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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Fiscal Year Ended September 30, 2006
-OR-
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Transition Period From __________ To __________
Commission File Number: 0-51214
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 68-0593604
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1834 OREGON AVENUE
PHILADELPHIA, PENNSYLVANIA
(Address of Principal Executive Offices)
Registrant's telephone number: (including area code) (215) 755-1500
Securities registered pursuant to Section 12(b) of the Act:
Name Of Each Exchange
Title Of Each Class On Which Registered
Common Stock (par value $0.01 per share) The Nasdaq Stock Market, LLC
---------------------------------------- ----------------------------
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. YES [_] NO [X]
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. YES [_] NO [X]
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large Accelerated Filer [_] Accelerated Filer [_] Non-Accelerated Filer [X]
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant based on the closing price of $13.50 on March 31, 2006, the last
business day of the Registrant's second quarter was $66,194,307 (12,367,650
shares outstanding less 7,464,368 shares held by affiliates at $13.50 per
share). Although directors and executive officers of the Registrant and certain
employee benefit plans were assumed to be "affiliates" of the Registrant for
purposes of the calculation, the classification is not to be interpreted as an
admission of such status.
As of the close of business on December 11, 2006 there were 12,017,750
shares of the Registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Definitive Proxy Statement for the 2007 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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Prudential Bancorp, Inc. Of Pennsylvania
FORM 10-K INDEX
For The Fiscal Year Ended September 30, 2006
Page
PART I
Item 1. Business...................................................... 1
Item 1A. Risk Factors.................................................. 34
Item 1B. Unresolved Staff Comments..................................... 37
Item 2. Properties.................................................... 37
Item 3. Legal Proceedings............................................. 38
Item 4. Submission of Matters to a Vote of Security Holders........... 38
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities............. 39
Item 6. Selected Financial Data....................................... 40
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 42
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.... 53
Item 8. Financial Statements and Supplementary Data................... 58
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 92
Item 9A. Controls and Procedures....................................... 92
Item 9B. Other Information............................................. 92
PART III
Item 10. Directors and Executive Officers of the Registrant............ 92
Item 11. Executive Compensation........................................ 92
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters............................... 93
Item 13. Certain Relationships and Related Transactions................ 93
Item 14. Principal Accounting Fees and Services........................ 93
PART IV
Item 15. Exhibits and Financial Statement Schedules.................... 93
Signatures
PART I
ITEM 1. BUSINESS
GENERAL
Our Company, Prudential Bancorp, Inc. of Pennsylvania (the "Company"
or "Prudential Bancorp"), is a Pennsylvania corporation which was organized as a
mid-tier holding company for our bank, Prudential Savings Bank, a
Pennsylvania-chartered, FDIC-insured savings bank (the "Bank" or "Prudential
Savings Bank"). Our Bank is a wholly owned subsidiary of the Company. The
Company's results of operations are primarily dependent on the results of the
Bank. As of September 30, 2006, the Company, on a consolidated basis, had total
assets of approximately $472.4 million, total deposits of approximately $347.3
million, and total stockholders' equity of approximately $87.4 million.
The Company was formed when the Bank reorganized from a mutual savings
bank to a mutual holding company structure in March 2005. Prudential Mutual
Holding Company, a Pennsylvania corporation, is the mutual holding company
parent of the Company. As of September 30, 2006, Prudential Mutual Holding
Company owns 57.3% (6,910,062) of the Company's outstanding common stock and
must continue to own at least a majority of the outstanding voting stock of the
Company.
Our Bank is a community-oriented savings bank headquartered in south
Philadelphia which was originally organized in 1886 as a Pennsylvania-chartered
building and loan association known as "The South Philadelphia Building and Loan
Association No. 2." We grew through a number of mergers with other mutual
institutions with our last merger being with Continental Savings and Loan
Association in 1983. We converted to a Pennsylvania-chartered savings bank in
August 2004. Our banking office network currently consists of our headquarters
and main office and five full-service branch offices. Five of our banking
offices are located in Philadelphia (Philadelphia County) and one is in Drexel
Hill in neighboring Delaware County, Pennsylvania. We maintain ATMs at five of
our banking offices. We also provide on-line banking services. A seventh office
in the Old City section of Philadelphia is scheduled to be opened in Spring
2007.
We are primarily engaged in attracting deposits from the general
public and using those funds to invest in loans and securities. Our principal
sources of funds are deposits, repayments of loans and mortgage-backed
securities, maturities of investment securities and interest-bearing deposits,
funds provided from operations and funds borrowed from the Federal Home Loan
Bank of Pittsburgh. These funds are primarily used for the origination of
various loan types including single-family residential mortgage loans,
construction and land development loans, non-residential or commercial real
estate mortgage loans, home equity loans and lines of credit, commercial
business loans and consumer loans. We are an active originator of residential
home mortgage loans and construction and land development loans in our market
area. Traditionally, our Bank focused on originating or purchasing fixed-rate,
long-term single-family residential mortgage loans for portfolio. In recent
years, we have substantially increased our involvement in construction and land
development lending. Such loans typically have higher yields as compared to
single-family residential mortgage loans and have adjustable rates of interest
and/or shorter terms to maturity. As a result of such emphasis, our construction
and land development loans have grown from $17.0 million or 8.9% of the total
loan portfolio at September 30, 2002 to $82.8 million or 32.3% of our total loan
portfolio at September 30, 2006. We expect to continue to emphasize such lending
but have not established any target level of investment. However, as long as
market conditions are favorable for this activity, we would expect such lending
to experience further growth, increasing both in terms of the amount of
investment as well as a percentage of the total loan portfolio.
1
The investment and mortgage-backed security portfolio has decreased
over the last several years from $236.0 million at September 30, 2004 to $225.8
million at September 30, 2006 as maturing and called securities have been
reinvested into the loan portfolio, in particular adjustable rate construction
loans. A significant portion of our investment securities consist of securities
with "step-up" interest rate adjustment features and an investment in a mutual
fund which invests primarily in high quality adjustable-rate mortgage-backed and
floating-rate securities. We have designated the substantial majority of our
investment and mortgage-backed securities as held to maturity since we have both
the intent and ability to hold them until their maturity. Although we chose to
invest in such securities rather than originate long-term, fixed-rate loans at
historically low rates, such course of action was not free of interest rate
risk. At September 30, 2006, our $182.4 million of investment and
mortgage-backed securities held to maturity had an aggregate gross unrealized
loss of $3.5 million due to the recent increases in market rates of interest.
However, with the recent rises in market rates of interest, we will consider
increasing our single-family residential mortgage loan origination and purchase
activities. During 2006, we classified mortgage-backed securities purchased of
$4.6 million as available for sale and may also consider designating more of our
securities purchased in the future as available for sale rather than as held to
maturity in order to increase our ability to adjust our asset mix as market and
competitive conditions change.
In addition to offering loans and deposits we also offer, on an agency
basis, securities and insurance products to our customers through an affiliation
with a third-party broker-dealer.
Even though we have increased and expanded our involvement in
construction and land development lending in recent years, at the same time we
have been able to maintain our high asset and credit quality. At September 30,
2006, our total non-performing assets amounted to $151,000 or 0.03% of total
assets and have steadily declined from the high point during the past several
years of $1.8 million or 0.51% of total assets at September 30, 2002. Loan
charge-offs, net of recoveries, averaged $15,000 for fiscal years 2006, 2005 and
2004. At September 30, 2006, the ratio of our allowance for loan losses to
non-performing loans was 409.7%. We attribute our credit quality to careful
underwriting and the knowledge and experience of our management team.
Our executive offices are located at 1834 Oregon Avenue, Philadelphia,
Pennsylvania and our telephone number is (215) 755-1500.
MARKET AREA AND COMPETITION
Our primary market area is Philadelphia, in particular South
Philadelphia and Center City, as well as Delaware County. We also are involved
in Bucks, Chester and Montgomery Counties which, along with Delaware County,
comprise the suburbs of Philadelphia. We also make loans in contiguous counties
in southern New Jersey. This area is referred to as the Delaware Valley region.
The Philadelphia metropolitan area is one of the leading regions for biotech and
pharmaceutical research with many of the largest pharmaceutical companies
maintaining a presence in the region. It is also a major health care area with a
number of teaching and research hospitals being operated.
We face significant competition in originating loans and attracting
deposits. This competition stems primarily from commercial banks, other savings
banks and savings associations and mortgage-banking companies. Many of the
financial service providers operating in our market area are significantly
larger, and have greater financial resources, than us. We face additional
competition for deposits from short-term money market funds and other corporate
and government securities funds, mutual funds and from other non-depository
financial institutions such as brokerage firms and insurance companies.
2
LENDING ACTIVITIES
GENERAL. At September 30, 2006, our net loan portfolio totaled $219.4
million or 46.4% of total assets. Historically, our principal lending activity
has been the origination of loans collateralized by one- to four-family, also
known as "single-family," residential real estate loans secured by properties
located in our market area. In addition, while we have been making construction
loans to developers and homebuilders for more than 25 years, we substantially
increased our construction and land development lending activities beginning in
fiscal 2000. We also originate, to a substantially lesser degree, multi-family
and commercial real estate loans, home equity loans and lines of credit,
commercial business loans and consumer loans.
During fiscal 2002 and 2003, due to concerns over the interest rate
risk inherent in originating or purchasing for portfolio long-term, fixed-rate
loans bearing historically very low interest rates, we reduced our emphasis on
originating and purchasing such loans or retaining those loans already in
portfolio which were being refinanced. Prior to fiscal 2002, a substantial
portion of our single-family residential mortgage loans had adjustable rates. As
market rates of interest declined, many of our borrowers with adjustable-rate
residential mortgage loans determined to refinance their mortgages, obtaining
long-term, fixed-rate loans. However, due to our concern over the interest rate
risk inherent in increasing our investment in long-term, fixed-rate loans
bearing historically low rates of interest, we were unwilling to offer rates as
attractive as many of our competitors. As a result, many of our customers
refinanced their residential mortgage loans with other lenders. Moreover, we did
not originate as many new loans as we had in prior periods due to our
unwillingness to originate or purchase for portfolio retention single-family
residential mortgage loans bearing low interest rates. This was particularly the
case in fiscal 2003. As a result, the amount of single-family residential loans
in portfolio declined from $158.9 million or 83.1% of the total loan portfolio
at September 30, 2002 to $114.9 million or 75.3% of the total loan portfolio at
September 30, 2003. In view of the modest increases in market rates of interest
experienced in 2004 through 2006, the level of single-family residential loans
has stabilized, increasing moderately to $155.5 million at September 30, 2006,
although such loans, as a percentage of our total loan portfolio, continue to
decline.
The types of loans that we may originate are subject to federal and
state laws and regulations. Interest rates charged by us on loans are affected
principally by the demand for such loans and the supply of money available for
lending purposes and the rates offered by our competitors. These factors are, in
turn, affected by general and economic conditions, the monetary policy of the
federal government, including the Federal Reserve Board, legislative tax
policies and governmental budgetary matters.
3
LOAN PORTFOLIO COMPOSITION. The following table shows the composition
of our loan portfolio by type of loan at the dates indicated.
September 30,
----------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
---------------- ---------------- ---------------- ---------------- ----------------
Amount % Amount % Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in Thousands)
Real estate loans:
One- to four-family
residential(1) $155,454 60.69% $135,394 67.22% $124,085 71.54% $115,880 75.98% $158,876 83.08%
Multi-family residential 5,074 1.98 2,541 1.26 3,181 1.84 3,539 2.32 4,665 2.44
Commercial real estate 11,339 4.42 9,875 4.90 5,608 3.23 7,457 4.89 9,474 4.95
Construction and land
development 82,800 32.33 52,093 25.86 39,217 22.61 24,199 15.87 17,006 8.89
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 254,667 99.42 199,903 99.24 172,091 99.22 151,075 99.06 190,021 99.36
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial business loans 234 0.09 188 0.09 145 0.08 145 0.10 145 0.08
Consumer loans 1,239 0.49 1,347 0.67 1,206 0.70 1,283 0.84 1,076 0.56
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 256,140 100.00% 201,438 100.00% 173,442 100.00% 152,503 100.00% 191,242 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed portion of
construction loans in process 36,257 25,824 21,338 13,737 8,323
Deferred loan fees (153) (35) (19) 287 351
Allowance for loan losses 618 558 558 553 621
-------- -------- -------- -------- --------
Net loans $219,418 $175,091 $151,565 $137,926 $181,947
======== ======== ======== ======== ========
----------
(1) Includes home equity loans and lines of credit.
CONTRACTUAL TERMS TO FINAL MATURITIES. The following table shows the
scheduled contractual maturities of our loans as of September 30, 2006, before
giving effect to net items. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The amounts shown below do not take into account loan prepayments.
One- To Construction Commercial
Four-Family Multi-Family Commercial And Land Business
Residential Residentail Real Estate Development Loans Consumer Total
----------- ------------ ----------- ------------ ---------- -------- --------
(In Thousands)
Amounts due after September 30, 2006
in:
One year or less $ 368 $1,248 $ 268 $39,667 $145 $ 72 $ 41,768
After one year through two years 1,858 -- 1,481 39,429 -- 60 42,828
After two years through three years 1,330 165 -- 3,704 70 63 5,332
After three years through five
years 4,088 183 997 -- -- 303 5,571
After five years through ten years 19,827 2,252 5,494 -- 19 187 27,779
After ten years through fifteen
years 86,463 1,154 2,988 -- -- 554 91,159
After fifteen years 41,520 72 111 -- -- -- 41,703
-------- ------ ------- ------- ---- ------ --------
Total $155,454 $5,074 $11,339 $82,800 $234 $1,239 $256,140
======== ====== ======= ======= ==== ====== ========
The following table shows the dollar amount of all loans due after one
year from September 30, 2006, as shown in the table above, which have fixed
interest rates or which have floating or adjustable interest rates.
Floating Or
Fixed-Rate Adjustable-Rate Total
---------- --------------- --------
(In Thousands)
One- to four-family residential $136,694 $18,392 $155,086
Multi-family residential 3,563 263 3,826
Commercial real estate 9,089 1,982 11,071
Construction and land development -- 43,133 43,133
Commercial business 19 70 89
Consumer 1,117 50 1,167
-------- ------- --------
Total $150,482 $63,890 $214,372
======== ======= ========
4
LOAN ORIGINATIONS. Our lending activities are subject to underwriting
standards and loan origination procedures established by our board of directors
and management. Loan originations are obtained through a variety of sources,
primarily existing customers as well as new customers obtained from referrals
and local advertising and promotional efforts. We also use loan correspondents
and brokers as a source for a substantial part of our residential mortgage
loans, either having them originate such loans using our documentation or
purchasing such loans from them immediately upon closing. Consumer loan
applications are taken at any of our offices while loan applications for all
other types of loans are taken only at our main office. All loan applications
are processed and underwritten centrally at our main office.
Our single-family residential mortgage loans are written on
standardized documents used by the Federal Home Loan Mortgage Corporation
("FHLMC" or "Freddie Mac") and Federal National Mortgage Association ("FNMA" or
"Fannie Mae"). Property valuations of loans secured by real estate are
undertaken by independent third-party appraisers approved by our board of
directors.
In addition to originating loans, we purchase single-family
residential loans from correspondents due to limited demand in our primary
market area. However, all of such loans are underwritten by us using our
underwriting criteria and approved by the executive committee or the full board
of directors prior to purchase. We also occasionally purchase participation
interests in larger balance loans, typically commercial real estate loans, from
other financial institutions in our market area. Such participations are
reviewed for compliance with our underwriting criteria and are approved by the
executive committee or the full board before they are purchased. Generally, loan
purchases have been without any recourse to the seller. However, we actively
monitor the performance of such loans through the receipt of regular reports
from the lead lender regarding the loan's performance, physically inspecting the
loan security property on a periodic basis, discussing the loan with the lead
lender on a regular basis and receiving copies of updated financial statements
from the borrower.
In addition, we have sold participation interests in construction and
land development loans originated by us to other institutions in our market
area. In addition, beginning in fiscal 2002, we have sold to the Federal Home
Loan Bank of Pittsburgh pursuant to the Mortgage Partnership Finance program
long-term, fixed-rate single-family loans originated which had interest rates
below certain levels established by the board of directors. Such sales provide
for a limited amount of recourse. At September 30, 2006, our recourse exposure
was approximately $64,000. When we have sold participation interests, it has
been done without recourse. We generally have sold participation interests in
loans only when a loan would exceed our loan-to-one borrower limits. With
respect to the sale of participation interests in such loans, we have received
commitments to purchase such participation interests prior to the time the loan
is closed. Under applicable Pennsylvania law, we are permitted to make loans to
one borrower in an aggregate amount of up to 15% of the capital accounts of the
Bank which consist of the aggregate of its capital, surplus, undivided profits,
capital securities and reserve for loan losses. At September 30, 2006, the
Bank's loans to one borrower limit was approximately $10.5 million. As of
September 30, 2006, the Bank had extended a number of loans to various
partnerships in which a number of the same individuals participate as limited
partner investors. If such relationships were construed as being so interrelated
as to constitute a single borrower for purposes of the loans to one borrower
limitation, then the Bank's extensions of credit to such partnerships would have
exceeded the permissible limit at September 30, 2006. In order to eliminate any
potential issue, the Bank sold additional participation interests in one of the
loans extended to such partnerships. As a consequence, as of the date of this
filing the largest loans to one borrower relationship was approximately $10.3
million. All of such loans were performing in accordance with their terms and
consist of loans to fund single-family residential condominium construction
projects. For more information on such loans, see "Construction and Land
Acquisition Lending".
5
The following table shows our total loans originated, purchased, sold
and repaid during the periods indicated.
Year Ended September 30,
---------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
Loan originations:
One- to four-family residential $46,368 $24,775 $26,974
Multi-family residential 2,631 802 480
Commercial real estate 1,365 6,012 298
Construction and land development 40,257 26,749 26,236
Commercial business 920 40 659
Consumer 455 562 2,559
------- ------- -------
Total loan originations 91,996 58,940 57,206
Loans purchased -- 17,787 11,053
------- ------- -------
Total loans originated and purchased 91,996 76,727 68,259
------- ------- -------
Loans sold(1) -- -- 354
Loan principal repayments 47,943 53,455 54,902
------- ------- -------
Total loans sold and principal
repayments 47,943 53,455 55,256
Increase or (decrease) due to other items, net(2) 274 254 636
------- ------- -------
Net increase (decrease) in loan portfolio $44,327 $23,526 $13,639
======= ======= =======
----------
(1) For the year ended September 30, 2004, consists of a participation interest
sold to another financial institution.
(2) Other items consist of loans in process, deferred fees and the allowance
for loan losses.
ONE-TO FOUR-FAMILY RESIDENTIAL MORTGAGE LENDING. Our primary lending
activity continues to be the origination or purchase of loans secured by first
mortgages on one- to four-family residences located in our market area. The
majority of our single-family residential mortgage loans are obtained through
correspondents. At September 30, 2006, $155.5 million of our total loan
portfolio consisted of single-family residential mortgage loans. Due primarily
to increased mortgage loan prepayments due to refinance activity as a result of
the low interest rate environment prevailing during recent years, our concerns
over originating or purchasing for portfolio long-term, fixed-rate loans bearing
low interest rates as well as our increased emphasis on construction and land
development loans, the percentage of single-family residential mortgage loans in
our portfolio has decreased from 84.8% at September 30, 2001 to 60.7% at
September 30, 2006. However, as market rates increase, we will consider
increasing our investment in single-family residential mortgage loans.
Our single-family residential mortgage loans generally are
underwritten on terms and documentation conforming with guidelines issued by
Freddie Mac and Fannie Mae. Applications for one-to four-family residential
mortgage loans are accepted only at our main office. We generally have retained
for portfolio a substantial portion of the single-family residential mortgage
loans that we originate, only selling certain long-term, fixed-rate loans
bearing interest rates below certain levels established by the board. All of
such sales have been sold to the Federal Home Loan Bank of Pittsburgh pursuant
to the Mortgage Partnership Finance Program. We service all loans that we have
originated, including loans that we subsequently sell. We currently originate
fixed-rate, fully amortizing mortgage loans with maturities of 15, 20 or 30
years. We also offer adjustable rate mortgage ("ARM") loans. However, due to
local market conditions, our originations of such loans have been limited in
recent years. At September 30, 2006, $17.8 million, or 13.0%, of our one- to
four-family residential loan portfolio (excluding home equity loans and lines of
credit) consisted of ARM loans.
6
We underwrite one- to four-family residential mortgage loans with
loan-to-value ratios of up to 95%, provided that the borrower obtains private
mortgage insurance on loans that exceed 80% of the appraised value or sales
price, whichever is less, of the secured property. We also require that title
insurance, hazard insurance and, if appropriate, flood insurance be maintained
on all properties securing real estate loans. A licensed appraiser appraises all
properties securing one- to four-family first mortgage loans. Our mortgage loans
generally include due-on-sale clauses which provide us with the contractual
right to deem the loan immediately due and payable in the event the borrower
transfers ownership of the property. Due-on-sale clauses are an important means
of adjusting the yields of fixed-rate mortgage loans in portfolio and we
generally exercise our rights under these clauses.
Our single-family residential mortgage loans also include home equity
loans and lines of credit, which amounted to $14.6 million and $7.8 million,
respectively, at September 30, 2006. The unused portion of home equity lines was
$4.4 million at such date. Our home equity loans are fully amortizing and have
terms to maturity of up to 20 years. While home equity loans also are secured by
the borrower's residence, we generally obtain a second mortgage position on
these loans. Our lending policy provides that our home equity loans have
loan-to-value ratios, when combined with any first mortgage, of 80% or less,
although the preponderance of our home equity loans have combined loan-to-value
ratios of 75% or less. We also offer home equity revolving lines of credit with
interest tied to the Wall Street Journal prime rate. Generally, we have a second
mortgage on the borrower's residence as collateral on our home equity lines. In
addition, our home equity lines generally have loan-to-value ratios (combined
with any loan secured by a first mortgage) of 75% or less. Our customers may
apply for home equity lines as well as home equity loans at any banking office.
CONSTRUCTION AND LAND ACQUISITION LENDING. We have been an active
originator of construction and land development loans for many years but have
substantially increased our construction loan efforts in recent years as a
growth area for us because they have shorter terms to maturity and they
generally have floating or adjustable interest rates. We have focused our
construction lending on making loans to developers and homebuilders in our
primary market area to acquire, develop and build single-family residences or
condominium projects. Our construction loans include, to a lesser extent, loans
for the construction of multi-family residential or mixed-use properties. At
September 30, 2006, our construction loans amounted to $82.8 million, or 32.3%
of our total loan portfolio. This amount includes $36.3 million of undisbursed
loans in process (of which $6.6 million relates to participation interests we
have sold). Our construction loan portfolio has grown appreciably since
September 30, 2002, when construction loans amounted to $17.0 million, or 8.9%
of our total loan portfolio.
A substantial amount of our construction loans are construction and
development loans to contractors and builders primarily to finance the
construction of condominium projects, single-family homes and small to
medium-sized residential subdivisions. Loans to finance the construction of
condominium projects or single-family homes and subdivisions are generally
offered to experienced builders in our primary market area with whom we have an
established relationship. Residential construction and development loans are
offered with terms of up to 36 months although typically the terms are 12 to 24
months. One or two six-month extensions may be provided for at our option and
upon payment of a fee by the borrower. The maximum loan-to-value limit
applicable to these loans is 75% of the appraised post construction value and do
not require amortization of the principal during the term of the loan. We often
establish interest reserves and obtain personal and/or corporate guarantees as
additional security on our construction loans. Construction loan proceeds are
disbursed periodically in increments as construction progresses and as
inspection by our approved appraisers or loan inspectors warrants. Our
construction loans are negotiated on an individual basis but typically have
floating rates of interest based upon the Wall Street Journal prime rate.
Additional fees may be charged as funds are disbursed. In addition to interest
payments during the term of the construction loan, we typically require that
payments to principal be made as units are completed and released. Generally
such principal
7
payments must be equal to 110% of the amount attributable to acquisition and
development of the lot plus 100% of the amount attributable to construction of
the individual home. We permit a pre-determined number of model homes to be
constructed on an unsold or "speculative" basis. All other units must be
pre-sold before we will disburse funds for construction. Our construction loans
also include loans to acquire land and loans to develop the basic
infrastructure, such as roads and sewers. The majority of our construction loans
are secured by properties located in Philadelphia and Chester Counties,
Pennsylvania. However, we also make construction loans in Bucks, Delaware and
Montgomery Counties, Pennsylvania as well as the New Jersey suburbs of
Philadelphia. In addition, we have sold participation interests in a number of
our larger construction projects, generally retaining at least a 25% interest.
Such sales do not provide for any recourse against the Bank.
Set forth below is a brief description of our five largest
construction loans, all of which have performed in accordance with their terms.
Our largest construction and development loan is a $20.0 million loan
to a limited partnership sponsored by a Philadelphia-based regional developer.
We sold participation interests totaling $15.0 million to four other local
financial institutions in connection with the closing of the loan in late 2004.
We also received additional collateral from the borrower consisting of
condominium units in another project with an estimated value of $4.6 million at
the time such collateral was pledged. The project involves the conversion of an
existing building into a mixed-use building which will contain, when completed,
approximately 200 loft condominiums above one floor of retail space. The project
also involves the construction of both indoor and outdoor parking lots. The loan
has a 36-month term with payments of interest only during the term of the loan
and a floating interest at the Wall Street Journal prime plus 1% with a floor of
5.0%. As of November 2006, the developer had received agreements of sale
covering 45 units and pre-sale (non-binding) reservations covering 3 units. The
Bank's outstanding loan balance (with respect to its interest) at September 30,
2006 was approximately $4.8 million with the total loan balance at such date
amounting to approximately $19.2 million. As of May 2006, the first phase of the
project was completed which involved the initial 34 pre-sale units and building
shell work. The developer elected to complete the remaining units in the
existing building before they began conveying and occupying sites in order to
limit the liability associated with construction site hazards and risks in
occupying a building under construction, and to accelerate the overall project
ahead of a potential market slowdown. During July 2006, we extended an
additional loan of $9.0 million for the second phase of the project. The new
loan terms call for payments of interest only during the term of the loan and a
floating interest at the Wall Street Journal prime plus 1% with a floor of 5.0%.
The new loan will mature in 36 months from the date of the original loan. In
late 2006, we sold participation interests related to the additional loan
totaling $5.1 million to three other local financial institutions in connection
with the closing of the loan. The Bank's outstanding loan balance (with respect
to its interest) at September 30, 2006 was approximately $1.5 million with the
total loan balance at such date amounting to approximately $3.0 million.
In October 2005, we extended a $5.0 million loan, also for the
conversion of an existing building located in Philadelphia into condominiums.
The limited partnership is operated by a Philadelphia-based construction
company. The project involves the conversion of the existing building into 34
loft condominium units with outside parking. The loan has a 24 month term with
interest only due during the term and a floating interest rate indexed to the
Wall Street journal prime plus 1%. The loan has a floor of 5.0%. The loan
provides for one six month extension upon the payment of a fee equal to .5% of
the outstanding balance as of the date of the extension. The loan-to-value ratio
at the date of origination was approximately 73%. We retained the entire
interest in the loan. At the date hereof, the outstanding loan balance was
approximately $1.6 million. Construction of the project is proceeding on
schedule and the contractor anticipates two sample units available for the
spring 2007 selling season.
8
In September 2005, we extended a $3.0 million construction and
development loan to a local developer to build a 17 townhouse project located in
Philadelphia. The loan has a 24-month term with payments of interest only during
the term of the loan and a floating interest rate at the Wall Street Journal
prime rate plus 1% and with a floor of 7.25%. The loan to value ratio of the
loan was approximately 68% at the date of origination without reference to the
additional collateral we received. The additional collateral consists of a condo
in Philadelphia and an office building in Sewell, New Jersey with estimated
equity of $540,000. In August 2006, we extended an additional $1.5 million in
order to facilitate successful completion of the project. At September 30, 2006,
the outstanding balance of the loan was approximately $4.1 million. As of
October 2006, one unit has been sold and an additional 10 units are under
agreement of sale.
In August 2005 we extended a $5.0 million construction and land
development loan to a local developer to convert an existing building into 17
loft condominium units located in Philadelphia. The loan has a 24-month term
with payments of interest only during the term of the loan and a floating
interest rate at the Wall Street Journal prime rate plus 1% and with a floor of
7.25%. The loan to value ratio of the loan was approximately 73% at the date of
origination. At September 30, 2006, the outstanding balance of the Bank's loan
was approximately $3.9 million. As of October 2006, two units have been sold and
an additional 10 units are under agreement of sale. Construction of the project
is proceeding on schedule.
In September 2004 we extended a $6.4 million construction and land
development loan to a local developer to build an 18 townhouse project located
in Philadelphia. Concurrently with closing the loan, we sold a 36.2%
participation interest to another local financial institution, retaining the
remaining 63.8%. The loan has a 24-month term with payments of interest only
during the term of the loan and a floating interest rate at the Wall Street
Journal prime rate plus 1% and with a floor of 5.00%. The loan to value ratio of
the loan was approximately 76% at the date of origination without reference to
the additional collateral we received. The additional collateral consists of two
small commercial properties located in Upper Darby, Pennsylvania with an
estimated value of $578,000. At September 30, 2006 the outstanding balance of
the Bank's portion of the loan was approximately $1.6 million with the total
loan balance outstanding at such date amounting to approximately $2.5 million.
The developer activated his six month extension clause to extend maturity until
February 2007. As of October 2006, four units have been sold.
