of this goodwill, or $23.0 million, is in the WSFS Bank reporting unit and is the result of a branch acquisition in 2008 and the acquisition of CB&T during 2010. The remaining $5.1 million is in the Trust and Wealth Management reporting unit and is mainly the result of the acquisition of CB&T.
Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of our reporting units with their carrying amounts, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step is performed comparing the implied fair value to the carrying amount of goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
When required, the goodwill impairment test involves a two-step process. The first test for goodwill impairment is done by comparing the reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair value exceeds the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the carrying value of the reporting unit were to exceed the aggregate fair value, a second test would be performed to measure the amount of impairment loss, if any. To measure any impairment loss the implied fair value would be determined in the same manner as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than the recorded goodwill an impairment charge would be recorded for the difference.
During 2011, ASU 2011-08, Intangibles—Goodwill and Other (Topic 350), was issued. Under the Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. In other words, before the first step of the existing guidance, the entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that the fair value of goodwill is less than carrying value. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step process is unnecessary. The entity has the option to bypass the qualitative assessment step for any reporting unit in any period and proceed directly to the first step of the exiting two-step process. The entity can resume performing the qualitative assessment in any subsequent period. The Update was effective for year ends beginning after December 15, 2011 but early adoption was permitted. The Company adopted the Update for the quarter ended December 31, 2011.
Based on the results of the annual impairment test it was determined that no goodwill impairment charges were required for the year ended December 31, 2011. Our next annual impairment test will be conducted during the quarter ending December 31, 2012. For the quarter ended June 30, 2012, we determined no triggering events had occurred and, therefore, did not conduct an interim impairment test of goodwill. Even though there was no goodwill impairment at June 30, 2012, declines in the value of our stock price or additional adverse changes in the operating environment of the financial services industry may result in a future impairment charge.
29
FASB ASC 350, also requires that an acquired intangible asset be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the asset can be sold, transferred, licensed, rented or exchanged, regardless of the acquirer’s intent to do so.
The following table summarizes other intangible assets:
Core deposits
Other
Total other intangible assets
Core deposits are amortized over their expected lives using the present value of the benefit of the core deposits and straight-line methods of amortization. During the six months ended June 30, 2012, we recognized amortization expense on other intangible assets of $488,000.
The following presents the estimated amortization expense of intangibles:
Remaining in 2012
2013
2014
2015
2016
Thereafter
30
12. LEGAL PROCEEDINGS
We previously reported two litigation matters: a class action filed in Delaware Superior Court captioned Joy v. Wilmington Savings Fund Society, FSB, and a patent infringement case filed in Delaware District Court captioned Pi-Net International, Inc. v. WSFS Financial Corporation. During the second quarter of 2012, both cases were settled and dismissed. The costs of the settlements were not material and were included in our second quarter results.
In addition and as previously reported in our filings pursuant to the Securities Exchange Act of 1934, as amended, in July 2011 we were sued in U.S. Bankruptcy Court by a bankruptcy trustee relating to a former WSFS Bank customer. There have been no material changes in this case during the second quarter of 2012.
There are no other significant pending legal proceedings involving us other than those arising out of routine operations. Management does not anticipate that the ultimate liability, if any, arising out of such other proceedings will have a material effect on the Consolidated Financial Statements.
31
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
WSFS Financial Corporation is parent to Wilmington Savings Fund Society, FSB (“WSFS Bank” or the “Bank”), the seventh oldest bank and trust in the United States continuously operating under the same name. A permanent fixture in the community, WSFS has been in operation for more than 180 years. In addition to its focus on stellar customer service, the Bank has continued to fuel growth and remain a leader in our community. We are a relationship-focused, locally-managed, community banking institution that has grown to become the largest thrift holding company in the State of Delaware, one of the top commercial lenders in the state, the third largest bank in terms of Delaware deposits and one of the top trust companies in the country. We state our mission simply: We Stand for Service and Strengthening Our Communities.
Our core banking business is commercial lending funded by customer-generated deposits. We have built a $2.2 billion commercial loan portfolio by recruiting the best seasoned commercial lenders in our markets and offering a high level of service and flexibility typically associated with a community bank. We fund this business primarily with deposits generated through commercial relationships and retail deposits. We service our customers primarily from our 52 offices located in Delaware (42), Pennsylvania (8), Virginia (1) and Nevada (1). We also offer a broad variety of consumer loan products, retail securities and insurance brokerage through our retail branches.