Construction financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of
the initial estimate of the property's value at completion of construction
compared to the estimated costs, including interest, of construction and other
assumptions. Additionally, if the estimate of value proves to be inaccurate, we
may be confronted with a project, when completed, having a value less than the
loan amount. We have attempted to minimize these risks by generally
concentrating on residential construction loans in our market area to
contractors with whom we have established relationships and by selling, with
respect to larger construction and land development loans, participation
interests. In the past, to the extent we have experienced any material
difficulties, they have primarily related to loan participations we have
purchased.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. At
September 30, 2006, our multi-family residential and commercial real estate
loans amounted to $16.4 million or 6.4% of our total loan portfolio. Although we
continue to offer such loans and will originate such loans when it is favorable
to us, multi-family residential loans have declined both in terms of the
aggregate amount outstanding as well as a percentage of the loan portfolio since
September 30, 2002. After declining since 2002, our commercial real estate loans
increased slightly at September 30, 2005 to $9.9 million and September 30, 2006
to $11.3 million.
9
Our commercial real estate and residential multi-family real estate
loan portfolio consists primarily of loans secured by small office buildings,
strip shopping centers, small apartment buildings and other properties used for
commercial and multi-family purposes located in our market area. At September
30, 2006, the average commercial and multi-family real estate loan size was
approximately $216,000. The largest multi-family residential or commercial real
estate loan at September 30, 2006 was $1.2 million which was performing in
accordance with its terms. Substantially all of the properties securing our
multi-family residential and commercial real estate loans are located in our
primary market area.
Although terms for commercial real estate and multi-family loans vary,
our underwriting standards generally allow for terms up to 20 years with
loan-to-value ratios of not more than 70%. Most of the loans are structured with
balloon payments with amortization periods of up to 25 years. Interest rates are
either fixed or adjustable, based upon designated market indices such as the
Wall Street Journal prime rate plus a margin or, with respect to our
multi-family residential loans, the Average Contract Interest Rate for
previously occupied houses as reported by the Federal Housing Finance Board. In
addition, fees of up to 2% are charged to the borrower at the origination of the
loan. We obtain personal guarantees of the principals as additional collateral
for commercial real estate and multi-family real estate loans.
Commercial real estate and multi-family real estate lending involves
different risks than single-family residential lending. These risks include
larger loans to individual borrowers and loan payments that are dependent upon
the successful operation of the project or the borrower's business. These risks
can be affected by supply and demand conditions in the project's market area of
rental housing units, office and retail space and other commercial space. We
attempt to minimize these risks by limiting loans to proven businesses, only
considering properties with existing operating performance which can be
analyzed, using conservative debt coverage ratios in our underwriting, and
periodically monitoring the operation of the business or project and the
physical condition of the property.
Various aspects of commercial and multi-family loan transactions are
evaluated in an effort to mitigate the additional risk in these types of loans.
In our underwriting procedures, consideration is given to the stability of the
property's cash flow history, future operating projections, current and
projected occupancy levels, location and physical condition. Generally, we
impose a debt service ratio (the ratio of net cash flows from operations before
the payment of debt service to debt service) of not less than 120%. We also
evaluate the credit and financial condition of the borrower, and if applicable,
the guarantor. Appraisal reports prepared by independent appraisers are reviewed
by us prior to the closing of the loan. With respect to participations, we
underwrite the loans as if we were the originating lender.
CONSUMER LENDING ACTIVITIES. We offer various types of consumer loans
such as loans secured by deposit accounts and unsecured personal loans. Consumer
loans are originated primarily through existing and walk-in customers and direct
advertising. At September 30, 2006, $1.2 million, or 0.5% of the total loan
portfolio consisted of these types of loans.
Consumer loans generally have higher interest rates and shorter terms
than residential loans. However, consumer loans have additional credit risk due
to the type of collateral securing the loan or in some cases the absence of
collateral.
COMMERCIAL BUSINESS LOANS. Our commercial business loans amounted to
$234,000 or 0.09% of the total loan portfolio at September 30, 2006.
Our commercial business loans typically are made to small to mid-sized
businesses in our market area primarily to provide working capital. Small
business loans may have adjustable or fixed rates of
10
interest and generally have terms of three years or less but may go up to 15
years. Our commercial business loans generally are secured by real estate. In
addition, we generally obtain personal guarantees from the principals of the
borrower with respect to all commercial business loans.
LOAN APPROVAL PROCEDURES AND AUTHORITY. Our board of directors
establishes Prudential Savings Bank's lending policies and procedures. Our
various lending policies are reviewed at least annually by our management team
and the board in order to propose modifications as a result of market
conditions, regulatory changes and other factors. All modifications must be
approved by our board of directors.
Home equity loans and lines of credit up to $100,000 can be approved
by one underwriter and either of two lending officers. Amounts in excess of the
individual lending limit with respect to home equity loans and lines of credit
must be approved by our two lending officers, and our President or Chief
Financial Officer. All mortgage loans must be approved by either the executive
committee of the board or the full board of directors of Prudential Savings
Bank.
ASSET QUALITY
GENERAL. One of our key objectives has been, and continues to be,
maintaining a high level of asset quality. In addition to maintaining credit
standards for new originations which we believe are sound, we are proactive in
our loan monitoring, collection and workout processes in dealing with delinquent
or problem loans. We also retain an independent, third party to undertake
periodic reviews of the credit quality of a random sample of new loans and all
of our major loans on an ongoing basis.
Reports listing all delinquent accounts are generated and reviewed by
management on a monthly basis. These reports include information regarding all
loans 30 days or more delinquent and all real estate owned and are provided to
the board of directors. The procedures we take with respect to delinquencies
vary depending on the nature of the loan, period and cause of delinquency and
whether the borrower is habitually delinquent. When a borrower fails to make a
required payment on a loan, we take a number of steps to have the borrower cure
the delinquency and restore the loan to current status. We generally send the
borrower a written notice of non-payment after the loan is first past due. Our
guidelines provide that telephone, written correspondence and/or face-to-face
contact will be attempted to ascertain the reasons for delinquency and the
prospects of repayment. When contact is made with the borrower at any time prior
to foreclosure, we will attempt to obtain full payment, work out a repayment
schedule with the borrower to avoid foreclosure or, in some instances, accept a
deed in lieu of foreclosure. In the event payment is not then received or the
loan not otherwise satisfied, additional letters and telephone calls generally
are made. If the loan is still not brought current or satisfied and it becomes
necessary for us to take legal action, which typically occurs after a loan is 90
days or more delinquent, we will commence foreclosure proceedings against any
real property that secures the loan. If a foreclosure action is instituted and
the loan is not brought current, paid in full, or refinanced before foreclosure
sale, the property securing the loan generally is sold at foreclosure and, if
purchased by us, becomes real estate owned.
On loans where the collection of principal or interest payments is
doubtful, the accrual of interest income ceases ("non-accrual" loans). On loans
90 days or more past due as to principal and interest payments, our policy, with
certain limited exceptions with respect to single-family residential mortgage
loans, is to discontinue accruing additional interest and reverse any interest
currently accrued. On occasion, this action may be taken earlier if the
financial condition of the borrower raises significant concern with regard to
his/her ability to service the debt in accordance with the terms of the loan
agreement. Interest income is not accrued on these loans until the borrower's
financial condition and payment record demonstrate an ability to service the
debt.
11
Real estate which is acquired as a result of foreclosure is classified
as real estate owned until sold. Real estate owned is recorded at the lower of
cost or fair value less estimated selling costs. Costs associated with acquiring
and improving a foreclosed property are usually capitalized to the extent that
the carrying value does not exceed fair value less estimated selling costs.
Holding costs are charged to expense. Gains and losses on the sale of real
estate owned are charged to operations, as incurred.
We account for our impaired loans under generally accepted accounting
principles. An impaired loan generally is one for which it is probable, based on
current information, that the lender will not collect all the amounts due under
the contractual terms of the loan. Large groups of smaller balance, homogeneous
loans are collectively evaluated for impairment. Loans collectively evaluated
for impairment include smaller balance commercial real estate loans, residential
real estate loans and consumer loans. These loans are evaluated as a group
because they have similar characteristics and performance experience. Larger
commercial real estate, construction and commercial business loans are
individually evaluated for impairment. We had no impaired loans as of September
30, 2005 and 2006.
Federal regulations and our policies require that we utilize an
internal asset classification system as a means of reporting problem and
potential problem assets. We have incorporated an internal asset classification
system, consistent with Federal banking regulations, as a part of our credit
monitoring system. We currently classify problem and potential problem assets as
"substandard," "doubtful" or "loss" assets. An asset is considered "substandard"
if it is inadequately protected by the current net worth and paying capacity of
the obligor or of the collateral pledged, if any. "Substandard" assets include
those characterized by the "distinct possibility" that the insured institution
will sustain "some loss" if the deficiencies are not corrected. Assets
classified as "doubtful" have all of the weaknesses inherent in those classified
"substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets classified
as "loss" are those considered "uncollectible" and of such little value that
their continuance as assets without the establishment of a specific loss reserve
is not warranted. Assets which do not currently expose the insured institution
to sufficient risk to warrant classification in one of the aforementioned
categories but possess weaknesses are required to be designated "special
mention."
When an insured institution classifies one or more assets, or portions
thereof, as "substandard" or "doubtful," it is required that a general valuation
allowance for loan losses be established for loan losses in an amount deemed
prudent by management. General valuation allowances represent loss allowances
which have been established to recognize the inherent losses associated with
lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
one or more assets, or portions thereof, as "loss," it is required either to
establish a specific allowance for losses equal to 100% of the amount of the
asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by
Federal and state bank regulators which can order the establishment of
additional general or specific loss allowances. The Federal banking agencies,
have adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation guidelines. Generally, the policy statement
recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; that management analyze all
significant factors that affect the collectibility of the portfolio in a
reasonable manner; and that management establish acceptable allowance evaluation
processes that meet the
12
objectives set forth in the policy statement. In July 2001, the SEC issued Staff
Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology
and Documentation Issues." The guidance contained in the SAB focuses on the
documentation the SEC staff normally expects registrants to prepare and maintain
in support of the allowance for loan and lease losses. Concurrent with the SEC's
issuance of SAB No. 102, the federal banking agencies, represented by the
Federal Financial Institutions Examination Council ("FFIEC"), issued an
interagency policy statement entitled "Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings Institutions" (Policy
Statement). The SAB and Policy Statement were the result of an agreement between
the SEC and the federal banking agencies in March 1999 to provide guidance on
allowance for loan and lease losses methodologies and supporting documentation.
Our allowance for loan losses includes a portion which is allocated by type of
loan, based primarily upon our periodic reviews of the risk elements within the
various categories of loans, as well as an unallocated portion. The specific
components relate to loans that are classified as either doubtful, substandard
or special mention. The general components covers non-classified loans and is
based on historical loss experience adjusted for qualitative factors. The
unallocated portion of the allowance is established upon consideration of
various qualitative and quantitative factors with respect to the overall loan
portfolio. Our management believes that, based on information currently
available, its allowance for loan losses is maintained at a level which covers
all known and inherent losses that are both probable and reasonably estimable at
each reporting date. However, actual losses are dependent upon future events
and, as such, further additions to the level of allowances for loan losses may
become necessary.
We review and classify assets on a quarterly basis and the board of
directors is provided with monthly reports on our classified assets. We classify
assets in accordance with the management guidelines described above. At
September 30, 2006, 2005 and 2004, we had no assets classified as "doubtful" or
"loss", and $151,000, $600,000 and $1.0 million, respectively, of assets
classified as "substandard." In addition, as of September 30, 2006, 2005 and
2004, we did not have any loans designated "special mention."
DELINQUENT LOANS. The following table shows the delinquencies in our
loan portfolio as of the dates indicated.
September 30, 2006 September 30, 2005
------------------------------------------- -------------------------------------------
30-89 90 Or More Days 30-89 90 Or More Days
Days Overdue Overdue Days Overdue Overdue
-------------------- -------------------- -------------------- --------------------
Number Principal Number Principal Number Principal Number Principal
Of Loans Balance Of Loans Balance Of Loans Balance Of Loans Balance
-------- --------- -------- --------- -------- --------- -------- ---------
(Dollars in Thousands)
One- to four-family residential 15 $1,502 4 $ 151 19 $1,856 5 $239
Multi-family residential -- -- -- -- -- -- -- --
Commercial real estate -- -- -- -- -- -- -- --
Construction and land
development -- -- -- -- 1 2,120 -- --
Commercial business 1 1 -- -- -- -- -- --
Consumer loans -- -- -- -- 3 32 -- --
--- ------ --- ----- --- ------ --- ----
Total delinquent loans 16 $1,503 4 $ 151 23 $4,008 5 $239
=== ====== === ===== === ====== === ====
Delinquent loans to total net loans 0.68% 0.07% 2.29% 0.14%
Delinquent loans to total loans 0.59% 0.06% 1.99% 0.12%
NON-PERFORMING LOANS AND REAL ESTATE OWNED. The following table sets
forth information regarding our non-performing loans and real estate owned. Our
general policy is to cease accruing interest on loans, other than single-family
residential loans, which are 90 days or more past due and to reverse all accrued
interest. We had no loans on non-accrual status during the years ended September
30, 2006 and 2005.
13
The following table shows the amounts of our non-performing assets
(defined as non-accruing loans, accruing loans 90 days or more past due and real
estate owned) at the dates indicated. We did not have troubled debt
restructurings at any of the dates indicated.
September 30,
----------------------------------------
2006 2005 2004 2003 2002
----- ----- ------ ------ ------
(Dollars in Thousands)
Non-accruing loans:
One- to four-family residential $ -- $ -- $ -- $ -- $ --
Multi-family residential -- -- -- -- --
Commercial real estate -- -- -- -- 448
Construction and land development -- -- -- 500 994
Commercial business -- -- -- -- --
Consumer -- -- -- -- --
----- ----- ------ ------ ------
Total non-accruing loans -- -- -- 500 1,442
----- ----- ------ ------ ------
Accruing loans 90 days or more past due:
One- to four-family residential 151 240 478 386 259
Multi-family residential -- -- -- -- --
Commercial real estate and land -- -- -- -- --
Construction and land development -- -- -- -- --
Commercial business -- -- -- -- --
Consumer -- -- 1 4 26
----- ----- ------ ------ ------
Total accruing loans 90 days or
more past due 151 240 479 390 285
----- ----- ------ ------ ------
Total non-performing loans(1) 151 240 479 890 1,727
----- ----- ------ ------ ------
Real estate owned, net(2) -- 360 548 626 43
----- ----- ------ ------ ------
Total non-performing assets $ 151 $ 600 $1,027 $1,516 $1,770
===== ===== ====== ====== ======
Troubled debt restructurings -- -- -- -- --
Total non-performing loans as a
percentage of loans, net 0.07% 0.14% 0.32% 0.65% 0.95%
===== ===== ====== ====== ======
Total non-performing loans as a
percentage of total assets 0.03% 0.05% 0.12% 0.22% 0.50%
===== ===== ====== ====== ======
Total non-performing assets as a
percentage of total assets 0.03% 0.13% 0.25% 0.38% 0.51%
===== ===== ====== ====== ======
----------
(1) Non-performing loans consist of non-accruing loans plus accruing loans 90
days or more past due.
(2) Real estate owned balances are shown net of related loss allowances and
consists solely of real property.
Interest income on impaired loans other than non-accrual loans is
recognized on an accrual basis. Interest income on non-accrual loans is
recognized only as collected. There was no such interest recognized for fiscal
2006 and 2005.
Property acquired by Prudential Savings Bank through foreclosure
is initially recorded at the lower of cost, which is the lesser of the carrying
value of the loan or fair value at the date of acquisition, or the fair value of
the related assets at the date of foreclosure, less estimated costs to sell.
Thereafter, if there is a further deterioration in value, we charge earnings for
the diminution in value. Our policy is to obtain an appraisal on real estate
subject to foreclosure proceedings prior to the time of foreclosure if the
property is located outside our market area or consists of other than
single-family residential property. We may obtain re-appraisals on a periodic
basis on foreclosed properties. We also conduct inspections on foreclosed
properties. As of September 30, 2006, the balance of real estate owned was $-0-.
In the second quarter of fiscal 2006, the lone real estate owned
property at September 30, 2005 was sold at a pre-tax gain of approximately
$106,000.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is
established through a provision for loan losses. We maintain the allowance at a
level believed, to the best of management's knowledge, to cover all known and
inherent losses in the portfolio that are both probable and reasonable to
estimate at each reporting date. Management reviews the allowance for loan
losses on no less than a quarterly basis
14
in order to identify those inherent losses and to assess the overall collection
probability for the loan portfolio. For each primary type of loan, we establish
a loss factor reflecting our estimate of the known and inherent losses in such
loan type using both a quantitative analysis as well as consideration of
qualitative factors. Our evaluation process includes, among other things, an
analysis of delinquency trends, non-performing loan trends, the level of
charge-offs and recoveries, prior loss experience, total loans outstanding, the
volume of loan originations, the type, size and geographic concentration of our
loans, the value of collateral securing the loan, the borrower's ability to
repay and repayment performance, the number of loans requiring heightened
management oversight, local economic conditions and industry experience. In
addition, each loan type is assigned a rating based on the assumed risk elements
of such loan types. Such risk ratings are periodically reviewed by management
and revised as deemed appropriate. The establishment of the allowance for loan
losses is significantly affected by management judgment and uncertainties and
there is a likelihood that different amounts would be reported under different
conditions or assumptions. Various regulatory agencies, as an integral part of
their examination process, periodically review our allowance for loan losses.
Such agencies may require us to make additional provisions for estimated loan
losses based upon judgments different from those of management. As of September
30, 2006, our allowance for loan losses was 0.24% of total loans receivable and
409.7% of non-performing loans. All of the amount of the allowance at each of
the dates set forth in the tables on the following page consisted of general
reserves.
We have reviewed the Interagency Policy Statement on the Allowance For
Loan and Lease Losses (ALLL), issued December 13, 2006. The purpose of this
policy statement is to issue guidance on important aspects of loan loss
allowance practices. We believe that our methodology for the evaluation of our
loan portfolio and the calculation of our ALLL is consistent with this
statement.
In the five-year period ended September 30, 2006, our loan charge-offs
have been relatively modest and two loans were responsible for the majority of
such charge-offs.
We will continue to monitor and modify our allowances for loan losses
as conditions dictate. No assurances can be given that our level of allowance
for loan losses will cover all of the inherent losses on our loans or that
future adjustments to the allowance for loan losses will not be necessary if
economic and other conditions differ substantially from the economic and other
conditions used by management to determine the current level of the allowance
for loan losses.
15
The following table shows changes in our allowance for loan losses
during the periods presented.
At Or For The Year Ended Septemver 30,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in Thousands)
Total loans outstanding at end of period $256,140 $201,438 $173,442 $152,503 $191,242
Average loans outstanding 197,913 163,166 142,348 156,894 186,698
Allowance for loan losses, beginning of period 558 558 553 621 736
Provision for loan losses 60 -- 50 180 150
-------- -------- -------- -------- --------
Charge-offs:
One- to four-family residential -- -- -- -- --
Multi-family -- -- -- -- --
Commercial real estate -- -- 50 172 250
Construction and land development -- -- 28 50 --
Commercial business -- -- -- -- 4
Consumer -- -- -- 51 12
-------- -------- -------- -------- --------
Total charge-offs -- -- 78 273 266
Recoveries on loans previously charged off -- -- 33 25 1
-------- -------- -------- -------- --------
Allowance for loan losses, end of period $ 618 $ 558 $ 558 $ 553 $ 621
======== ======== ======== ======== ========
Allowance for loan losses as a percent of
non-performing loans 409.66% 233.47% 116.49% 62.13% 35.96%
======== ======== ======== ======== ========
Ratio of net charge-offs during the period
to average loans outstanding during the
period --% --% 0.03% 0.16% 0.14%
======== ======== ======== ======== ========
The following table shows how our allowance for loan losses is
allocated by type of loan at each of the dates indicated.
September 30,
-------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------------- ------------------- ------------------- ------------------- -------------------
Loan Loan Loan Loan Loan
Category Category Category Category Category
Amount As A % Amount As A % Amount As A % Amount As A % Amount As A %
Of Of Total Of Of Total Of Of Total Of Of Total Of Of Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
--------- -------- --------- -------- --------- -------- --------- -------- --------- --------
(Dollars in Thousands)
One- to four-family
residential $148 60.69% $163 67.21% $182 70.92% $137 75.32% $188 82.56%
Multi-family residential 23 1.98 13 1.26 16 1.83 18 2.32 23 2.44
Commercial real estate 102 4.42 98 4.90 44 2.53 69 4.22 90 4.44
Construction and land
development 343 32.33 227 25.86 197 22.69 226 15.87 210 8.89
Commercial business 2 .09 2 .09 29 1.70 21 1.83 22 1.41
Consumer -- .49 1 .67 1 0.33 10 0.44 6 0.26
Unallocated -- -- 54 -- 89 -- 72 -- 82 --
---- ------ ---- ------ ---- ------ ---- ------ ---- ------
Total $618 100.00% $558 100.00% $558 100.00% $553 100.00% $621 100.00%
==== ====== ==== ====== ==== ====== ==== ====== ==== ======
Our overall allowance for loan losses increased by $60,000 from
September 30, 2005 to September 30, 2006 due primarily to loan growth,
particularly in the construction and land development portfolio. There was also
a re-distribution in the allocation of such allowance due to shifts in the
composition of the portfolio as well as an analysis of the risk elements
inherent therein. Most notably, the allocation of the allowance related to
construction and land development loans increased due to the amount of such
loans increasing by $30.7 million or 58.9% between September 30, 2005 and
September 30, 2006.
16
INVESTMENT ACTIVITIES
GENERAL. We invest in securities in accordance with policies approved
by our board of directors. The investment policy designates our President, our
Chief Financial Officer and our Treasurer as the Investment Committee, which
committee is authorized by the board to make the Bank's investments consistent
with the investment policy. The board of directors of Prudential Savings Bank
reviews all investment activity on a monthly basis.
Our investment policy is designed primarily to manage the interest
rate sensitivity of our assets and liabilities, to generate a favorable return
without incurring undue interest rate and credit risk, to complement our lending
activities and to provide and maintain liquidity. In recent periods, we
substantially increased our investment and mortgage-backed securities portfolio
due to concerns over the interest risk inherent in investing in long-term,
fixed-rate residential mortgage loans in the low interest environment that has
existed in recent years.
At September 30, 2006, our investment and mortgage-backed securities
amounted to $225.8 million or 47.8% of total assets at such date. The largest
component of our securities portfolio in recent periods has been U.S. Government
and agency obligations, which amounted to $132.1 million or 58.5% of the
securities portfolio at September 30, 2006. In addition, we invest in
mortgage-backed securities and to a significantly lesser degree, municipal
securities and other securities. Included in our investment securities available
for sale is a $34.1 million investment in a mutual fund that invests primarily
in adjustable-rate mortgages and floating-rate securities. At September 30,
2006, we had unrecognized loss on this investment of approximately $930,000
which reduced our total equity accordingly.
Approximately $48.7 million of U.S. Government and agency securities
at September 30, 2006 were "step-up" securities. These securities require the
issuer to pay increased interest rates in the future according to pre-determined
schedules and formulas. Our portfolio currently contains securities that call
for various interest rate increases at various repricing intervals. The
repricing periods range from monthly to every five years with interest rate
adjustments ranging from 0.10% to 2.0%. In addition, these securities are
callable at the option of the issuers. Although designed to protect the investor
in a rising rate environment, the rate increases on these securities may not
keep pace with rising interest rates in a rapidly rising interest rate
environment. Also, because of the call feature, the securities may be called by
the issuer at a time when we are not able to reinvest the proceeds of the called
security at a rate comparable to that which we were earning on the security at
the time it was called.
Pursuant to Statement of Financial Accounting Standards ("SFAS") No.
115, our securities are classified as available for sale, held to maturity, or
trading, at the time of acquisition. Securities classified as held to maturity
must be purchased with the intent and ability to hold that security until its
final maturity, and can be sold prior to maturity only under rare circumstances.
Held to maturity securities are accounted for based upon the amortized cost of
the security. Available for sale securities can be sold at any time based upon
needs or market conditions. Available for sale securities are accounted for at
fair value, with unrealized gains and losses on these securities, net of income
tax provisions, reflected in retained earnings as accumulated other
comprehensive income. At September 30, 2006, we had $132.1 million of investment
securities classified as held to maturity, $38.7 million of investment
securities classified as available for sale, $50.4 million of mortgage-backed
securities classified as held to maturity, $4.6 million of mortgage-backed
securities classified as available for sale, and no securities classified as
trading account.
We do not purchase mortgage-backed derivative instruments nor do we
purchase corporate obligations which are not rated investment grade or better.
17
Our mortgage-backed securities consist primarily of mortgage
pass-through certificates issued by the Government National Mortgage Association
("GNMA" or "Ginnie Mae"), Fannie Mae ("FNMA") or Freddie Mac ("FHLMC"). We have
not invested in collateralized mortgage obligations ("CMOs") issued by such
agencies. At September 30, 2006, all of our mortgage-backed securities were
issued by the GNMA, FNMA or FHLMC.
Investments in mortgage-backed securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby changing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
Ginnie Mae is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. Ginnie Mae securities are backed by loans insured by the Federal
Housing Administration, or guaranteed by the Veterans Administration. The timely
payment of principal and interest on Ginnie Mae securities is guaranteed by
Ginnie Mae and backed by the full faith and credit of the U.S. Government.
Freddie Mac is a private corporation chartered by the U.S. Government. Freddie
Mac issues participation certificates backed principally by conventional
mortgage loans. Freddie Mac guarantees the timely payment of interest and the
ultimate return of principal on participation certificates. Fannie Mae is a
private corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. Fannie Mae guarantees the timely payment of
principal and interest on Fannie Mae securities. Freddie Mac and Fannie Mae
securities are not backed by the full faith and credit of the U.S. Government,
but because Freddie Mac and Fannie Mae are U.S. Government-sponsored
enterprises, these securities are considered to be among the highest quality
investments with minimal credit risks.
The following table sets forth certain information relating to our
investment and mortgage-backed securities portfolios at the dates indicated.
September 30,
-------------------------------------------------------------
2006 2005 2004
------------------- ------------------- -------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In Thousands)
Mortgage-backed securities $ 54,894 $ 54,142 $ 66,828 $ 67,124 $ 80,932 $ 82,074
U.S. Government and agency
obligations 132,198 129,675 129,954 128,163 116,395 116,122
Municipal obligations 2,884 2,853 2,884 2,847 2,409 2,380
ARM mutual fund 34,982 34,052 34,982 34,123 34,982 34,544
-------- -------- -------- -------- -------- --------
Total 224,958 220,722 234,648 232,257 234,718 235,120
-------- -------- -------- -------- -------- --------
FHLB stock 2,217 2,217 1,811 1,811 2,074 2,074
FHLMC stock 26 1,754 26 1,493 26 1,725
FNMA stock 1 7 1 5 1 8
-------- -------- -------- -------- -------- --------
Total mortgage backed and
investment securities $227,202 $224,700 $236,486 $235,566 $236,819 $238,927
======== ======== ======== ======== ======== ========
18
The following tables set forth the amount of investment and
mortgage-backed securities which mature during each of the periods indicated and
the weighted average yields for each range of maturities at September 30, 2006.
Tax-exempt yields have not been adjusted to a tax-equivalent basis.
Amounts At Septemver 30, 2006 Which Mature In
----------------------------------------------------------------------------------------
Over One
Weighted Year Weighted Over Five Weighted Over Weighted
One Year Average Through Average Through Average Ten Average
Or Less Yield Five Years Yield Ten Years Yield Years Yield
-------- -------- ---------- -------- --------- -------- -------- --------
(Dollars in Thousands)
Bonds and other debt securities:
U.S. Government and agency
obligations $13,085 4.28% $33,084 4.10% $38,102 5.05% $ 47,928 5.34%
Municipal obligations -- -- -- -- 2,884 3.62 -- --
Mortgage-backed securities -- -- 1,920 4.50 26 6.76 52,948 5.11
------- ------- ------- --------
Total $13,085 4.28% $35,004 4.12% $41,012 4.95% $100,876 5.22%
======= ==== ======= ==== ======= ==== ======== ====
The following table sets forth the composition of our mortgage-backed
securities portfolio at each of the dates indicated all of which were classified
as held to maturity in fiscal 2005 and 2004 while a portion was classified as
available-for-sale in fiscal 2006. The securities all bear fixed rates of
interest.
September 30,
---------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
GNMA $46,991 $62,449 $79,626
FHLMC 1,920 2,541 818
FNMA 5,983 1,838 488
------- ------- -------
Total mortgage-backed
securities $54,894 $66,828 $80,932
======= ======= =======
Information regarding the contractual maturities and weighted average
yield of our mortgage-backed securities portfolio at September 30, 2006 is
presented below. Due to repayments of the underlying loans, the actual
maturities of mortgage-backed securities generally are substantially less than
the scheduled maturities.
Amounts At September 30, 2006 Which Mature In
------------------------------------------------------------------
Weighted Over One Weighted Weighted
One Year Average Through Average Over Five Average
Or Less Yield Five Years Yield Years Yield
-------- -------- ---------- -------- --------- --------
(Dollars in Thousands)
GNMA $-- --% $ -- --% $46,991 5.03%
FHLMC -- -- 1,920 4.50 -- --
FNMA -- -- -- -- 5,983 5.76
--- ------ -------
Total mortgage-backed securities $-- --% $1,920 4.50% $52,974 5.11%
=== === ====== ==== ======= ====
19
The following table sets forth the purchases, and principal repayments
of our mortgage-backed securities during the periods indicated.
At Or For The
Year Ended September 30,
------------------------------
2006 2005 2004
-------- -------- --------
(Dollars in Thousands)
Mortgage-backed securities at beginning of period $ 66,828 $ 80,932 $ 82,556
Purchases 4,610 4,481 21,771
Repayments (12,011) (18,615) (23,422)
Sales (4,564) -- --
Amortizations of premiums, net 31 30 27
-------- -------- --------
Mortgage-backed securities at end of period $ 54,894 $ 66,828 $ 80,932
======== ======== ========
Weighted average yield at end of period 5.09% 5.16% 5.24%
======== ======== ========
SOURCES OF FUNDS
GENERAL. Deposits, loan repayments and prepayments, proceeds from
sales of loans, cash flows generated from operations and FHLB advances are the
primary sources of our funds for use in lending, investing and for other general
purposes.
DEPOSITS. We offer a variety of deposit accounts with a range of
interest rates and terms. Our deposits consist of checking, both
interest-bearing and non-interest-bearing, money market, savings and certificate
of deposit accounts. At September 30, 2006, 50.6% of the funds deposited with
Prudential Savings Bank were in core deposits, which are deposits other than
certificates of deposit.
The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and
competition. Our deposits are obtained predominantly from the areas where its
branch offices are located. We have historically relied primarily on customer
service and long-standing relationships with customers to attract and retain
these deposits; however, market interest rates and rates offered by competing
financial institutions significantly affect our ability to attract and retain
deposits. The interest rates offered on our deposits are competitive in the
market place and have increased over the past year as market rates have
increased.
Prudential Savings Bank uses traditional means of advertising its
deposit products, including broadcast and print media and generally does not
solicit deposits from outside its market area.
We do not actively solicit certificate accounts of $100,000 and above,
known as "jumbo CDs," or use brokers to obtain deposits. At September 30, 2006,
our jumbo CDs amounted to $44.9 million, of which $32.6 million are scheduled to
mature within twelve months. At September 30, 2006, the weighted average
remaining maturity of our certificate of deposit accounts was 11.8 months.
20
The following table shows the distribution of, and certain other
information relating to, our deposits by type of deposit, as of the dates
indicated.
September 30,
---------------------------------------------------------
2006 2005 2004
----------------- ----------------- -----------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
(Dollars in Thousands)
Certificate accounts:
0.00% - 1.99% $ -- --% $ 618 0.18% $ 1,022 0.29%
2.00% - 2.99% 617 0.18 45,973 13.66 91,393 26.18
3.00% - 3.99% 30,933 8.91 52,903 15.72 23,165 6.63
4.00% - 4.99% 70,410 20.27 30,212 8.98 20,308 5.82
5.00% - 5.99% 69,642 20.05 14,611 4.35 15,062 4.31
6.00% - 6.99% -- -- -- -- -- --
-------- ------ -------- ------ -------- ------
Total certificate accounts 171,602 49.41 144,317 42.89 150,950 43.23
-------- ------ -------- ------ -------- ------
Transaction accounts:
Savings 76,989 22.17 87,709 26.07 94,868 27.17
Checking:
Interest-bearing 29,675 8.55 41,094 12.21 51,948 14.88
Noninterest-bearing 4,528 1.30 3,441 1.02 2,232 0.64
Money market 64,498 18.57 59,907 17.81 49,161 14.08
-------- ------ -------- ------ -------- ------
Total transaction accounts 175,690 50.59 192,151 57.11 198,209 56.77
--------- ------- --------- ------- --------- ------
Total deposits $347,292 100.00% $336,468 100.00% $349,159 100.00%
======== ====== ======== ====== ======== ======
The following table shows the average balance of each type of deposit
and the average rate paid on each type of deposit for the periods indicated.
Year Ended September 30,
-------------------------------------------------------------------------------------------
2006 2005 2004
----------------------------- ----------------------------- -----------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Expense Rate Paid Balance Expense Rate Paid Balance Expense Rate Paid
-------- -------- --------- -------- -------- --------- -------- -------- ---------
(Dollars in Thousands)
Savings accounts $ 81,472 $ 2,458 3.02% $ 91,821 $1,728 1.88% $ 94,565 $1,654 1.75%
Interest-bearing checking
and money market accounts 98,112 3,081 3.14 101,146 2,273 2.25 96,472 1,865 1.93
Certificate accounts 156,869 5,304 3.38 144,445 4,521 3.13 156,472 4,686 2.99
-------- ------- -------- ------ -------- ------
Total interest-bearing deposits 336,453 $10,843 3.22 337,412 $8,522 2.53 347,509 $8,205 2.36
-------- ======= -------- ====== -------- ======
Non-interest-bearing checking 3,789 10,066 2,771
-------- -------- --------
Total deposits $340,242 3.19% $347,478 2.45% $350,280 2.34%
======== ==== ======== ==== ======== ====
21
The following table shows our savings flows during the periods
indicated.
Year Ended September 30,
---------------------------------
2006 2005 2004
--------- --------- ---------
(In Thousands)
Total deposits $ 488,409 $ 504,735 $ 411,005
Total withdrawals (485,532) (524,140) (409,093)
Interest credited 7,948 6,714 6,470
--------- --------- ---------
Total increase (decrease) in deposits $ 10,825 $ (12,691) $ 8,382
========= ========= =========
The following table presents, by various interest rate categories and
maturities, the amount of certificates of deposit at September 30, 2006.
Balance At September 30, 2006
Maturing In The 12 Months Ending September 30,
---------------------------------------------------
Certificates Of Deposit 2007 2008 2009 Thereafter Total
----------------------------- -------- ------- ------ ---------- --------
(In Thousands)
Less than 2.00% $ -- $ -- $ -- $ -- $ --
2.00% - 2.99% 617 -- -- -- 617
3.00% - 3.99% 20,542 7,078 3,313 -- 30,933
4.00% - 4.99% 49,408 14,094 1,585 5,323 70,410
5.00% - 5.99% 53,832 6,127 -- 9,683 69,642
-------- ------- ------ ------- --------
Total certificate accounts $124,399 $27,299 $4,898 $15,006 $171,602
======== ======= ====== ======= ========
The following tables show the maturities of our certificates of
deposit of $100,000 or more at September 30, 2006, by time remaining to
maturity.
Weighted
Quarter Ending: Amount Average Rate
------------------------------------- ------- ------------
(Dollars in Thousands)
December 31, 2006 $ 7,170 4.54%
March 31, 2007 13,679 5.04
June 30, 2007 3,088 4.74
September 30, 2007 8,635 4.96
After September 30, 2007 12,346 4.41
-------
Total certificates of deposit with
balances of $100,000 or more $44,918 4.75%
======= ====
BORROWINGS. We utilize advances from the Federal Home Loan Bank of
Pittsburgh as an alternative to retail deposits to fund our operations as part
of our operating strategy. These FHLB advances are collateralized primarily by
certain of our mortgage loans and mortgage-backed securities and secondarily by
our investment in capital stock of the Federal Home Loan Bank of Pittsburgh.
FHLB advances are made pursuant to several different credit programs, each of
which has its own interest rate and range of maturities. The maximum amount that
the Federal Home Loan Bank of Pittsburgh will advance to member institutions,
including Prudential Savings Bank, fluctuates from time to time in accordance
with the policies of the Federal Home Loan Bank. At September 30, 2006, we had
$31.8 million in outstanding FHLB advances and $128.0 million of additional FHLB
advances available. At such date, maturities range from one month to four years.
We have not utilized any other types of borrowings such as securities sold under
agreements to repurchase. The increase in borrowings during fiscal 2006 was to
meet increased loan demand.
22
The following table shows certain information regarding our borrowings
at or for the dates indicated:
At Or For The Year
Ended September 30,
---------------------------
2006 2005 2004
------- ------- -------
(Dollars in Thousands)
FHLB advances:
Average balance outstanding $19,628 $13,841 $13,880
Maximum amount outstanding at any
month-end during the period $31,784 $13,859 $13,897
Balance outstanding at end of period $31,784 $13,823 $13,862
Average interest rate during the period 5.564% 3.574% 3.574%
Weighted average interest rate at end
of period 5.487% 5.526% 5.517%
We have six FHLB advances made under a low-income housing program in which
we participate. Four of the FHLB advances amortize over the period to maturity.
Three of these advances are at an interest rate of 3.0% and one is at 2.0%. The
other two FHLB advances bear a zero percent interest rate. The total of these
six FHLB advances is $784,000. At September 30, 2006, repayments of $41,000 are
due within one year as part of the program. Advances from the FHLB which are not
part of the low-income housing program total $31.0 million, with interest rates
ranging from 5.45% to 5.98% and maturities ranging from October 2006 to
September 2010.
SUBSIDIARIES
The Company has only one direct subsidiary: Prudential Savings Bank. The
Bank's sole subsidiary as of September 30, 2006 was PSB Delaware, Inc. ("PSB"),
a Delaware-chartered company established to hold certain investments of the
Bank. As of September 30, 2006, PSB has assets of $63.5 million primarily
consisting of mortgage backed securities. We may consider the establishment of
one or more additional subsidiaries in the future.
EMPLOYEES
At September 30, 2006, we had 68 full-time employees, and six part-time
employees. None of such employees are represented by a collective bargaining
group, and we believe that our relationship with our employees is good.
REGULATION
Set forth below is a brief description of certain laws relating to the
regulation of Prudential Bancorp, Prudential Mutual Holding Company and
Prudential Savings Bank. This description does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations.
GENERAL
Prudential Savings Bank as a Pennsylvania chartered savings bank with
deposits insured by the Deposit Insurance Fund administered by the Federal
Deposit Insurance Corporation, is subject to extensive regulation and
examination by the Pennsylvania Department of Banking and by the Federal Deposit
Insurance Corporation. The federal and state laws and regulations applicable to
banks regulate, among other things, the scope of their business, their
investments, the reserves required to be kept against deposits, the timing of
the availability of deposited funds and the nature and amount of and collateral
for
23
certain loans. This regulatory structure also gives the federal and state
banking agencies extensive discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with respect
to the classification of assets and the establishment of adequate loan loss
reserves for regulatory purposes. The laws and regulations governing Prudential
Savings Bank generally have been promulgated to protect depositors and not for
the purpose of protecting shareholders.
Federal law provides the federal banking regulators, including the
Federal Deposit Insurance Corporation and the Federal Reserve Board, with
substantial enforcement powers. This enforcement authority includes, among other
things, the ability to assess civil money penalties, to issue cease-and-desist
or removal orders, and to initiate injunctive actions against banking
organizations and institution-affiliated parties, as defined. In general, these
enforcement actions may be initiated for violations of laws and regulations and
unsafe or unsound practices. Other actions or inactions may provide the basis
for enforcement action, including misleading or untimely reports filed with
regulatory authorities. Any change in such regulation, whether by the
Pennsylvania Department of Banking, the Federal Deposit Insurance Corporation,
the Federal Reserve Board or the United States Congress, could have a material
impact on us and our operations.
Prudential Bancorp and Prudential Mutual Holding Company are
registered as bank holding companies under the Bank Holding Company Act and are
subject to regulation and supervision by the Federal Reserve Board and by the
Pennsylvania Department of Banking. Prudential Bancorp and Prudential Mutual
Holding Company file annually a report of their operations with, and are subject
to examination by, the Federal Reserve Board and the Pennsylvania Department of
Banking. This regulation and oversight is generally intended to ensure that
Prudential Bancorp and Prudential Mutual Holding Company limit their activities
to those allowed by law and that they operate in a safe and sound manner without
endangering the financial health of Prudential Savings Bank.
In connection with the reorganization completed in March 2005,
Prudential Bancorp registered its common stock with the SEC under the Securities
Exchange Act of 1934. Prudential Bancorp is subject to the proxy and tender
offer rules, insider trading reporting requirements and restrictions, and
certain other requirements under the Securities Exchange Act of 1934. Prudential
Bancorp's common stock is listed on the Nasdaq Global Market under the symbol
"PBIP." The Nasdaq Stock Market listing requirements impose additional
requirements on us, including, among other things, rules relating to corporate
governance and the composition and independence of our board of directors and
various committees of the board, such as the audit committee.
REGULATION OF PRUDENTIAL BANCORP AND PRUDENTIAL MUTUAL HOLDING COMPANY
BANK HOLDING COMPANY ACT ACTIVITIES AND OTHER LIMITATIONS. Under the
Bank Holding Company Act, Prudential Bancorp and Prudential Mutual Holding
Company must obtain the prior approval of the Federal Reserve Board before they
may acquire control of another bank or bank holding company, merge or
consolidate with another bank holding company, acquire all or substantially all
of the assets of another bank or bank holding company, or acquire direct or
indirect ownership or control of any voting shares of any bank or bank holding
company if, after such acquisition, Prudential Bancorp and Prudential Mutual
Holding Company would directly or indirectly own or control more than 5% of such
shares.
Federal statutes impose restrictions on the ability of a bank holding
company and its nonbank subsidiaries to obtain extensions of credit from its
subsidiary bank, on the subsidiary bank's investments in the stock or securities
of the holding company, and on the subsidiary bank's taking of the holding
company's stock or securities as collateral for loans to any borrower. A bank
holding company and its
24
subsidiaries are also prevented from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property, or
furnishing of services by the subsidiary bank.
A bank holding company is required to serve as a source of financial
and managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, it is the policy of the
Federal Reserve Board that a bank holding company should stand ready to use
available resources to provide adequate capital to its subsidiary banks during
periods of financial stress or adversity and should maintain the financial
flexibility and capital-raising capacity to obtain additional resources for
assisting its subsidiary banks. A bank holding company's failure to meet its
obligations to serve as a source of strength to its subsidiary banks will
generally be considered by the Federal Reserve Board to be an unsafe and unsound
banking practice or a violation of the Federal Reserve Board regulations, or
both.
NON-BANKING ACTIVITIES. The business activities of Prudential Bancorp
and Prudential Mutual Holding Company, as bank holding companies, are restricted
by the Bank Holding Company Act. Under the Bank Holding Company Act and the
Federal Reserve Board's bank holding company regulations, bank holding companies
may only engage in, or acquire or control voting securities or assets of a
company engaged in,
o banking or managing or controlling banks and other subsidiaries
authorized under the Bank Holding Company Act; and
o any Bank Holding Company Act activity the Federal Reserve Board
has determined to be so closely related that it is incidental to
banking or managing or controlling banks.
The Federal Reserve Board has determined by regulation that certain
activities are closely related to banking including operating a mortgage
company, finance company, credit card company, factoring company, trust company
or savings association; performing certain data processing operations; providing
limited securities brokerage services; acting as an investment or financial
advisor; acting as an insurance agent for certain types of credit-related
insurance; leasing personal property on a full-payout, non-operating basis;
providing tax planning and preparation services; operating a collection agency;
and providing certain courier services. However, as discussed below, certain
other activities are permissible for a bank holding company that becomes a
financial holding company.
FINANCIAL MODERNIZATION. The Gramm-Leach-Bliley Act permits greater
affiliation among banks, securities firms, insurance companies, and other
companies under a new type of financial services company known as a "financial
holding company." A financial holding company essentially is a bank holding
company with significantly expanded powers. Financial holding companies are
authorized by statute to engage in a number of financial activities previously
impermissible for bank holding companies, including securities underwriting,
dealing and market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; and merchant banking activities. The
Gramm-Leach-Bliley Act also permits the Federal Reserve Board and the Treasury
Department to authorize additional activities for financial holding companies if
they are "financial in nature" or "incidental" to financial activities. A bank
holding company may become a financial holding company if each of its subsidiary
banks is well capitalized, well managed, and has at least a "satisfactory"
Community Reinvestment Act rating. A financial holding company must provide
notice to the Federal Reserve Board within 30 days after commencing activities
previously determined by statute or by the Federal Reserve Board and Department
of the Treasury to be permissible. Prudential Bancorp and Prudential Mutual
Holding Company have not submitted notices to the Federal Reserve Board of their
intent to be deemed financial holding companies. However, they are not precluded
from submitting a notice in the future should they wish to engage in activities
only permitted to financial holding companies.
25
REGULATORY CAPITAL REQUIREMENTS. The Federal Reserve Board has adopted
capital adequacy guidelines pursuant to which it assesses the adequacy of
capital in examining and supervising a bank holding company and in analyzing
applications to it under the Bank Holding Company Act. The Federal Reserve
Board's capital adequacy guidelines for Prudential Bancorp, on a consolidated
basis, are similar to those imposed on Prudential Savings Bank by the Federal
Deposit Insurance Corporation. See "-Regulation of Prudential Savings Bank -
Regulatory Capital Requirements."
RESTRICTIONS ON DIVIDENDS. Prudential Bancorp's ability to declare and
pay dividends may depend in part on dividends received from Prudential Savings
Bank. The Pennsylvania Banking Code regulates the distribution of dividends by
savings banks and states, in part, that dividends may be declared and paid out
of accumulated net earnings, provided that the bank continues to meet its
surplus requirements. In addition, dividends may not be declared or paid if
Prudential Savings Bank is in default in payment of any assessment due the
Federal Deposit Insurance Corporation.
A Federal Reserve Board policy statement on the payment of cash
dividends states that a bank holding company should pay cash dividends only to
the extent that the holding company's net income for the past year is sufficient
to cover both the cash dividends and a rate of earnings retention that is
consistent with the holding company's capital needs, asset quality and overall
financial condition. The Federal Reserve Board also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends. Furthermore, under the federal prompt corrective action
regulations, the Federal Reserve Board may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized." See "-Regulation of Prudential Savings Bank - Prompt
Corrective Action," below.
SARBANES-OXLEY ACT OF 2002. On July 30, 2002, President George W. Bush
signed into law the Sarbanes-Oxley Act of 2002, which generally establishes a
comprehensive framework to modernize and reform the oversight of public company
auditing, improve the quality and transparency of financial reporting by those
companies and strengthen the independence of auditors. Among other things, the
new legislation (i) created a public company accounting oversight board which is
empowered to set auditing, quality control and ethics standards, to inspect
registered public accounting firms, to conduct investigations and to take
disciplinary actions, subject to SEC oversight and review; (ii) strengthened
auditor independence from corporate management by, among other things, limiting
the scope of consulting services that auditors can offer their public company
audit clients; (iii) heightened the responsibility of public company directors
and senior managers for the quality of the financial reporting and disclosure
made by their companies; (iv) adopted a number of provisions to deter wrongdoing
by corporate management; (v) imposed a number of new corporate disclosure
requirements; (vi) adopted provisions which generally seek to limit and expose
to public view possible conflicts of interest affecting securities analysts; and
(vii) imposed a range of new criminal penalties for fraud and other wrongful
acts, as well as extended the period during which certain types of lawsuits can
be brought against a company or its insiders.
On August 9, 2006, the SEC issued proposed rules for smaller public
companies, such as Prudential Bancorp, further extending the dates for their
compliance with the internal control requirements mandated by Section 404 of the
Sarbanes-Oxley Act of 2002. Pursuant to the proposal, a non-accelerated filer
would not be required to provide management's report on internal control over
financial reporting until it files an annual report for a fiscal year ending on
or after December 15, 2007. If, however, the SEC has not issued additional
guidance for management on how to complete its assessment of internal control
over financial reporting in time to be of assistance in connection with annual
reports filed for fiscal years ending on or after December 15, 2007, this
deadline could be further postponed. Under the proposal, the auditor's
attestation report on internal control over financial reporting would not be
required until a non-accelerated filer files an annual report for a fiscal year
ending on or
26
after December 15, 2008. If revisions to Auditing Standard No. 2 have not been
finalized in time to be of assistance in connection with annual reports filed
for fiscal years ending on or after December 15, 2008, this deadline could also
be further postponed.
RESTRICTIONS APPLICABLE TO MUTUAL HOLDING COMPANIES. While regulations
governing Pennsylvania-chartered mutual holding companies have not been adopted,
under authority of Section 115.1 of the Pennsylvania Banking Code of 1965, as
amended, and a policy statement issued by the Pennsylvania Department of
Banking, the Department approved the reorganization of Prudential Saving Bank to
the mutual holding company form of organization.
Pursuant to Pennsylvania law, a mutual holding company may engage only
in the following activities:
o investing in the stock of one or more financial institution
subsidiaries;
o acquiring one or more additional financial institution
subsidiaries into a subsidiary of the holding company;
o merging with or acquiring another holding company, one of whose
subsidiaries is a financial institution subsidiary;
o investing in a corporation the capital stock of which is
available for purchase by a savings bank under federal law or
under the Pennsylvania Banking Code;
o engaging in such activities as are permitted, by statute or
regulation, to a holding company of a federally chartered insured
mutual institution under federal law; and
o engaging in such other activities as may be permitted by the
Pennsylvania Department of Banking.
If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from such
merger or acquisition may only invest in assets and engage in activities listed
above, and has a period of two years to cease any non-conforming activities and
divest of any non-conforming investments.
The mutual holding company will be subject to such regulations as the
Pennsylvania Department of Banking may prescribe. No mutual holding company
regulations have been issued to date by the Department.
REGULATION OF PRUDENTIAL SAVINGS BANK
PENNSYLVANIA SAVINGS BANK LAW. The Pennsylvania Banking Code contains
detailed provisions governing the organization, location of offices, rights and
responsibilities of directors, officers, and employees, as well as corporate
powers, savings and investment operations and other aspects of Prudential
Savings Bank and its affairs. The code delegates extensive rule-making power and
administrative discretion to the Pennsylvania Department of Banking so that the
supervision and regulation of state-chartered savings banks may be flexible and
readily responsive to changes in economic conditions and in savings and lending
practices.
The Pennsylvania Banking Code also provides that state-chartered
savings banks may engage in any activity permissible for a federal savings
association, subject to regulation by the Pennsylvania
27
Department of Banking. The Federal Deposit Insurance Act, however, prohibits
Prudential Savings Bank from making new investments, loans, or becoming involved
in activities as principal and equity investments which are not permitted for
national banks unless:
o the Federal Deposit Insurance Corporation determines the activity
or investment does not pose a significant risk of loss to the
Deposit Insurance Fund; and
o Prudential Savings Bank meets all applicable capital
requirements.
Accordingly, the additional operating authority provided to Prudential Savings
Bank by the Pennsylvania Banking Code is significantly restricted by the Federal
Deposit Insurance Act.
INSURANCE OF ACCOUNTS. The deposits of Prudential Savings Bank are
insured to the maximum extent permitted by the Deposit Insurance Fund, which is
administered by the Federal Deposit Insurance Corporation, and are backed by the
full faith and credit of the U.S. Government. As insurer, the Federal Deposit
Insurance Corporation is authorized to conduct examinations of, and to require
reporting by, insured institutions. It also may prohibit any insured institution
from engaging in any activity the Federal Deposit Insurance Corporation
determines by regulation or order to pose a serious threat to the Federal
Deposit Insurance Corporation. The Federal Deposit Insurance Corporation also
has the authority to initiate enforcement actions against savings institutions.
Each Federal Deposit Insurance Corporation insured institutions is
assigned to one of three capital groups which are based solely on the level of
an institution's capital - "well capitalized," "adequately capitalized" and
"undercapitalized" - which are defined in the same manner as the regulations
establishing the prompt corrective action system discussed below. These three
groups are then divided into three subgroups which reflect varying levels of
supervisory concern, from those which are considered to be healthy to those
which are considered to be of substantial supervisory concern. The matrix so
created results in nine assessment risk classifications, with rates during the
last six months of 2005 ranging from zero for well capitalized, healthy
institutions, such as Prudential Savings Bank, to 27 basis points for
undercapitalized institutions with substantial supervisory concerns. Prudential
Savings Bank currently is considered well capitalized and has a zero assessment
rate.
In addition, all institutions with deposits insured by the Federal
Deposit Insurance Corporation are required to pay assessments to fund interest
payments on bonds issued by the Financing Corporation, a mixed-ownership
government corporation established to recapitalize the predecessor to the
Savings Association Insurance Fund. The assessment rate for the fourth quarter
of 2006 was .0124% of insured deposits and is adjusted quarterly. These
assessments will continue until the Financing Corporation bonds mature in 2019.
The Federal Deposit Insurance Corporation may terminate the deposit
insurance of any insured depository institution, including Prudential Savings
Bank, if it determines after a hearing that the institution has engaged or is
engaging in unsafe or unsound practices, is in an unsafe or unsound condition to
continue operations, or has violated any applicable law, regulation, order or
any condition imposed by an agreement with the Federal Deposit Insurance
Corporation. It also may suspend deposit insurance temporarily during the
hearing process for the permanent termination of insurance, if the institution
has no tangible capital. If insurance of accounts is terminated, the accounts at
the institution at the time of the termination, less subsequent withdrawals,
shall continue to be insured for a period of six months to two years, as
determined by the Federal Deposit Insurance Corporation. Management is aware of
no existing circumstances which would result in termination of Prudential
Savings Bank's deposit insurance.
28
DEPOSIT INSURANCE REFORM. On February 8, 2006, President George W. Bush signed
into law legislation that merged the Bank Insurance Fund and the Savings
Association Insurance Fund to form the Deposit Insurance Fund, eliminated any
disparities in bank and thrift risk-based premium assessments, reduced the
administrative burden of maintaining and operating two separate funds and
established certain new insurance coverage limits and a mechanism for possible
periodic increases. The legislation also gave the Federal Deposit Insurance
Corporation greater discretion to identify the relative risks all institutions
present to the Deposit Insurance Fund and set risk-based premiums.
Major provisions in the legislation include:
o merging the Savings Association Insurance Fund and Bank Insurance
Fund, which became effective March 31, 2006;
o maintaining basic deposit and municipal account insurance
coverage at $100,000 but providing for a new basic insurance
coverage for retirement accounts of $250,000. Insurance coverage
for basic deposit and retirement accounts could be increased for
inflation every five years in $10,000 increments beginning in
2011;
o providing the Federal Deposit Insurance Corporation with the
ability to set the designated reserve ratio within a range of
between 1.15% and 1.50%, rather than maintaining 1.25% at all
times regardless of prevailing economic conditions;
o providing a one-time assessment credit of $4.7 billion to banks
and savings associations in existence on December 31, 1996, which
may be used to offset future premiums with certain limitations;
and
o requiring the payment of dividends of 100% of the amount that the
insurance fund exceeds 1.5% of the estimated insured deposits and
the payment of 50% of the amount that the insurance fund exceeds
1.35% of the estimated insured deposits (when the reserve is
greater than 1.35% but no more than 1.5%).
Pursuant to the Reform Act, the Federal Deposit Insurance Corporation
has determined to maintain the designated reserve ratio at its current 1.25%,
which will be reviewed annually. The Federal Deposit Insurance Corporation has
also adopted a new risk-based premium system that provides for quarterly
assessments based on an insured institution's ranking in one of four risk
categories based upon supervisory and capital evaluations. Beginning in 2007,
well-capitalized institutions (generally those with CAMELS composite ratings of
1 or 2) will be grouped in Risk Category I and will be assessed for deposit
insurance at an annual rate of between five and seven basis points. The
assessment rate for an individual institution is determined according to a
formula based on a weighted average of the institution's individual CAMEL
component ratings plus either five financial ratios or, in the case of an
institution with assets of $10.0 billion or more, the average ratings of its
long-term debt. Institutions in Risk Categories II, III and IV will be assessed
at annual rates of 10, 28 and 43 basis points, respectively. Prudential Savings
Bank anticipates that it will be able to offset its deposit insurance premium
for 2007 with the special assessment credit.
REGULATORY CAPITAL REQUIREMENTS. The Federal Deposit Insurance
Corporation has promulgated capital adequacy requirements for state-chartered
banks that, like Prudential Savings Bank, are not members of the Federal Reserve
Board System. The capital regulations establish a minimum 3% Tier 1 leverage
capital requirement for the most highly rated state-chartered, non-member banks,
with an additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively increases the minimum Tier
1 leverage ratio for such other banks to 4% to 5% or more. Under the Federal
Deposit Insurance Corporation's regulations, the highest-rated banks are those
that the Federal Deposit Insurance Corporation determines are not anticipating
or experiencing significant growth and have well diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high
29
liquidity, good earnings and, in general, which are considered a strong banking
organization, rated composite 1 under the Uniform Financial Institutions Rating
System. Tier 1, or leverage capital, is defined as the sum of common
shareholders' equity, including retained earnings, noncumulative perpetual
preferred stock and related surplus, and minority interests in consolidated
subsidiaries, minus all intangible assets other than certain purchased mortgage
servicing rights and purchased credit card relationships.
The Federal Deposit Insurance Corporation's regulations also require
that state-chartered, non-member banks meet a risk-based capital standard. The
risk-based capital standard requires the maintenance of total capital, defined
as Tier 1 capital and supplementary (Tier 2) capital, to risk weighted assets of
8%. In determining the amount of risk-weighted assets, all assets, plus certain
off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based
on the risks the Federal Deposit Insurance Corporation believes are inherent in
the type of asset or item. The components of Tier 1 capital for the risk-based
standards are the same as those for the leverage capital requirement. The
components of supplementary (Tier 2) capital include cumulative perpetual
preferred stock, mandatory subordinated debt, perpetual subordinated debt,
intermediate-term preferred stock, up to 45% of unrealized gains on equity
securities and a portion of a bank's allowance for loan losses. Allowance for
loan losses includable in supplementary capital is limited to a maximum of 1.25%
of risk-weighted assets. Overall, the amount of supplementary capital that may
be included in total capital is limited to 100% of Tier 1 capital.
A bank that has less than the minimum leverage capital requirement is
subject to various capital plan and activities restriction requirements. The
Federal Deposit Insurance Corporation's regulations also provide that any
insured depository institution with a ratio of Tier 1 capital to total assets
that is less than 2.0% is deemed to be operating in an unsafe or unsound
condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and
could be subject to potential termination of deposit insurance.
Prudential Savings Bank is also subject to minimum capital
requirements imposed by the Pennsylvania Department of Banking on Pennsylvania
chartered depository institutions. Under the Pennsylvania Department of
Banking's capital regulations, a Pennsylvania bank or savings association must
maintain a minimum leverage ratio of Tier 1 capital, as defined under the
Federal Deposit Insurance Corporation's capital regulations, to total assets of
4%. In addition, the Pennsylvania Department of Banking has the supervisory
discretion to require a higher leverage ratio for any institution or association
based on inadequate or substandard performance in any of a number of areas. The
Pennsylvania Department of Banking incorporates the same Federal Deposit
Insurance Corporation risk-based capital requirements in its regulations.
At September 30, 2006, Prudential Savings Bank exceeded all of its
regulatory capital requirements, with leverage and total risk-based capital
ratios of 14.74% and 31.56%, respectively.