We have two consolidated subsidiaries, WSFS Bank and Montchanin Capital Management, Inc. (“Montchanin”) and one unconsolidated affiliate, WSFS Capital Trust III (“the Trust”).
WSFS Bank has two wholly owned subsidiaries, WSFS Investment Group, Inc. and Monarch Entity Services, LLC (“Monarch”). WSFS Investment Group, Inc., markets various third-party investment and insurance products, such as single-premium annuities, whole life policies and securities primarily through the Bank’s retail banking system and directly to the public. Monarch provides commercial domicile services which include employees, directors, sublease of office facilities and registered agent services in Delaware and Nevada.
Our Cash Connect division is a premier provider of ATM Vault Cash and related services in the United States. Cash Connect manages nearly $455 million in vault cash in nearly 13,000 ATMs nationwide and also provides online reporting and ATM cash management, predictive cash ordering, armored carrier management, ATM processing and equipment sales. Cash Connect also operates over 430 ATMs for WSFS Bank, which has, by far, the largest branded ATM network in Delaware.
We offer trust and wealth management services through Christiana Trust, Cypress Capital Management, LLC (Cypress), WSFS Investment Group brokerage and our Private Banking group. The Christiana Trust division provides investment, fiduciary, agency and commercial domicile services from locations in Delaware and Nevada and has over $13 billion in assets under administration. These services are provided to individuals and families as well as corporations and institutions. The Christiana Trust division of WSFS Bank provides these services to customers locally, nationally and internationally making use of the advantages of its branch facilities in Delaware and Nevada. Cypress is an investment advisory firm that manages nearly $600 million of portfolios for individuals, trusts, retirement plans and endowments. WSFS Investment Group, Inc. markets various third-party insurance products and securities through the Bank’s retail banking system.
Until July 21, 2011, WSFS Financial Corporation and WSFS Bank were regulated by the Office of Thrift Supervision. As of July 21, 2011, WSFS Financial Corporation’s primary federal regulator became the Federal Reserve and WSFS Bank’s primary federal regulator became the Office of the Comptroller of the Currency. While we do not anticipate the change in primary regulators will have a material impact on our operations, there can be no assurance that the interpretation by these agencies of the regulations governing our business will not be different than that of the Office of Thrift Supervision which may affect the manner in which we conduct our business in the future.
32
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, and exhibits thereto, contains estimates, predictions, opinions, projections and other statements that may be interpreted as “forward-looking statements” as that phrase is defined in the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, references to our financial goals, management’s plans and objectives for future operations, financial and business trends, business prospects, and management’s outlook or expectations for earnings, revenues, expenses, capital levels, liquidity levels, asset quality or other future financial or business performance, strategies or expectations. Such forward-looking statements are based on various assumptions (some of which may be beyond the Company’s control) and are subject to risks and uncertainties (which change over time) and other factors which could cause actual results to differ materially from those currently anticipated. Such risks and uncertainties include, but are not limited to, those related to the economic environment, particularly in the market areas in which the Company operates; the volatility of the financial and securities markets, including changes with respect to the market value of financial assets; changes in market interest rates, changes in government regulation affecting financial institutions, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules being issued in accordance with this statute and potential expenses associated therewith; and the costs associated with resolving any problem loans, litigation and other risks and uncertainties, discussed in documents filed by WSFS Financial Corporation with the Securities and Exchange Commission from time to time. Forward looking statements are as of the date they are made, and the Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in conformity with U.S. generally accepted accounting principles. The preparation of these Consolidated Financial Statements requires us to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenue and expenses. We regularly evaluate these estimates and assumptions including those related to the allowance for loan losses, deferred taxes, fair value measurements, goodwill and other intangible assets. We base our estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Although our current estimates contemplate current economic conditions and how we expect them to change in the future, for the remainder of 2012, it is reasonably possible that actual conditions may be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Actual results may differ from these estimates under different assumptions or conditions.
The following are critical accounting policies that involve more significant judgments and estimates. See further discussion of these critical accounting policies in the 2011 Annual Report on Form 10-K.
We maintain allowances for loan losses and charge losses to these allowances when realized. We consider the determination of the allowance for loan losses to be critical because it requires significant judgment reflecting our best estimate of impairment related to specifically evaluated impaired loans as well as the inherent risk of loss for those in the remaining loan portfolio. Our evaluation is based upon a continuing review of the portfolio, with consideration given to evaluations resulting from examinations performed by regulatory authorities.
Deferred Taxes
We account for income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, Income Taxes (“ASC 740”), which requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We consider our accounting policies on deferred taxes to be critical because we regularly assess the need for valuation allowances on deferred income tax assets that may result from, among other things, limitations imposed by Internal Revenue Code and uncertainties, including the timing of settlement and realization of these differences. No valuation allowance is required as of June 30, 2012.
33
Fair Value Measurements
We adopted FASB ASC 820-10 Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. We consider our accounting policies related to fair value measurements to be critical because they are important to the portrayal of our financial condition and results, and they require our subjective and complex judgment as a result of the need to make estimates about the effects of matters that are inherently uncertain. See Note 7, Fair Value Disclosures of Financial Assets to our Consolidated Financial Statements.
Goodwill and Other Intangible Assets
In accordance with FASB ASC 805, Business Combinations, and FASB ASC 350, Intangibles—Goodwill and Other, all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles and other intangibles are recorded at fair value. We consider our accounting policies related to goodwill and other intangible assets to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions or judgment could have a significant impact on our financial condition or results of operations.
For additional information regarding our goodwill and other intangible assets, see Note 11 to the Consolidated Financial Statements.
FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY
Financial Condition
During the second quarter of 2012 we completed our previously announced Assets Strategies. As a result, the Company significantly improved its asset quality, improved earnings and built capital levels. Bulk loan sales of $42.7 million in recorded balances decreased pre-tax income by $14.6 million, with $14.2 million recorded as increased provision for loan losses and $435,000 recorded through loan workout and OREO costs. Additionally, sales of $419.4 million in MBS provided $13.3 million in net gains on sales, nearly offsetting the impact of the bulk loan sales. Our securities portfolio now includes no RE-REMICs, non-agency MBS or downgraded securities, protecting us from potential future other-than-temporary-impairment and reducing our credit, prepayment and price risks in the portfolio.
Classified assets decreased $96.4 million, or 30%, from $317.5 million as of March 31, 2012 (or 69.6% of total Tier 1 capital plus the allowance for loan losses “ALLL”) to $221.1 million as of June 30, 2012 (or 48.7% of Tier 1 + ALLL). In addition to the bulk loan sales, other drivers behind the decrease in classified loans were: pay-downs and payoffs of $20.9 million, net positive loan risk-rating migration of $20.9 million, $11.5 million in charge-offs and $2.8 million in sales of OREO.
Our total assets decreased $96.6 million or 2% to $4.2 billion during the six months ended June 30, 2012. Included in this decrease was a $45.1 million, or 2% decrease in net loans, and a $52.1 million, or 6%, decrease in investment securities. These decreases were mainly due to the successful completion of the previously announced Asset Strategies aimed at improving asset quality during the second quarter of 2012. In addition, and partially offsetting these decreases, loans held-for-sale increased by $9.4 million during the six months ended June 30, 2012.
Total liabilities decreased $106.4 million during the six months ended June 30, 2012 to $3.8 billion. This decrease was primarily the result of decreased Federal Home Loan Bank advances of $145.8 million, or 27% as a result of repayments. In addition, other borrowed funds decreased by $39.1 million during the period, mainly due to the repayment of $30.0 million of unsecured Temporary Liquidity Guarantee Program (“TLGP”) debt. Partially offsetting these decreases was a $50.0 million increase in federal funds purchased and securities sold under agreements to repurchase and a $29.1 million increase in total deposits.
Capital Resources
Stockholders’ equity increased $9.8 million between December 31, 2011 and June 30, 2012. This increase was mainly due to net income of $12.4 million. Partially offsetting this increase was a decrease of $1.9 million in the value of our available-for-sale securities portfolio (mainly the result of sales activity during the period) combined with the payment of common and preferred dividends of $3.4 million during the six months ended June 30, 2012.
34
Book value per common share was $46.16 at June 30, 2012 an increase of $0.97 from $45.19 reported at December 31, 2011. Tangible common book value per common share (a non-GAAP measurement) was $36.26 at June 30, 2012, an increase of $1.06, or 3% from $35.20 reported at December 31, 2011.