PROMPT CORRECTION ACTION. The following table shows the amount of
capital associated with the different capital categories set forth in the prompt
correction action regulations.
Total Tier 1 Tier 1
Capital Category Risk-Based Capital Risk-Based Capital Leverage Capital
------------------------------ ------------------ ------------------ ----------------
Well capitalized 10% or more 6% or more 5% or more
Adequately capitalized 8% or more 4% or more 4% or more
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly undercapitalized Less than 6% Less than 3% Less than 3%
30
In addition, an institution is "critically undercapitalized" if it has
a ratio of tangible equity to total assets that is equal to or less than 2.0%.
Under specified circumstances, a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category, except that the
Federal Deposit Insurance Corporation may not reclassify a significantly
undercapitalized institution as critically undercapitalized.
An institution generally must file a written capital restoration plan
which meets specified requirements within 45 days of the date that the
institution receives notice or is deemed to have notice that it is
undercapitalized, significantly undercapitalized or critically undercapitalized.
A federal banking agency must provide the institution with written notice of
approval or disapproval within 60 days after receiving a capital restoration
plan, subject to extensions by the agency. An institution which is required to
submit a capital restoration plan must concurrently submit a performance
guaranty by each company that controls the institution. In addition,
undercapitalized institutions are subject to various regulatory restrictions,
and the appropriate federal banking agency also may take any number of
discretionary supervisory actions.
At September 30, 2006, Prudential Savings Bank was deemed a well
capitalized institution for purposes of the above regulations and as such is not
subject to the above mentioned restrictions.
The table below sets forth the Company and the Bank's capital position
relative to its regulatory capital requirements at September 30, 2006.
To Be Well
Capitalized
Required For Under Prompt Excess Over
Capital Adequacy Corrective Action Well-Capitalized
Actual Purposes Provisions Provisions
--------------- ---------------- ----------------- ----------------
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- ----- ------- -----
(Dollars in Thousands)
Total risk-based capital
Company $87,894 39.68% $17,722 8.00% N/A N/A N/A N/A
Bank 69,917 31.56 17,722 8.00 $22,153 10.00% $47,764 21.56%
Tier 1 risk-based capital
Company 86,914 39.23 8,861 4.00 N/A N/A N/A N/A
Bank 68,937 31.12 8,861 4.00 13,292 6.00 55,645 31.12
Tier 1 leverage capital
Company 86,914 18.64 18,646 4.00 N/A N/A N/A N/A
Bank 68,937 14.74 18,703 4.00 23,379 5.00 45,558 9.74
AFFILIATE TRANSACTION RESTRICTIONS. Federal laws strictly limit the
ability of banks to engage in transactions with their affiliates, including
their bank holding companies. Such transactions between a subsidiary bank and
its parent company or the nonbank subsidiaries of the bank holding company are
limited to 10% of a bank subsidiary's capital and surplus and, with respect to
such parent company and all such nonbank subsidiaries, to an aggregate of 20% of
the bank subsidiary's capital and surplus. Further, loans and extensions of
credit generally are required to be secured by eligible collateral in specified
amounts. Federal law also requires that all transactions between a bank and its
affiliates be on terms as favorable to the bank as transactions with
non-affiliates.
FEDERAL HOME LOAN BANK SYSTEM. Prudential Savings Bank is a member of
the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal
Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank
for its members within its assigned region. It is funded primarily from funds
deposited by member institutions and proceeds from the sale of consolidated
obligations of the Federal Home Loan Bank System. It makes loans to members
(i.e., advances) in
31
accordance with policies and procedures established by the board of directors of
the Federal Home Loan Bank. At September 30, 2006, Prudential Savings Bank had
$31.8 million in FHLB advances.
As a member, Prudential Savings Bank is required to purchase and
maintain stock in the Federal Home Loan Bank of Pittsburgh in an amount equal to
the greater of 1% of its aggregate unpaid residential mortgage loans, home
purchase contracts or similar obligations at the beginning of each year or 5% of
its outstanding advances from the Federal Home Loan Bank. At September 30, 2006,
Prudential Savings Bank had $2.2 million in stock of the Federal Home Loan Bank
of Pittsburgh which was in compliance with this requirement.
FEDERAL RESERVE BOARD SYSTEM. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts, which are primarily checking and NOW
accounts, and non-personal time deposits. The balances maintained to meet the
reserve requirements imposed by the Federal Reserve Board may be used to satisfy
the liquidity requirements that are imposed by the Pennsylvania Department of
Banking. At September 30, 2006, Prudential Savings Bank was in compliance with
these reserve requirements.
DIVIDEND WAIVERS BY PRUDENTIAL MUTUAL HOLDING COMPANY
It has been the policy of a number of mutual holding companies to
waive the receipt of dividends declared by their subsidiary companies. In
connection with its approval of the reorganization, however, the Federal Reserve
Board imposed certain conditions on the waiver by Prudential Mutual Holding
Company of dividends paid on the common stock by Prudential Bancorp. In
particular, the Federal Reserve Board requires that Prudential Mutual Holding
Company obtain the prior approval of the Federal Reserve Board before Prudential
Mutual Holding Company may waive any dividends from Prudential Bancorp. As of
the date hereof, we are not aware that the Federal Reserve Board has given its
approval to any waiver of dividends by any mutual holding company that has
requested such approval.
The Federal Reserve Board approval of the reorganization also required
that the amount of any dividends waived by Prudential Mutual Holding Company
will not be available for payment to the public stockholders of Prudential
Bancorp (i.e., shareholders except for Prudential Mutual Holding Company) and
that such amounts will be excluded from Prudential Bancorp's capital for
purposes of calculating dividends payable to the public shareholders. Moreover,
Prudential Savings Bank would be required to maintain the cumulative amount of
dividends waived by Prudential Mutual Holding Company in a restricted capital
account that would be added to the liquidation account established in the
reorganization. This amount would not be available for distribution to public
stockholders. The restricted capital account and liquidation account amounts
would not be reflected in Prudential Savings Bank's financial statements, but
would be considered as a notational or memorandum account of Prudential Savings
Bank. These accounts would be maintained in accordance with the laws, rules,
regulations and policies of the Pennsylvania Banking Department and the plan of
reorganization. The plan of reorganization also provides that if Prudential
Mutual Holding Company converts to stock form in the future (commonly referred
to as a second step reorganization), any waived dividends would reduce the
percentage of the converted company's shares of common stock issued to public
shareholders in connection with any such transaction.
Prudential Mutual Holding Company does not expect to seek the prior
approval of the Federal Reserve Board to waive dividends declared by Prudential
Bancorp. If Prudential Mutual Holding Company decides that it is in its best
interest to waive a particular dividend to be paid by Prudential Bancorp and the
Federal Reserve Board approves such waiver, then Prudential Bancorp would pay
such dividend only to its public shareholders. The amount of the dividend waived
by Prudential Mutual Holding Company would be treated in the manner described
above. Prudential Mutual Holding
32
Company's decision as to whether or not to waive a particular dividend will
depend on a number of factors, including Prudential Mutual Holding Company's
capital needs, the investment alternatives available to Prudential Mutual
Holding Company as compared to those available to Prudential Bancorp, and the
possibility of regulatory approvals.
TAXATION
FEDERAL TAXATION
GENERAL. Prudential Bancorp, Prudential Mutual Holding Company and
Prudential Savings Bank are subject to federal income taxation in the same
general manner as other corporations with some exceptions listed below. The
following discussion of federal, state and local income taxation is only
intended to summarize certain pertinent income tax matters and is not a
comprehensive description of the applicable tax rules. Prudential Savings Bank's
federal and state income tax returns for taxable years through September 30,
2002 have been closed for purposes of examination by the Internal Revenue
Service or the Pennsylvania Department of Revenue.
Prudential Bancorp files a consolidated federal income tax return with
Prudential Savings Bank and its subsidiary, PSB Delaware, Inc. Accordingly, any
cash distributions made by Prudential Bancorp to its shareholders will be
treated as cash dividends and not as a non-taxable return of capital to
shareholders for federal and state tax purposes.
METHOD OF ACCOUNTING. For federal income tax purposes, Prudential
Bancorp and Prudential Savings Bank report income and expenses on the accrual
method of accounting and file their federal income tax return on a calendar year
basis.
BAD DEBT RESERVES. The Small Business Job Protection Act of 1996
eliminated the use of the reserve method of accounting for bad debt reserves by
savings associations, effective for taxable years beginning after 1995. Prior to
that time, Prudential Savings Bank was permitted to establish a reserve for bad
debts and to make additions to the reserve. These additions could, within
specified formula limits, be deducted in arriving at taxable income. As a result
of the Small Business Job Protection Act of 1996, savings associations must use
the specific charge-off method in computing their bad debt deduction beginning
with their 1996 federal tax return. In addition, federal legislation required
the recapture over a six year period of the excess of tax bad debt reserves at
December 31, 1995 over those established as of December 31, 1987.
TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the Small Business Job
Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were
subject to recapture into taxable income if Prudential Savings Bank failed to
meet certain thrift asset and definitional tests. New federal legislation
eliminated these savings association related recapture rules. However, under
current law, pre-1988 reserves remain subject to recapture should Prudential
Savings Bank make certain non-dividend distributions or cease to maintain a bank
charter.
At September 30, 2006, the total federal pre-1988 reserve was
approximately $6.6 million. The reserve reflects the cumulative effects of
federal tax deductions by Prudential Savings Bank for which no federal income
tax provisions have been made.
ALTERNATIVE MINIMUM TAX. The Internal Revenue Code imposes an
alternative minimum tax at a rate of 20% on a base of regular taxable income
plus certain tax preferences. The alternative minimum tax is payable to the
extent such alternative minimum tax income is in excess of the regular income
tax. Net operating losses, of which Prudential Savings Bank has none, can offset
no more than 90% of alternative minimum taxable income. Certain payments of
alternative minimum tax may be used as
33
credits against regular tax liabilities in future years. Prudential Savings Bank
has not been subject to the alternative minimum tax.
NET OPERATING LOSS CARRYOVERS. For net operating losses in tax years
beginning before August 6, 1997, Prudential Savings Bank may carry back net
operating losses to the three years preceding the loss year and then forward to
fifteen years following the loss years. For net operating losses in years
beginning after August 5, 1997, net operating losses can be carried back to the
two years preceding the loss year and forward to the 20 years following the loss
year. At September 30, 2006, Prudential Savings Bank had no net operating loss
carry forwards for federal income tax purposes.
CORPORATE DIVIDENDS RECEIVED DEDUCTION. Prudential Bancorp may exclude
from its income 100% of dividends received from Prudential Savings Bank as a
member of the same affiliated group of corporations. The corporate dividends
received deduction is 80% in the case of dividends received from corporations
which a corporate recipient owns less than 80%, but at least 20% of the
distribution corporation. Corporations which own less than 20% of the stock of a
corporation distributing a dividend may deduct only 70% of dividends received.
STATE AND LOCAL TAXATION
PENNSYLVANIA TAXATION. Prudential Bancorp is subject to the
Pennsylvania Corporate Net Income Tax, Capital Stock and Franchise Tax. The
Corporation Net Income Tax rate for 2006 is 9.99% and is imposed on
unconsolidated taxable income for federal purposes with certain adjustments. In
general, the Capital Stock and Franchise Tax is a property tax imposed on a
corporation's capital stock value at a statutorily defined rate, such value
being determined in accordance with a fixed formula based upon average net
income and net worth.
Prudential Savings Bank is subject to tax under the Pennsylvania
Mutual Thrift Institutions Tax Act, as amended to include thrift institutions
having capital stock. Pursuant to the Mutual Thrift Institutions Tax, the tax
rate is 11.50%. The Mutual Thrift Institutions Tax exempts Prudential Savings
Bank from other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The Mutual
Thrift Institutions Tax is a tax upon net earnings, determined in accordance
with generally accepted accounting principles with certain adjustments. The
Mutual Thrift Institutions Tax, in computing income according to generally
accepted accounting principles, allows for the deduction of interest earned on
state and federal obligations, while disallowing a percentage of a thrift's
interest expense deduction in the proportion of interest income on those
securities to the overall interest income of Prudential Savings Bank. Net
operating losses, if any, thereafter can be carried forward three years for
Mutual Thrift Institutions Tax purposes.
ITEM 1A. RISK FACTORS.
IN ANALYZING WHETHER TO MAKE OR TO CONTINUE AN INVESTMENT IN OUR
SECURITIES, INVESTORS SHOULD CONSIDER, AMONG OTHER FACTORS, THE FOLLOWING RISK
FACTORS.
OUR PORTFOLIO OF LOANS WITH A HIGHER RISK OF LOSS IS INCREASING
In recent years, we have increased our originations or purchases of
construction and land development loans. These loans have a higher risk of
default and loss than single-family residential mortgage loans. Construction and
land development loans have increased from $17.0 million or 8.9% of our total
loan portfolio at September 30, 2002 to $82.8 million or 32.3% of the total loan
portfolio at September 30, 2006. At the same time, both the dollar amount and
the percentage of the loan portfolio
34
comprised of single-family residential mortgage loans has decreased.
Single-family residential mortgage loans held by Prudential Savings Bank have
decreased from $158.9 million or 83.1% of our total loan portfolio at September
30, 2002 to $155.5 million or 60.7% at September 30, 2006. Construction and land
development loans generally have a higher risk of loss than single-family
residential mortgage loans. The risk of loss on construction and land
development loans depends largely upon the accuracy of the initial estimate of
the property's value at completion of construction compared to the estimated
cost, including interest, of construction and other assumptions. Furthermore, if
the estimates of value prove to be inaccurate, we can be confronted with
projects, when completed, having values less than the loan amounts. In addition,
such loans have significantly higher average loan balances compared to
single-family residential mortgage loans. Consequently, an adverse development
with respect to one loan or credit relationship could expose us to a
significantly greater risk of loss compared to an adverse development with
respect to a single-family residential mortgage loan. We may also be required to
increase our allowance for loan losses both due to actual losses or the increase
in the estimated loss inherent in our portfolio which would reduce our net
income. We have also originated or committed to originate substantially larger
construction loans in recent periods and our portfolio of such loans is not
seasoned.
OUR LOANS ARE CONCENTRATED TO BORROWERS IN OUR MARKET AREA
At September 30, 2006, the preponderance of our total loans were to
individuals and/or secured by properties located in our primary market area of
the Philadelphia metropolitan area. We have relatively few loans outside of our
market. As a result, we may have a greater risk of loan defaults and losses in
the event of an economic downturn in our market area.
OUR RESULTS OF OPERATIONS ARE SIGNIFICANTLY DEPENDENT ON ECONOMIC CONDITIONS AND
RELATED UNCERTAINTIES.
Commercial banking is affected, directly and indirectly, by domestic
and international economic and political conditions and by governmental monetary
and fiscal policies. Conditions such as inflation, recession, unemployment,
volatile interest rates, real estate values, government monetary policy,
international conflicts, the actions of terrorists and other factors beyond our
control may adversely affect our results of operations. Changes in interest
rates, in particular, could adversely affect our net interest income and have a
number of other adverse effects on our operations, as discussed in the
immediately succeeding risk factor. Adverse economic conditions also could
result in an increase in loan delinquencies, foreclosures and nonperforming
assets and a decrease in the value of the property or other collateral which
secures our loans, all of which could adversely affect our results of
operations. We are particularly sensitive to changes in economic conditions and
related uncertainties in Eastern Pennsylvania because we derive substantially
all of our loans, deposits and other business from this area. Accordingly, we
remain subject to the risks associated with prolonged declines in national or
local economies.
CHANGES IN INTEREST RATES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
OPERATIONS.
The operations of financial institutions such as ours are dependent to
a large extent on net interest income, which is the difference between the
interest income earned on interest-earning assets such as loans and investment
securities and the interest expense paid on interest-bearing liabilities such as
deposits and borrowings. Changes in the general level of interest rates can
affect our net interest income by affecting the difference between the weighted
average yield earned on our interest-earning assets and the weighted average
rate paid on our interest-bearing liabilities, or interest rate spread, and the
average life of our interest-earning assets and interest-bearing liabilities.
Changes in interest rates also can affect our ability to originate loans; the
value of our interest-earning assets and our ability to realize gains from the
sale of such assets; our ability to obtain and retain deposits in competition
with other available
35
investment alternatives; the ability of our borrowers to repay adjustable or
variable rate loans; and the fair value of the derivatives carried on our
balance sheet, derivative hedge effectiveness testing and the amount of
ineffectiveness recognized in our earnings. Interest rates are highly sensitive
to many factors, including governmental monetary policies, domestic and
international economic and political conditions and other factors beyond our
control. Although we believe that the estimated maturities of our
interest-earning assets currently are well balanced in relation to the estimated
maturities of our interest-bearing liabilities (which involves various estimates
as to how changes in the general level of interest rates will impact these
assets and liabilities), there can be no assurance that our profitability would
not be adversely affected during any period of changes in interest rates.
WE ARE SUBJECT TO EXTENSIVE REGULATION WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND OPERATIONS.
We and our subsidiaries are subject to extensive federal and state
governmental supervision and regulation, which are intended primarily for the
protection of depositors. In addition, we and our subsidiaries are subject to
changes in federal and state laws, as well as changes in regulations,
governmental policies and accounting principles. The effects of any such
potential changes cannot be predicted but could adversely affect the business
and operations of us and our subsidiaries in the future.
WE FACE STRONG COMPETITION WHICH MAY ADVERSELY AFFECT OUR PROFITABILITY.
We are subject to vigorous competition in all aspects and areas of
our business from banks and other financial institutions, including savings and
loan associations, savings banks, finance companies, credit unions and other
providers of financial services, such as money market mutual funds, brokerage
firms, consumer finance companies and insurance companies. We also compete with
non-financial institutions, including retail stores that maintain their own
credit programs and governmental agencies that make available low cost or
guaranteed loans to certain borrowers. Certain of our competitors are larger
financial institutions with substantially greater resources, lending limits,
larger branch systems and a wider array of commercial banking services.
Competition from both bank and non-bank organizations will continue.
OUR ABILITY TO SUCCESSFULLY COMPETE MAY BE REDUCED IF WE ARE UNABLE TO MAKE
TECHNOLOGICAL ADVANCES.
The banking industry is experiencing rapid changes in technology. In
addition to improving customer services, effective use of technology increases
efficiency and enables financial institutions to reduce costs. As a result, our
future success will depend in part on our ability to address our customers'
needs by using technology. We cannot assure you that we will be able to
effectively develop new technology-driven products and services or be successful
in marketing these products to our customers. Many of our competitors have far
greater resources than we have to invest in technology.
WE AND OUR BANKING SUBSIDIARY ARE SUBJECT TO CAPITAL AND OTHER REQUIREMENTS
WHICH RESTRICT OUR ABILITY TO PAY DIVIDENDS.
Our ability to pay dividends to our shareholders may depend upon the
dividends we receive from Prudential Savings Bank. Dividends paid by the Bank
are subject to restrictions under Pennsylvania and federal laws and regulations.
In addition, Prudential Savings Bank must maintain certain capital levels, which
may restrict the ability of the Bank to pay dividends to us and our ability to
pay dividends to our shareholders.
36
HOLDERS OF OUR COMMON STOCK HAVE NO PREEMPTIVE RIGHTS AND ARE SUBJECT TO
POTENTIAL DILUTION.
Our articles of incorporation do not provide any shareholder with a
preemptive right to subscribe for additional shares of common stock upon any
increase thereof. Thus, upon the issuance of any additional shares of common
stock or other voting securities of Prudential Bancorp or securities convertible
into common stock or other voting securities, shareholders may be unable to
maintain their pro rata voting or ownership interest in us.
ITEM 1B.UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2. PROPERTIES
We currently conduct business from our main office and five banking
offices. The following table sets forth the net book value of the land, building
and leasehold improvements and certain other information with respect to the our
offices at September 30, 2006. All the offices are owned by us.
Date Of Net Book
Lease Value Amount Of
Description/Address Leased/Owned Expiration Of Property Deposits
--------------------------- ------------ ---------- ----------- ---------
(In Thousands)
Main Office Owned N/A $574 $185,695
1834 Oregon Avenue
Philadelphia, PA 19145-4725
Snyder Branch Owned N/A 6 24,784
2101 South 19th Street
Philadelphia, PA 19145-3709
Center City Branch Owned N/A 18 25,945
112 South 19th Street
Philadelphia, PA 19103-4667
Broad Street Branch Owned N/A 244 48,049
1722 South Broad Street
Philadelphia, PA 19145-2388
Pennsport Branch Owned N/A 66 37,266
238A Moore Street
Philadelphia, PA 19148-1925
Drexel Hill Branch Owned N/A 96 25,553
601 Morgan Avenue
Drexel Hill, PA 19026-3105
The Company has filed an application with the Pennsylvania Department
of Banking and the Federal Deposit Insurance Corporation for approval to
establish a new branch office in the Old City section of Philadelphia. The new
branch is anticipated to commence operations in the Spring of 2007.
37
ITEM 3. LEGAL PROCEEDINGS
On October 4, 2006, Stilwell Value Partners I, L.P. ("Stilwell") filed
suit in the United States District Court for the Eastern District of
Pennsylvania against Prudential Mutual Holding Company (the "MHC"), Prudential
Bancorp, Inc. of Pennsylvania (the "Company") and each of the directors of the
MHC and the Company individually seeking equitable relief including (i)
enjoining the Company and the directors from allowing the MHC to participate in
any shareholder vote to consider the adoption of proposed stock option and stock
recognition and retention plans (collectively, the "Stock Plans") and (ii)
enjoining MHC from participating in any shareholder vote to approve the Stock
Plans. In the event that the MHC and the Company are not enjoined, Stilwell is
seeking damages, the amount to be determined at trial.
Stilwell alleges that the Company's prospectus used to solicit offers
to purchase shares of the Company's common stock in connection with the mutual
holding reorganization of Prudential Savings Bank "promised" that the Stock
Plans would be submitted only for consideration by the Company's public
shareholders and not the MHC which controls a majority of the Company's issued
and outstanding shares of common stock and that Stilwell relied on such promise
in determining to invest in the common stock of the Company. Stilwell also
alleges the individual directors have violated their fiduciary duties to
Stilwell by delaying the consideration of the Stock Plans until such time that
MHC can vote its shares on the Stock Plans assuring their approval by
shareholders. The Company believes Stilwell's allegations are without merit and
intends to vigorously defend the case. On November 20, 2006, the Company, the
MHC and the director defendants filed a motion to dismiss the complaint,
asserting, among other things, that the prospectus contained no "promise,"
implied or otherwise, that the MHC would never vote on the adoption of the Stock
Plans and that the breach of fiduciary duty claim, with respect to the timing of
any such vote, is legally insufficient.
Since the case is in its early stages and discovery has not commenced,
no prediction can be made as to the outcome thereof.
Other than the above referenced litigation, the Company is involved in
various legal proceedings occurring in the ordinary course of business.
Management of the Company, based on discussions with litigation counsel,
believes that such proceedings will not have a material adverse effect on the
financial condition or operations of the Company. There can be no assurance that
any of the outstanding legal proceedings to which the Company is a party will
not be decided adversely to the Company's interests and have a material adverse
effect on the financial condition and operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
38
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
(a) Our common stock is traded on the NASDAQ Global Market (NASDAQ)
under the symbol "PBIP". At December 14, 2006, there were approximately 321
registered shareholders of record, not including the number of persons or
entities whose stock is held in nominee or "street" name through various
brokerage firms and banks. The following table shows the quarterly high and low
trading prices of our stock and the amount of cash dividends declared per share
for fiscal 2006 and the last three fiscal 2005 quarters. Our common stock
commenced trading on Nasdaq on March 30, 2005.
Stock Price Cash
--------------- Dividends
Quarter ended: High Low Per Share
------ ------ ---------
September 30, 2006... $13.45 $13.10 $0.04
June 30, 2006........ 14.02 12.82 0.04
March 31, 2006....... 13.96 11.70 0.04
December 31, 2005... 11.98 10.70 0.04
Quarter ended:
September 30, 2005... $12.90 $10.70 $0.04
June 30, 2005........ 11.05 8.50 0.04
March 31, 2005....... 10.05 9.55 --
(b) Not applicable
(c) The following table presents the repurchasing activity of the stock
repurchase program during the fourth quarter of fiscal 2006:
Maximum
Total Number Number Of
Of Shares Shares That
Purchased As May Yet Be
Total Part Of Publicly Purchased
Number Of Average Announced Under The
Shares Price Paid Plans Or Plans Or
Period Purchased Per Share Programs Programs
------ --------- ---------- ---------------- -----------
Month #1 July 1, 2006 - July 31, 2006............. 26,830 $13.24 26,830 191,570
Month #2 August 1, 2006 - August 31, 2006......... 95,000 13.30 95,000 96,570
Month #3 September 1, 2006 - September 30, 2006... 50,000 13.30 50,000 46,570
------- ------ ------- ------
Total.......................................... 171,830 $13.29 171,830 46,570
======= ====== ======= ======
----------
Notes to the table.
(1) On April 6, 2006, the Company announced its second stock repurchase
program to repurchase 269,000 shares or approximately 5% of the
Company's outstanding common stock held by shareholders other than
Prudential Mutual Holding Company, such program to commence upon
completion of the first program (which was completed in May 2006). The
second stock repurchase program was completed during November 2006.
39
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is selected financial and other data of Prudential
Bancorp. Prior to March 29, 2005, the date we completed the reorganization, such
data only reflects information with respect to Prudential Savings Bank.
At September 30,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in Thousands)
SELECTED FINANCIAL AND OTHER DATA:
Total assets $472,381 $446,592 $406,638 $395,825 $344,830
Cash and cash equivalents 13,428 26,815 10,061 24,108 29,087
Investment securities:
Held-to-maturity 132,084 129,840 114,806 98,991 23,987
Available-for-sale 38,747 38,584 40,287 43,175 36,264
Mortgage-backed securities:
Held-to-maturity 50,360 66,828 80,932 82,556 66,130
Available-for-sale 4,615 -- -- -- --
Loans receivable, net 219,418 175,091 151,565 137,926 181,947
Deposits 347,292 336,468 349,159 340,777 292,312
FHLB advances 31,784 13,823 13,862 13,900 13,937
Total equity, substantially restricted 87,448 90,825 39,099 36,548 34,382
Banking offices 6 6 6 6 6
Year Ended September 30,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in Thousands)
SELECTED OPERATING DATA:
Total interest income $ 24,542 $ 21,077 $ 19,513 $ 18,813 $ 19,215
Total interest expense 11,935 9,297 9,002 9,707 10,365
-------- -------- -------- -------- --------
Net interest income 12,607 11,780 10,511 9,106 8,850
Provision for loan losses 60 -- 50 180 150
-------- -------- -------- -------- --------
Net interest income after provision
for loan losses 12,547 11,780 10,461 8,926 8,700
Total non-interest income 938 567 581 742 613
Total non-interest expense 7,875 7,069 7,323 6,047 5,421
-------- -------- -------- -------- --------
Income before income taxes 5,610 5,278 3,719 3,621 3,892
Income taxes 1,773 1,886 1,246 1,253 1,398
-------- -------- -------- -------- --------
Net income $ 3,837 $ 3,392 $ 2,473 $ 2,368 $ 2,494
======== ======== ======== ======== ========
Basic Earnings per share (1) 0.32 0.15 -- -- --
Diluted earnings per share (1) 0.32 0.15 -- -- --
SELECTED OPERATING RATIOS(2):
Average yield on interest-earning assets 5.58% 5.03% 4.97% 5.18% 6.21%
Average rate on interest-bearing liabilities 3.34 2.64 2.48 2.91 3.65
Average interest rate spread(3) 2.24 2.39 2.49 2.27 2.56
Net interest margin(3) 2.87 2.81 2.68 2.51 2.86
Average interest-earning assets to average
interest-bearing liabilities 122.94 118.81 108.13 108.67 108.85
Net interest income after provision
for loan losses to non-interest expense 159.33 166.64 142.85 147.61 160.49
Total non-interest expense to average assets 1.73 1.64 1.80 1.61 1.69
Efficiency ratio(4) 58.14 57.25 66.02 61.40 57.43
Return on average assets 0.84 0.79 0.61 0.63 0.78
Return on average equity 4.26 5.14 6.50 6.64 7.56
Average equity to average assets 19.82 15.30 9.36 9.52 10.28
(FOOTNOTES ON NEXT PAGE)
40
At Or For The
Year Ended September 30,
----------------------------------------
2006 2005 2004 2003 2002
------ ------ ------ ----- -----
ASSET QUALITY RATIOS(5):
Non-performing loans as a percent of
total loans receivable(6) 0.07% 0.14% 0.32% 0.65% 0.95%
Non-performing assets as a percent of
total assets(6) 0.03 0.13 0.25 0.38 0.51
Allowance for loan losses as a percent of
non-performing loans 409.66 233.47 116.49 62.13 35.96
Net charge-offs to average loans receivable -- -- 0.03 0.16 0.14
CAPITAL RATIOS(5):
Tier 1 leverage ratio
Company 18.64% 20.98% N/A N/A N/A
Bank 14.74 14.55 9.39% 9.03% 9.69%
Tier 1 risk-based capital ratio
Company 39.23% 48.54% N/A N/A N/A
Bank 31.12 34.71 24.50 21.95 20.29
Total risk-based capital ratio
Company 39.68% 48.98% N/A N/A N/A
Bank 31.56 35.16 25.22 22.29 20.66
----------
(1) Due to the timing of the Bank's reorganization into the mutual holding
company form and the completion of the Company's initial public offering on
March 29, 2005, earnings per share for the year ended September 30, 2005 is
for the six month period ended September 30, 2005. There were no shares of
common stock of the Company outstanding during the pre 2005 periods.
(2) With the exception of end of period ratios, all ratios are based on average
monthly balances during the indicated periods.
(3) Average interest rate spread represents the difference between the average
yield on interest-earning assets and the average rate paid on
interest-bearing liabilities, and net interest margin represents net
interest income as a percentage of average interest-earning assets.