Below is a table comparing the Bank’s consolidated capital position to the minimum regulatory requirements as of June 30, 2012:
Total Capital (to Risk-Weighted Assets)
Core Capital (to Adjusted Total Assets)
Tangible Capital (to Tangible Assets)
Tier 1 Capital (to Risk-Weighted Assets)
Under guidelines issued by banking regulators, savings institutions such as the Bank must maintain “tangible” capital equal to 1.5% of adjusted total assets, “core” capital equal to 4.0% of adjusted total assets, “Tier 1” capital equal to 4.0% of risk weighted assets and “total” or “risk-based” capital (a combination of core and “supplementary” capital) equal to 8.0% of risk-weighted assets. Failure to meet minimum capital requirements can initiate certain mandatory actions and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our bank’s financial statements.
At June 30, 2012, the Bank was in compliance with regulatory capital requirements and was considered a “well-capitalized” institution. The Bank’s core capital ratio of 9.82%, Tier 1 capital ratio of 12.74% and total risk based capital ratio of 13.99%, all remain substantially in excess of “well-capitalized” regulatory benchmarks, the highest regulatory capital rating. In addition, and not included in Bank capital, the holding company held $10.8 million in cash to support dividends, acquisitions, strategic growth plans.
Liquidity
We manage our liquidity and funding needs through our Treasury function and our Asset/Liability Committee. We have a policy that separately addresses liquidity, and management monitors our adherence to policy limits. Also, liquidity risk management is a primary area of examination by the banking regulators.
As a financial institution, the Bank has ready access to several sources to fund growth and meet its liquidity needs. Among these are: net income, retail deposit programs, loan repayments, borrowing from the FHLB, repurchase agreements, access to the Federal Discount Window, and access to the brokered deposit market as well as other wholesale funding avenues. In addition, we have a large portfolio of high-quality, liquid investments, primarily short-duration mortgage-backed securities and government sponsored enterprises (“GSE”) notes that provide a near-continuous source of cash flow to meet current cash needs, or can be sold to meet larger discrete needs for cash. Management believes these sources are sufficient to maintain required and prudent levels of liquidity.
During the six months ended June 30, 2012, cash and cash equivalents decreased $766,000 to $467.3 million. This decrease was primarily a result of the following: cash usages for a $145.6 million decrease in FHLB advances; $34.4 million increase in net loans and a $30.0 million repayment of unsecured bank debt. Offsetting these decreases in cash were: $50.0 million increase in cash provided through an increase in securities sold under agreements to repurchase; $47.3 million provided by funds related to operations: $26.4 million in cash provided through the sales of nonperforming and commercial loans; $21.5 million increase in demand, savings, and time deposits and $10.1 million increase from the sales of assets acquired through foreclosure.
35
NONPERFORMING ASSETS
The following table shows our nonperforming assets and past due loans at the dates indicated. Nonperforming assets include nonaccruing loans, nonperforming real estate, assets acquired through foreclosure and restructured mortgage and home equity consumer debt. Nonaccruing loans are those on which the accrual of interest has ceased. Loans are placed on nonaccrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and the value of the collateral is insufficient to cover principal and interest. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the amortization of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal and interest. Past due loans are loans contractually past due 90 days or more as to principal or interest payments but which remain on accrual status because they are considered well secured and in the process of collection.
Nonaccruing loans:
Owner-occupied commercial (1)
Commercial mortgage
Residential mortgage
Total nonaccruing loans
Troubled debt restructuring (accruing)
Total nonperforming assets
Past due loans (2):
Commercial and commercial mortgage
Total past due loans
Ratios:
Allowance for loan losses to total loans (3)
Nonperforming assets to total assets
Nonaccruing loans to total loans (3)
Loan loss allowance to nonaccruing loans
Loan loss allowance to total nonperforming assets
Prior to 2012, owner-occupied loans were included in commercial loan balances.
Past due loans are accruing loans which are contractually past due 90 days or more as to principal or interest. These loans are well secured and in the process of collection.
Total loans exclude loans held for sale.