(4) The efficiency ratio represents the ratio of non-interest expense divided
by the sum of net interest income and non-interest income.
(5) Asset quality ratios and capital ratios are end of period ratios, except
for net charge-offs to average loans receivable. The Bank converted to a
Pennsylvania-chartered savings bank in August 2004 and thus became subject
to the Federal Deposit Insurance Corporation regulatory capital
regulations. Prior thereto, the Bank was a Pennsylvania- chartered savings
association subject to regulations by the Office of Thrift Supervision.
Under Federal Deposit Insurance Corporation regulations, capital ratios for
the Bank are based on average assets rather than assets, as adjusted, at
the relevant date as required by the regulations of the Office of Thrift
Supervision. Since the Company did not have any capital stock outstanding
prior to March 29, 2005, no capital ratios are presented for the pre 2005
periods.
(6) Non-performing assets consist of non-performing loans and real estate
owned. Non-performing loans consist of all loans 90 days or more past due
and loans in excess of 90 days delinquent and still accruing interest. It
is our policy to cease accruing interest on all loans, other than
single-family residential mortgage loans, 90 days or more past due. Real
estate owned consists of real estate acquired through foreclosure and real
estate acquired by acceptance of a deed-in-lieu of foreclosure.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a community oriented savings bank headquartered in
Philadelphia, Pennsylvania. We operate six banking offices in Philadelphia and
Delaware Counties. Our primary business consists of attracting deposits from the
general public and using those funds together with funds we borrow to originate
loans to our customers and invest primarily in U.S. Government and agency
securities and mortgage-backed securities. At September 30, 2006, we had total
assets of $472.4 million, including $219.4 million in net loans and $225.8
million of investment and mortgage-backed securities, total deposits of $347.3
million and total equity of $87.4 million.
This Management's Discussion and Analysis section is intended to
assist in understanding the financial condition and results of operations of
Prudential Bancorp. The results of operations of Prudential Bancorp are
primarily dependent on the results of the Bank. The information contained in
this section should be read in conjunction with our financial statements and the
accompanying notes to the consolidated financial statements and other sections
contained in Item 8 of this Form 10-K.
FORWARD-LOOKING STATEMENTS.
In addition to historical information, this Annual Report on Form 10-K
includes certain "forward-looking statements" based on management's current
expectations. The Company's actual results could differ materially, as such term
is defined in the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, from management's expectations. Such
forward-looking statements include statements regarding management's current
intentions, beliefs or expectations as well as the assumptions on which such
statements are based. These forward-looking statements are subject to
significant business, economic and competitive uncertainties and contingencies,
many of which are not subject to the Company's control. You are cautioned that
any such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and that actual results may differ materially
from those contemplated by such forward-looking statements. Factors that could
cause future results to vary from current management expectations include, but
are not limited to, general economic conditions, legislative and regulatory
changes, monetary and fiscal policies of the federal government, changes in tax
policies, rates and regulations of federal, state and local tax authorities,
changes in interest rates, deposit flows, the cost of funds, demand for loan
products, demand for financial services, competition, changes in the quality or
composition of the Company's loan and investment securities portfolios, changes
in accounting principles, policies or guidelines and other economic,
competitive, governmental and technological factors affecting the Company's
operations, markets, products, services and fees.
The Company undertakes no obligation to update or revise any
forward-looking statements to reflect changed assumptions, the occurrence of
unanticipated events or changes to future operating results that occur
subsequent to the date such forward-looking statements are made.
CRITICAL ACCOUNTING POLICIES
In reviewing and understanding financial information for Prudential
Bancorp, you are encouraged to read and understand the significant accounting
policies used in preparing our financial statements. These policies are
described in Note 2 of the notes to our financial statements included in Item 8
hereof. The accounting and financial reporting policies of Prudential Bancorp
conform to accounting principles generally accepted in the United States of
America and to general practices within the banking industry. Accordingly, the
financial statements require certain estimates, judgments and assumptions, which
are
42
believed to be reasonable, based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of income and expenses
during the periods presented. The following accounting policies comprise those
that management believes are the most critical to aid in fully understanding and
evaluating our reported financial results. These policies require numerous
estimates or economic assumptions that may prove inaccurate or may be subject to
variations which may significantly affect our reported results and financial
condition for the period or in future periods.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is
established through a provision for loan losses charged to expense. Loans are
charged against the allowance for loan losses when management believes that the
collectibility of the principal is unlikely. Subsequent recoveries are added to
the allowance. The allowance is an amount that management believes will cover
known and inherent losses in the loan portfolio, based on evaluations of the
collectibility of loans. The evaluations take into consideration such factors as
changes in the types and amount of loans in the loan portfolio, historical loss
experience, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral, estimated losses relating to
specifically identified loans, and current economic conditions. This evaluation
is inherently subjective as it requires material estimates including, among
others, exposure at default, the amount and timing of expected future cash flows
on impacted loans, value of collateral, estimated losses on our commercial,
construction and residential loan portfolios and general amounts for historical
loss experience. All of these estimates may be susceptible to significant
change.
While management uses the best information available to make loan loss
allowance evaluations, adjustments to the allowance may be necessary based on
changes in economic and other conditions or changes in accounting guidance.
Historically, our estimates of the allowance for loan loss have not required
significant adjustments from management's initial estimates. In addition, the
Pennsylvania Department of Banking and the Federal Deposit Insurance
Corporation, as an integral part of their examination processes, periodically
review our allowance for loan losses. The Pennsylvania Department of Banking and
the Federal Deposit Insurance Corporation may require the recognition of
adjustments to the allowance for loan losses based on their judgment of
information available to them at the time of their examinations. To the extent
that actual outcomes differ from management's estimates, additional provisions
to the allowance for loan losses may be required that would adversely impact
earnings in future periods.
INCOME TAXES. We make estimates and judgments to calculate some of our
tax liabilities and determine the recoverability of some of our deferred tax
assets, which arise from temporary differences between the tax and financial
statement recognition of revenues and expenses. We also estimate a reserve for
deferred tax assets if, based on the available evidence, it is more likely than
not that some portion or all of the recorded deferred tax assets will not be
realized in future periods. These estimates and judgments are inherently
subjective. In the past, our estimates and judgments to calculate our deferred
tax accounts have not required significant revision to our initial estimates.
In evaluating our ability to recover deferred tax assets, we consider
all available positive and negative evidence, including our past operating
results, recent cumulative losses and our forecast of future taxable income. In
determining future taxable income, we make assumptions for the amount of taxable
income, the reversal of temporary differences and the implementation of feasible
and prudent tax planning strategies. These assumptions require us to make
judgments about our future taxable income and are consistent with the plans and
estimates we use to manage our business. Any reduction in estimated future
taxable income may require us to record an additional valuation allowance
against our deferred tax assets. An increase in the valuation allowance would
result in additional income tax expense in the period and could have a
significant impact on our future earnings.
43
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING
OF FINANCIAL ASSETS- AN AMENDMENT OF FASB STATEMENT NO. 140 ("SFAS No. 140" and
"SFAS No. 156"). SFAS No. 140 establishes, among other things, the accounting
for all separately recognized servicing assets and servicing liabilities. SFAS
No. 156 amends SFAS No. 140 to require that all separately recognized servicing
assets and servicing liabilities be initially measured at fair value, if
practicable. SFAS No. 156 permits, but does not require, the subsequent
measurement of separately recognized servicing assets and servicing liabilities
at fair value. Under SFAS No. 156, an entity can elect subsequent fair value
measurement to account for its separately recognized servicing assets and
servicing liabilities. Adoption of SFAS No. 156 is required as of the beginning
of the first fiscal year that begins after September 15, 2006. Upon adoption,
the Company will apply the requirements for recognition and initial measurement
of servicing assets and servicing liabilities prospectively to all transactions.
The Company will adopt SFAS No. 156 for the fiscal year beginning October 1,
2006 and currently has not determined if it will adopt SFAS No. 156 using the
fair value election. The Company does not anticipate any material impact to its
financial condition or results of operations as a result of the adoption of SFAS
No. 156.
On July 13, 2006, the FASB issued Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes" ("FIN 48"), which is effective for fiscal years
beginning after December 15, 2006. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with FASB Statement No. 109, "Accounting for Income Taxes." This Interpretation
prescribes a comprehensive model for how a company should recognize, measure,
present and disclose in its financial statements uncertain tax positions that
the company has taken or expects to take on a tax return. The Company is
currently assessing the impact of FIN 48 on its financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurement." SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. This Statement does not require any
new fair value measurements. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007 and interim periods within those fiscal years.
The Company is currently assessing the impact of SFAS No. 157 on its financial
statements.
In September 2006, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 158, "Employer's Accounting for Defined Benefit Pension and
Other Postretirement Plans--an amendment of FASB Statements No. 87, 88, 106, and
132(R)." SFAS No. 158 requires an employer to recognize in its statement of
financial position an asset for a plan's overfunded status or a liability for a
plan's underfunded status, measure a plan's assets and its obligations that
determine its funded status as of the end of the employer's fiscal year, and
recognize changes in the funded status of a defined benefit postretirement plan
in the year in which the changes occur. Those changes will be reported in
comprehensive income and as a separate component of stockholders' equity. SFAS
No. 158 is effective for publicly held companies for fiscal years ending after
December 15, 2006. The Bank participates in a muti-employer defined benefit
plan. We do not anticipate that the implementation of SFAS No. 158 will have any
impact on our financial position, results of operations and cash flows because
it is not applicable to muti-employer defined benefit plans.
In February 2006, the FASB issued SFAS No. 155, "Accounting For
Certain Hybrid Financial Instruments." This statement amends FASB Statements No.
133, "Accounting For Derivative Instruments and Hedging Activities, and FASB
SFAS No. 140, "Accounting For Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities". FAS 155 permits fair value re-measurement for
any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation, clarifies which interest-only strips and
principal-only strips are not subject to the
44
requirements of Statement 133, establishes a requirement to evaluate interests
in securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation, clarifies that concentrations of credit risk
in the form of subordination are not embedded derivatives, and amends Statement
140 to eliminate the prohibition on a qualifying special purpose entity from
holding a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. FAS 155 is effective for all
financial instruments acquired or issued after the beginning of an entities
first fiscal year that begins after September 15, 2006. The adoption of the
statement did not have a material effect on the financial statements.
In September 2006, the Securities and Exchange Commission ("SEC")
issued SAB No. 108 expressing the SEC staff's views regarding the process of
quantifying financial statement misstatements and the build up of improper
amounts on the balance sheet. SAB 108 requires that registrants quantify errors
using both a balance sheet and income statement approach and evaluate whether
either approach results in a misstated amount that, when all relevant
quantitative and qualitative factors are considered, is material. The built up
misstatements, while not considered material in the individual years in which
the misstatements were built up, may be considered material in a subsequent year
if a company were to correct those misstatements through current period
earnings. Initial application of SAB No. 108 allows registrants to elect not to
restate prior periods but to reflect the initial application in their annual
financial statements covering the first fiscal year ending after November 15,
2006. The cumulative effect of the initial application should be reported in the
carrying amounts of assets and liabilities as of the beginning of that fiscal
year and the offsetting adjustment, net of tax, should be made to the opening
balance of retained earnings for that year.
The Company implemented SAB 108 on October 1, 2006 which resulted in
an increase to Mortgage-backed securities held to maturity of approximately
$320,000, an increase in deferred income tax liability of approximately $142,000
and a cumulative adjustment to increase beginning Retained Earnings of
approximately $178,000. The adjustment relates to two separate accounting
entries. The first entry pertains to the method of accounting that was utilized
in past years for the recognition of investment income on Mortgage-backed
securities. Prior to 2006, the Company used the straight line method over the
contractual life of the securities rather than using the effective yield method
prescribed by SFAS No. 91, Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases. The impact of this entry was the correction of an understatement of
Mortgage-backed securities by approximately $320,000 and deferred income tax
liability of $102,000. The second entry relates to a write off of a deferred tax
asset of approximately $40,000 that was incorrectly accounted for in prior
periods.
In prior periods, management performed a quantitative and qualitative
analysis of the differences between these two methods of accounting and
concluded that there was not a material impact on any past individual quarter or
annual reporting periods.
DERIVATIVE FINANCIAL INSTRUMENTS, CONTRACTUAL OBLIGATIONS AND OTHER
COMMITMENTS. A derivative financial instrument includes futures, forwards,
interest rate swaps, option contracts, and other financial instruments with
similar characteristics. We have not used derivative financial instruments in
the past and do not currently have any intent to do so in the future.
While we have not used derivative financial instruments, we are a
party to financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of our customers. These financial
instruments include commitments to extend credit and the unused portions of
lines of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated statements of financial condition. Commitments to extend
45
credit generally have fixed expiration dates and may require additional
collateral from the borrower if deemed necessary. Commitments to extend credit
are not recorded as an asset or liability by us until the instrument is
exercised.
The following tables summarize our outstanding commitments to
originate loans and to advance additional amounts pursuant to outstanding
letters of credit, lines of credit and under our construction loans at the dates
indicated.
COMMITMENTS
The following tables summarize our outstanding commitments to
originate loans and to advance additional amounts pursuant to outstanding
letters of credit, lines of credit and undisbursed construction loans at
September 30, 2006.
Amount Of Commitment Expiration
- Per Period
Total -----------------------------------
Amounts To 1-3 4-5 After 5
Committed 1 Year Years Years Years
--------- ------- ------- ----- -------
(In Thousands)
Letters of credit $ 110 $ 110 $ -- $-- $ --
Lines of credit 6,706 -- -- -- 6,706
Undisbursed portions of loans in
process 36,258(1) 15,388 20,870 -- --
Commitments to originate loans 4,933 4,933 -- -- --
------- ------- ------- --- ------
Total commitments $48,007 $20,431 $20,870 $-- $6,706
======= ======= ======= === ======
----------
(1) Includes participation interests sold to other financial institutions
totaling $6.6 million; Prudential Savings Bank will fund such amount and be
reimbursed by the participants.
CONTRACTUAL CASH OBLIGATIONS
The following table summarizes our contractual cash obligations at September 30,
2006.
Payments Due By Period
--------------------------------------
TO 1-3 4-5 AFTER 5
TOTAL 1 YEAR YEARS YEARS YEARS
-------- -------- ------- ------- -------
(In Thousands)
Certificates of deposit $171,602 $124,399 $32,197 $15,006 $ --
FHLB advances(1) 31,784 18,041 84 13,088 571
Other borrowed money -- -- -- -- --
-------- -------- ------- ------- ----
Total long-term debt 203,386 142,440 32,281 28,094 571
Operating lease obligations 166 61 105 -- --
-------- -------- ------- ------- ----
Total contractual obligations $203,552 $142,501 $32,386 $28,094 $571
======== ======== ======= ======= ====
----------
(1) Does not include approximately $760,000 in interest expense due annually on
FHLB advances through the year 2010.
46
AVERAGE BALANCES, NET INTEREST INCOME, AND YIELDS EARNED AND RATES
PAID. The following table shows for the periods indicated the total dollar
amount of interest from average interest-earning assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. Tax-exempt
income and yields have not been adjusted to a tax-equivalent basis. All average
balances are based on monthly balances. Management does not believe that the
monthly averages differ significantly from what the daily averages would be.
Year Ended September 30,
--------------------------------------------------------------------------------------
2006 2005 2004
--------------------------- --------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate(1) Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- ------- -------- -------- --------
(Dollars in Thousands)
Interest-earning assets:
Investment securities $173,713 $ 8,019 4.62% $157,648 $ 6,758 4.29% $148,377 $ 6,147 4.14%
Mortgage-backed securities 60,750 3,147 5.18 72,771 3,783 5.20 84,439 4,475 5.30
Loans receivable(1) 197,913 13,077 6.61 163,166 9,885 6.06 142,348 8,584 6.03
Other interest-earning assets 7,307 299 4.09 25,512 651 2.55 17,142 307 1.79
-------- ------- -------- ------- -------- -------
Total interest-earning assets 439,683 24,542 5.58% 419,097 21,077 5.03% 392,306 19,513 4.97%
------- ------ ------- ------ ------- ------
Non-interest-earning assets 14,786 12,073 14,063
-------- -------- --------
Total assets $454,469 $431,170 $406,369
======== ======== ========
Interest-bearing liabilities:
Savings accounts $ 81,472 2,449 3.01% $ 91,821 1,719 1.87% $ 94,565 1,654 1.75%
Checking and money market accounts 98,112 3,081 3.14 101,146 2,273 2.25 96,472 1,865 1.93
Certificate accounts 156,869 5,304 3.38 144,445 4,520 3.13 156,472 4,686 2.99
-------- ------- -------- ------- -------- -------
Total deposits 336,453 10,834 3.22 337,412 8,512 2.52 347,509 8,205 2.36
FHLB advances 19,628 1,092 5.56 13,842 775 5.60 13,880 778 5.61
Real estate tax escrow accounts 1,552 9 0.58 1,490 10 0.67 1,306 12 0.92
Other interest-bearing liabilities -- -- -- -- -- -- 116 7 6.02
-------- ------- -------- ------- -------- -------
Total interest-bearing liabilities 357,633 11,935 3.34% 352,744 9,297 2.64% 362,811 9,002 2.48%
------- ------ ------- ------ ------- ------
Non-interest-bearing liabilities 6,762 12,459 5,511
-------- -------- --------
Total liabilities 364,395 365,203 368,322
Stockholders' Equity 90,074 65,967 38,047
-------- -------- --------
Total liabilities and Stockholders' Equity $454,469 $431,170 $406,369
======== ======== ========
Net interest-earning assets $ 82,050 $ 66,354 $ 29,495
======== ======== ========
Net interest income; interest rate spread $12,607 2.24% $11,780 2.39% $10,511 2.49%
======= ====== ======= ====== ======= ======
Net interest margin(2) 2.87% 2.81% 2.68%
====== ====== ======
Average interest-earning assets to
average interest-bearing liabilities 122.94% 118.81% 108.13%
====== ====== ======
----------
(1) Includes nonaccrual loans during the respective periods. Calculated net of
deferred fees and discounts, loans in process and allowance for loan
losses.
(2) Equals net interest income divided by average interest-earning assets.
47
RATE/VOLUME ANALYSIS. The following table shows the extent to which
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities affected our interest income and expense during the
periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in rate, which is the change in rate multiplied by prior year
volume, and (2) changes in volume, which is the change in volume multiplied by
prior year rate. The combined effect of changes in both rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
2006 vs. 2005 2005 vs. 2004
-------------------------------------- ------------------------------------
Increase (Decrease) Due To Increase (Decrease) Due To
-------------------------- --------------------------
Total Total
Rate/ Increase Rate/ Increase
Rate Volume Volume (Decrease) Rate Volume Volume (Decrease)
------- ------ ------ ---------- ----- ------ ------ ----------
(In Thousands)
Interest income:
Investment securities $ 519 $ 689 $ 53 $ 1,261 $ 214 $ 384 $ 13 $ 611
Mortgage-backed securities (13) (625) 2 (636) (85) (618) 12 (692)
Loans receivable, net 896 2,105 191 3,192 40 1,255 6 1,301
Other interest-earning assets 393 (465) (280) (352) 130 150 64 344
------- ------ ----- ------- ----- ------ ---- -------
Total interest-earning assets 1,795 1,704 (34) 3,465 299 1,171 95 1,564
------- ------ ----- ------- ----- ------ ---- -------
Interest expense:
Savings accounts 1,041 (194) (117) 730 109 (48) (3) 58
Checking accounts 903 (68) (27) 808 303 90 15 408
(interest-bearing and
non-interest bearing)
Certificate accounts 364 389 31 784 211 (360) (16) (165)
------- ------ ----- ------- ----- ------ ---- -------
Total deposits 2,308 127 (113) 2,322 623 (318) (4) 301
------- ------ ----- ------- ----- ------ ---- -------
FHLB advances (5) 324 (2) 317 (1) (2) -- (3)
Other interest-bearing liabilities (1) -- -- (1) (3) 2 -- (2)
------- ------ ----- ------- ----- ------ ---- -------
Total interest-bearing liabilities 2,302 451 (115) 2,638 619 (318) (4) 296
------- ------ ----- ------- ----- ------ ---- -------
Increase (decrease) in net interest income $ (507) $1,253 $ 81 $ 827 $(320) $1,489 $ 99 $ 1,268
======= ====== ===== ======= ===== ====== ==== =======
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
The Company's total assets increased by $25.8 million or 5.8% to
$472.4 million at September 30, 2006 from September 30, 2005 primarily due to
continued growth of the loan portfolio. The Company's net loan portfolio
experienced a $44.3 million or 25.3% increase to $219.4 million at September 30,
2006 as management continued its emphasis on growing the Company's loan
portfolio. The majority of the growth was concentrated in the single-family
construction and residential mortgage loan portfolios. Partially offsetting such
increase were decreases in cash and cash equivalents as well as mortgage-backed
securities. The $13.4 million decrease in cash and cash equivalents to $13.4
million at September 30, 2006 reflected the systematic investment of funds
received in the subscription offering in loans and other higher yielding
investments while the $11.9 million decline in the mortgage-backed securities
portfolios reflected the Company's determination to re-invest proceeds from
maturing securities into loans.
48
Total liabilities increased by $29.2 million or 8.2% to $384.9 million
at September 30, 2006 from September 30, 2005 reflecting increased Federal Home
Loan Bank borrowings ("FHLB") and deposits in order to assist funding loan
demand. Advances from the FHLB increased $18.0 million to $31.8 million at
September 30, 2006 from $13.8 million at September 30, 2005. At September 30,
2006, total deposits increased $10.8 million or 3.2% to $347.3 million from
$336.5 million as of September 30, 2005. The increase was due to a $27.3 million
increase in certificates of deposit, partially offset by a $16.5 million
decrease in core deposits. The increase in certificates resulted primarily from
implementation of a more aggressive deposit pricing strategy combined with
increased customer demand for attractive short-term investments in the rising
interest rate market experienced throughout fiscal 2006.
Stockholders' equity decreased by $3.4 million to $87.4 million at
September 30, 2006 as compared to $90.8 million at September 30, 2005 in large
part due to the repurchase during fiscal 2006 of 433,130 shares of common stock
at a total cost of $5.8 million combined with the payment of $1.9 million in
dividends, offset in part by $3.8 million in net income for the year ended
September 30, 2006.
The Company previously announced in April 2006 that the Board had
approved the commencement of its second stock repurchase program of up to an
additional 269,000 shares or approximately 5% of the Company's outstanding
common stock held by other than Prudential Mutual Holding Company. The Company's
second repurchase program commenced in May 2006 upon completion of its first
repurchase program covering 277,000 shares. The average cost per share of the
499,430 shares which had been repurchased during fiscal 2006 and 2005 was $12.86
per share.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED SEPTEMBER 30, 2006 AND
SEPTEMBER 30, 2005
GENERAL. We had net income of $3.8 million for the year ended
September 30, 2006 as compared to $3.4 million for the prior fiscal year. The
results for the year ended September 30, 2006 as compared to the year ended
September 30, 2005 reflected primarily the effects of an $827,000 increase in
net interest income combined with a $370,000 increase in non-interest income
offset by a $806,000 increase in non-interest expenses. The increase in net
interest income reflected in large part the increase in the average net
interest-earning assets for the year ended September 30, 2006 compared to the
year ended September 30, 2005, as the stock reorganization only reflected half
of the 2005 fiscal year. Our non-interest expenses increased due primarily to
additional expenses incurred from operating as a public company for a full year.
INTEREST INCOME. Our total interest income was $24.5 million for the
year ended September 30, 2006 compared to $21.1 million for the year ended
September 30, 2005, an increase of $3.5 million or 16.4%. The higher amount of
interest income in fiscal 2006 primarily reflected the effects of increases in
the average balances of interest-earning assets and to a lesser extent the
increase in the net interest margin. The primary reason for the increase in
interest income was a $3.2 million increase in interest income and fees earned
on our loan portfolio for the year ended September 30, 2006 compared to the year
ended September 30, 2005 and a $908,000 increase in interest and dividends
earned on our investment securities portfolio, partially offset by a $636,000
decrease in interest on mortgage-backed securities for fiscal 2006 as compared
to 2005. The primary reason for the increase in interest income on our loan
portfolio was the 21.3% increase in the average balance of such assets for the
year ended September 30, 2006 compared to the year ended September 30, 2005.
Likewise, the average yield earned on the loan portfolio increased 55 basis
points to 6.61% for fiscal 2006 compared to fiscal 2005.
INTEREST EXPENSE. Our interest expense increased during the year ended
September 30, 2006 compared to the year ended September 30, 2005, reflecting the
current rising interest rate environment. Total interest expense amounted to
$11.9 million during the year ended September 30, 2006 compared to $9.3 million
for the year ended September 30, 2005, an increase of $2.6 million or 28.4%. The
primary
49
reason for the increase in interest expense was a 70 basis point increase in the
average rate paid on deposits to 3.22% for the year ended September 30, 2006
compared to the year ended September 30, 2005. As a result, interest expense on
total deposits was $10.8 million in the year ended September 30, 2006 compared
to $8.5 million in fiscal 2005. Interest expense on FHLB advances increased by
$317,000 due to an increase in the average balance of $5.8 million for fiscal
2006 compared to fiscal 2005.
PROVISION FOR LOAN LOSSES. We have identified the evaluation of the
allowance for loan losses as a critical accounting policy where amounts are
sensitive to material variation. This policy is significantly affected by our
judgment and uncertainties and there is a likelihood that materially different
amounts would be reported under different, but reasonably plausible, conditions
or assumptions. Our activity in the provision for loan losses, which consists of
charges or recoveries to operating results, is undertaken in order to maintain a
level of total allowance for losses that management believes covers all known
and inherent losses that are both probable and reasonably estimable at each
reporting date. Our evaluation process includes, among other things, an analysis
of delinquency trends, non-performing loan trends, the level of charge-offs and
recoveries, prior loss experience, total loans outstanding, the volume of loan
originations, the type, size and geographic concentration of our loans, the
value of collateral securing the loan, the borrower's ability to repay and
repayment performance, the number of loans requiring heightened management
oversight, local economic conditions and industry experience. In recent periods,
in establishing the allowance for loan losses we have given particular
consideration to the growth in our construction and land development loan
portfolio. For each primary type of loan, we establish a loss factor reflecting
our estimate of the known and inherent losses in each loan type using the
quantitative analysis as well as consideration of the qualitative factors. Such
risk ratings are periodically reviewed by management and revised as deemed
appropriate. The establishment of the allowance for loan losses is significantly
affected by management judgment and uncertainties and there is a likelihood that
different amounts would be reported under different conditions or assumptions.
Various regulatory agencies, as an integral part of their examination process,
periodically review our allowance for loan losses. Such agencies may require us
to make additional provisions for estimated loan losses based upon judgments
different from those of management. Furthermore, the amount of the allowance for
loan losses is only an estimate and actual losses may vary from this estimate.
We established an additional provision for loan losses for the year
ended September 30, 2006 of $60,000. No provision was made during fiscal 2005.
We did not have any charge-offs in our allowance for loan losses for the year
ended September 30, 2006 or 2005. Historically, we have experienced a modest
level of charge-offs. The provision was established due to continued growth in
the loan portfolio, primarily with regard to increases in construction and land
development loans. Our allowance for loan losses amounted to $618,000, or 0.24%
of total loans outstanding at September 30, 2006 compared to $558,000 or 0.28%
of total loans outstanding at September 30, 2005.
NON-INTEREST INCOME. Our non-interest income is comprised of fees and
other service charges on customer accounts, and other operating income. Our
total non-interest income amounted to $938,000 for the year ended September 30,
2006 compared to $567,000 for the year ended September 30, 2005, a $370,000 or
65.3% increase. The primary reason for the increase in non-interest income in
the 2006 period compared to the 2005 period was income from Bank Owned Life
Insurance (BOLI) of $166,000 in 2006 which was not applicable in the 2005 fiscal
year. The BOLI, purchased during fiscal 2006, provides an attractive tax-exempt
return to the Company and is being used by the Company to fund various employee
benefit plans. Also contributing the increase was gain on sale of a real estate
owned property of $106,000, increased ATM fees of $73,000, and gain on sale of
mortgage-backed securities of $48,000.
NON-INTEREST EXPENSE. Non-interest expense is comprised primarily of
salaries and employee benefits expense, net occupancy and depreciation costs,
data processing costs, professional service fees, directors compensation and
various other operating expenses. Our total non-interest expense amounted to
50
$7.9 million for the year ended September 30, 2006, a $806,000 or 11.4% increase
from $7.1 million of non-interest expense for the year ended September 30, 2005.
The increase reflected increased employee and director compensation and benefit
expense of $428,000 due primarily to an increase in retirement plan expenses and
normal merit pay rate increases combined with an increase in professional
services expense of $247,000 reflecting the additional expenses incurred due to
operating as a public company, as we were only operating as a public company for
approximately half of the 2005 fiscal year.