36
Nonperforming assets decreased $29.4 million between December 31, 2011 and June 30, 2012. As a result, non-performing assets as a percentage of total assets decreased from 2.14% at December 31, 2011 to 1.49% at June 30, 2012 and our ratio of allowance for loan losses to nonaccruing loans improved significantly from 75% at December 31, 2011 to 109% at June 30, 2012. This decrease in nonperforming assets was mainly due to the bulk loan sales, which resulted in the sale of $22.5 million of nonperforming loans. Additional collections of $28.3 million and charge-offs of $18.4 million during the first six months of 2012 also contributed to the decrease from December 31, 2011. Partially offsetting these decreases were $40.0 million of new nonperforming assets during the first six months of 2012.
The following table summarizes the changes in nonperforming assets during the period indicated:
Additions
Collections
Collections from loan dispositions
Transfers to accrual
Charge-offs / write-downs, net
The timely identification of problem loans is a key element in our strategy to manage our loan portfolio. Timely identification enables us to take appropriate action and, accordingly, minimize losses. An asset review system established to monitor the asset quality of our loans and investments in real estate portfolios facilitates the identification of problem assets. In general, this system utilizes guidelines established by federal regulation.
INTEREST SENSITIVITY
The matching of maturities or repricing periods of interest rate-sensitive assets and liabilities to promote a favorable interest rate spread and mitigate exposure to fluctuations in interest rates is our primary tool for achieving our asset/liability management strategies. We regularly review our interest-rate sensitivity and adjust the sensitivity within acceptable tolerance ranges established by the Board of Directors. At June 30, 2012, interest-earning assets exceeded interest-bearing liabilities that mature or reprice within one year (interest-sensitive gap) by $138.6 million. Our interest-sensitive assets as a percentage of interest-sensitive liabilities within the one-year window increased from 102.8% at December 31, 2011, to 106.5% at June 30, 2012. Likewise, the one-year interest-sensitive gap as a percentage of total assets changed to 3.31% at June 30, 2012 from 1.54% at December 31, 2011. The change in sensitivity since March 31, 2012 reflects the current interest rate environment and our continuing effort to effectively manage interest rate risk.
37
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in our lending, investing, and funding activities. To that end, we actively monitor and manage our interest rate risk exposure. One measure, required to be performed by federal regulation, measures the impact of an immediate change in interest rates in 100 basis point increments on the net portfolio value ratio. The economic value of equity ratio is defined as the economic value of the estimated cash flows from assets and liabilities as a percentage of economic value of cash flows from total assets. The table below shows the estimated impact of immediate changes in interest rates on our net interest margin and net portfolio value ratio at the specified levels at June 30, 2012 and December 31, 2011:
% Change in
Interest Rate
(Basis Points)
Net Interest
Margin (1)
Economic
Value of
Equity (2)
+300
+200
+100
—
-100
-200 (3)
-300 (3)
We also engage in other business activities that are sensitive to changes in interest rates. For example, mortgage banking revenues and expenses can fluctuate with changing interest rates. These fluctuations are difficult to model and estimate.
COMPARISON OF THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
Results of Operations
During the second quarter of 2012, we successfully completed our previously announced Asset Strategies. As a result, we completed bulk loan sales of $42.7 million in recorded balances which decreased pre-tax income by $14.6 million, with $14.2 million recorded as increased provision for loan losses and $435,000 recorded through loan workout and OREO costs. Additionally, sales of $419.4 million in MBS provided $13.3 million in net gains on sales, nearly offsetting the impact of the bulk loan sales. These activities significantly improved the credit quality of our loan and securities portfolio and decreased prepayment risk.
We recorded net income of $7.3 million for the quarter ended June 30, 2012, a 33% increase over $5.5 million for the quarter ended June 30, 2011. Income allocable to common stockholders’ (after preferred stock dividends) was $6.6 million, or $0.76 per diluted common share for the quarter ended June 30, 2012, compared to income allocable to common shareholders’ of $4.8 million, or $0.55 per diluted common share, for the quarter ended June 30, 2011 (a 38% increase in diluted EPS). Credit/debit card and ATM fees, deposit service charges, and fiduciary & investment management income all increased during second quarter of 2012 reflecting strong franchise growth. In addition, noninterest income for second quarter of 2011 included $1.2 million of unanticipated BOLI income. Noninterest expenses for the second quarter of 2012 totaled $33.0 million compared to $30.7 million in the second quarter of 2011. The $2.4 million increase was mainly due to the increase in salaries, benefits, and other compensation, along with increases in loan workout and OREO expenses due to Asset Strategies and other asset dispositions during the quarter.