INCOME TAX EXPENSE. Our income tax expense for the year ended
September 30, 2006 amounted to $1.8 million with an effective income tax rate of
31.6% compared to income tax expense of $1.9 million with an effective income
tax rate of 35.7% for the year ended September 30, 2005. This decrease in the
effective tax rate reflected the implementation of various tax strategies as
well as the recognition of certain tax benefits as a result of the adjustment of
a valuation allowance during the first fiscal quarter of 2006.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED SEPTEMBER 30, 2005 AND
SEPTEMBER 30, 2004
GENERAL. We had net income of $3.4 million for the year ended
September 30, 2005 as compared to $2.5 million for the prior fiscal year. The
results for the year ended September 30, 2005 as compared to the year ended
September 30, 2004 reflected primarily the effects of a $1.3 million increase in
net interest income combined with a $50,000 decrease in the provision for loan
losses and a $253,000 decrease in non-interest expenses. The increase in net
interest income reflected in large part the increase in the net interest margin
by 13 basis points to 2.81% for the year ended September 30, 2005 compared to
2.68% for the year ended September 30, 2004. Although the weighted average yield
on our interest-earning assets increased by 6 basis points, the average rate
paid on our interest-bearing liabilities increased to a greater degree,
increasing 16 basis points. We have continued to maintain our rates on our
checking and savings accounts above those of many of our competitors for
competitive reasons based on the demographics and composition of our customer
base, although we may not do so in the future. The increase in the net interest
margin reflected the effects of the infusion of the net proceeds of the
Company's initial public offering in March 2005 which offset the decline in our
interest rate spread. Our non-interest expenses decreased due primarily to an
aggregate $236,000 decrease in salaries and employee benefit expense and a
$134,000 decrease in litigation expense. However, partially offsetting the
increase in net interest income and the decline in non-interest expense was the
decline in non-interest income. We experienced a $14,000 decline in our
non-interest income to $567,000 for the year ended September 30, 2005 as
compared to fiscal 2004 primarily due to a $17,000 decrease in fees and other
service charges, offset in part by a $4,000 increase in other non-interest
income. The decline in fees and other service charges reflected a reduced volume
of fee-based transactions, in particular, mortgage loan prepayment fees.
INTEREST INCOME. Our total interest income was $21.1 million for the
year ended September 30, 2005 compared to $19.5 million for the year ended
September 30, 2004, an increase of $1.6 million or 8.0%. The higher amount of
interest income in fiscal 2005 primarily reflected the effects of increases in
the average balances of interest-earning assets and to a lesser extent the
increase in the net interest margin. The primary reason for the increase in
interest income was a $1.3 million increase in interest and fees income earned
on our loan portfolio for the year ended September 30, 2005 compared to the year
ended September 30, 2004 and a $956,000 increase in interest and dividends
earned on our investment securities portfolio, partially offset by a $692,000
decrease in interest on mortgage-backed securities for fiscal 2005 as compared
to 2004. The primary reason for the increase in interest income on our loan
portfolio was the 14.6% increase in the average balance of such assets for the
year ended September 30, 2005 compared to the year ended September 30, 2004.
Likewise, the average yield earned on the loan portfolio increased 3 basis
points to 6.06% for fiscal 2005 compared to fiscal 2004.
51
INTEREST EXPENSE. Our interest expense increased during the year ended
September 30, 2005 compared to the year ended September 30, 2004, reflecting the
rising interest rate environment during fiscal 2005. Total interest expense
amounted to $9.3 million during the year ended September 30, 2005 compared to
$9.0 million for the year ended September 30, 2004, an increase of $295,000 or
3.3%. The primary reason for the increase in interest expense was a 16 basis
point increase in the average rate paid on deposits to 2.52% for the year ended
September 30, 2005 compared to the year ended September 30, 2004 which more than
offset the 2.9% decrease in the average balance of deposits in the period. As a
result, interest expense on total deposits was $8.5 million in the year ended
September 30, 2005 compared to $8.2 million in fiscal 2004. Interest expense on
FHLB advances remained essentially the same during both periods as the average
balance and rate paid were relatively unchanged.
PROVISION FOR LOAN LOSSES. We did not establish a provision for loan
losses for the year ended September 30, 2005 compared to a provision of $50,000
for the year ended September 30, 2004. We did not have any charge-offs in our
allowance for loan losses for the year ended September 30, 2005 compared to
$45,000 in charge-offs, net of recoveries, for fiscal 2004. Historically, we
have experienced a modest level of charge-offs. All of the charge-offs in the
year ended September 30, 2004 related to two lending relationships, both of
which consisted of participation interests in commercial real estate loans. One
loan was secured by a golf course and golf house while the other was secured by
a storage facility. Our allowance for loan losses amounted to $558,000, or 0.28%
of total loans outstanding at September 30, 2005.
NON-INTEREST INCOME. Our non-interest income is comprised of fees and
other service charges on customer accounts, and other operating income. Our
total non-interest income amounted to $567,000 for the year ended September 30,
2005 compared to $581,000 for the year ended September 30, 2004, a $14,000 or
2.3% decrease. The primary reason for the decrease in non-interest income in the
2005 period compared to the 2004 period was a $17,000 decrease in fees and other
service charges due to a reduced volume of fee generating transactions, in
particular, mortgage loan prepayment fees (as mortgage refinancing activity
declined) and late charges. Such declines were offset in part due to a $4,000
increase in other non-interest income which consists of miscellaneous operating
income.
NON-INTEREST EXPENSE. Non-interest expense is comprised primarily of
salaries and employee benefits expense, net occupancy and depreciation costs,
data processing costs, professional service fees, directors compensation and
various other operating expenses. Our total non-interest expense amounted to
$7.1 million for the year ended September 30, 2005, a $253,000 or 3.5% decrease
from $7.3 million of non-interest expense for the year ended September 30, 2004.
The decrease was due primarily to an aggregate $236,000 decrease in salary and
employee benefits expense and a $134,000 decrease in litigation expense. The
increase in professional service expense of $193,000 was due primarily to our
reorganization completed during the fiscal year and additional expenses related
to being a public company. In addition, director compensation expense increased
$77,000 due in large part to a one-time expense incurred during the mutual
holding company reorganization resulting from the payment of $38,250 to a
director in connection with the termination of a supplemental retirement plan.
In addition, due to the increased time commitments, responsibilities and
obligations imposed on the directorate as a result of the Bank being part of a
public company, the annual retainer and committee fees for service on the Bank's
Board increased. Excluding the one-time expense related to the benefit
settlement, director compensation expense amounted to $219,000 for fiscal 2005
as compared to $181,000 for fiscal 2004.
INCOME TAX EXPENSE. Our income tax expense was $1.9 million for fiscal
year 2005 and $1.2 million for fiscal year 2004. Our effective tax rate was
35.7% for the year ended September 30, 2005 compared to 33.5% for the year ended
September 30, 2004 reflected in large part the increase in the Company's net
income before taxes.
52
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of funds are from deposits, scheduled principal
and interest payments on loans, loan prepayments and the maturity of loans,
mortgage-backed securities and other investments, and other funds provided from
operations. While scheduled payments from the amortization of loans and
mortgage-backed securities and maturing investment securities are relatively
predictable sources of funds, deposit flows and loan prepayments can be greatly
influenced by general interest rates, economic conditions and competition. We
also maintain excess funds in short-term, interest-bearing assets that provide
additional liquidity. At September 30, 2006, our cash and cash equivalents
amounted to $13.4 million. In addition, our available for sale investment and
mortgage-backed securities amounted to an aggregate of $43.4 million at
September 30, 2006.
We use our liquidity to fund existing and future loan commitments, to
fund maturing certificates of deposit and demand deposit withdrawals, to invest
in other interest-earning assets, and to meet operating expenses. At September
30, 2006, we had certificates of deposit maturing within the next 12 months
amounting to $124.4 million. Based upon historical experience, we anticipate
that a significant portion of the maturing certificates of deposit will be
redeposited with us.
In addition to cash flow from loan and securities payments and
prepayments as well as from sales of available for sale securities, we have
significant borrowing capacity available to fund liquidity needs should the need
arise. Our borrowings consist solely of advances from the Federal Home Loan Bank
of Pittsburgh, of which we are a member. Under terms of the collateral agreement
with the Federal Home Loan Bank, we pledge residential mortgage loans and
mortgage-backed securities as well as our stock in the Federal Home Loan Bank as
collateral for such advances. At September 30, 2006, we had $31.8 million in
outstanding FHLB advances and we had $128.0 million in additional FHLB advances
available to us.
We anticipate that we will continue to have sufficient funds and
alternative funding sources to meet our current commitments.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements, accompanying notes, and related
financial data of Prudential Bancorp presented in Item 8. Financial Statements
and Supplementary Data in Part II of this Annual Report on Form 10-K have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in purchasing power of money
over time due to inflation. The impact of inflation is reflected in the
increased cost of operations. Most of our assets and liabilities are monetary in
nature; therefore, the impact of interest rates has a greater impact on its
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HOW WE MANAGE MARKET RISK. Market risk is the risk of loss from
adverse changes in market prices and rates. Our market risk arises primarily
from the interest rate risk which is inherent in our lending, investment and
deposit gathering activities. To that end, management actively monitors and
manages interest rate risk exposure. In addition to market risk, our primary
risk is credit risk on our loan portfolio. We attempt to manage credit risk
through our loan underwriting and oversight policies.
53
The principal objective of our interest rate risk management function
is to evaluate the interest rate risk embedded in certain balance sheet
accounts, determine the level of risk appropriate given our business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. We seek to
manage our exposure to risks from changes in interest rates while at the same
time trying to improve our net interest spread. We monitor interest rate risk as
such risk relates to our operating strategies. We have established an
Asset/Liability Committee which is comprised of our President and Chief
Executive Officer, Chief Financial Officer, Chief Lending Officer, Treasurer and
Controller. The Asset/Liability Committee meets on a regular basis and is
responsible for reviewing our asset/liability policies and interest rate risk
position. Both the extent and direction of shifts in interest rates are
uncertainties that could have a negative impact on future earnings.
In recent years, we primarily have utilized the following strategies
in our efforts to manage interest rate risk:
o we have increased our originations of shorter term loans and/or
loans with adjustable rates of interest, particularly
construction and land development loans;
o we have invested in securities with "step-up" rate features
providing for increased interest rates prior to maturity
according to a pre-determined schedule and formula; and
o we have maintained moderate levels of short-term liquid assets.
However, notwithstanding the foregoing strategies, we remain subject
to a significant level of interest rate risk in a rising rate environment due to
the high proportion of our loan portfolio that consists of fixed-rate loans as
well as our decision to invest a significant amount of our assets in long-term,
fixed-rate investment and mortgage-backed securities designated as held to
maturity. In addition, our interest rate spread and margin have been adversely
affected due to the tightening of the yield curve. Likewise, our unwillingness
to originate long-term, fixed-rate residential mortgage loans at low rates has
resulted in borrowers in many cases refinancing loans elsewhere, requiring us to
reinvest the resulting proceeds from the loan payoffs at low current market
rates of interest. Thus, both of these strategies have increased our interest
rate risk.
GAP ANALYSIS. The matching of assets and liabilities may be analyzed
by examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring the Bank's interest rate sensitivity "gap." An
asset and liability is said to be interest rate sensitive within a specific time
period if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of rising interest rates, a negative gap would tend to affect adversely
net interest income while a positive gap would tend to result in an increase in
net interest income. Conversely, during a period of falling interest rates, a
negative gap would tend to result in an increase in net interest income while a
positive gap would tend to affect adversely net interest income.
The table on the next page sets forth the amounts of our
interest-earning assets and interest-bearing liabilities outstanding at
September 30, 2006, which we expect, based upon certain assumptions, to reprice
or mature in each of the future time periods shown (the "GAP Table"). Except as
stated below, the amounts of assets and liabilities shown which reprice or
mature during a particular period were
54
determined in accordance with the earlier of term to repricing or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at September
30, 2006, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within a three-month period and subsequent selected
time intervals. The loan amounts in the table reflect principal balances
expected to be redeployed and/or repriced as a result of contractual
amortization and anticipated prepayments of adjustable-rate loans and fixed-rate
loans, and as a result of contractual rate adjustments on adjustable-rate loans.
Annual prepayment rates for adjustable-rate and fixed-rate single-family and
multi-family residential and commercial mortgage loans are assumed to range from
7.9% to 25.2%. The annual prepayment rate for mortgage-backed securities is
assumed to range from 7.0% to 20.6%. Money market deposit accounts, savings
accounts and interest-bearing checking accounts are assumed to have annual rates
of withdrawal, or "decay rates," based on information from the Federal Deposit
Insurance Corporation. For savings accounts and checking accounts, the decay
rates are 60% in one to three years, 20% in three to five years and 20% in five
to 10 years. For money market accounts, the decay rates are 50% in three to 12
months and 50% in 13 to 36 months.
55
More Than More Than More Than
3 Months 3 Months 1 Year 3 Years More Than
Or Less To 1 Year To 3 Years To 5 Years 5 Years Total Amount
-------- --------- ---------- ---------- -------- ------------
(Dollars in Thousands)
Interest-earning assets(1):
Investment securities $ 20,234 $ 24,964 $ 22,087 $ 18,090 $ 84,717 $170,092
Mortgage-backed securities 1,541 4,167 6,414 10,031 32,741 54,894
Loans receivable(2) 61,473 25,730 43,390 29,214 60,229 220,036
Other interest-earning assets(3) 9,902 -- -- -- -- 9,902
-------- -------- -------- -------- -------- --------
Total interest-earning
assets $ 93,150 $ 54,861 $ 71,891 $ 57,335 $177,687 $454,924
======== ======== ======== ======== ======== ========
Interest-bearing liabilities:
Savings accounts $ 772 $ 116 $ 45,592 $ 15,197 $ 15,197 $ 76,874
Checking accounts/money
market -- 32,249 49,217 5,657 5,657 92,780
Certificate accounts 32,055 92,344 32,197 15,006 -- 171,602
FHLB advances 18,000 -- -- 13,000 784 31,784
Real estate tax escrow accounts -- -- -- -- 1,230 1,230
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities $ 50,827 $124,709 $127,006 $ 48,860 $ 22,868 $374,270
======== ======== ======== ======== ======== ========
Interest-earning assets
less interest-bearing
liabilities $ 42,323 $(69,848) $(55,115) $ 8,475 $154,819 $ 80,654
======== ======== ======== ======== ======== ========
Cumulative interest-rate
sensitivity gap(4) $ 42,323 $(27,525) $(82,640) $(74,165) $ 80,654
======== ======== ======== ======== ========
Cumulative interest-rate
gap as a percentage of total
assets at September 30, 2006 8.96% (5.83)% (17.49)% (15.70)% 17.07%
======== ======== ======== ======== ========
Cumulative interest-
earning assets as a
percentage of cumulative
interest-bearing
liabilities at September 30, 2006 183.27% 84.32% 72.68% 78.89% 121.55%
======== ======== ======== ======== ========
----------
(1) Interest-earning assets are included in the period in which the balances
are expected to be redeployed and/or repriced as a result of anticipated
prepayments, scheduled rate adjustments and contractual maturities.
(2) For purposes of the gap analysis, loans receivable includes non-performing
loans gross of the allowance for loan losses, undisbursed loan funds,
unamortized discounts and deferred loan fees.
(3) Includes FHLB stock.
(4) Interest-rate sensitivity gap represents the difference between net
interest-earning assets and interest-bearing liabilities.
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates both on a short-term basis and
over the life of the asset. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Finally, the ability of many borrowers
to service their adjustable-rate loans may decrease in the event of an interest
rate increase.
NET PORTFOLIO VALUE ANALYSIS. Our interest rate sensitivity also is
monitored by management through the use of a model which generates estimates of
the changes in our net portfolio value ("NPV") over a range of interest rate
scenarios. NPV is the present value of expected cash flows from assets,
56
liabilities and off-balance sheet contracts. The NPV ratio, under any interest
rate scenario, is defined as the NPV in that scenario divided by the market
value of assets in the same scenario. The following table sets forth our NPV as
of September 30, 2006 and reflects the changes to NPV as a result of immediate
and sustained changes in interest rates as indicated.
NPV As % Of
Change In Portfolio
Interest Rates Net Portfolio Value Value Of Assets
In Basis Points ------------------------------ -----------------
(Rate Shock) Amount $ Change % Change NPV Ratio Change
--------------- -------- -------- -------- --------- ------
(Dollars in Thousands)
300bp $ 61,093 $(33,398) (35.35)% 14.61% (5.67)%
200 71,385 (23,106) (24.45) 16.48 (3.80)
100 82,668 (11,823) (12.51) 18.40 (1.88)
Static 94,491 -- -- 20.28 --
(100) 100,191 5,700 6.03 21.01 0.73
(200) 97,849 3,358 3.55 20.40 0.12
(300) 95,322 831 0.88 19.75 (0.53)
As is the case with the GAP Table, certain shortcomings are inherent
in the methodology used in the above interest rate risk measurements. Modeling
changes in NPV require the making of certain assumptions which may or may not
reflect the manner in which actual yields and costs respond to changes in market
interest rates. In this regard, the models presented assume that the composition
of our interest sensitive assets and liabilities existing at the beginning of a
period remains constant over the period being measured and also assumes that a
particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV model provides an indication of
interest rate risk exposure at a particular point in time, such model is not
intended to and does not provide a precise forecast of the effect of changes in
market interest rates on net interest income and will differ from actual
results.
57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders' of
Prudential Bancorp, Inc. of Pennsylvania and subsidiary
Philadelphia, Pennsylvania
We have audited the accompanying consolidated statements of financial condition
of Prudential Bancorp, Inc. of Pennsylvania and subsidiary (the "Company") as of
September 30, 2006 and 2005, and the related consolidated statements of income,
stockholders' equity and comprehensive income, and cash flows for each of the
three years in the period ended September 30, 2006. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Prudential Bancorp, Inc. of
Pennsylvania and subsidiary as of September 30, 2006 and 2005, and the results
of their operations and their cash flows for each of the three years in the
period ended September 30, 2006, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
December 20, 2006
58
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
--------------------------------------------------------------------------------
September 30,
---------------------------
2006 2005
------------ ------------
ASSETS
Cash and amounts due from depository institutions $ 5,742,356 $ 5,874,475
Interest-bearing deposits 7,685,180 20,940,542
------------ ------------
Total cash and cash equivalents 13,427,536 26,815,017
Investment securities held to maturity (estimated fair value--
September 30, 2006, $129,593,126; September 30, 2005, $128,046,676) 132,083,883 129,839,512
Investment securities available for sale (amortized cost--
September 30, 2006, $38,007,246; September 30, 2005, $38,007,143) 38,747,089 38,584,474
Mortgage-backed securities held to maturity (estimated fair value--
September 30, 2006, $49,526,374; September 30, 2005, $67,123,459) 50,359,734 66,827,615
Mortgage-backed securities available for sale (amortized cost--
September 30, 2006, $4,534,743) 4,615,307 --
Loans receivable--net of allowance for loan losses (September 30, 2006, $617,956;
September 30, 2005, $557,956) 219,417,531 175,090,988
Accrued interest receivable:
Loans receivable 1,251,172 925,618
Mortgage-backed securities 236,404 290,650
Investment securities 1,707,547 1,583,442
Real estate owned -- 360,284
Federal Home Loan Bank stock--at cost 2,217,100 1,811,500
Office properties and equipment--net 1,721,138 1,746,599
Prepaid expenses and other assets 6,596,897 2,658,636
Deferred income taxes, net -- 57,628
------------ ------------
TOTAL ASSETS $472,381,338 $446,591,963
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing $ 6,035,712 $ 3,440,681
Interest-bearing 341,256,779 333,027,159
------------ ------------
Total deposits 347,292,491 336,467,840
Advances from Federal Home Loan Bank 31,783,751 13,823,411
Accrued interest payable 2,892,319 1,924,883
Advances from borrowers for taxes and insurance 1,230,216 1,113,835
Accounts payable and accrued expenses 1,117,053 1,954,890
Accrued dividend payable 464,481 481,806
Deferred income taxes, net 153,387 --
------------ ------------
Total liabilities 384,933,698 355,766,665
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 13)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01par value, 10,000,000 shares authorized; none issued -- --
Common stock, $.01 par value, 40,000,000 shares authorized; issued 12,563,750;
outstanding - 12,064,320 at September 30, 2006: 12,497,450 at September 30, 2005 125,638 125,638
Additional paid-in capital 54,798,121 54,733,760
Unearned ESOP shares (4,126,501) (4,349,611)
Treasury stock, at cost: 499,430 shares at September 30, 2006;
66,300 shares at September 30, 2005 (6,422,478) (654,415)
Retained earnings 42,538,790 40,594,661
Accumulated other comprehensive income 534,070 375,265
------------ ------------
Total stockholders' equity 87,447,640 90,825,298
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $472,381,338 $446,591,963
============ ============
See notes to consolidated financial statements.
59
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Years Ended September 30,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
INTEREST INCOME:
Interest and fees on loans $13,077,080 $ 9,884,634 $ 8,583,749
Interest on mortgage-backed securities 3,146,953 3,782,535 4,474,936
Interest and dividends on investments 8,318,281 7,410,044 6,454,327
----------- ----------- -----------
Total interest income 24,542,314 21,077,213 19,513,012
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 10,843,080 8,522,472 8,204,756
Interest on borrowings 1,091,896 774,677 797,208
----------- ----------- -----------
Total interest expense 11,934,976 9,297,149 9,001,964
----------- ----------- -----------
NET INTEREST INCOME 12,607,338 11,780,064 10,511,048
PROVISION FOR LOAN LOSSES 60,000 -- 50,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 12,547,338 11,780,064 10,461,048
----------- ----------- -----------
NON-INTEREST INCOME:
Fees and other service charges 549,369 470,386 487,612
Gain on sale of real estate owned 105,673 -- --
Gain on sale of mortgage-backed securities 47,632 -- --
Other 235,045 97,034 93,385
----------- ----------- -----------
Total non-interest income 937,719 567,420 580,997
----------- ----------- -----------
NON-INTEREST EXPENSES:
Salaries and employee benefits 4,465,450 4,060,405 4,296,623
Data processing 468,411 476,708 423,513
Professional services 600,187 353,514 160,210
Office occupancy 327,646 305,853 305,025
Depreciation 242,452 261,055 270,462
Payroll taxes 256,188 235,777 221,103
Director compensation 259,925 257,398 180,552
Litigation expense -- 120,000 254,013
Other 1,254,819 998,768 1,211,130
----------- ----------- -----------
Total non-interest expenses 7,875,078 7,069,478 7,322,631
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 5,609,979 5,278,006 3,719,414
----------- ----------- -----------
INCOME TAXES:
Current 1,646,330 1,734,209 957,224
Deferred 126,744 152,222 289,227
----------- ----------- -----------
Total 1,773,074 1,886,431 1,246,451
----------- ----------- -----------
NET INCOME $ 3,836,905 $ 3,391,575 $ 2,472,963
=========== =========== ===========
BASIC EARNINGS PER SHARE (1) (2) $ 0.32 $ 0.15 N/A
DILUTED EARNINGS PER SHARE (1) (2) $ 0.32 $ 0.15 N/A
----------
(1) No shares of common stock were outstanding for the 2004 period.
(2) Due to the timing of the Bank's reorganization into the mutual holding
company form and the completion of the Company's initial public offering on
March 29, 2005, earnings per share information for 2005 are for the period March
30, 2005 through September 30, 2005.
See notes to consolidated financial statements.
60
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME
--------------------------------------------------------------------------------
AdditinalL Unearned
Common Paid-In ESOP Treasury
Stock Capital Shares Stock
-------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 2003 $ -- $ -- $ -- $ --
Comprehensive income:
Net income
Net unrealized holding gain on
available for sale securities
arising during the period, net
of income tax expense of $41,712
Comprehensive income
-------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 2004 -- -- -- --
Comprehensive income:
Net income
Net unrealized holding loss on
available for sale securities
arising during the period, net
of income tax benefit of $245,847
Comprehensive income
Capitalization of mutual
holding company
Cash dividends
Issuance of common stock 125,638 54,724,693
Treasury stock purchased (654,415)
Purchase of ESOP shares (4,461,166)
ESOP shares committed to
be released 9,067 111,555
-------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 2005 $125,638 $54,733,760 $(4,349,611) $ (654,415)
======== =========== =========== ===========
Comprehensive income:
Net income
Net unrealized holding gain on
available for sale securities
arising during the period, net
of income tax expense of $84,271
Comprehensive income
Cash dividends
Treasury stock purchased (5,768,063)
ESOP shares committed to
be released 64,361 223,110
-------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 2006 $125,638 $54,798,121 $(4,126,501) $(6,422,478)
======== =========== =========== ===========
Accumulated
Other Total
Retained Comprehensive Stockholders' Comprehensive
EarningS Income (Loss) Equity Income
----------- ------------- ------------- -------------
BALANCE, SEPTEMBER 30, 2003 $35,793,735 $ 754,373 $36,548,108
Comprehensive income:
Net income 2,472,963 2,472,963 2,472,963
Net unrealized holding gain on
available for sale securities
arising during the period, net
of income tax expense of $41,712 77,466 77,466 77,466
----------
Comprehensive income $2,550,429
----------- --------- ----------- ==========
BALANCE, SEPTEMBER 30, 2004 38,266,698 831,839 39,098,537
Comprehensive income:
Net income 3,391,575 3,391,575 3,391,575
Net unrealized holding loss on
available for sale securities
arising during the period, net
of income tax benefit of $245,847 (456,574) (456,574) (456,574)
----------
Comprehensive income $2,935,001
==========
Capitalization of mutual
holding company (100,000) (100,000)
Cash dividends (963,612) (963,612)
Issuance of common stock 54,850,331
Treasury stock purchased (654,415)
Purchase of ESOP shares (4,461,166)
ESOP shares committed to
be released 120,622
----------- --------- -----------
BALANCE, SEPTEMBER 30, 2005 $40,594,661 $ 375,265 $90,825,298
=========== ========= ===========
Comprehensive income:
Net income 3,836,905 3,836,905 3,836,905
Net unrealized holding gain on
available for sale securities
arising during the period, net
of income tax expense of $84,271 158,805 158,805 158,805
----------
Comprehensive income $3,995,710
==========
Cash dividends (1,892,776) (1,892,776)
Treasury stock purchased (5,768,063)
ESOP shares committed to
be released 287,471
----------- --------- -----------
BALANCE, SEPTEMBER 30, 2006 $42,538,790 $534,070 $87,447,640
=========== ========= ===========
See notes to consolidated financial statements.
61
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARY
STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Years Ended September 30,
------------------------------------------
2006 2005 2004
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income $ 3,836,905 $ 3,391,575 $ 2,472,963
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 60,000 -- 50,000
Depreciation 242,252 261,055 270,462
Net gain on sale of real estate owned (105,673) -- --
Net gain on sale of mortgage-backed securities held to maturity (47,632) -- --
Net accretion of premiums/discounts (48,821) (66,255) (44,216)
Income from bank owned life insurance (165,594) -- --
Amortization of deferred loan fees (333,651) (254,111) (253,048)
Amortization of ESOP 287,471 120,622 --
Deferred income tax expense 126,744 152,222 289,227
Changes in assets and liabilities which (used) provided cash:
Accounts payable and accrued expenses (837,837) 335,152 (35,061)
Accrued interest payable 967,436 73,644 (105,467)
Prepaid expenses and other assets (3,772,664) (801,485) (152,871)
Accrued interest receivable (395,413) (152,043) (247,972)
------------ ------------ ------------
Net cash (used in) provided by operating activities (186,477) 3,060,376 2,244,017
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchase of investment securities held to maturity (6,226,562) (46,265,260) (45,977,394)
Purchase of investment securities available for sale -- -- (2,000,000)
Purchase of mortgage-backed securities held to maturity -- (4,481,237) (21,770,915)
Purchase of mortgage-backed available for sale (4,610,148) -- --
Principal collected on loans 47,942,831 53,454,853 54,901,705
Principal payments received on mortgage-backed securities:
Held-to-maturity 11,933,713 18,615,442 23,422,075
Available for sale 76,540 -- --
Loans originated or acquired (91,995,723) (76,727,037) (68,259,000)
Proceeds from call/maturity or sale of investment securities:
Held to maturity 4,000,000 31,268,182 30,180,410
Available for sale -- 1,000,000 5,005,837
Proceeds from sale of mortgage-backed securities 4,611,571 -- --
Purchase of Federal Home Loan Bank stock (405,600) (183,900) (100,500)
Proceeds from redemption of Federal Home Loan Bank stock -- 446,400 245,100
Proceeds from sale of real estate owned 465,957 187,500 --
Purchases of equipment (216,791) (128,287) (305,152)
------------ ------------ ------------
Net cash used in investing activities (34,424,212) (22,813,344) (24,657,834)
------------ ------------ ------------
FINANCING ACTIVITIES:
Net (decrease) increase in demand deposits, NOW accounts,
and savings accounts (16,460,437) (6,058,057) 13,812,596
Net increase (decrease) in certificates of deposit 27,285,088 (6,632,614) (5,430,754)
Net borrowing (repayment) with Federal Home Loan Bank 17,960,340 (38,716) (37,796)
Increase in advances from borrowers for taxes and insurance 116,381 83,667 22,809
Proceeds from the issuance of stock -- 54,850,331 --
Capitalization of mutual holding company -- (100,000) --
Cash dividend paid (1,910,101) (481,806) --
Purchase stock for ESOP -- (4,461,166) --
Purchase of treasury stock (5,768,063) (654,415) --
------------ ------------ ------------
Net cash provided by financing activities 21,223,208 36,507,224 8,366,855
------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (13,387,481) 16,754,256 (14,046,962)
CASH AND CASH EQUIVALENTS--Beginning of year 26,815,017 10,060,761 24,107,723
------------ ------------ ------------
CASH AND CASH EQUIVALENTS--End of year $ 13,427,536 $ 26,815,017 $ 10,060,761
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Interest paid on deposits and advances from Federal
Home Loan Bank $ 10,967,658 $ 9,223,505 $ 9,107,431
============ ============ ============
Income taxes paid $ 1,616,000 $ 1,680,711 $ 1,010,000
============ ============ ============
See notes to consolidated financial statements.
62
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2006, 2005 AND 2004
--------------------------------------------------------------------------------
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Prudential Bancorp, Inc. of Pennsylvania (the "Company") is a Pennsylvania
corporation, which was organized to be the mid-tier holding company for
Prudential Savings Bank (the "Bank"), which is a Pennsylvania-chartered,
FDIC-insured savings bank with six full service branches in the
Philadelphia area. The Company was organized in conjunction with the Bank's
reorganization from a mutual savings bank to the mutual holding company
structure in March 2005. Financial statements prior to the reorganization
were the financial statements of the Bank. The Bank is principally in the
business of attracting deposits from its community through its branch
offices and investing those deposits, together with funds from borrowings
and operations, primarily in single-family residential loans. The Bank's
sole subsidiary as of September 30, 2006 was PSB Delaware, Inc. ("PSB"), a
Delaware-chartered company established to hold certain investments of the
Bank. As of September 30, 2006, PSB has assets of $63.5 million primarily
consisting of mortgage backed securities.