Net income for the first six months of 2012 was $13.8 million as compared to $9.7 million for the first six months of 2011. Net income allocable to common stockholders was $12.4 million, or $1.41 per diluted common share, compared to net income allocable to common stockholder of $8.3 million, or $0.96 per diluted common share, for the six months ended June 30, 2011, or a 47% increase. Consistent with the quarterly results, earnings for the first six months of 2012 were impacted by Asset Strategies and continued franchise growth.
38
Net Interest Income
The following tables provide information concerning the balances, yields and rates on interest-earning assets and interest-bearing liabilities during the periods indicated.
Interest-earning assets:
Loans (2) (3):
Commercial real estate loans
Residential real estate loans (6)
Commercial loans
Consumer loans
Loans held for sale (7)
Total loans
Mortgage-backed securities (4)
Investment securities (4) (5)
Other interest-earning assets
Total interest-earning assets
Bank-owned life insurance
Other noninterest-earning assets
Interest-bearing liabilities:
Interest-bearing deposits:
Customer time deposits
Total interest-bearing customer deposits
Brokered certificates of deposit
Total interest-bearing deposits
FHLB of Pittsburgh advances
Total interest-bearing liabilities
Noninterest-bearing demand deposits
Other noninterest-bearing liabilities
Stockholders’ equity
Excess of interest-earning assets over interest-bearing liabilities
Net interest and dividend income
Interest rate spread
Net interest margin
39
Net interest income for the second quarter of 2012 improved by $891,000, or 3%, when compared to the second quarter of 2011. The increase in net interest income reflects effective management of funding costs, including wholesale funding rates.
The net interest margin for the second quarter of 2012 was 3.53% an eight basis point decrease compared to 3.61% for the second quarter of 2011. The decrease in net interest margin reflects the impact of our Assets Strategies as MBS sales were reinvested at current low rates. In addition, the historically low interest rate environment continues to impact our loan and security portfolio yields and is partially offset by ongoing funding rate management.
40
Net interest income for the six months ended June 30, 2012 was $64.6 million compared to $61.4 million for the same period in 2011. The net interest margin for the six months ended June 30, 2012 was 3.54%, down four basis points from the same period in 2011. Similar to the quarterly discussion above, our MBS portfolio yields decreased over the prior year as a result of Asset Strategies. While net interest income improved over prior year due to ongoing funding rate management and loan portfolio growth, our asset yields continue to be impacted by the historically low rate environment.
We maintain allowances for loan losses and charge losses to these allowances when such losses are identified. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of probable loan losses related to specifically identified loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios.
41
Revised our loan risk rating system based on recommendations from industry experts.
The above changes to the calculation of the allowance for loan losses did not have a material impact on the allowance for loan loss at June 30, 2012 or the amount of provision for loan losses recorded during the period.
The provision for loan losses was $16.4 million in the quarter ending June 30, 2012 compared to $8.6 million in the same quarter of 2011. Total credit costs (including the provision for loan losses, loan workout expense, OREO expense and other credit reserves) increased to $18.3 million from $10.2 in the second quarter of 2011. These increased costs are a result of the Asset Strategies and other significant problem asset dispositions. These dispositions resulted in $14.6 million of additional credit costs during the second quarter of 2012 ($14.2 million in provisions for loan losses).
The table below represents a summary of the changes in the allowance for loan losses during the periods indicated.
Provision for loan losses,
Charge-offs:
Residential real estate
Commercial real estate
Owner-occupied commercial(1)
Overdrafts
Total charge-offs
Recoveries:
Total recoveries
Net charge-offs
Net charge-offs to average gross loans outstanding, net of unearned income (2)
42
Noninterest Income
Noninterest income increased $13.0 million to $29.0 million for the quarter ended June 30, 2012 from $16.0 million in the second quarter of 2011. Excluding the effect of net securities gains in both periods and the $1.2 million of unanticipated BOLI income during the second quarter of 2011, noninterest income increased by $1.4 million, or 10%. Credit/ debit card and ATM fees increased by $585,000, or 11% reflecting growth in Cash Connect (our ATM division), fiduciary and investment management income increased $359,000, or 12% reflecting growth in the trust and wealth management segment, and deposit service charges increased by $273,000, or 7% from the same period in 2011 due to continued franchise growth.