Prudential Mutual Holding Company, a Pennsylvania corporation, is the
mutual holding company parent of the Company. As of September 30, 2006,
Prudential Mutual Holding Company owns 57.3% (6,910,062 shares) of the
Company's outstanding common stock and must always own at least a majority
of the voting stock of the Company. In addition to the shares of the
Company, Prudential Mutual Holding Company was capitalized with $100,000 in
cash from the Bank in connection with the completion of the reorganization.
The consolidated financial statements of the Company include the accounts
of the Company and the Bank. All significant intercompany balances and
transactions have been eliminated.
Prior to the reorganization described above, the Board of Directors
approved a plan of charter conversion in May 2004 pursuant to which the
Bank would convert its charter from a Pennsylvania-chartered mutual savings
and loan association to a Pennsylvania-chartered mutual savings bank. Such
conversion was subject to receipt of both member and regulatory approval.
The members of the Bank approved the plan of conversion at a special
meeting held on July 20, 2004 and the Pennsylvania Department of Banking
approved the Bank's application to convert its charter on July 21, 2004.
The conversion to a Pennsylvania-chartered mutual savings bank was
completed on August 20, 2004. As a result of the charter conversion, the
Bank's primary federal banking regulator changed from the Office of Thrift
Supervision to the Federal Deposit Insurance Corporation. The Pennsylvania
Department of Banking remains as the Bank's state banking regulator.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION -The accompanying consolidated financial statements include
the accounts of the Company and the Bank. All significant intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS--The
preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts
63
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of income and expenses during the reporting period. The most
significant estimates and assumptions in the Company's financial statements
are recorded in the allowance for loan losses and deferred income taxes.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS--For purposes of reporting cash flows, cash and
cash equivalents include cash and amounts due from depository institutions
and interest-bearing deposits (maturing within 90 days).
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES--The Bank classifies
and accounts for debt and equity securities as follows:
HELD TO MATURITY--Debt securities that management has the positive intent
and ability to hold until maturity are classified as held to maturity and
are carried at their remaining unpaid principal balance, net of unamortized
premiums or unaccreted discounts. Premiums are amortized and discounts are
accreted using the interest method over the estimated remaining term of the
underlying security.
AVAILABLE FOR SALE--Debt and equity securities that will be held for
indefinite periods of time, including securities that may be sold in
response to changes in market interest or prepayment rates, needs for
liquidity, and changes in the availability of and the yield of alternative
investments, are classified as available for sale. These assets are carried
at fair value. Fair value is determined using published and brokers' quotes
as of the close of business at the period-ends presented. Unrealized gains
and losses are excluded from earnings and are reported net of tax as a
separate component of stockholders' equity until realized. Realized gains
or losses on the sale of investment and mortgage-backed securities are
reported in earnings as of the trade date and determined using the adjusted
cost of the specific security sold.
LOANS RECEIVABLE--Mortgage loans consist of loans secured primarily by
first liens on 1-4 family residential properties and are stated at their
unpaid principal balances net of unamortized net fees/costs. Other loans
consist of residential construction loans, consumer loans, commercial real
estate loans, commercial business loans, and loans secured by savings
accounts which are likewise stated at their unpaid principal balances net
of unamortized net fees/costs. Generally, the intent of management is to
hold loans originated and purchased to maturity. The Bank defers all loan
fees, net of certain direct loan origination costs. The balance is accreted
into interest income as a yield adjustment over the life of the loan using
the interest method.
ALLOWANCE FOR LOAN LOSSES--The allowance for loan losses is increased by
charges to income and decreased by charge-offs (net of recoveries).
Management's periodic evaluation of the adequacy of the allowance is based
on the Bank's past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect a borrower's ability to
repay, the estimated value of any underlying collateral and current
economic conditions.
The allowance consists of specific and general components. The specific
component relates to loans that are classified as either doubtful,
substandard or special mention. The general component covers nonclassified
loans and is based on historical loss experience adjusted for qualitative
factors.
A loan is considered to be impaired when, based upon current information
and events, it is probable that the Bank will be unable to collect all
amounts due according to the contractual terms of the loan. The Bank
measures impaired loans based on the present value of expected future cash
flows
64
discounted at the loan's effective interest rate, or the loan's observable
market price, or the fair value of the collateral if the loan is
collateral-dependent. Impairment losses are included in the provision for
loan losses.
MORTGAGE SERVICING RIGHTS--The Bank originates mortgage loans held for
investment and held for sale. At origination, the mortgage loan is
identified as either held for sale or for investment. Mortgage loans held
for sale are carried at the lower of cost or the value of forward committed
contracts (which approximates market), determined on a net aggregate basis.
The Bank had no loans classified as held for sale at September 30, 2006 and
2005.
The Bank assesses the retained interest in the servicing asset or liability
associated with the sold loans based on the relative fair values. The
servicing asset or liability is amortized in proportion to and over the
period during which estimated net servicing income or net servicing loss,
as appropriate, will be received. Assessment of the fair value of the
retained interest is performed on a continual basis. At September 30, 2006
and 2005, mortgage servicing rights of $28,689 and $35,230, respectively,
were included in other assets. No valuation allowance was deemed necessary
at the periods presented.
Amortization of the servicing asset totaled $6,541, $7,508, and $8,979 for
the years ended September 2006, 2005 and 2004, respectively.
UNAMORTIZED PREMIUMS AND DISCOUNTS--Unamortized premiums and discounts on
loans receivable, mortgage-backed securities, and investment securities are
amortized over the estimated average lives of the loans, certificates or
securities purchased using a method which approximates the interest method.
REAL ESTATE OWNED--Real estate acquired through, or in lieu of, loan
foreclosure is initially recorded at the lower of book value or the
estimated fair value at the date of acquisition, less estimated selling
costs, establishing a new cost basis. Revenues and expenses from operations
are included in other expense. Additions to the valuation allowance are
included in other expense. Costs related to the development and improvement
of real estate owned properties are capitalized and those relating to
holding the properties are charged to expense. After foreclosure,
valuations are periodically performed by management and an allowance for
losses is established, if necessary, by a charge to operations if the
carrying value of a property exceeds its estimated fair value minus
estimated costs to sell.
FHLB STOCK - FHLB stock is classified as a restricted equity security
because ownership is restricted and there is not an established market for
its resale. FHLB stock is carried at cost and is evaluated for impairment.
OFFICE PROPERTIES AND EQUIPMENT--Land is carried at cost. Office properties
and equipment are recorded at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the expected
useful lives of the assets. The costs of maintenance and repairs are
expensed as they are incurred, and renewals and betterments are capitalized
and depreciated over their useful lives.
65
CASH SURRENDER VALUE OF LIFE INSURANCE--The Bank funds the premiums for
insurance policies on the lives of certain directors of the Bank. The cash
surrender value of the insurance policies, up to the total amount of
premiums paid, is recorded as an asset in the statements of financial
condition and included in other assets. In fiscal 2006, the Company
purchased $5.0 million of bank owned life insurance ("BOLI"). The BOLI
provides an attractive tax-exempt return to the Company and is being used
by the Company to fund various employee benefit plans. The BOLI is included
in other assets at its cash surrender value.
DIVIDEND PAYABLE - On September 20, 2006, the Company's Board of Directors
declared a quarterly cash dividend of $.04 per share on the common stock of
the Company payable on October 31, 2006 to the shareholders of record at
the close of business on October 13, 2006. The Company had 12,064,320
shares outstanding at the time of the dividend declaration resulting in a
payable of $464,481 at September 30, 2006. A portion of the cash dividend
was payable to Prudential Mutual Holding Company on its shares of the
Company's common stock and totaled $276,402.
EMPLOYEE STOCK OWNERSHIP PLAN - In fiscal year 2005, the Bank established
an employee stock ownership plan ("ESOP") for substantially all of its
full-time employees. The ESOP purchased 452,295 shares of the Company's
common stock on the open market for approximately $4.5 million. The Bank
accounts for its ESOP in accordance with Statement of Position ("SOP")
93-6, EMPLOYERS' ACCOUNTING FOR EMPLOYEE STOCK OWNERSHIP PLANS. Shares of
the Company's common stock purchased by the ESOP are held in a suspense
account until released for allocation to participants. Shares released will
be allocated to each eligible participant based on the ratio of each such
participant's compensation, as defined in the ESOP, to the total
compensation of all eligible plan participants. As the unearned shares are
released from suspense, the Company recognizes compensation expense equal
to the fair value of the ESOP shares during the periods in which they
become committed to be released. To the extent that the fair value of the
ESOP shares released differs from the cost of such shares, the difference
is recorded to equity as additional paid-in capital. As of September 30,
2006 the Company had allocated a total of 16,965 shares from the suspense
account to participants and committed to release an additional 16,965
shares. For the year ended September 30, 2006, the Company recognized
$287,471 in compensation expense related to the ESOP.
TREASURY STOCK - Stock held in treasury by the Company is accounted for
using the cost method, which treats stock held in treasury as a reduction
to total stockholders' equity. In April 2006, the Company announced the
commencement of its second stock repurchase program of up to an additional
269,000 shares or approximately 5% of the Company's outstanding common
stock held by other than Prudential Mutual Holding Company. The Company's
second repurchase program commenced upon completion of its first repurchase
program covering 277,000 shares. The average cost per share of the 499,430
shares which had been repurchased was $13.32 and $9.87 per share during
fiscal 2006 and 2005, respectively. The repurchased shares are available
for general corporate purposes.
COMPREHENSIVE INCOME--The Company presents in the statement of
comprehensive income those amounts from transactions and other events which
currently are excluded from the statement of income and are recorded
directly to stockholders' equity. For the years ended September 30, 2006,
2005 and 2004, the only components of comprehensive income were net income
and unrealized holding gains and losses, net of income tax expense and
benefit, on available for sale securities. Comprehensive income totaled
$3,995,710, $2,935,001 and $2,550,429 for the years ended September 30,
2006, 2005 and 2004, respectively.
66
LOAN ORIGINATION AND COMMITMENT FEES--The Bank defers loan origination and
commitment fees, net of certain direct loan origination costs. The balance
is accreted into income as a yield adjustment over the life of the loan
using the level-yield method.
INTEREST ON LOANS--The Bank recognizes interest on loans on the accrual
basis. Income recognition is generally discontinued when a loan becomes 90
days or more delinquent. Any interest previously accrued is deducted from
interest income. Such interest ultimately collected is credited to income
when collection of principal and interest is no longer in doubt.
INCOME TAXES--Deferred income taxes are recognized for the tax consequences
of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities. The
effect on deferred taxes of a change in tax rates is recognized in income
in the period that includes the enactment date.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES--The Company
adopted the provisions of Statement of Financial Accounting Standards
("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, as amended by SFAS Nos. 137 and 138, and as interpreted by the
FASB and the Derivatives Implementation Group through "Statement 133
Implementation Issues," as of October 1, 2000. Currently, the Company has
no instruments with embedded derivatives. The Company currently does not
employ hedging activities that require designation as either fair value or
cash flow hedges, or hedges of a net investment in a foreign operation.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES--The Company accounts for transfers and servicing of financial
assets in accordance with SFAS No. 140, ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES (a
replacement of SFAS No. 125). This statement revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but it carries over most of
the provisions of SFAS No. 125 without reconsideration. The statement
requires an entity to recognize the financial and servicing assets it
controls and the liabilities it has incurred, derecognize financial assets
when control has been surrendered, and derecognize liabilities when
extinguished. It requires that servicing assets and other retained
interests in the transferred assets be measured by allocating the previous
carrying amount between the asset sold, if any, and retained interests, if
any, based on their relative fair values at the date of transfer.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF
FINANCIAL ASSETS- AN AMENDMENT OF FASB STATEMENT NO. 140 ("SFAS No. 140"
and "SFAS No. 156"). SFAS No. 140 establishes, among other things, the
accounting for all separately recognized servicing assets and servicing
liabilities. SFAS No. 156 amends SFAS No. 140 to require that all
separately recognized servicing assets and servicing liabilities be
initially measured at fair value, if practicable. SFAS No. 156 permits, but
does not require, the subsequent measurement of separately recognized
servicing assets and servicing liabilities at fair value. Under SFAS No.
156, an entity can elect subsequent fair value measurement to account for
its separately recognized servicing assets and servicing liabilities.
Adoption of SFAS No. 156 is required as of the beginning of the first
fiscal year that begins after September 15, 2006. Upon adoption, the
Company will apply the requirements for recognition and initial measurement
of servicing assets and servicing liabilities prospectively to all
transactions. The Company will adopt SFAS No. 156 for the fiscal year
beginning October 1, 2006 and currently has not determined if it will adopt
SFAS No. 156 using the fair value election. The Company does not
67
anticipate any material impact to its financial condition or results of
operations as a result of the adoption of SFAS No. 156.
On July 13, 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN 48"), which is effective for fiscal
years beginning after December 15, 2006. FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in the financial statements in
accordance with FASB Statement No. 109, "Accounting for Income Taxes." This
Interpretation prescribes a comprehensive model for how a company should
recognize, measure, present and disclose in its financial statements
uncertain tax positions that the company has taken or expects to take on a
tax return. The Company is currently assessing the impact of FIN 48 on its
financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurement."
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures
about fair value measurements. This Statement does not require any new fair
value measurements. SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007 and interim periods within those fiscal years. The
Company is currently assessing the impact of SFAS No. 157 on its financial
statements.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 158, "Employer's Accounting for Defined Benefit Pension and Other
Postretirement Plans--an amendment of FASB Statements No. 87, 88, 106, and
132(R)." SFAS No. 158 requires an employer to recognize in its statement of
financial position an asset for a plan's overfunded status or a liability
for a plan's underfunded status, measure a plan's assets and its
obligations that determine its funded status as of the end of the
employer's fiscal year, and recognize changes in the funded status of a
defined benefit postretirement plan in the year in which the changes occur.
Those changes will be reported in comprehensive income and as a separate
component of stockholders' equity. SFAS No. 158 is effective for publicly
held companies for fiscal years ending after December 15, 2006. The Bank
participates in a muti-employer defined benefit plan. We do not anticipate
that the implementation of SFAS No. 158 will have any impact on our
financial position, results of operations and cash flows because it is not
applicable to muti-employer defined benefit plans.
In February 2006, the FASB issued SFAS No. 155, "Accounting For Certain
Hybrid Financial Instruments." This statement amends FASB Statements No.
133, "Accounting For Derivative Instruments and Hedging Activities, and
FASB SFAS No. 140, "Accounting For Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities". FAS 155 permits fair value
re-measurement for any hybrid financial instrument that contains an
embedded derivative that otherwise would require bifurcation, clarifies
which interest-only strips and principal-only strips are not subject to the
requirements of Statement 133, establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation, clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends Statement 140 to eliminate the prohibition on a
qualifying special purpose entity from holding a derivative financial
instrument that pertains to a beneficial interest other than another
derivative financial instrument. FAS 155 is effective for all financial
instruments acquired or issued after the beginning of an entities first
fiscal year that begins after September 15, 2006. The adoption of the
statement did not have a material effect on the financial statements.
In September 2006, the Securities and Exchange Commission ("SEC") issued
SAB No. 108 expressing the SEC staff's views regarding the process of
quantifying financial statement misstatements and the build up of improper
amounts on the balance sheet. SAB 108 requires that
68
registrants quantify errors using both a balance sheet and income statement
approach and evaluate whether either approach results in a misstated amount
that, when all relevant quantitative and qualitative factors are
considered, is material. The built up misstatements, while not considered
material in the individual years in which the misstatements were built up,
may be considered material in a subsequent year if a company were to
correct those misstatements through current period earnings. Initial
application of SAB No. 108 allows registrants to elect not to restate prior
periods but to reflect the initial application in their annual financial
statements covering the first fiscal year ending after November 15, 2006.
The cumulative effect of the initial application should be reported in the
carrying amounts of assets and liabilities as of the beginning of that
fiscal year and the offsetting adjustment, net of tax, should be made to
the opening balance of retained earnings for that year.
The Company implemented SAB 108 on October 1, 2006 which resulted in an
increase to Mortgage-backed securities held to maturity of approximately
$320,000, an increase in deferred income tax liability of approximately
$142,000 and a cumulative adjustment to increase beginning Retained
Earnings of approximately $178,000. The adjustment relates to two separate
accounting entries. The first entry pertains to the method of accounting
that was utilized in past years for the recognition of investment income on
Mortgage-backed securities. Prior to 2006, the Company used the straight
line method over the contractual life of the securities rather than using
the effective yield method prescribed by SFAS No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases. The impact of this entry was the
correction of an understatement of Mortgage-backed securities by
approximately $320,000 and deferred income tax liability of $102,000. The
second entry relates to a write off of a deferred tax asset of
approximately $40,000 that was incorrectly accounted for in prior periods.
In prior periods, management performed a quantitative and qualitative
analysis of the differences between these two methods of accounting and
concluded that there was not a material impact on any past individual
quarter or annual reporting periods.
RECLASSIFICATIONS--Certain reclassifications have been made to the 2005 and
2004 financial statements to conform to the 2006 presentation. Such
reclassifications had no impact on reported net income.
69
3. EARNINGS PER SHARE
Basic earnings per common share is computed based on the weighted average
number of shares outstanding. Diluted earnings per share is computed based
on the weighted average number of shares outstanding and common share
equivalents ("CSEs") that would arise from the exercise of dilutive
securities. As of September 30, 2006, the Company did not issue and does
not have outstanding any CSEs. Due to the timing of the Bank's
reorganization into the mutual holding company form and the completion of
the Company's initial public offering on March 29, 2005, earnings per share
for 2005 is for the period March 30, 2005 through September 30, 2005.
The calculated basic and diluted earnings per share are as follows:
For The Year Ended For The Period March 30,
September 30, 2006 2005 To September 30, 2005
------------------------- -------------------------
Basic Diluted Basic Diluted
----------- ----------- ----------- -----------
Net income $ 3,836,905 $ 3,836,905 $ 1,800,242 $ 1,800,242
Weighted average shares outstanding used in
basic earnings per share computation 11,919,101 11,919,101 12,076,315 12,076,315
Effect of CSEs -- -- -- --
----------- ----------- ----------- -----------
Adjusted weighted average shares used in
diluted earnings per share computation 11,919,101 11,919,101 12,076,315 12,076,315
----------- ----------- ----------- -----------
Earnings per share - basic and diluted $ 0.32 $ 0.32 $ 0.15 $ 0.15
=========== =========== =========== ===========
70
4. INVESTMENT SECURITIES
The amortized cost and fair value of securities, with gross unrealized
gains and losses, are as follows:
September 30, 2006
------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ---------- ----------- ------------
Securities Held to Maturity:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies $129,199,382 $ -- $(2,458,930) $126,740,452
Debt securities - Municipal bonds 2,884,501 6,574 (38,401) 2,852,674
------------ ---------- ----------- ------------
Total securities held to maturity $132,083,883 $ 6,574 $(2,497,331) $129,593,126
============ ========== =========== ============
Securities Available for Sale:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies $ 2,998,800 $ -- $ (64,425) $ 2,934,375
FNMA stock 84 6,625 -- 6,709
Mutual fund 34,982,453 -- (930,081) 34,052,372
FHLMC preferred stock 25,909 1,727,724 -- 1,753,633
------------ ---------- ----------- ------------
Total securities available for sale $ 38,007,246 $1,734,349 $ (994,506) $ 38,747,089
============ ========== =========== ============
SEPTEMBER 30, 2005
------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ----------- ------------
Securities Held to Maturity:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies $126,955,087 $ 8,640 $(1,764,472) $125,199,255
Debt securities - Municipal bonds 2,884,425 6,889 (43,893) 2,847,421
------------ ---------- ----------- ------------
Total securities held to maturity $129,839,512 $ 15,529 $(1,808,365) $128,046,676
============ ========== =========== ============
Securities Available for Sale:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies $ 2,998,697 $ -- $ (34,946) $ 2,963,751
FNMA stock 84 5,294 -- 5,378
Mutual fund 34,982,453 -- (859,797) 34,122,656
FHLMC preferred stock 25,909 1,466,780 -- 1,492,689
------------ ---------- ----------- ------------
Total securities available for sale $ 38,007,143 $1,472,074 $ (894,743) $ 38,584,474
============ ========== =========== ============
71
There were no sales of investment securities during the years ended
September 30, 2006 or September 30, 2005. During the year ended September
30, 2004, the Bank sold $5,837 of available for sale securities, which
yielded no gain or loss.
The following table shows the gross unrealized losses and related estimated
fair values of the Company's investment securities, aggregated by
investment category and length of time that individual securities have been
in a continuous loss position at September 30, 2006:
Less Than 12 Months More Than 12 Months
----------------------- -------------------------
Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ---------- ---------- ------------
Securities held to maturity:
U.S. Treasury and Government agencies $76,277 $8,919,209 $2,382,653 $114,821,242
Municipal bonds -- -- 38,401 1,601,100
------- ---------- ---------- ------------
Total securities held to maturity 76,277 8,919,209 2,421,054 116,422,342
------- ---------- ---------- ------------
Securities available for sale:
U.S. Treasury and Government agencies -- -- 64,425 2,934,375
Mutual fund -- -- 930,081 34,052,372
------- ---------- ---------- ------------
Total securities available for sale -- -- 994,506 36,986,747
------- ---------- ---------- ------------
Total $76,277 $8,919,209 $3,415,560 $153,409,089
======= ========== ========== ============
72
The following table shows the gross unrealized losses and related estimated
fair values of the Company's investment securities, aggregated by
investment category and length of time that individual securities have been
in a continuous loss position at September 30, 2005:
Less Than 12 Months More Than 12 Months
------------------------ ------------------------
Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----------- ---------- -----------
Securities held to maturity:
U.S. Treasury and Government agencies $584,260 $78,824,578 $1,180,212 $42,368,882
Municipal bonds 4,750 470,250 39,143 1,125,283
-------- ----------- ---------- -----------
Total securities held to maturity 589,010 79,294,828 1,219,355 43,494,165
-------- ----------- ---------- -----------
Securities available for sale:
U.S. Treasury and Government agencies 34,946 2,963,750 -- --
Mutual fund -- -- 859,797 34,122,656
-------- ----------- ---------- -----------
Total securities available for sale 34,946 2,963,750 859,797 34,122,656
-------- ----------- ---------- -----------
Total $623,956 $82,258,578 $2,079,152 $77,616,821
======== =========== ========== ===========
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market
concerns warrant such evaluation. For all securities that are in an
unrealized loss position for an extended period of time and for all
securities whose fair value is significantly below amortized cost, the
Company performs an evaluation of the specific events attributable to the
market decline of the security. The Company considers the length of time
and extent to which the security's market value has been below cost as well
as the general market conditions, industry characteristics, and the
fundamental operating results of the issuer to determine if the decline is
other-than-temporary. The Company also considers as part of the evaluation
its intent and ability to hold the security until its market value has
recovered to a level at least equal to the amortized cost. When the Company
determines that a security's unrealized loss is other-than-temporary, a
realized loss is recognized in the period in which the decline in value is
determined to be other-than-temporary. The write-downs are measured based
on public market prices of the security at the time the Company determines
the decline in value was other-than-temporary.
At September 30, 2006, securities in a gross unrealized loss position for
twelve months or longer consist of 122 securities having an aggregate
depreciation of 2.2% from the Company's amortized cost basis. Securities in
a gross unrealized loss position for less than twelve months consist of 9
securities having an aggregate depreciation of 0.8% from the Company's
amortized cost basis. The unrealized losses disclosed above are primarily
related to movement in market interest rates. Although the fair value will
fluctuate as the market interest rates move, the majority of the Company's
investment portfolio consists of low-risk securities from U.S. government
agencies or government sponsored enterprises. If held to maturity, the
contractual principal and interest payments of such securities are expected
to be received in full. As such, no loss in value is expected over the
lives of the securities. Although not all of the securities are classified
as held to maturity, the Company has the ability to hold these securities
until they mature and does not intend to sell the securities at a loss. The
Company also has a significant investment in a mutual fund that invests in
short-term adjustable-rate mortgage-backed securities. Management believes
that the estimated fair
73
value of the mutual fund is also primarily dependent upon the movement in
market interest rates. Although the investment in the mutual fund is
classified as available for sale, the Company has the intent and ability to
hold the mutual fund until the fair value increases and does not intend to
sell it at a loss. Based on the above, management believes that the
unrealized losses are temporary. The determination of whether a decline in
market value is temporary is necessarily a matter of subjective judgment.
The timing and amount of any realized losses reported in the Company's
financial statements could vary if conclusions other than those made by
management were to determine whether an other-than-temporary impairment
exists.
The amortized cost and estimated fair value of debt securities, by
contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
September 30, 2006
-----------------------------------------------------
Held To Maturity Available For Sale
--------------------------- -----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ---------- ----------
Due within one year $ 13,084,653 $ 13,033,970 $ -- $ --
Due after one through five years 33,084,146 32,601,588 -- --
Due after five through ten years 39,986,258 39,355,977 1,000,000 984,375
Due after ten years 45,928,826 44,601,591 1,998,800 1,950,000
------------ ------------ ---------- ----------
Total $132,083,883 $129,593,126 $2,998,800 $2,934,375
============ ============ ========== ==========
September 30, 2005
-----------------------------------------------------
Held To Maturity Available For Sale
--------------------------- -----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ---------- ----------
Due within one year $ 4,000,000 $ 3,976,875 $ -- $ --
Due after one through five years 40,568,573 40,172,591 -- --
Due after five through ten years 41,342,845 40,907,632 1,000,000 988,125
Due after ten years 43,928,094 42,989,578 1,998,697 1,975,626
------------ ------------ ---------- ----------
Total $129,839,512 $128,046,676 $2,998,697 $2,963,751
============ ============ ========== ==========
74
5. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are summarized as follows:
Held To Maturity
September 30, 2006
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
GNMA pass-through certificates $46,991,401 $157,936 $(896,360) $46,252,977
FNMA pass-through certificates 1,448,326 -- (52,683) 1,395,643
FHLMC pass-through certificates 1,920,007 22 (42,275) 1,877,754
----------- -------- --------- -----------
Total $50,359,734 $157,958 $(991,318) $49,526,374
=========== ======== ========= ===========
Available For Sale
September 30, 2006
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
FNMA pass-through certificates $ 4,534,743 $ 80,564 $-- $4,615,307
----------- -------- --- ----------
Total $ 4,534,743 $ 80,564 $-- $4,615,307
=========== ======== === ==========
Held To Maturity
September 30, 2005
---------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
GNMA pass-through certificates $62,448,606 $775,040 $(445,674) $62,777,972
FNMA pass-through certificates 1,837,531 4,618 (32,129) 1,810,020
FHLMC pass-through certificates 2,541,478 12,158 (18,169) 2,535,467
----------- -------- --------- -----------
Total $66,827,615 $791,816 $(495,972) $67,123,459
=========== ======== ========= ===========
During fiscal 2006, $4.6 million of mortgage-backed securities were sold at
a pre-tax gain of $48,000. Although these securities were classified under
FASB Statement No. 115 as "Held to Maturity", at the time of purchase, the
sale was permissible because the remaining balances of the investments were
15% or less than their original purchased par value. Simultaneously, we
purchased $4.6 million in mortgage-backed securities classified as
available-for-sale.
75
The following table shows the gross unrealized losses and related estimated
fair values of the Company's mortgage-backed securities and length of time
that individual securities have been in a continuous loss position at
September 30, 2006, all mortgage-backed-securities available-for-sale were
in an unrealized gain position:
Less Than 12 Months More Than 12 Months
------------------------ ------------------------
Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----------- ---------- -----------
Securities held to maturity:
GNMA pass-through certificates $526,169 $25,601,666 $370,191 $11,199,818
FNMA pass-through certificates 52,209 1,395,273 474 369
FHLMC pass-through certificates 42,275 1,876,570 -- --
-------- ----------- -------- -----------
Total $620,653 $28,873,509 $370,665 $11,200,187
======== =========== ======== ===========
The following table shows the gross unrealized losses and related estimated
fair values of the Company's mortgage-backed securities, aggregated by
investment category and length of time that individual securities have been
in a continuous loss position at September 30, 2005:
Less Than 12 Months More Than 12 Months
------------------------ ------------------------
Gross Estimated Gross Estimated
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----------- ---------- -----------
Securities held to maturity:
GNMA pass-through certificates $164,896 $17,370,682 $280,778 $6,883,330
FNMA pass-through certificates 31,588 1,628,044 541 641
FHLMC pass-through certificates 1,323 2,003,186 16,846 128,191
-------- ----------- -------- ----------
Total $197,807 $21,001,912 $298,165 $7,012,162
======== =========== ======== ==========
76
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market
concerns warrant such evaluation. For all securities that are in an
unrealized loss position for an extended period of time and for all
securities whose fair value is significantly below amortized cost, the
Company performs an evaluation of the specific events attributable to the
market decline of the security. The Company considers the length of time
and extent to which the security's market value has been below cost as well
as the general market conditions, industry characteristics, and the
fundamental operating results of the issuer to determine if the decline is
other-than-temporary. The Company also considers as part of the evaluation
its intent and ability to hold the security until its market value has
recovered to a level at least equal to the amortized cost. When the Company
determines that a security's unrealized loss is other-than-temporary, a
realized loss is recognized in the period in which the decline in value is
determined to be other-than-temporary. The write-downs are measured based
on public market prices of the security at the time the Company determines
the decline in value was other-than-temporary.
At September 30, 2006, mortgage-backed securities in a gross unrealized
loss position for twelve months or longer consist of 7 securities having an
aggregate depreciation of 3.2% from the Company's amortized cost basis.