For the six months ended June 30, 2012 noninterest income increased $16.1 million to $45.8 million compared to the same period in 2011. Excluding the effect of net securities gains in both periods and the unanticipated BOLI income during the second quarter of 2011, noninterest income increased by $2.9 million, or 11%. Similar to the quarterly comparison the increase in fee income was largely due to continued franchise growth. The increase includes $1.3 million, or 13% in credit/ debit card and ATM fees, a $723,000 increase in deposit service charges and a $563,000, or 10%, increase in fiduciary and investment management income.
Noninterest Expense
Noninterest expenses increased $2.4 million, or 8% to $33.0 million in the second quarter of 2012 compared to the same period in 2011. Included in the second quarter of 2012 was $1.3 million in loan workout and OREO expenses from Asset Strategies and other asset dispositions undertaken during the quarter. In addition, increases in salaries, benefits and other compensation, occupancy, equipment and data processing and operations expenses reflect the two new branch openings and the relocation of the Company’s operations center. Also impacting noninterest expenses in 2012 were added compensation costs related to the Company’s improved performance in 2012 and changes in timing of awards.
For the six months ended June 30, 2012, noninterest expense increased $2.0 million, or 3% to $64.0 million compared to the same period in 2011. Similar to the quarterly comparison the main reasons for this increase were higher loan workout and OREO expenses from Asset Strategies and other asset dispositions. Also contributing to the increase were expenses associated with strategic investments, including the opening and renovation of seven branches and the relocation of the Company’s operations center in the second half of 2011 and completed in early 2012. In addition, similar to the quarter the increase includes added compensation costs related to the Company’s improved performance in 2012.
Income Taxes
We and our subsidiaries file a consolidated Federal income tax return and separate state income tax returns. Income taxes are accounted for in accordance with ASC 740, which requires the recording of deferred income taxes for tax consequences of temporary differences. We recorded an income tax expense of $4.3 million and $8.0 million during the three months and six months ended June 30, 2012, respectively, compared to an income tax expense of $2.5 million and $4.9 million for the same periods in 2011. The second quarter of 2011 included the recognition of tax benefits related to $1.2 million of tax-free income from life insurance proceeds received from our BOLI investment. No such tax benefits were recorded in 2012. Our effective tax rate was 37.2% and 36.6% for the three and six months ended June 30, 2012, respectively, compared to 30.8% and 33.3% during the same periods in 2011. Excluding the tax-free BOLI proceeds, our effective tax rates were 35.9% and 36.0% for the three and six months ended June 30, 2011.
The effective tax rate reflects the recognition of certain tax benefits in the financial statements including those benefits from tax-exempt interest income (including a 50% interest income exclusion on a loan to an Employee Stock Ownership Plan) and BOLI income. These tax benefits are offset by the tax effect of stock-based compensation expense related to incentive stock options and a provision for state income tax expense.
We frequently analyze our projections of taxable income and make adjustments to our provision for income taxes accordingly.
43
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2011, the FASB issued an update (“ASU” No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring) which clarifies when creditors should classify loan modifications as troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. A provision in Update 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by Update 2010-20. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements.
In April 2011, the FASB issued an update (“ASU” No. 2011-03, Reconsideration of Effective Control in Repurchase Agreements) which removes from the assessment of effective control the criterion related to the transferor’s ability to repurchase or redeem financial assets on substantially agreed terms, even in the event of default by the transferee. In addition, this guidance also eliminates the requirement to demonstrate that a transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The new guidance is effective for interim and annual periods beginning on or after December 15, 2011, and applies prospectively to transactions or modifications of existing transactions occurring on or after the effective date. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements.
In May 2011, the FASB issued an update (“ASU” No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS) to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. While the overall guidance is consistent with U.S. GAAP, the amendment includes additional fair value disclosure requirements. The amendments in the guidance are effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements; however, the adoption did have an impact on our fair value disclosures.
In June 2011, the FASB issued an update (“ASU” No. 2011-05, Presentation of Comprehensive Income) to eliminate the option to present the components of other comprehensive income as part of the statement of changes in shareholder’s equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements; however, the adoption did have an impact on our presentation of comprehensive income.
In September 2011, the FASB issued an update (“ASU” No. 2011-08, Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment) to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements.