Mortgage-backed securities in a gross unrealized loss position for less
than twelve months consist of 26 securities having an aggregate
depreciation of 2.1% from the Company's amortized cost basis. The
unrealized losses disclosed above are primarily related to movement in
market interest rates. Although the fair value will fluctuate as the market
interest rates move, the majority of the Company's mortgage-backed
securities portfolio consists of low-risk securities from U.S. government
sponsored enterprises. If held to maturity, the contractual principal and
interest payments of such securities are expected to be received in full.
As such, no loss in value is expected over the lives of the securities.
Although not all of the securities are classified as held to maturity, the
Company has the ability to hold these securities until they mature and does
not intend to sell the securities at a loss. Based on the above, management
believes that the unrealized losses are temporary. The determination of
whether a decline in market value is temporary is necessarily a matter of
subjective judgment. The timing and amount of any realized losses reported
in the Company's financial statements could vary if conclusions other than
those made by management were to determine whether an other-than-temporary
impairment exists.
77
6. LOANS RECEIVABLE
Loans receivable consist of the following:
September 30,
------------ ------------
2006 2005
------------ ------------
One-to-four family residential $155,453,827 $135,393,637
Multi-family residential 5,073,903 2,541,328
Commercial real estate 11,338,845 9,874,562
Construction and land development 82,800,690 52,093,242
Commercial business 233,979 188,429
Consumer 1,239,063 1,346,470
------------ ------------
Total loans 256,140,307 201,437,668
Less:
Undisbursed portion of loans-in-process (36,257,661) (25,823,681)
Deferred loan fees 152,841 34,957
Allowance for loan losses (617,956) (557,956)
------------ ------------
Net $219,417,531 $175,090,988
============ ============
The Bank originates loans to customers in its local market area. The
ultimate repayment of these loans is dependent, to a certain degree, on the
local economy and real estate market.
The Bank originates or purchases both adjustable and fixed interest rate
loans. At September 30, 2006 and 2005, the Bank had $67,772,442 and
$52,179,447 of adjustable-rate loans, respectively. The adjustable-rate
loans have interest rate adjustment limitations and are generally indexed
to the one-year U.S. Treasury note rate, Prime rate or the Average Contract
Interest Rate for previously occupied houses as reported by the Federal
Housing Finance Board.
Certain officers of the Bank have loans with the Bank. Such loans were made
in the ordinary course of business at the Bank's normal credit terms,
including interest rate and collateralization, and do not represent more
than a normal risk of collection. The aggregate dollar amount of these
loans outstanding to related parties along with an analysis of the activity
is summarized as follows:
Year Ended September 30,
-------------------------------
2006 2005 2004
--------- -------- --------
Balance--beginning of year $ 543,047 $561,363 $536,807
Additions 475,000 -- 42,560
Repayments (341,538) (18,316) (18,004)
--------- -------- --------
Balance--end of year $ 676,509 $543,047 $561,363
========= ======== ========
78
The following schedule summarizes the changes in the allowance for loan
losses:
Year Ended September 30,
-------- -------------------
2006 2005 2004
-------- -------- --------
Balance, beginning of year $557,956 $557,956 $553,422
Provision for loan losses 60,000 -- 50,000
Charge-offs -- -- (78,000)
Recoveries -- -- 32,534
-------- -------- --------
Balance, end of year $617,956 $557,956 $557,956
======== ======== ========
A loan is considered to be impaired when, based upon current information
and events, it is probable that the Bank will be unable to collect all
amounts due according to the contractual terms of the loan. During the
periods presented, loan impairment was evaluated based on the fair value of
the loan's collateral. Impairment losses are included in the provision for
loan losses. Large groups of smaller balance, homogeneous loans are
collectively evaluated for impairment, except for those loans restructured
under a troubled debt restructuring. Loans collectively evaluated for
impairment include smaller balance commercial real estate loans,
residential real estate loans and consumer loans. The Bank had no loans
determined to be impaired at September 30, 2006 or 2005.
Interest income on impaired loans other than nonaccrual loans is recognized
on an accrual basis. Interest income on nonaccrual loans is recognized only
as collected.
Nonperforming loans (which consist of nonaccrual loans and loans in excess
of 90 days delinquent and still accruing interest) at September 30, 2006
and 2005, amounted to approximately $151,000 and $239,000, respectively.
7. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized by major classifications as
follows:
September 30,
-------------------------
2006 2005
----------- -----------
Land $ 246,594 $ 246,594
Buildings and improvements 2,081,509 2,051,909
Furniture and equipment 2,405,682 2,286,487
Automobiles 72,062 72,062
----------- -----------
Total 4,805,847 4,657,052
Accumulated depreciation (3,084,709) (2,910,453)
----------- -----------
Total office properties and equipment,
net of accumulated depreciation $ 1,721,138 $ 1,746,599
=========== ===========
79
For the years ended September 30, 2006, 2005 and 2004, depreciation expense
amounted to $242,452, $261,055 and $270,462, respectively.
8. DEPOSITS
Deposits consist of the following major classifications:
September 30,
-----------------------------------------------
2006 2005
---------------------- ----------------------
Amount Percent Amount Percent
Money market deposit accounts $ 64,498,290 18.6% $ 59,906,583 17.8%
NOW accounts 34,202,808 9.8 44,535,148 13.2
Passbook, club and statement savings 76,989,307 22.2 87,709,111 26.1
Certificates maturing in six months or less 77,904,032 22.4 44,709,277 13.3
Certificates maturing over six months or more 93,698,054 27.0 99,607,721 29.6
------------ ----- ------------ -----
Total $347,292,491 100.0% $336,467,840 100.0%
============ ===== ============ =====
At September 30, 2006 and 2005, the weighted average cost of deposits was
3.5% and 2.7%, respectively.
The amount of scheduled maturities of certificate accounts was as follows:
September 30, 2006
------------------
One year or less $124,398,763
One through two years 27,299,416
Two through three years 4,897,645
Three through four years 4,859,721
Four through five years 10,146,541
------------
Total $171,602,086
============
80
The weighted average rate paid on certificates at September 30, 2006 and
2005, was 4.6% and 3.5%, respectively. Certificates of deposit of $100,000
or more at each of such dates were approximately $44,918,000 and
$32,490,000, respectively.
Interest expense on deposits was comprised of the following:
Year Ended September 30,
-------------------------------------
2006 2005 2004
----------- ---------- ----------
NOW and money market deposits accounts $ 3,080,777 $2,272,596 $1,865,247
Passbook, club and statement
savings accounts 2,458,610 1,728,980 1,654,235
Certificate accounts 5,303,693 4,520,896 4,685,274
----------- ---------- ----------
Total $10,843,080 $8,522,472 $8,204,756
=========== ========== ==========
9. ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank totaled $31,783,751 and $13,823,411 at
September 30, 2006 and 2005, respectively.
The following is a schedule of six advances made under the low-income
housing program in which the Bank is a participant. Three of the advances
are at an interest rate of 3.0%, one advance is at an interest rate of 2.0%
and two advances are non-interest bearing. Repayment of the advances is as
follows:
September 30,
-------------------
2006 2005
-------- --------
1 to 12 months $ 40,630 $ 39,661
13 to 24 months 41,625 40,630
25 to 36 months 42,644 41,625
Thereafter 658,852 701,495
-------- --------
Total $783,751 $823,411
======== ========
81
Advances from Federal Home Loan Bank, not part of the low-income housing
program at September 30, 2006 and 2005, consist of the following:
September 30,
-----------------------------------------------
2006 2005
---------------------- ----------------------
Fixed Fixed
Interest Interest
DUE Amount Rate Amount Rate
----------- -------- ----------- --------
October 2006 $18,000,000 5.45% $ --
July 2010 2,000,000 5.98% 2,000,000 5.98%
August 2010 3,000,000 5.93% 3,000,000 5.93%
September 2010 8,000,000 5.69% 8,000,000 5.69%
----------- -----------
$31,000,000 $13,000,000
=========== ===========
The advances are collateralized by all of the Federal Home Loan Bank stock
and substantially all qualifying first mortgage loans.
10. INCOME TAXES
The Company's income tax provision consists of the following:
Year Ended September 30,
------------------------------------
2006 2005 2004
---------- ---------- ----------
Current:
Federal $1,595,998 $1,568,607 $ 911,346
State 50,332 165,602 45,878
---------- ---------- ----------
Total current taxes 1,646,330 1,734,209 957,224
Deferred income tax expense 126,744 152,222 289,227
---------- ---------- ----------
Total income tax provision $1,773,074 $1,886,431 $1,246,451
========== ========== ==========
82
Items that gave rise to significant portions of deferred income taxes are
as follows:
September 30,
--------------------
2006 2005
--------- --------
Deferred tax assets:
Deposit premium $ 314,054 $362,998
Allowance for loan losses 246,632 255,030
Other 39,639 41,092
--------- --------
Total 600,325 659,120
--------- --------
Deferred tax liabilities:
Unrealized gain on available for sale securities 286,336 202,066
Property 406,834 363,009
Mortgage servicing 9,754 11,978
Deferred loan fees 50,788 10,466
Employee stock ownership plan -- 13,973
--------- --------
Total 753,712 601,492
--------- --------
Net deferred tax (liability) asset $(153,387) $ 57,628
========= ========
The income tax expense differs from that computed at the statutory federal
corporate tax rate as follows:
Year Ended September 30,
---------------------------------------------------------------------------
2006 2005 2004
----------------------- ----------------------- -----------------------
Percentage Percentage Percentage
Of Pretax Of Pretax Of Pretax
Amount Income Amount Income Amount Income
---------- ---------- ---------- ---------- ---------- ----------
Tax at statutory rate $1,907,392 34.0% $1,794,522 34.0% $1,249,002 34.0%
Adjustments resulting from:
State tax, net of federal tax 33,218 0.6 109,297 2.1 30,279 0.8
effect Other (167,536) (3.0) (17,388) (0.3) (32,830) (0.9)
---------- ---- ---------- ---- ---------- ----
Income tax expense per statements of
income $1,773,074 31.6% $1,886,431 35.7% $1,246,451 33.5%
========== ==== ========== ==== ========== ====
83
As of October 1, 1997, the Bank changed its method of computing reserves
for bad debts to the experience method. The bad debt deduction allowable
under this method is available to small banks with assets of less than $500
million. Generally, this method allows the Bank to deduct an annual
addition to the reserve for bad debts equal to the increase in the balance
of the Bank's reserve for bad debts at the end of the year to an amount
equal to the percentage of total loans at the end of the year, computed
using the ratio of the previous six years' net charge-offs divided by the
sum of the previous six years' total outstanding loans at year-end.
A thrift institution required to change its method of computing reserves
for bad debts treats such change as a change in a method of accounting
determined solely with respect to the "applicable excess reserves" of the
institution. The amount of the applicable excess reserves is being taken
into account ratably over a six-taxable-year period. The timing of this
recapture was delayed for a one-year period since certain residential loan
requirements were met. For financial reporting purposes, the Bank has not
incurred any additional tax expense. Stockholders' Equity includes
approximately $6,575,000 at both September 30, 2006 and 2005, representing
bad debt deductions for which no deferred income taxes have been provided.
11. REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could
have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company's and the Bank's capital
amounts and the Bank's classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the table below) of Tier 1 capital (as defined in the
regulations) to average assets (as defined) and risk-weighted assets (as
defined), and of total capital (as defined) to risk-weighted assets.
Management believes, as of September 30, 2006 and 2005, that the Company
and the Bank met all regulatory capital adequacy requirements to which they
are subject.
As of September 30, 2006 and 2005, the most recent notification from the
Federal Deposit Insurance Corporation categorized the Bank as well
capitalized under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, the Bank must maintain minimum Tier 1
capital, Tier 1 risk-based, and total risk-based ratios as set forth in the
table. There are no conditions or events since that notification that
management believes have changed the Bank's category.
84
The Company's and the Bank's actual capital amounts and ratios are also
presented in the following table:
To Be
Well Capitalized
Required Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
--------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
September 30, 2006:
Tier 1 capital (to average assets)
Company $86,914 18.64% $18,646 4.0% N/A N/A
Bank 68,937 14.74 18,703 4.0 $23,379 5.0%
Tier 1 capital (to risk weighted assets)
Company 86,914 39.23 8,861 4.0 N/A N/A
Bank 68,937 31.12 8,861 4.0 13,292 6.0
Total capital (to risk weighted assets)
Company 87,894 39.68 17,722 8.0 N/A N/A
Bank 69,917 31.56 17,722 8.0 22,153 10.0
September 30, 2005:
Tier 1 capital (to average assets)
Company $90,450 20.98% $17,247 4.0% N/A N/A
Bank 64,681 14.55 17,783 4.0 $22,229 5.0%
Tier 1 capital (to risk weighted assets)
Company 90,450 48.54 7,454 4.0 N/A N/A
Bank 64,681 34.71 7,454 4.0 11,181 6.0
Total capital (to risk weighted assets)
Company 91,284 48.98 14,908 8.0 N/A N/A
Bank 65,515 35.16 14,908 8.0 18,635 10.0
12. EMPLOYEE BENEFITS
The Bank is a member of a multi-employer defined benefit pension plan
covering all employees meeting certain eligibility requirements. The Bank's
policy is to fund pension costs accrued. Information regarding the
actuarial present values of vested and nonvested benefits and fair value of
plan assets for the separate employers in the plan is not available. The
expense relating to this plan for the years ended September 30, 2006, 2005,
and 2004 was $549,700, $437,900 and $1,071,935, respectively.
The Bank also has a defined contribution plan for employees meeting certain
eligibility requirements. The defined contribution plan may be terminated
at any time at the discretion of the Bank. The expense relating to this
plan for the years ended September 30, 2006, 2005 and 2004 was $-0-,
$71,461 and $119,225, respectively. The elimination of the expense in 2006
reflected the Company's decision to discontinue the employer match in
conjunction with the establishment of the employee stock ownership plan
discussed below.
In fiscal 2005, the Bank established an employee stock ownership plan
("ESOP") for substantially all of its full-time employees meeting certain
eligibility requirements. The purchase of shares of the Company's common
stock by the ESOP was funded by a loan from the Company. The loan will be
repaid principally from the Bank's contributions to the ESOP. Shares of the
Company's common stock purchased by the ESOP are held in a suspense account
and released for allocation to
85
participants on a pro rata basis as debt service payments are made on the
loan. Shares released are allocated to each eligible participant based on
the ratio of each such participant's base compensation, as defined in the
ESOP, to the total base compensation of all eligible plan participants. As
the unearned shares are released and allocated among participants, the Bank
recognizes compensation expense equal to the current market price of the
shares released. The ESOP purchased 452,295 shares of the Company's common
stock on the open market for approximately $4.5 million. The average
purchase price was $9.86 per share. As of September 30, 2006 the Company
had allocated a total of 16,965 shares from the suspense account to
participants and committed to release an additional 16,965 shares. The
expense relating to this plan for the years ended September 30, 2006, 2005
and 2004 was $287,471, 120,622, and $-0- respectively.
13. COMMITMENTS AND CONTINGENT LIABILITIES
At September 30, 2006, the Bank had $4,932,800 in outstanding commitments
to originate fixed and variable-rate loans with market interest rates
ranging from 6.00% to 9.25%. At September 30, 2005, the Bank had
$21,371,785 in outstanding commitments to originate fixed and variable-rate
loans with market interest rates ranging from 5.50% to 7.75%.
The Bank also had commitments under unused lines of credit of $6,706,481
and $5,966,399 and letters of credit outstanding of $110,000 and $110,000
at September 30, 2006 and 2005, respectively.
The Company is subject to various pending claims and contingent liabilities
arising in the normal course of business which are not reflected in the
accompanying consolidated financial statements. Management considers that
the aggregate liability, if any, resulting from such matters will not be
material.
Among the Bank's contingent liabilities are exposures to limited recourse
arrangements with respect to the Bank's sales of whole loans and
participation interests. At September 30, 2006, the exposure, which
represents a portion of credit risk associated with the sold interests,
amounted to $64,451. This exposure is for the life of the related loans and
payables, on our proportionate share, as actual losses are incurred.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS.
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market
data to develop the estimates of fair value.
86
Accordingly, the estimates presented herein are not necessarily indicative
of the amounts the Company could realize in a current market exchange. The
use of different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.
September 30,
---------------------------------------------------------
2006 2005
--------------------------- ---------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents $ 13,427,536 $ 13,427,536 $ 26,815,017 $ 26,815,017
Investment securities held
to maturity 132,083,883 129,593,126 129,839,512 128,046,676
Investment securities held
available for sale 38,747,089 38,747,089 38,584,474 38,584,474
Mortgage-backed securities
held to maturity 50,359,734 49,526,374 66,827,615 67,123,459
Mortgage-backed securities
available for sale 4,615,307 4,615,307 -- --
Loans receivable, net 219,417,531 216,235,333 175,090,988 174,652,932
Federal Home Loan Bank stock 2,217,100 2,217,100 1,811,500 1,811,500
Liabilities:
NOW accounts 34,202,808 34,202,808 44,535,148 44,535,148
Money market deposit accounts 64,498,290 64,498,290 59,906,583 59,906,583
Passbook, club and statement
savings accounts 76,989,307 76,989,307 87,709,110 87,709,110
Certificates of deposit 171,602,086 171,659,900 144,316,998 144,887,781
Advances from Federal Home
Loan Bank 31,783,751 32,053,344 13,823,411 14,405,169
CASH AND CASH EQUIVALENTS--For cash and cash equivalents, the carrying
amount is a reasonable estimate of fair value.
INVESTMENTS AND MORTGAGE-BACKED SECURITIES--The fair value of investment
securities and mortgage-backed securities is based on quoted market prices,
dealer quotes, and prices obtained from independent pricing services.
LOANS RECEIVABLE--The fair value of loans is estimated based on present
value using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities.
FEDERAL HOME LOAN BANK (FHLB) STOCK--Although FHLB stock is an equity
interest in an FHLB, it is carried at cost because it does not have a
readily determinable fair value as its ownership is restricted and it lacks
a market. The estimated fair value approximates the carrying amount.
NOW ACCOUNTS, MONEY MARKET DEPOSIT ACCOUNTS, PASSBOOK ACCOUNTS, CLUB
ACCOUNTS, STATEMENT SAVINGS ACCOUNTS, AND CERTIFICATES OF DEPOSIT--The fair
value of passbook accounts, club accounts, statement savings accounts, NOW
accounts, and money market deposit accounts is the amount
87
reported in the financial statements. The fair value of certificates of
deposit is based on a present value estimate using rates currently offered
for deposits of similar remaining maturity.
ADVANCES FROM FEDERAL HOME LOAN BANK--The fair value of advances from FHLB
is the amount payable on demand at the reporting date.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT--The majority of the
Bank's commitments to extend credit and letters of credit carry current
market interest rates if converted to loans. Because commitments to extend
credit and letters of credit are generally unassignable by either the Bank
or the borrower, they only have value to the Bank and the borrower. The
estimated fair value approximates the recorded deferred fee amounts, which
are not significant. As discussed in Note 13, the related amounts at
September 30, 2006 and 2005 were $11,749,281 and $27,448,184, respectively.
The fair value estimates presented herein are based on pertinent
information available to management as of September 30, 2006 and 2005,
respectively. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have
not been comprehensively revalued for purposes of these financial
statements since that date and, therefore, current estimates of fair value
may differ significantly from the amounts presented herein.
88
15. PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA (PARENT COMPANY ONLY)
STATEMENT OF FINANCIAL CONDITION
At September 30, 2006 2005
-------------------------------------------------------------------------------
Assets:
Cash $14,158,770 $21,787,223
ESOP loan receivable 4,273,287 4,430,233
Accrued interest receivable on ESOP loan -- 63,684
Investment in Bank 69,470,789 65,057,120
Other assets 27,367 18,092
----------- -----------
Total assets $87,930,213 $91,356,352
=========== ===========
Liabilities:
Accrued dividend payable $ 482,573 $ 499,898
Accounts payable and accrued expenses 31,156
----------- -----------
Total liabilities 482,573 531,054
----------- -----------
Stockholders' equity:
Preferred stock -- --
Common stock 125,638 125,638
Additional paid-in-capital 54,798,121 54,733,760
Unearned ESOP shares (4,126,501) (4,349,611)
Treasury stock (6,422,478) (654,415)
Retained earnings 42,538,790 40,594,661
Accumulated other comprehensive income 534,070 375,265
----------- -----------
Total stockholders' equity 87,447,640 90,825,298
----------- -----------
Total liabilities and stockholders' equity $87,930,213 $91,356,352
=========== ===========
89
INCOME STATEMENT
For the year ended September 30, 2006 2005
--------------------------------------------------------------------------------
Interest on ESOP loan $ 250,291 $ 108,844
Equity in the undistributed earnings of the Bank 3,967,394 1,860,836
Other income 520 275
---------- ----------
Total income 4,218,205 1,969,955
---------- ----------
Professional services 302,382 122,385
Other expense 128,576 10,694
---------- ----------
Total expense 430,958 133,079
---------- ----------
Income before income taxes 3,787,247 1,836,876
Income tax (benefit) expense (49,658) 15,000
---------- ----------
Net income $3,836,905 $1,821,876
========== ==========
CASH FLOWS
For the year ended September 30, 2006 2005
-------------------------------------------------------------------------------
Operating activities:
Net income $ 3,836,905 $ 1,821,876
Decrease (increase) in assets 54,410 (45,593)
(Decease) increase in liabilities (31,156) 13,064
Equity in the undistributed earnings of the Bank (3,967,394) (1,860,836)
----------- -----------
Net cash provided by operating activities (107,235) (71,489)
----------- -----------
Investing activities:
ESOP loan to Bank -- (4,461,166)
Repayments received on ESOP loan 156,946 30,933
----------- -----------
Net cash provided by (used in) investing activities 156,946 (4,430,233)
----------- -----------
Financing activities:
Proceeds from issuance of common stock -- 27,425,166
Cash dividends paid (1,910,101) (481,806)
Payment to repurchase common stock (5,768,063) (654,415)
----------- -----------
Net cash (used in) provided by financing activities (7,678,164) 26,288,945
----------- -----------
Net (decrease) increase in cash and cash equivalents (7,628,453) 21,787,223
----------- -----------
Cash and cash equivalents, beginning of year 21,787,223 --
----------- -----------
Cash and cash equivalents, end of year $14,158,770 $21,787,223
=========== ===========
90
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly financial data for the years ended September 30, 2006
and 2005 is as follows:
September 30, 2006 September 30, 2005
--------------------------------- ---------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Qtr Qtr Qtr Qtr Qtr Qtr Qtr Qtr
------ ------ ------ ------ ------ ------ ------ ------
(In thousands) (In thousands)
Interest income $5,786 $5,922 $6,235 $6,599 $4,994 $5,124 $5,414 $5,546
Interest expenses 2,620 2,754 3,110 3,451 2,235 2,291 2,285 2,486
------ ------ ------ ------ ------ ------ ------ ------
Net interest income 3,166 3,168 3,125 3,148 2,759 2,833 3,129 3,060
Provision for loan losses 0 0 30 30 0 0 0 0
------ ------ ------ ------ ------ ------ ------ ------
Net income after provision
for loan losses 3,166 3,168 3,095 3,118 2,759 2,833 3,129 3,060
------ ------ ------ ------ ------ ------ ------ ------
Non-interest income 170 299 209 259 164 137 127 138
Non-interest expense 1,828 2,005 2,008 2,034 1,863 1,601 1,682 1,923
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes 1,508 1,462 1,296 1,343 1,060 1,369 1,574 1,275
Income tax expense 422 507 414 430 363 475 567 482
------ ------ ------ ------ ------ ------ ------ ------
Net income $1,086 $ 955 $ 882 $ 913 $ 697 $ 894 $1,007 $ 793
====== ====== ====== ====== ====== ====== ====== ======
Per share:
Earnings for share - basic $ 0.09 $ 0.08 $ 0.07 $ 0.08 (1) (2) $ 0.08 $ 0.07
Earnings per share - diluted 0.09 0.08 0.07 0.08 (1) (2) 0.08 0.07
Dividends per share 0.04 0.04 0.04 0.04 (1) (2) 0.04 0.04
(1) For periods prior to March 29, 2005, no shares of common stock were
outstanding. Therefore, there is no earnings per share or dividends per share
data for those periods noted.
(2) Due to timing of the Bank's reorganization into the mutual holding company
form and the completion of the Company's initial public offering on March 29,
2005, earnings per share information for the quarter ended March 31, 2005 is not
considered meaningful and is not shown. There were no dividends declared during
the period March 29, 2005 and March 31, 2005.
17. SUBSEQUENT EVENTS
The Company, at its Board of Directors meeting held on December 20, 2006,
declared a quarterly cash dividend of $0.04 per share on the common stock
of the Company payable on January 31, 2007 to the shareholders of record at
the close of business on January 12, 2007.
******
91
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief
Executive Officer and Chief Financial Officer, the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of September 30, 2006. Based on
such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and are operating in an effective manner.
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934)
occurred during the fourth fiscal quarter of fiscal 2006 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein is incorporated by reference from the
sections captioned "Information with Respect to Nominees for Director,
Continuing Directors and Executive Officers" and "Beneficial Ownership of Common
Stock by Certain Beneficial Owners and Management - Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Definitive Proxy Statement for
the Annual Meeting of Shareholders to be held on February 9, 2007, which will be
filed with the SEC on or about January 5, 2007 ("Definitive Proxy Statement").
The Company has adopted a code of ethics policy, which applies to its
principal executive officer, principal financial officer, principal accounting
officer, as well as its directors and employees generally. The Company will
provide a copy of its code of ethics to any person, free of charge, upon
request. Any requests for a copy should be made to our shareholder relation's
administrator, Prudential Bancorp, Inc. of Pennsylvania, 1834 Oregon Avenue,
Philadelphia, Pennsylvania 19145.
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the
sections captioned "Management Compensation," "Report of the Compensation
Committee" and "Performance Graph" in the Company's Definitive Proxy Statement.
The report of the Compensation Committee included in the Definitive
Proxy Statement should not be deemed filed or incorporated by reference into
this filing or any other filing by the Company under the Exchange Act or
Securities Act of 1933 except to the extent the Company specifically
incorporates said reports herein or therein by reference thereto.
92
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and
management is incorporated by reference to "Beneficial Ownership of Common Stock
by Certain Beneficial Owners and Management" in the Definitive Proxy Statement.
EQUITY COMPENSATION PLAN INFORMATION. As of September 30, 2006, the
Company did not have any shares of common stock that may be issued under equity
compensation plans.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein is incorporated by reference from the
section captioned "Management Compensation - Indebtedness of Management and
Related Party Transactions" in the Definitive Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required herein is incorporated by reference from the
section captioned "Ratification of Appointment of Independent Registered Public
Accounting Firm" in the Definitive Proxy Statement.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents Filed as Part of this Report.
(1) The following financial statements are incorporated by reference from Item
8 hereof:
Consolidated Statements of Financial Condition
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(2) All schedules for which provision is made in the applicable accounting
regulation of the SEC are omitted because of the absence of conditions
under which they are required or because the required information is
included in the consolidated financial statements and related notes
thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this list
includes the Exhibit Index.
Exhibit No. Description
----------- -------------------------------------------------------------
3.1 Articles of Incorporation of Prudential Bancorp, Inc. of
Pennsylvania(1)
3.2 Bylaws of Prudential Bancorp, Inc. of Pennsylvania(1)
4.0 Form of Stock Certificate of Prudential Bancorp, Inc. of
Pennsylvania(1)
10.1 Employment Agreement by and between Thomas A. Vento,
Prudential Bancorp, Inc. of Pennsylvania and Prudential
Savings Bank(2)*
10.2 Employment Agreement by and between Joseph R. Corrato,
Prudential Bancorp, Inc. of Pennsylvania and Prudential
Savings Bank(2)*
93
10.3 Form of Endorsement Split Dollar Insurance Agreement, dated
January 1, 2006, by and between, Thomas Vento, Joseph
Corrato and David Krauter (3)*
10.4 Prudential Savings Bank 2006 Bonus Program (3)*
21.0 Subsidiaries of the Registrant - Reference is made to
"Item 1. Business - Subsidiaries" for the required
information
23.0 Consent of Deloitte & Touche LLP
31.1 Section 1350 Certification of the Chief Executive Officer
31.2 Section 1350 Certification of the Chief Financial Officer
32.0 Section 906 Certification
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K pursuant to Item 15(b) hereof.
(1) Incorporated by reference from the Company's Registration Statement on
Form S-1 (Commission File No. 333-119130) filed with the Commission on
September 30, 2004.
(2) Incorporated by reference from the Company's Current Report on Form
8-K, dated March 29, 2005 and filed with the Commission on March 30,
2005 (Commission File No. 000-51214).
(3) Incorporated by reference from the Company's Current Report on Form
8-K, filed with the Commission on December 21, 2006 (Commission File
No. 000-51214).
(b) Exhibits
The exhibits listed under (a)(3) of this Item 15 are filed herewith.
(c) Reference is made to (a)(2) of this Item 15.
94
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA
December 22, 2006 By: /S/ THOMAS A. VENTO
-------------------------------------
Thomas A. Vento
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
/S/ JOSEPH W. PACKER, JR. December 22, 2006
---------------------------------------
Joseph W. Packer, Jr.
Chairman of the Board
/S/ THOMAS A. VENTO December 22, 2006
---------------------------------------
Thomas A. Vento
President and Chief Executive Officer
/S/ JEROME R. BALKA, ESQ. December 22, 2006
---------------------------------------
Jerome R. Balka, Esq.
Director
/S/ A. J. FANELLI
--------------------------------------- December 22, 2006
A. J. Fanelli
Director
/S/ JOHN P. JUDGE
--------------------------------------- December 22, 2006
John P. Judge
Director
/S/ FRANCIS V. MULCAHY
--------------------------------------- December 22, 2006
Francis V. Mulcahy
Director
/S/ JOSEPH R. CORRATO December 22, 2006
---------------------------------------
Joseph R. Corrato
Executive Vice President, Chief
Financial Officer and Chief Accounting
Officer