In December 2011, the FASB issued an update (“ASU” No. 2011-11, Balance Sheet (Topic 350) - Offsetting) to address balance sheet offsetting. An entity is required to disclose information about offsetting and related arrangements so that users of the financial statements can understand the effect of those arrangements on its financial position. Entities are required to disclose both gross information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. The instruments and transactions include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This amendment is effective for interim and annual reporting periods beginning on or after January 1, 2013. We do not expect the adoption of this guidance to have a material impact on our financial statements.
In December 2011, the FASB issued an update (“ASU” No. 2011-12, Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05) which under ASU 2011-05 defers the effective date
44
pertaining to reclassification adjustments out of other accumulated other comprehensive income (AOCI). Concerns were raised that reclassifications of items out of AOCI would be costly for preparers and may add unnecessary complexity to financial statements. All other requirements in ASU 2011-05 are not affected by this Update. This amendment is effective for interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material effect on our Consolidated Financial Statements.
In July 2012, the FASB issued an update (“ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment) which permits entities to perform an optional qualitative assessment for determining whether it is more likely than not that an indefinite-lived intangible asset is impaired. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We are evaluating the impact of ASU 2012-02; however, we do not expect the adoption of this guidance to have a material impact on our financial statements.
RECENT LEGISLATION
On July 21, 2010, the President signed the Dodd-Frank Act into law. This legislation makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. While the full effects of the legislation on us cannot yet be determined, this legislation was opposed by the American Bankers Association and is generally perceived as negatively impacting the banking industry. This legislation may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect our business. There are many parts of the Dodd-Frank Act that have yet to be determined and implemented however, as a direct result of the Act, the following rulings have been adopted or will be adopted in the coming years:
On August 10, 2010 the Board of Directors of the FDIC adopted a final ruling permanently increasing the standard maximum deposit insurance amount from $100,000 to $250,000, which became effective on July 22, 2010.
During January of 2011, a timeframe and preliminary implementation plan for the phase out of the Office of Thrift Supervision (“the OTS”), one of our current banking regulators was announced by the joint agencies, and its merger into the Office of the Comptroller of the Currency. The provisions of the plan include a transition from the Thrift Financial Report, which we file each quarter, to the Call Report, which began with the March 2012 reporting period.
On February 7, 2011, the Federal Reserve approved a final ruling the changes the Deposit Insurance Fund (“DIF”) assessment from domestic deposits to average assets minus tangible equity. The changes went into effect during the second quarter of 2011 and were payable at the end of September. It is the intent of the FDIC that banks with over $10 billion in assets pay a larger share of the assessments into the DIF.
In June 2011, the Federal Reserve adopted the “Durbin Amendment” in which debit interchange fees would be capped at 21 cents plus 5 basis points of the transaction, with the possibility of an additional cent if the issuer implements certain fraud-prevention standards. This rule directly affects banks with $10 billion or more in assets.
On July 21, 2011, the Federal Reserve repealed Federal prohibitions on the payment of interest on demand deposits.
On July 21, 2011, the Consumer Financial Protection Bureau (“CFPB”) was created to centralize responsibility for consumer financial protection. The bureau has been given the responsibility for implementing, examining and enforcing compliance with Federal consumer protection laws.
In June 2012, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation approved three proposals that would amend the existing capital adequacy requirements of banks and bank holding companies. The three proposals would, among other things, implement the Basel III capital standards, as well as the Basel II standardized approach for almost all banking organizations in the United States including us. The Basel III proposal would increase the minimum levels of required capital, narrow the definition of capital, and places greater emphasis on common equity. The Basel II standardized proposal would modify the risk weights for various asset classes. We are still in the process of assessing the impacts of these complex proposals.
45
Incorporated herein by reference from Item 2, of this quarterly report on Form 10-Q.
Part II. OTHER INFORMATION
Incorporated herein by reference to Note 12 – Legal Proceedings to the Consolidated Financial Statements
Our management does not believe there have been any material changes to the risk factors previously disclosed under Item 1A. of the Company’s Form 10-K for the year ended December 31, 2011, previously filed with the Securities and Exchange Commission.
The following table represents information with respect to repurchases of common stock made by us during the three months ended June 30, 2012. These shares were delivered to us by employees as payment for taxes on the vesting of restricted stock or exercise of stock options.
2012
April
May
June
Total (1)
46
Not applicable
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Mark A. Turner
Date: August 9, 2012
/s/ Stephen A. Fowle
48